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A story of big gambles, big assumptions, and spark spreads now turned upside down.

Major battles are being fought over the movement of natural gas from Canadian soil to U.S. homes and businesses. Spurred by the new Alliance pipeline system, and its aggressive bid for market share, pipeline companies are fighting for shippers to use their systems for moving gas. And now, just in time for the pipeline's assumed startup date of Oct. 30, comes a dramatic rise in natural gas prices, bringing both good news and bad for all those who cast their lot with the pipeline, betting on market assumptions formed years ago.

The dynamics are complex-even counterintuitive. Each new development can undo the best of plans.

In the pipeline wars, in the battle for shippers, the shakeout already has begun. Canada's large natural gas pipeline company, TransCanada, is losing share to Westcoast Energy, the firm that has the most riding on the success of Alliance. Westcoast has large equity interests in both Alliance and Vector, a new U.S. pipeline that will connect indirectly with Alliance at its downstream end to help carry gas past Chicago and on to East Coast markets. Alliance, rooted in the Western Canadian Sedimentary Basin (WCSB), the major producing area in Canada, offers several potential advantages over longer lines. With a newer plant, it offers greater efficiency and promises greater flexibility to shippers. It also distinguishes itself in competition by its ability to diversify and transport raw material for the chemicals industry.

Vector plays a key role in these skirmishes. Vector promises to transform trading relationships and movements of existing gas in the United States. Not surprisingly, two of the three companies with an equity interest in Vector also have an equity interest in Alliance. And at its downstream end, Vector will connect with other new pipes, such as Millennium, designed to bring the gas the last mile to New York City and other East Coast areas hungry both for gas and electricity. Westcoast also has a major equity interest in Millennium. In the short term, the success of Alliance and Vector depend on the ability to steal market share from TransCanada. Farther out, however, in the immediate term, the key will lie in serving new customers using natural gas to generate electricity.

Yet it is here, in the power generation market, where spark spread is king, that the danger grows of assumptions gone wrong.

Gas-fired generation is crucial for extracting the full economic value of new pipelines such as Alliance, Vector and Millennium. But if natural gas prices remain at their current high levels (high, that is, relative to the past few years, when these pipes were planned), gas will lose much of its advantage in the fuel mix for generation. Of course, high prices should spur greater upstream production, eventually swelling supply and forcing prices down, but that has not yet happened, and may not for some time to come.

Overall, the Alliance story is marked by a volatile mix of conflicting assumptions and market trends, as shown in the following timeline, which covers the formative years of Alliance.

Planning Stages (1996):

Construction Stages (1998-99):

Market Stage (2000):

The Future:

Nevertheless, despite all this uncertainty in natural gas markets, the arrival of Alliance is as important in its own right, for what it has told us about the market so far, and about the companies that supported the project and built the pipe.

From Plan to Startup: A Time of Shifting Assumptions

When plans for Alliance were being formulated in 1996 and 1997, the natural gas price in Alberta often hovered near or below $1.00 per million Btu. The price of natural gas in the United States often exceeded the cost of gas in Alberta by more than $1.00/MMBtu . After that, however, market conditions and prices changed dramatically.

By May 2000, the Alberta price was three times its 1996 value. By this fall, the price had jumped to five times as large. These higher prices, which of course are great news for producers and marketers, will continue if supplies continue to be tight. Also, as prices rose in Alberta and at Henry Hub, a very close relationship developed between Henry Hub and Chicago prices . This close relationship enhances price discovery and supports the completion of business and the effective hedging of price risk, adding potential value to the Alliance venture. At the same time, however, these high gas prices thwart investment in electric generation fueled by natural gas.

Competitive relationships between pipelines also played a role during this time.

Early on Alliance was envisioned to give producers greater access to export markets and relieve a perceived shortage of pipe capacity leading out of the Canadian Rockies to points East. In 1996, NOVA was the major gas pipeline in Alberta, while TransCanada had most of the pipe business outside of the province and an equity interest in many of the pipes taking delivery of Canadian gas on points along the U.S. border. NOVA also included a chemical arm that processed the raw natural gas to produce ethane, propane, and other liquids.1 NOVA processed these liquids to produce styrene and other basic material for a variety of plastic products.

