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Natural-Gas Procurement: A Hard Look at Incentive Mechanisms

Better designs are needed to realize the goal of lower-cost gas.

Fortnightly Magazine - February 2006

An example of a benchmark that adapts to changes in relative prices is PG&E (CA).

8. Examples of GPIMs with more limited scope are MidAmerican (IA), which provides incentives for commodity and pipeline reservation costs, but excludes gas sales and capacity release, and New England Gas (RI), which applies only to the upstream commodity portion of certain “discretionary purchases,” with a separate incentive plan for fixed costs associated with gas supply, storage, and transportation, including capacity release.

9. Examples of GPIMs that use actual volumes in the benchmark calculation are SoCalGas (CA), Southwest Gas (CA), NIPSCO (IN), Louisville G&E (KY), Atmos (TN), and MidAmerican (IA).

10. An example is the SoCalGas incentive mechanism during the 2000-2001 period. In 2000, SoCalGas injected relatively little gas for its customers during the spring and early summer, when prices into the SoCal system (SoCal Topock) were in the $2 to $4 range, and had to catch up during July to October when prices rose to the $4 to $6 range. In 2001, SoCalGas injection had the opposite pattern, with a very large amount injected before July 1 and very little after July 1; but prices were above $10 until June-July, after which they fell back under $4. The SoCalGas incentive mechanism reflects the actual pattern of storage injections in the benchmark, so the cost impact of the actual injection pattern relative to, for instance, a ratable injection pattern is not reflected in the calculations of ratepayer benefits or utility reward. In its reviews of the SoCalGas incentive mechanism during this period, the Office of Ratepayer Advocates stated that SoCalGas did an effective job of managing gas procurement, saving ratepayers $192.7 million and $192.4 million in 2000-2001 and 2001-2002, respectively. SoCalGas received large incentive rewards for each year that are subject to modification as a result of an ongoing investigation in CPUC Docket No. I.02-11-040. More recently, ORA has recommended that SoCalGas be required to inject gas ratably.

11. SoCalGas’ incentive mechanism has this characteristic. See Comparison of Incentives Under Gas Procurement Incentive Mechanisms, prepared testimony of James F. Wilson on behalf of Pacific Gas and Electric Co., filed Dec. 10, 2003, in California Public Utilities Commission Docket No. I-02-11-040, p. 21.

12. NIPSCO’s incentive mechanism explicitly states that contracts with such supplier recall rights are benchmarked to first-of-month prices, with “any replacement gas” also benchmarked to first-of-month prices. However, virtual storage deals, and parks and loans, are not benchmarked, and these or other approaches potentially could be used to replace any recalled gas with little or no impact on incentive reward.

13. See, for example, Monitoring and Evaluation Report of Southern California Gas Company’s Gas Cost Incentive Mechanism for April 1, 2004 through March 31, 2005, Office of Ratepayer Advocates, California Public Utilities Commission, Docket No. A.05-06-030, Nov. 30, 2005 (p. 1-1, “ORA’s review also confirmed that application of the sharing mechanism approved in D.02-06-023 results in a ratepayer benefit of $28.9 million and a shareholder reward of $2.5 million” and p. 1-6 Table 1-2, summarizing “Total Gas Cost Savings For Ratepayers”).

14. See, for example,