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FERC's Mandatory Gas Auctions: Are We Bidding the Right Product?

Fortnightly Magazine - January 1 1999

electricity.

Make It Universal

As mentioned, the auction of gas imbalances will make every transporter a participant in the auction process, not just the few electric utilities that have dominated the gray market in flowing gas. This universal participation is accomplished without the customer changing its mode of operation. Transportation customers would continue to estimate their daily consumption and then nominate a delivery of approximately the same amount. They wouldn't also have to determine a strategy for setting the price of any available capacity because this price would be automatically determined. Pipeline imbalance penalties may now bias the nomination process, in that some customers will perceive an advantage to being slightly long during some periods and slightly short during other periods. However, the nomination is supposed to equal the amount of gas the transporter expects to use.

The actual take of gas always differs slightly from the nomination. In most cases, the slight difference is smaller than the tolerance allowed by the pipeline. The pipeline imposes no penalty for an imbalance this small and carries the imbalance over to the next day. Under an auction of gas imbalances, these slight differences would be cashed out at the auction price shown in the graph.

Avoid Trading in Derivatives

The NOPR acknowledges on page 15 that "the implicit value of transportation between two such points is the spot price of gas at the delivery point minus the spot price of gas at the receipt point." Thus, the value of the gas transportation rights that FERC proposes to auction is a derivative of other values. I discussed my concern about the market for such derivatives in "Electric Transmission Pricing: Are Long-term Contracts Really Futures Contracts?" Public Utilities Fortnightly, Oct. 15, 1994, p. 29.

Auctioning gas imbalances reduces the "futures contracts" nature of the auction. The commodities market typically identifies two types of markets: a spot market and a futures market. In a futures market, the seller has time to change production levels by such means as planting and harvesting a crop. In a spot market, the seller makes delivery on the spot from inventory, generally during the same time period or in the next two or three time periods. Natural gas is dispatched continuously; compressor settings may be changed several times per day. Thus the spot delivery of gas occurs now or perhaps in the next few hours from inventory already in the pipeline near the delivery point. This is certainly consistent with the term spot market as used when discussing the sale of gas imbalances.

Though financial derivatives are used to manage risk, derivatives such as capacity rights on a pipeline also can create inordinate risk. This was seen in the collapse of the Orange County, Calif., municipal system in 1996 and the collapse of the competitive market for electricity in the Midwest during the week of June 22, 1998, as I noted in "Electricity Is Too Chunky," Public Utilities Fortnightly, Sept. 1, 1998, p. 20. Selling gas imbalances via auction reduces the risk associated with financial derivatives.

Simplify the Process

Fewer Auctions. I