Many producers worried that with just two companies controlling much of the processing and shipment of gas from the major producing province, they were not getting the best deal for their product. The Alliance system represented the chance for them to acquire some control over the gas processing, transport, and distribution.

In the legal proceedings in Canada for approval of Alliance, the pipeline was recognized as a speculative undertaking. Alliance received the right to proceed based on commitments by companies to ship gas on the pipe. The pipeline did not have natural gas reserves committed to the pipe. At the hearings, Foothills Pipeline raised the issue that if supplies were not available, then some pipe capacity somewhere would be a stranded asset. That now has occurred for the TransCanada system.

At the time, and for much of the 1990s, Canada had become the backstop source for North America. Many believed that Canadian supplies of natural gas would continue to be available for the United States. Indeed, the Federal Energy Regulatory Commission in its Environmental Impact Statement, an important document in the approval process, assumed that supplies would be available from Canada to fill all pipes.

Yet new supplies are not coming on-stream even now, despite the very high prices that have prevailed this year. That, in part, is a consequence of longer-term trends, but also special conditions in the gas industry that occurred in December 1998, when the last major expansion of pipeline capacity into the United States was completed and about when Alliance received final approval. At that time, mild weather, low oil prices, high storage levels, and overall robust supplies2 conspired to pummel prices to $1.00 per million Btu at Henry Hub and $0.70 per million Btu in Alberta.

It was not until seven months later, in July 1999, that Henry Hub prices pushed back up above $2.50-providing enough of a return for many companies to cover the costs associated with supplying new or incremental gas to pipelines headed toward end-use markets on an ongoing basis. Compare that number to the situation today, with current prices regularly above or near $5.00 at Henry Hub.

And other factors besides price affect gas production.

Since 1998, gas production in North America has become more expensive. Finding costs have increased and lifting costs no longer are declining. Labor costs also have risen in a tight labor market. But the normal profit associated with producing and marketing gas also has risen in the last five years. Company executives and managers are expected to do more and assume more risk than in the past. Opportunities for returns on available funds have increased on international and domestic markets, and investors demand higher earnings growth. Hence, normal profits have increased in the gas industry. That necessarily increases the cost of supplying gas to market.

Not surprisingly, producing companies in late 1998 and early 1999 were reluctant to commit funds to additional gas development. Prices still were not high enough. Instead they looked for alternative ways to invest in the ever-expanding world economy. Luckily, Alliance already was in development after several years of intense review.

The Players: Some at Risk More Than Others

An interesting mix of companies holds an equity interest in Alliance. Four of the five companies are well-known energy companies: Westcoast Energy, Enbridge, The Williams Companies, and Coastal Corp., soon to be part of El Paso Energy.3

Equity interests for Westcoast and Enbridge, the Canadian companies, are about 24 percent, and for Williams and Coastal, the U.S. companies, about 14 percent. These last two companies, especially when Coastal is considered part of El Paso, already are known for their enormous strategic stakes in natural gas infrastructure. Williams also has a major position in communications-in particular, the soaring fiber optics industry.

Williams and El Paso Gas together own about 40 percent of the miles of pipe and deliver about 40 percent of the natural gas delivered in interstate commerce in the United States. These are the two major pipelines in terms of deliveries and miles of pipe in the United States, and, along with Enron, they account for more than 50 percent of deliveries and pipe miles on U.S. soil. These three companies also account for about 50 percent of pipe capacity. In addition, Alliance extends Williams' reach in the liquids business, where it has impressive stakes. Its stake in the risky chemicals industry has increased significantly in the last year, which may explain the volatility of its stock price this year .

Westcoast, in addition to being the gatherer and transporter of most gas in British Columbia, also owns Toronto-based Union, a major utility in North America. Westcoast has a 37.5 percent interest in Maritimes & Northeast, a 50 percent interest in Foothills Pipeline, and a 50 percent interest in Empire State Pipeline. Thus, in addition to having its hand in the pocket of the WCSB with Alliance, it has a hand in Sable Island gas on the East Coast, and pipes engaged in the export of Alberta gas into the North Central and Northeastern parts of the United States.

Enbridge is the owner of the largest gas utility in Canada, Consumers Gas in Toronto (70 percent of its revenues are obtained from this source), and also operates the world's largest oil and liquids pipeline system. It is the major transporter of Canadian oil into the United States. In recent years, its major new investments have been in natural gas pipelines.

