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The Electric and Gas Industries are Converging: What Does it Mean?

Fortnightly Magazine - April 1 1995

will of the competitive market. The production and sale of energy will be almost completely free of price and sales controls. High-voltage transmission will likely witness joint federal and state jurisdiction, with the Federal Energy Regulatory Commission taking the lead role. Either voluntarily or forcibly, local regulated gas and electric entities will give up their sales tariffs (em soon in high energy price areas, and later in lower priced areas.

Regulated electricity distribution (little wires) will separate from regulated electricity transmission (big wires) as various states deregulate electricity. This separation will bring a phased consolidation of regulated electricity distribution and regulated gas distribution companies. The pace will stay leisurely until most of the large consuming states have embraced utility deregulation and Wall Street discovers a way to pay for the premium over book that mergers entail. Regulated transmission companies will exchange stock to create multistate and multiregion entities to better serve natural transmission markets. Moreover, a few mergers (or quasi-mergers through alliances) of regional electricity transmission and gas pipeline companies may occur. The business of transporting molecules and electrons long distances is likely to evolve into an "intelligent network" business where the truly innovative companies will perform feats of regional or continental logistical magic, accepting energy at one node of a transportation system and making it appear as a package of energy and services at another.

To accommodate the growing sophistication of inter-financial market gas/electric futures, swaps and options instruments, and strategies, one or more of these enormous intelligent network companies (or alliances) may find it lucrative to accept molecules and redeliver electrons, and vice versa. This would, in essence, combine a physical logistical service with a financial molecule/

electron crack spread service, enabling producers of gas and electricity to participate directly in the hundreds of thousands of interregional and inter-energy market arbitrage opportunities that always exist in vast, fairly fragmented, and rapidly moving markets. Such a service could, in theory, enable a gas producer in West Texas to contract with an electricity wholesaler or even a retailer in Northern California to directly sell electrons in a composite one- to two-year location/ energy swap transaction, receiving a netback price for the gas. The netback could come from an electricity hub or network nodal pricing point in either state.

As a corollary to these pipe and wire combinations, deregulation functions, and increased efficiency, scores of billions of dollars will be squeezed out of the shrinking energy rate base. A portion will simply be extinguished; other losses will come at the expense of stock and bondholders of uncompetitive asset-based companies; the rest will be repatriated to their holding companies and nonregulated affiliates. In almost equal amounts, surplus liberated capital will seek North American and foreign outlets. Nonregulated U.S., Canadian, and eventually, Mexican gas and electricity producers, among others, will find great receptivity for their many proposals to absorb the North American component of this mobile capital. This new flow of capital, could, in fact, hasten the integration of the gas and electric industries.

PRODUCERS (em NICHE, MERCHANT, AND GEMCO

Large gas producers (more than