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Rethinking the Secondary Market for Natural Gas Transportation

Fortnightly Magazine - April 1 1995

in future rate cases by sharing in the incremental revenue above costs earned from selective discounting. Also, some customers would now find natural gas transportation attractive at the discounted rate. These customers presumably would be better off than without selective discounting. Since selective discounting would make some customers better off without making other customers worse off, selective discounting would increase economic efficiency.

The FERC contrasted selective discounting against a fixed tariff or a uniform discount, finding the later options inefficient. First of all, a uniform discount would imply a tariff above the level required to balance supply and demand, thus leaving some pipeline capacity unused. And why would a uniform discount imply a tariff above the market-clearing level? The reason is price inelasticity. Unless demand is highly responsive to price, the lost revenues from discounting current customers will more than offset the additional revenues from new customers.

After Capacity Release. Today, in a world with pipeline capacity release, selective discounting is still beneficial. Nevertheless, it is now less important for efficient resource allocation.

The introduction of capacity release allows holders of firm capacity rights to sell these rights either as firm capacity rights or as capacity rights subject to recall. Before capacity release, firm capacity was economic as long the value of its use exceeded variable cost. This was the situation under Order 436. With the introduction of capacity release or brokering, the opportunity cost of using firm capacity was made equal to its value in the capacity-release market. When this value exceeds the variable cost of firm capacity, then capacity release will reallocate firm capacity more efficiently than without a secondary market.

How does this change affect selective discounting? The impact of capacity release on selective discounting depends on the number of competitors in the capacity release market. If the market features many competitors, the price of capacity in the secondary market will allocate capacity efficiently without selective discounting. Selective discounting is simply not needed. On the other hand, in a market with few competitors, resource allocation may be improved substantially by selective discounting.

Monopoly Behavior. If one shipper controls the rights to all firm transport capacity, the shipper will attempt to behave as a monopoly and set the price above the competitive market price for released capacity. But if the capacity is not used, it reverts to the pipeline. If the pipeline is allowed to discount selectively, it will behave as described under Order 436, and the competitive market level of transportation will be achieved.

Again, if our shipper attempts to use the excess capacity, it can only temporarily affect capacity availability. For example, the shipper could use more capacity than is optimal by increasing storage injections in the market area. But once storage is full or is drawn down at the end of the peak season, this use of excess pipeline capacity will stop. So storage injections will affect pipeline supply only by shifting the timing of capacity availability. If a shipper holds firm capacity and sells natural gas to other capacity holders or would-be holders, he has not