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Rethinking the Secondary Market for Natural Gas Transportation

Fortnightly Magazine - April 1 1995

capacity-release mechanism (see "Gray Markets," below). Finally, if capacity cannot be reassigned to marketers or bundled with gas supplies, the capacity-release mechanism could prohibit aggregation of capacity and the rebundling of services. When Order 636 was issued, the FERC argued that the loss of aggregation and bundling would be replaced by independent marketing organizations for those who needed bundled services. By strictly enforcing the posting requirement, however, the FERC may eliminate services it expected to develop under Order 636.

Secondary Sales (em

Why a Price Ceiling?

The secondary market for transportation is likely to be more competitive than would be indicated by a typical analysis of industry concentration. In the short run, the supply of pipeline capacity is fixed. Any attempt by primary holders of transportation rights to hold capacity off the market and raise prices would make transportation capacity available to the pipeline. Unless the pipeline colludes, the allocation of pipeline capacity is likely to be efficient. The likelihood of collusion is reduced by allowing selective discounting.

Also, most interruptible customers enjoy alternate fuel capability, which imposes market competition when the delivered price of gas is high enough for customers to switch. These factors seem to indicate that a secondary-market price ceiling is unnecessary. On the other hand, some markets are not very competitive. Where a market is served by a single pipeline whose capacity is controlled by a LDC, that LDC might hesitate to release capacity if it would facilitate transportation service for its distribution customers. Such a market might not warrant removing the price ceiling. Equity may also justify a ceiling. Nevertheless, because the cost of enforcing price ceilings is likely to be extremely high, a compelling argument supports its removal in the secondary market.

Gray Markets. Because of the high costs and the posting requirement, many buyers and sellers will find ways around them (in fact, they already are doing this). One method is the so-called "gray market," a term used to describe transactions that market firm capacity without using the capacity-release mechanism.

The most common form of gray market activity is the so-called "buy/sell" arrangement. Buy/sell arrangements are not well defined, but generally involve a holder of firm capacity such as an LDC, which buys gas designated by second party, ships the gas using its own firm capacity rights, and then resells the gas delivered to the second party. These arrangements not only avoid the regulatory requirements of capacity-release arrangements; they also allow the sale of the joint product of unregulated gas and regulated transportation at market prices.

End Runs. For example, assume the market price of natural gas into the pipeline is $2 per MMBtu, and the highest-cost transportation to that market is $1.20. These economics suggest that a marginal shipper would expect to pay $3.20. However, if an LDC previously acquired rights to pipeline capacity at a cost of $0.65 per MMBtu (instead of $1.20), it can avoid the price ceiling on capacity release and share in the higher marginal price, by simply charging a higher commodity price for the gas (em as much as