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Gas Marketing Affiliates: Why Mandate a Corporate Separation?

Fortnightly Magazine - May 1 1997

3) elimination of the LDC merchant function. %n5%n (It appears that this last item has surfaced as the principal goal of deregulated marketers.) The proponents maintain the market requires these extreme measures to develop workable, competitive retail natural gas.

From a consumer perspective, these restrictions on LDCs and affiliates likely will reduce competition and consumer choice, particularly for small retail consumers. However, the proponents of a utility-affiliate code of conduct have advanced many arguments. They maintain that such regulation is critical in developing a level playing field for competition at the retail level. Proponents of universal separation rules refer to the Federal Energy Regulatory Commission's adoption of Order 497, part of the pipeline unbundling process, in support of their position.

The Pipeline Example (em Not Always Instructive

While it might have been necessary to constrain activities between pipelines and marketing affiliates to encourage the development of third-party-marketer businesses in the 1980s, the circumstances in today's energy market are very different.

In 1985 when the FERC implemented Order 436, pipeline marketing affiliates represented the dominant supplier alternatives to pipeline merchant service. The same situation is not true for LDC marketing affiliates. To the contrary, today there are many well-established, national and regional marketing companies effectively competing with LDCs and marketing affiliates when there is open access to the end-use market.

Unlike the fledgling, start-up marketing companies of the early 1980s, today's marketing companies have significant financial resources. These companies are experienced network information managers that control and sell large volumes of natural gas on a daily and annual basis. %n6%n Compared with most utility marketing affiliates, or natural gas utilities themselves, the marketing company giants like Enron, Natural Gas Clearinghouse and PanEnergy, enjoy far greater market power over gas supply sales in open access markets.

As utilities continue to unbundle services and expand direct access to end users, including residential consumers, competition from the national marketing companies will only increase. These same national marketing companies that now dominate the wholesale market (some of which are leading the charge for retail affiliate separation) will stand well positioned to dominate the retail gas commodity market. The use of rigorous code of conduct and separation rules will only reinforce the market position of these companies by making it much more difficult for start-up LDC marketing affiliates to compete.

Affiliate Restrictions (em

The Negative Impacts

What are the likely consequences of imposing rigorous separation rules on start-up marketing companies? At a minimum, both the affiliate and the utility will see an increase in administrative costs. In addition, depending upon the degree of required separation, the transaction costs of both companies likely will increase because of a ban on shared staff. Moreover, divorcement of the marketing affiliate's corporate identity from the utility will adversely affect its market position and its cost of doing business. Thus, any potential competitive synergies between the LDC and its affiliate are minimized, if not eliminated.

While transactions between LDCs and marketing affiliates are becoming increasingly, if not disproportionately, burdensome, traditional pricing mechanisms (gas cost recovery factors) are making it impossible for LDCs to