[BETA] Fortnightly

Gas pipeline reform is looming on the horizon like the stealth bomber. It faded from view a couple years ago, when the Federal Energy Regulatory Commission (FERC) completed Order 636 and turned to electric issues. Yet gas reforms are more pressing: They began earlier, their direction is clearer, and their completion is closer at hand. In fact, without a more price-responsive market for gas transportation, we cannot fashion an efficient and integrated energy industry. Electric restructuring, too, could fall short of its full potential.

New Players, New Theories

Deregulation in natural gas has created many new players, such as marketers, brokers, and service providers that offer natural gas balancing, price hedging, and storage capabilities. In this new environment, shippers have gained opportunities to tailor services to their needs.

As shippers and pipelines become accustomed to a more competitive market, regulators are responding. At the federal level, regulatory reform has included both market-based rates and incentive-based ratemaking. Some interstate oil pipelines are regulated today with this combination. In markets that have been declared workably competitive, the FERC has allowed oil pipelines to set their prices according to market. At the same time, however, the FERC maintained oversight by requiring shippers and pipelines to submit periodic reports to ensure the market remains competitive. In markets found not to be workably competitive, the FERC has turned to rate regulation, either by cost-of-service or by incentive-based ratemaking, limiting future rate increases to the average change in competitive markets.

Following its policy for oil pipelines, the FERC has recently requested comments on alternative pricing methods for natural gas pipelines. The FERC seeks to develop a framework for analyzing alternatives to traditional cost-of-service ratemaking proposals. While the request focuses on market-based rates, the FERC has in a previous rulemaking outlined policy objectives for incentive-based ratemaking.

True reform will not come piecemeal. It will cover all pipeline services. Otherwise, reform proposals will fail. The market for natural gas services consists of many different offerings that interact in complex ways. These services create a market that is extremely competitive in some respects and monopolistic in others. For example, firm transmission during certain times of the year may best be provided by a regulated monopolist. However, that same pipeline during its shoulder or nonpeak months may face extensive competition from capacity release.

Nevertheless, regulators should not act with too much caution. Efforts to blunt pipeline market power may actually impede competitive behavior. Natural gas storage provides a good example. In some situations, storage competes with firm transmission for seasonal peak and even daily peak loads. Storage markets are generally competitive, and there market-based rates are appropriate. Storage providers will set their rates and terms to compete with firm transmission services. But pipelines ought to be able to adjust their rates, terms, and conditions of service in response to competitive storage operations. Without this bilateral market activity, the full economic benefits of competition will not emerge. The situation becomes more complex when a pipeline also operates storage facilities. Any regulatory reform proposal must be robust enough to enhance competition while preventing abuses