Gas-on-Gas Discounting: Still a Zero-Sum Game

Captive shippers still face rate hikes without reward under the FERC's new rule on short-term pipeline capacity.

In its final rule issued on short-term gas pipeline capacity, announced Feb. 9 in Order No. 637,[Fn.1] the Federal Energy Regulatory Commission squanders a precious opportunity to end a discrimination inherent in its pipeline rate discounting policy.

In practice, that policy permits interstate pipelines to raise rates for captive customers to offset discounts they give to other customers that enjoy access to competing interstate pipelines. The theory behind this privilege is simple. The pipelines justify their discounts on the claim that all customers, including non-favored customers that get no discounts or lesser discounts, will benefit. How? The benefit, it is said, comes from an increase in units of service provided - a result of the discounting.

Alas, that common theory rests on a mistaken assumption. Not one more dekatherm flows in the interstate pipeline grid because of this pipeline-on-pipeline (or "gas-on-gas") discounting. Instead, one pipeline's increased units of service merely other pipeline loads; their combined units of service do not increase. Furthermore, the FERC's answer of adjusting ratemaking throughput[Fn.2] to recoup such discounts discriminates against non-favored customers because their higher rates subsidize discounts to the favored customers. The extra units of gas are not real. The gas-on-gas discounting emperor has no clothes.

The FERC's 1998 Notice of Inquiry,[Fn.3] heralding the Final Rule, asked two questions relevant to this issue. First: Do these discount-related rate adjustments unfairly affect captive customers (those whose short-term demands do not vary with price)? Second: What constitutes a reasonable limit on the extent to which pipelines can recover the costs of their discounts? For gas-on-gas discounting, fairness dictates two straight-forward answers: (1) "yes," and (2) "no rate adjustments are reasonable." Yet the Final Rule leaves those questions dangling, noting only that the FERC is "still considering ... whether to permit discount adjustments."[Fn.4]

While the Final Rule takes a pass, gas-on-gas rate prejudice against captive customers endures. The Final Rule's standard gas-on-gas regulatory model remains open to challenge, whether at the FERC by complaint as "pernicious,"[Fn.5] in pipeline rate case hearings, or in a later court appeal. Instead of waiting for such a challenge, the FERC should repair the gas-on-gas standard model.

The Policy: Blind Faith in Supply-Side Subsidy

Since opening access to the interstate grid in 1985, the FERC has allowed pipelines to discount their transportation services at will and then to regain those discounted dollars by commensurate adjustments lowering the volume of throughput that is entered in the ratemaking formula, thus raising rates. The FERC argues such subsidized discounting (by customers not awarded the discounts), including subsidized gas-on-gas discounts, benefits all customers by allowing a pipeline to maximize actual physical throughput, thus spreading fixed costs over "more units of service."[Fn.6]

The Final Rule acknowledges that pipelines exercise market power through such selective discounting at rates below the FERC-set maximum rate ("in effect price discriminating").[Fn.7] Nevertheless, the Final Rule then sets out the standard, broad-brush rationale that increased units of service, leading to higher annual