Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

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

result from the utility pursuing a reasonable procurement strategy absent the incentives provided by the GPIM. It is unlikely that this is ever the case. Instead, GPIM benchmarks are based on simplified formulas that in some ways reflect relatively mechanical procurement strategies that are often easy to beat. In addition, for GPIMs that provide distorted incentives, the magnitude of the difference between benchmark and actual costs partially may reflect utility actions that raised the benchmark. Consequently, while the utility may have achieved “savings” relative to its benchmark formula, it may not have achieved savings relative to the procurement strategy it would have pursued absent the GPIM incentives, or relative to a merely reasonable procurement strategy that another, similarly situated utility might have pursued.

Final Observations

A GPIM that provides strong incentives for a broad range of procurement-related costs and revenues, using a benchmark that is both exogenous and adaptive to external circumstances, can benefit consumers through lower gas costs and reduced need for regulatory oversight of the procurement function. A GPIM can incent more active use of utility storage and other assets, which can contribute to market efficiency and mitigate market volatility, benefiting both utility customers and the broader market. Incentive mechanisms also can encourage hedging to some extent. If a target level and schedule of hedging is reflected in the benchmark, the utility minimizes its risk by staying close to the targets.

However, GPIM designs often reflect tradeoffs between competing principles, and the best balance between the various principles will depend upon each utility’s particular circumstances. Under some circumstances it may be difficult to design a GPIM that provides sound incentives while not exposing the utility to substantial risks, or customers to the potential cost of windfall rewards, without significant complexity in the benchmark formula. Accordingly, GPIMs may not be appropriate for some utility circumstances.

 

Endnotes:

1. See, for instance, “Madigan Calls For $160 Million Refund For Nicor Customers,” press release dated Nov. 21, 2003, by Illinois Attorney General Lisa Madigan, alleging that Nicor Gas improperly sold low-cost gas reserves in order to profit under its gas procurement incentive mechanism. The incentive mechanism has been cancelled and the refunds are a subject of Illinois Commerce Commission Docket No. 01-0705.

2. As examples, GPIMs were once in place but have since been terminated for Nicor Gas (IL), Minnegasco (MN), Columbia Gas of Pennsylvania (PA), and Avista Utilities (WA). Laclede Gas (MO) had a GPIM that was terminated but later redesigned and reinstated.

3. Examples of GPIMs with benchmarks that assume little or no hedging are PG&E (CA), SoCalGas (CA), Laclede Gas (MO), Superior WL&P (WI), LG&E (KY), MidAmerican (IA), among others.

4. An example of a GPIM benchmark that includes a schedule for hedging is New England Gas (RI).

5. Examples of fairly comprehensive GPIMs are PG&E (CA), LG&E (KY), Atmos (TN), and Nashville (TN).

6. Examples are Laclede Gas (MO), whose benchmark uses fixed percentages by location; Alliant/Wisc. P&L (WI), whose benchmark uses pipeline reservation quantities; and Superior WP&L (WI), whose benchmark uses volumes from its Gas Supply Plan.

7.