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Firm Transportation Contracts: When They Expire - A Five-Step Primer for Pipeline Shippers

Fortnightly Magazine - March 1 2000

and were concerned about reliability. Today, however, many of the justifications for long-term capacity contracts no longer exist. The transportation market is unbundled; shippers have options to release capacity and pipelines face competitive pressures both from peers and marketers. Pipelines are now positioned to compete for shippers to renew contracts, and challenged in some cases to maintain the same return as the long-term contracts that are expiring. If the capacity is not sold, the pipeline needs to find an equitable way to spread the costs among ratepayers and shareholders.

Nevertheless, shippers that have contracts expiring may be at risk regardless of whether overall demand is up or down at the time of expiration.

If demand is up, shippers with expiring contracts that decide not to renew must either play the release market or depend on a marketer to deliver to the citygate. The release market or citygate purchases may provide discounting on a monthly basis, but there is always the risk of capacity not being consistently available or recalled during peak periods. The challenge for shippers is to identify viable options that can provide the same level of service as primary firm capacity at a competitive rate.

If demand is down, captive shippers are at risk even as the pipelines lose firm customers. Captive shippers are at risk because base rates could climb on the pipeline if the carrier cannot find a home for the turned-back capacity and then seeks to recover stranded costs. The remaining shippers may find themselves on the hook.

The issue of cost allocation is addressed in a rate case. The pipeline will seek to justify a passthrough of costs to customers rather than shareholders. That is why it is important for the shipper to pay attention to what other shippers are doing on the pipeline system at all times as well as what the pipeline is planning to do in terms of pending rate cases.

FIHT OR FLIGHT

Alternative Supply Options?

Shippers must clearly identify and evaluate their particular needs prior to negotiating a new transportation contract.

For example, a shipper needs to consider whether its demand levels will rise or fall over the long term due to market expansion or cutbacks (or, in the case of an end-user, because of anticipated changes in production). Seasonal variations in demand, which cause the contract load factor to drop during the summer months, also need to be considered. The shipper should identify ways to best manage its load factor and develop tools for managing contract utilization as part of negotiation.

The shipper's ability to benefit from turned-back capacity will be dependent upon the pipeline's ability to sell turned-back capacity at maximum rates and for the longest term. Whatever nets the pipeline the highest net present value (NPV) will dictate what it does with turned-back capacity. If the pipeline has exhausted all other maximum-rate, long-term options, it will consider shorter-term discounted contracts. Again, whatever yields the highest NPV is what the pipeline will pursue.

A shipper looking to replace an expired term contract with capacity from the release market should