Into the future of the gas industry, the roles of Williams and El Paso seem secure. These companies continue to demonstrate an ability to grow persistently in a changing environment, and, perhaps, are viewed by investors as having much control over their corporate destiny. Significant cash flows are secured on the regulatory side of the business, while significant profits are obtained on the non-regulated side.

On the other hand, however, there is much uncertainty about the role of Westcoast and Enbridge in the future energy industry. As seen in Figure 3, variations in recent stock performance for these various investors seem to reflect these differences in size and stature.

Westcoast is different from the remaining companies in that it lacks a distinct presence. Westcoast has the most to gain and the most to lose from a full success for Alliance.

Westcoast also has a 30 percent equity interest in Vector, a 100 percent interest in Millennium West in Ontario, and a 21 percent interest in the Millennium project in New York. Westcoast's utility, Union Gas, also will be connected to Vector and Millennium West. Millennium West will transport gas from Vector and other systems through Ontario and then under Lake Erie into New York state, where the Millennium Pipeline will transport natural gas into New York City. This pipeline initially will have a capacity of 700 MMcf per day.4 Union, which also owns 137 Bcf of working gas storage capacity, is the largest holder of storage capacity in Canada and among the largest in North America. Westcoast's strategic importance will grow in North America if natural gas-fueled generation markets develop as expected; that is, if supplies are available to fill the pipes at competitive rates.

In the early 1990s, the strategic reach of Westcoast largely was contained to the British Columbia border, where it was involved in gathering and processing raw natural gas and then transporting it to markets. The only other major gas company in British Columbia was BC Gas, which distributed gas in the populated Vancouver area.

The dominance of Westcoast in British Columbia soon will be reduced when BC Gas begins transporting 250 MMcf of Alberta gas within British Columbia on its Southern Crossing System. In addition to reducing Westcoast influence in the province, that system will raise natural gas prices in the Northwestern United States and California in the short-run. Less Canadian gas will be available for U.S. markets at current prices, so customers in the California and the Pacific Northwest will need to bid more for Canadian supplies. These factors should boost prices for gas in the U.S. Rockies, and boost incentives to move that gas east and west within the United States.

Note, however, that Westcoast failed in two targeted areas in the 1990s: (1) marketing natural gas, and (2) owning and managing gas utilities in Canada. During the 1990s, it had joined with Coastal to form the gas and power marketer Engage Energy, and had purchased several utilities, including Centra Manitoba. This year Coastal ended the Engage relationship, and Engage ranked only No. 11 in the Gas Daily 1999 survey of gas marketers.5 It marketed 5.6 Bcf per day, a decline of 1.4 Bcf per day from its previous year's level. Enron, ranked first among marketers by Gas Daily, marketed 13.3 Bcf per day. Westcoast also sold Centra Manitoba, the gas utility in Manitoba, after Centra experienced problems with its trading/hedging program. This problem had cost the utility more than $10 million.

Westcoast is notable for its ability to dust itself off and move forward. It now appears to hold a new playbook with enormous potential.

Economic Analysis: The State of the Markets

By June of this past summer, some noted that when Alliance came on line this fall it would supplement low inventories heading into the winter heating season. That has not happened. Instead, supplies now are tight not just in the lower 48 states, but also throughout North America.

The Alliance system was designed to deliver more than 1.3 billion cubic feet (Bcf) of natural gas per day on a firm basis from the gas-producing regions of northeastern British Columbia and northwestern Alberta to the Chicago area, where it interconnects with the North American pipeline grid. Thus, Chicago should continue to grow in importance as a natural gas market because of Alliance. Yet back on the East Coast, Alliance will not likely prove any more important than Transco Zone 6. In fact, Alliance and adjoining new pipes should lead to a better integration of eastern and Chicago markets. Alliance also is likely to help better integrate the eastern U.S. markets with the Alberta producing area. On the other hand, however, Alliance and other pipe projects have made gas markets in the western United States a bit more complicated. These markets will continue to go through adjustments, largely because of inefficiencies in gas markets.

