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Barbarians at the City Gate

Fortnightly Magazine - September 15 1995

margins. That is why marketers protect themselves contractually from liability for failure to provide firm service. A typical "firm" end-user contract makes the marketer liable only for replacement fuel costs. If there is no replacement fuel, the customer may get a "credit" for undelivered volumes (i.e., the customer won't pay for what it didn't get). The marketer will disclaim all other

liability.

In this way, marketers substitute "virtual firm" for real firm. It is undeniably attractive to the customer and the marketer. The customer is paying less for "firm" gas; the marketer is doing very well. So what's wrong with this picture?

How it Shakes Out

One might observe that the gas industry has held up reliably since Order 636, and that the problem of virtual firm is just the complaint of utilities that can't compete. Why worry?

Anomalies need not manifest themselves overnight to create problems. Wellhead price controls were instituted in the 1950s, but curtailment didn't hit until the 1970s. That doesn't mean wellhead price controls were a good idea for the years in between.

The same is true of virtual firm. Right now it is background noise to the trillions of cubic feet that flow. The industry infrastructure that met demand in 1993 was still working in 1994 and in 1995. The pipeline and utility gas-control departments continue to do their job, just as they would if everyone involved in transactions and regulations disappeared from the face of the earth tomorrow.

The day of reckoning is a little further off. The spread of virtual firm will cause utilities to calculate lower peak-day requirements than needed for system supply. New peak-day capacity will not be built. Because design days occur infrequently, the day of reckoning could be years away. But it will come. And when the problem is made manifest there will be no quick fix (em new pipeline capacity cannot be created overnight.

But if the competitive market works elsewhere, why not here?

Good question. There are really two answers. First, the gas industry differs from most other

businesses (except other regulated utilities) in that the product is intrinsically commingled. Consider the gas industry's competitor, heating oil. The risk of nondelivery of heating oil to a consumer is a function of whatever preparation and arrangements the consumer has or has not made. Gas transportation customers can simply take it through the meter (em if they cannot use alternate fuels they will take the gas and there is no way to stop them. Risk is invisibly shifted from marketer customers to the utility's entire system.

Second, we have the political reality. The local gas utility is considered ultimately responsible for gas service. Imagine a scene in which patients are being evacuated from a hospital in sub-zero weather because some marketer had its capacity recalled. Can the utility expect to convince anyone that the shortage is the inevitable consequence of the hospital's unwise selection of a marketer promising lower-cost gas? Those in the utility business know that the competitive market flies out the window in such an emergency. Marketers know it