July 1, 2001
L.A. Loves a Loophole
There's no getting around it...
An interesting time for pipeline capacity markets looms as the first winter under Federal Energy Regulatory Commission Order 637 begins. FERC's new rule was implemented to encourage that capacity flow to its most valued use in peak-demand periods. To achieve this goal, FERC released the price cap on short-term capacity release transactions. Market participants now can increase capacity price bids until holders of capacity are willing to curtail their demand or take their chances in the interruptible markets. Other market changes arising from Rule 637 include mechanisms for seasonal or term-differentiated rates, such as hourly structures for power producers; standardization of segmenting rules-the breaking up of capacity parcels; and changes in the priority rights for replacement shippers.
This winter's exceedingly tight supply/demand balance in gas markets and low storage inventories will set the stage for the first real test of the new capacity rules. Basis differentials among markets are set by the cost of moving the incremental decatherm necessary to satisfy demand in the market. In previous years, when the value of capacity exceeded the regulated maximum rate, gas sellers would turn to downstream bundled sales markets to sell their supplies. In these peak value periods, capacity holders had no incentive to release capacity because the most they could receive was the maximum rate. Furthermore, shippers that placed a high value on the capacity had no mechanism to reveal their preference. This winter, capacity holders that can use multiple fuels or have peak shaving capability that previously may not have received enough value from capacity markets to release capacity can offer capacity at its true value. That should lead to more capacity flowing back to the market in peak periods, lessening constraints and lowering capacity prices for all shippers ultimately.
One region where this new dynamic in transportation markets will play out is the Mid-Atlantic. Last January, significant price spikes occurred at the New York City hub, reflecting an already tight pipeline capacity market. The situation this year could be much tighter for several reasons. First, last winter was relatively mild, and a return to normal temperatures will increase space-heating demand. Second, the low levels of gas in storage will make customers hesitant to pull from storage facilities early in the winter. Finally, significant amounts of combined-cycle generating capacity have come online in New England. These plants typically will run year-round, and while Sable Island gas and liquefied natural gas will serve part of the load, supplies will need to flow through the Mid-Atlantic to meet generation demand.
This uncertainty already is factored into the forward basis markets for this winter. In early October, December-to-March basis was in excess of $1.50 per decatherm for deliveries from Henry Hub, La. to New York City (Transcontinental pipeline zone 6). Historically, capacity has been valued at a much lower rate and clearly was constrained by the maximum rate cap. During the last two winters, released capacity has sold at close to the maximum rate, while transactions have declined. In addition, 85 percent of the capacity has been released by three firm capacity holders: South Jersey