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

Fortnightly Magazine - April 1 1996

response: "Nobody ever asked us to change it."

The revenue pie available to support fixed utility costs can be enlarged. The annual net commodity margin associated with current nonutility sales (approximately 6 quads) to LDC C/I markets in the United States, while not immense, brings in an estimated half-billion dollars annually. Regulators and legislators take note: Not a penny of this margin supports local utility infrastructure. Further, it generally represents a cash outflow for the consuming state. Utility investors in the United States should also consider that little of this margin flows to individual LDC or parent corporate earnings.

I believe that the activities of many LDCs (and the response of many regulators) run contrary to the long-term well-being of both. They will play directly into the hands of the major gas-marketing firms. One 1995 survey found that approximately 265 major gas-marketing firms operate in the United States (em a number that continues to shrink rapidly.2 About 10 percent of these firms account for 90 percent of the throughput. These "Majors" are the big production companies and pipeline affiliates, some owned completely or partially by foreign firms. The current frenzy among LDCs to get out of the merchant function is exactly what the Majors want.


Evolve, Devolve, or Degenerate

A simple biological analogy illustrates the choices facing the gas distribution industry (see diagram on page 21).

Devolution. The simplest course is "business as usual," which requires no real effort by the LDC or, perhaps, just a bit of reactionary entrenchment. The result of this dull path: LDC Insipidus. Over time, much if not most of the LDC's C/I sales market will have eroded, to be served by independent marketers. Portions of its core market may also be served by third-party gas. But the LDC can rest assured that it will retain those segments of its markets most prone to uncollectible accounts.

Transportation and associated services will become increasingly varied and complex. All utility functions will become unbundled. Rebundling in competitive markets in an effort to capture economies of scope will be thwarted by Majors crying "competitive disadvantage." Administrative costs will grow. The LDC supply portfolio will shrink, but the obligation to serve and provide backup will not.

Although many utilities complain about the obligation to serve, the political reality is that regulated utilities are the only players that state and local officials can effectively hold accountable. Consequently, the LDC's WACOG will rise, further eroding its sales market share and provoking heightened scrutiny of its supply portfolio. Regulation will naturally become more complex and intrusive.

Risk of gas-cost disallowance will grow as the LDC sees its supply options shrink along with its declining sales base. Sales rates to remaining core customers will increase; cost-cutting measures will become the order of the day. LDC marketing departments will be the first to shrink and eventually disappear. (This shrinkage is occurring at many utilities now.) Main extensions and system expansions will slow down.

Depreciation will exert an increasingly detrimental effect on rate base. Payout ratios will rise and/or dividends will stagnate. The simple reality is