Nowhere are the failings of traditional utility regulation more evident than on Long Island. The New York Public Service Commission (PSC) has raised rates for the Long Island Lighting Co. (LILCO)...
Decontracting: Stranded Costs for Interstate Pipelines?
"solution." The FERC has emphatically declared that existing customers are not to be penalized by higher rates for continuing to receive their current level and quality of service. (See sidebar on page 24 for citations.)
Allocating stranded costs to remaining FT customers would mark a poor policy choice. Increasing pipeline rates might well drive customers with newly expired FT contracts to find lower-cost alternatives, creating a death spiral of higher rates and ever fewer FT customers.
Another idea, proposed by El Paso, would charge an exit fee to departing FT holders, thus granting prospective reimbursement to the pipeline for its stranded costs. The FERC rejected this solution, however, as contrary to the basic notion that a party's contractual obligations should not survive the contract's expiration.
Yet another alternative would have pipeline stockholders absorb all uncontracted capacity costs. This approach obviously holds no appeal to the pipelines and, in fact, has not been proposed in any proceedings. Besides being inequitable to shareholders where decontracting is driven by purely external forces (as opposed to strategic miscalculation), such action would raise the cost of capital and debt across the pipeline industry as the perceived risk to cost recovery increased.
The FERC's Transwestern order as well as orders issued in the El Paso and NGPL proceedings clearly favor multiparty negotiations to split the costs associated with decontracting. The FERC also appears willing to consider solutions based on rate design, including departure from the straight fixed-variable (SFV) method.
The SFV rate design has been widely branded as the chief villain in this soap opera. First, pipelines allege that SFV has greatly increased the cost of reserving firm capacity, creating economic incentives for LDCs to develop lower-cost alternatives for peaking needs. Nevertheless, a strong case has been made that decontracting is only a temporary phenomenon, and that the choice of future rate design will not necessarily determine how much long-term FT capacity is held under contract.
Over the next few years, the industry will work through the capacity turnback problem. The FERC's evolving solution, negotiated cost-sharing, should facilitate this process by encouraging stakeholders to enter into agreements that address both short- and long-term economic considerations. The following mechanisms could help increase natural gas demand while minimizing both pipeline costs and transportation rates.
Rate design should encourage efficiency and flexibility. Whatever rate design paradigm the FERC adopts for future use must facilitate both the remarketing of FT capacity and the development of new markets. Any departure from existing policy must preserve efficiencies resulting from Order 636. Flexibility must accommodate a potential customer's need to index gas costs to the price fluctuations of another commodity or product. Also, innovative rate designs such as seasonal SFV (em in which the volume of subscribed FT and the monthly demand charges more accurately reflect both the need for and value of capacity (em should be considered if they enable the pipeline to remarket its capacity.
Tariff terms and conditions should encourage customers to contract for firm capacity. The FERC should institute confiscatory unauthorized overrun penalties at least equivalent to the annual