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Decontracting: Stranded Costs for Interstate Pipelines?

Fortnightly Magazine - April 1 1996

diversified portfolio of gas supplies and providing alternatives for meeting peak-day demands. When combined with released firm or interruptible capacity, market center services (especially storage) help reduce the need for long-haul FT capacity. Decontracting occurs when the combined cost of alternative services is less than the cost of holding primary FT capacity, and when shippers with access to multiple pipelines find gas delivered by another pipeline to be less expensive than gas delivered by their current transporter.

Who's at Risk?

California leads the way, as is so often the case. To serve that growing market, pipelines have competed to construct long-haul capacity connecting new and lower-cost gas-supply sources. But when market demand fails to increase as projected, and fails to keep pace with the growth in aggregate pipeline deliverability, the resulting capacity surplus can lead to decontracting.

In California the development of new and lower-cost gas supplies triggered nearly simultaneous expansions from a number of constrained supply basins (San Juan, Central Rockies, Western Canada). Because of economic recession and low oil prices, however, market demand did not develop as expected. A large surplus developed in pipeline capacity. California LDCs, having lost noncore load, announced plans to relinquish capacity. The El Paso and Transwestern pipelines were affected first, but not because of their capacity costs (em simply because their FT contracts were the first to expire.

Elsewhere, Natural Gas Pipeline Co. (NGPL) has become the first Midwestern pipeline to experience post-Order 636 capacity turnbacks. LDCs are turning back FT as they become more proficient at using their contractual and system assets (em in particular, using on-system storage capacity to meet customer peaking needs. NGPL's ability to retain FT has also been affected by competition from pipelines that offer LDCs and other shippers lower-cost alternatives for transportation services and access to lower-cost Canadian supplies.

Pipelines that serve the Northeast markets have so far escaped any significant decontracting, but their relatively high costs and upcoming contract expirations make them likely candidates. On pipelines like Tennessee and Texas Eastern, end users shifting from LDC sales service to transportation may cause LDCs to relinquish capacity. Northeast LDCs and other marketers are developing storage to serve peak demands. And new supplies from the Sable Island area and liquefied natural gas landed in Boston, MA, could cause decontracting if those supplies can be delivered to LDC city gates at costs below the firm tariff rates of current transporters.

The increasingly competitive market gives shippers an economic incentive to minimize their transportation costs. In markets where surplus capacity develops, decontracting will likely affect pipelines as their contracts expire. Relative cost and level of customer service will not necessarily drive capacity turnback.

What's the Solution?

Various proposals for resolving decontracting problems have surfaced in pipeline proceedings at the Federal Energy Regulatory Commission (FERC). One approach suggests that costs attributable to newly stranded firm capacity should be allocated to existing customers through higher rates, either applied now or deferred for future recovery. Existing firm customers would bear all the risks of unused capacity. Needless to say, neither customers nor the FERC have