For example, natural gas markets operate at the mercy of several unsettling factors: (1) the complexity of geology in producing areas, (2) the "lumpiness" of most new major pipe investments, (3) poor information on capacity available to ship gas, and (4) the market power (open to debate) of incumbent pipes and utilities. Hence, price behavior at different locations does not follow the model of one price-or at least not for extended periods of time in this growing and changing market. The result is price behavior like that observed out West this summer and observed between Alberta and Henry Hub, La., markets between 1996 and fall 1998 .

Gas prices in the West this summer reflected several factors. Among these was a lack of pipe capacity to move gas out of the Rockies to western markets—a possible market power problem, as evidenced by a complaint by the California Public Service Commission to federal regulators.6 Another factor was unworkable scheduling rules. These rules leave producers unable to ship their gas when pipes may be operating at less than full capacity. As a consequence, prices remain high in an end-use market when demand shifts up, but decline or remain low in a producing market where gas competes with gas for room on scarce pipe space. This situation seems to benefit particular companies, but disadvantages most producers and consumers. Alliance will have little effect on this particular behavior. Prices could remain high in the West as long as capacity appears to be tight on particular systems.

Moreover, prices in the Rockies will continue to increase if Alberta supplies remain tight overall. In general, once Alliance is operating on a regular schedule and Alberta gas is serving the new system by BC Gas, designed to deliver 250 million cubic feet (MMcf) per day, and once TransCanada regularly promotes programs to reduce its cost of service, then smaller amounts of Alberta gas will be available for western markets. Already TransCanada has reduced its fuel cost from 8 percent to 6 percent, which at today's natural gas price amounts to between $0.08 to $0.10 per million Btu of gas shipped.

Under the current tight supply conditions and normal weather conditions, Alberta gas moving to Chicago along Alliance will have little influence on overall price behavior except that it should reduce volatility during winter cold spells. It also will tend to reduce the large difference between Henry Hub and Alberta prices observed at times this past summer. However, as stated, Alliance will contribute to increasing price levels in the Western United States. That will hasten the building of pipes heading west out of the Rockies. The difference between prices in the Rockies and East, as well as the robust reserves in the Rockies, probably also will be great enough to support the building of pipes carrying significant amounts of natural gas out of the Rockies heading East.

Eventually producing areas will be able to make more supplies available. This supply will amount to as much as 680 Bcf over a year's time from U.S. producing sites, or growth equivalent to more than 3 percent of natural gas consumption. When that occurs, prices will decline significantly. The full impact of Alliance will be felt as both Alliance and TransCanada and connecting pipes are used more uniformly throughout the year. At that time, they will be bringing large amounts of gas to power generators in the summer and conventional space heating customers in the winter. Thus, the meal that Alliance and connecting pipes are serving to all stakeholders in the natural gas industry is still cooking in the oven.

Long-Term Outlook: Uncertainty in Merchant Power

Only the addition of new electric generation customers with their large additional gas requirements will justify significant investments in additional pipe capacity. These customers may be conventional utilities, merchant plants, or industrial customers that produce power for their own use and for sale onto the wholesale market.

The full commercial value of gas shipments on Alliance is dependent on the shipment of gas on Vector and other connecting pipes. If Vector results in the creation of new power-generation markets in Indiana and Michigan, the added value could be substantial. If Vector merely re-channels Canadian gas to Vector from TransCanada and connecting pipes, there may be an increase in shipping costs for remaining shippers on TransCanada and these other pipes.

TransCanada has admitted losing firm shipments in Alberta that amount to about 1 Bcf per day. Total lost revenues from firm shipments on TransCanada and jointly owned systems such as Great Lakes Pipeline could exceed $100 million. TransCanada at some point will have to increase its firm transportation rates if it does not replace lost shippers.

If supplies remain tight and prices remain high, investments in gas-fueled generation will be less attractive. The benefits these power generation projects would bring in terms of year-round levelized load and resulting lower gas prices for all consumers also will disappear. Not only will developers slow their plans to bring new gas-fueled generation investments online, but they may back out of some investments until the gain from power produced from natural gas improves relative to the cost of power generated from coal and nuclear. They'll work harder to use coal, nuclear, and other types of generation, or refurbish retired or partially retired plants until the price of gas declines relative to the cost of using these other types of generation.

