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Gas Transport Rates: A Puzzling Prospect

Why does FERC want to limit pipeline discounts?

Fortnightly Magazine - April 2005

It's certainly puzzling, if not downright peculiar.

That's the feeling one gets after studying the notice of inquiry (NOI) that the Federal Energy Regulatory Commission (FERC) launched late last year, after nearly 10 years of dragging its feet, to re-examine the wisdom of encouraging the practice of rate discounting by interstate natural gas pipelines.

Since 1985, and with the blessing of the courts coming two years later, the commission has allowed pipelines to go off the tariff and cut deals for customers for gas transportation, a service still treated under federal statutes as a natural monopoly governed by regulated rates tied to cost. It has even allowed the pipelines can recover the shortfall in a succeeding rate case, by deliberately understating throughput.

The current policy arose from FERC Order Nos. 436 and 636-as a natural outgrowth of the commission's highly successful effort, begun in the early 1980s to force the unbundling pipeline transportation from the underlying commodity markets. Under this unbundling regime, pipelines would sell only gas transport . Shippers would contract directly with producers or marketers for the natural gas volumes. To allow shippers to better align their purchases of pipeline services with their physical gas needs, they could release unused capacity on the open market, reselling transportation service back to the pipeline or to the highest third-party bidder.

By allowing shippers to release capacity and pocket the profits (subject at first to a price cap), FERC created a new class of market players to control a portion of pipeline capacity and to compete against the pipeline owners for sale of transport services. And so to allow the pipelines to meet this new competition (not to mention the competition arising from pipeline expansions or new projects), FERC allowed pipelines to offer discounts below cost-of-service rates stated in the tariff. By this device, regulators could hold on to the fiction that all service flowed at the maximum lawful (regulated) rate. The tariff, though mandated by the Natural Gas Act to reflect just and reasonable rates, in effect became nothing more than a classic price cap, especially since FERC also relieved the pipelines of any obligation to file periodic rate cases.

In retrospect, FERC's then-radical new policies—unbundling, capacity release, discounting, and so on could be seen simply as a rational response to changing market conditions. Thereafter, in fact, gas prices fell for the greater part of two decades, with gas markets blossoming as never before. Hubs, futures, basis differential, and spark spread became the new coins of the realm. All of this left the feds free to bask in the sunshine of a notable regulatory success.

So why now would FERC choose to walk away from any aspect of this success? Why would it fault the pipelines for acting like any competent capitalist-by discounting prices when demand falls short of supply?

Contrast the historical experience with the call to arms sounded recently by William Froelich, director