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Fossil in Your Future? A Survival Plan for the Local Gas Distributor

Fortnightly Magazine - April 1 1996

LDC Minimus, LDC Insipidus,

LDC Robustus? Which Would You Rather Be?

Post-Order 636 evolution depends on aggressive regulatory and legislative reform.

"Get out of the gas business. Drop the merchant function. We can't make any money selling gas and we are constantly at risk to having gas costs disallowed. It's a no-win situation. Our only hope of moving the ball forward is to set up a nonregulated gas marketing affiliate in the end zone."

I believe such opinions may overlook future opportunities. The nay-sayers assume an intransigent regulatory environment; their advice may prompt actions that jeopardize earnings for stockholders. Unfortunately, however, many local distribution companies (LDCs) have already set this course. Higher earnings, increased customer satisfaction, and lower rates are achievable, but only by reversing direction. Above all, it will take a courageous effort at state regulatory reform.

Three major obstacles stand in the way of a truly competitive natural gas industry, as envisioned by the Federal Energy Regulatory Commission (FERC). All three involve state law and regulation:

s Inconsistencies in state and local taxes assessed on LDC and third-party sales1

s Price distortions between customer classes, stemming from rules on gas-cost allocation

s Rules barring LDCs from realizing corporate profits on gas commodity sales in competitive markets.

No two LDCs are fully comparable. They vary in size and structure. Consequently, one cannot fully appreciate the comments, or the silence, of LDC executives without understanding the economic, competitive, and regulatory environment in which each company operates. To bring order to this seemingly chaotic picture, I recently conducted a survey of regulatory practices at the public utility commissions (PUCs) in all 50 states, including the District of Columbia. Some key elements of this survey are provided in the accompanying table.

Rate Methods: A PUC Survey

A truly competitive market requires clear pricing signals and a minimum of subsidies between customer classes. The extent to which regulators embrace that proposition can be seen in their required approach to allocating gas costs in LDC rates. The full cost of gas required to serve low-load customers can rise significantly above that required for high-load customers. For tariff-based rates, a uniform method allocates the same cost of gas to all firm rate classes, regardless of usage characteristics; a cost-based method recognizes the differences in the cost of gas between customer classes. [Editor's Note: Throughout this section, italicized words refer to the table of survey results opposite.]

Some jurisdictions permit both methods. Obviously, if an LDC's service territory encompasses a relatively homogenous customer group, the method makes little competitive difference. But many LDCs serve large and distinctly differing customer groups. Uniform gas-cost allocation puts these LDCs at a competitive disadvantage, both with competing alternative energy sources and with third-party marketers serving high load-factor markets. About two-thirds of PUCs currently require a uniform method of gas-cost allocation.

A more telling indication of the regulator's focus on competitive issues lies with market-based sales rates. Market-based rates permit an LDC to respond in real time to fluctuating market forces, such as alternative fuel prices. Some jurisdictions don't allow market-based rates because

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