"People are starting to talk about ISOs on the gas side." So says Jerry Pfeffer, lay advisor on energy industries for Skadden, Arps, Meagher & Flom, the New York law firm well known for its work in mergers and acquisitions.
Pfeffer's comment alludes to events now unfolding in Southern California, that fount of fashion, where each round of "deregulation" only doubles the ante in billable hours. This time it's natural gas pipelines. Do they have market power too?
"It Would Not Surprise Me"
Southern California Edison Co. has now alleged that Southern California Gas Co. is manipulating capacity on natural gas pipelines. Edison accuses SoCalGas of limiting access by Edison to cheap gas for electric generation.
Edison's allegations parallel the issues at play in electric restructuring. Remember that California has formed a power exchange plus an independent system operator to ensure fair dealing over electric transmission lines. Now comes Edison, seeing the same need on the gas side. This idea carries implications for the proposed merger (actually a corporate reorganization) between Pacific Enterprises, the parent company of SoCalGas, and Enova Corp., which owns San Diego Gas & Electric Co., Edison's rival for electric sales.
None of this has escaped the attention of the Federal Energy Regulatory Commission, where the merger approval docket is stocked with "convergence mergers" between electric and gas companies.
In February, in its order approving the merger between Enron and Portland General Electric Co., the FERC asked whether the vertical consolidation of Enron's natural gas pipeline and Portland Electric's generation assets could "potentially present a problem" for competitors who rely on gas-fired generation.
In that case, however, the FERC saw "no indication" that Enron could restrict gas supply to drive up costs to PGE's competitors.
But that was then. Speaking on May 22, at the Restructuring and Convergence conference sponsored by PUBLIC UTILITIES FORTNIGHTLY, Commissioner Donald Santa predicted that the issue will likely come up again at the FERC:
"In the only convergence merger that we have acted on so far (em Enron/PGE (em we didn't address the gas/electric market power questions because no one raised the issue.
"It would not surprise me if, in reviewing the Enova/PE merger, we are asked to review that question again."
(Note: The FERC approved the convergence merger between PanEnergy and Duke Power some six days later, but at press time the commission had not yet released its 21-page opinion, nor explained whether it had reviewed pipeline market power in electric generation.)
"We Have Evidence"
"We have hard evidence of what SoCalGas is doing," says Stephen Pickett, associate general counsel for Edison. "About 60 percent of the gas flowing over the SoCal system is Edison gas. This happens
primarily during the shoulder months, when
SoCalGas is injecting into storage."
Pickett claims that SoCalGas is releasing gas pipeline capacity at a price set purposefully high to discourage buyers. Then, when no bid comes forward, SoCal pockets the capacity for its own core customers through an "internal transfer" at a price below market. Reportedly, SoCal posts the released capacity on its bulletin board. (The company escapes FERC jurisdiction in some respects as an exempt intrastate "Hinshaw" pipeline; the FERC cannot force SoCalGas to post released capacity on interstate pipeline bulletin boards.)
Adds Picket, "What they're doing essentially is reserving capacity for themselves at a below-market price."
The FERC has denied that claim. In an order issued May 14 (So. Calif. Edison Co. v. So. Calif. Gas Co., Docket No. RP97-284-000), the FERC refused to censure SoCalGas gas. The Commission said the company had not violated the commission's price cap imposed on the resale of pipeline capacity in the secondary market. Said the FERC: "So long as transactions take place at or beneath the price cap, the [FERC] does not inquire into the potential for the releasing shipper (or the pipeline) to exercise market power.
"Since shippers buying the release capacity are paying no more ... than the regulated rates for pipeline capacity, the release rates are just and reasonable."
Edison, however, suggests the FERC should be looking beyond the pipeline's transportation tariff. What about the opportunity cost (em the value of pipeline capacity in the generation market?
"We were surprised and puzzled," says Pickett, "as to what we see as a clear violation of policy of FERC policy to create a vibrant market in the capacity release market."
Fred John, senior vice president of Pacific Enterprises, shares no such puzzlement. Quite naturally, he describes Edison's claims as "totally without merit."
According to SoCalGas, Edison has "failed to cite any specific violations of any FERC orders or regulation in its complaint because no such violations have occurred." Further, the company denies requiring any sort of "minimum bid" for released capacity. In fact, SoCalGas says it regularly has sold capacity "above, equal to and below the open-offer rate." It adds that 70 percent of its capacity releases during the 1995-96 winter heating season sold at "below the open-offer rate," including some capacity sold to Edison.
"We have been posting since May 1996," says John. "Since then, Edison has never been denied the capacity they have sought. [T]here is absolutely no abuse of market power.
"It has been clear to most observers that Edison is attacking partnerships that pose a threat to their dominant position in the Southern California electric market."
Edison intends to fight on. "We will pursue [our] claim in both dockets," counters Pickett. "On rehearing at the FERC and in the Enova/PE merger before the state PUC.
"In the merger proceeding, we see [this activity] as evidence of pre-existing anti-competitive behavior that needs to be remedied, that will have greater impact if the merger goes forward."
Edison was to file its testimony at the California PUC in the Enova/PE merger case by June 20.
A Role for Antitrust?
If SoCalGas has not violated any federal or state law or rule, then why fix what ain't broke?
Pfeffer, for one, believes that the California power exchange should allay any fears of market power, even after a merger between Enova and PE.
As Pfeffer notes, the PUC has required all investor-owned electric utilities in California to buy wholesale power from the power exchange for at least five years. If Enova should attempt to withhold gas pipeline capacity (through its future affiliate, SoCalGas) to manipulate power prices, it would gain no edge over Edison, says Pfeffer, because both must buy through the pool. He adds that since California has capped retail electric rates, any increase in generating costs would cut into the "headroom" (margin) available for recovery of stranded costs.
Mark Frankena, an economist who testified at the FERC on market power and transmission constraints in the case of the doomed Primergy merger, agrees essentially with Pfeffer's analysis. But Frankena adds that gas pipeline constraints should not affect wholesale power markets unless gas-fired generation operating on the margin sets the price in the pool.
Is federal policy tied in knots? Should Congress step in?
Douglas W. Smith, deputy general counsel for energy policy at the U.S. Department of Energy, wowed the audience at the FORTNIGHTLY conference when he posed this question: "What about market power outside the merger context? Does the federal government need more regulatory authority than it already has?"
Peter Fox-Penner, formerly of the DOE, and now a principal and director at the Brattle Group, took Smith's comment as a hint of a greater enforcement of antitrust laws: "I see DOE responding to issues arising from state-level restructuring. Yet any new federal law that would take market power analysis beyond its traditional antitrust context would represent a bold move."
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