Of course, the cost of coal and nuclear units will rise from refurbishment and operating them at a higher level. The end result is that the future cost of power will increase by more than previously expected. The upper limit on this increased cost of power will be determined ultimately by the price of commodity natural gas, which has more than doubled in just this year.

In any case, natural gas-fueled generation plants still will be sited where obvious shortages of generation exist, because they can be installed more quickly and with less harm to the environment than these other types of generation. Nonetheless, the deceleration of the rate at which this generation is installed will tend to sustain high price volatility.

The success of the Millennium and Millennium West projects, which are connected to each other and to Vector, is particularly dependent on the building of new gas-fueled generation markets in the New York City metropolitan area and nearby markets. As the demand for natural gas for power generation declines because the price of the fuel remains high, the value of Millennium also declines.

Winners and Losers: Takeover Candidates?

Alliance brings clear evidence that competition is alive in the pipes part of gas industry. As evidence, TransCanada already has retired assets in an attempt to lower costs and shore up business with lower fees for service. It also has become increasingly involved in power generation markets, including the acquisition of generation assets.

As of now, Alliance is the winner and TransCanada is the loser in the battle for shipments. Westcoast continues to run through its business playbook, hoping that investors will believe that all of its pipe pieces will fit together to form a competitive advantage.

Its attempt to serve shippers through a rational treatment of available space could make Alliance a model for other pipes. On the other hand, the chemical industry is too risky to expect that many future pipe builds will be engineered to also transport wet gas. Alliance is a special case in this regard. But this capability most probably will enable Alliance to steal some customers from NOVA Chemicals.

The involvement of Williams and El Paso in Alliance supports their continued dominance of pipe markets in the United States. Each is involved in major (greater than 500 MMcf per day) proposed pipeline builds out of the Rockies heading east-COCO, proposed by Colorado Interstate Gas and soon to be an El Paso affiliate, and Frontier, proposed by Williams.

Some might think that Westcoast is involved in Alliance out of desperation, while Enbridge is involved because it wants to be recognized as adept in the pipe business, able to work efficiently in both oil and natural gas business environments. Westcoast, however, may become the owner of some of the most valuable pipe space per square inch in North America if gas prices decline sufficiently and natural gas generators again become impressive investments. On the other hand, the financials of both Westcoast and Enbridge suggest that other companies may purchase them after the difficult work is done and the road ahead is clearer.

High Gas Prices: What Looms Ahead

Given the recent and huge runup in natural gas prices, two events could change market conditions quickly and dramatically, and make Alliance a huge success for all parts of the industry, including companies with natural gas-fueled generation:

Either of these events would eventually force gas prices down, increasing the rate at which new gas-fueled generation is installed, especially accounting for the better capability of natural gas generators to take advantage of price movements throughout the day.

Additional supplies from Canada could lower prices to between $3.50 and $4.50 per million Btu. Increased supplies of gas from Canada also would provide TransCanada with new opportunities to more fully use available space on its system and possibly lower its transportation rates.

Similarly, if gas use per customer is reduced due to high prices,7 the effect also will be an increase in available supplies. Residential and commercial customers this winter are expected to conserve gas, lowering their use significantly because of expected 30 percent to 50 percent increases in the cost of gas service. If the winter weather is similar to last year, this conservation could reduce gas consumption in these sectors from 1999 levels by at least 10 percent. That, in effect, would increase available supplies by several hundred billion cubic feet.

Market Strategy:
More Efficient, More Flexible, More Products

Alliance always was viewed as a producer's pipeline. Yet it is also designed in an operational scale to make prices and services much more attractive for shippers than those on competing systems.

Efficiency. The chance of flows being interrupted from operational problems on Alliance would be expected to be less than on TransCanada, simply because the TransCanada system is much older. Thus, shippers would incur fewer costs associated with service disruptions.

Flexibility. Alliance provides shippers with approved shipment overruns amounting to 25 percent of their firm shipments. Alliance also intends to work with shippers to avoid imbalance penalties, an onus for many shippers. Yet whether the intention is followed by action remains to be seen. The operational integrity of a pipeline system depends on the independence of unexpected changes from the various shippers' scheduled receipts and deliveries. If these changes are independent, then imbalances, in effect, are balanced by offsetting amounts of the different shippers. If, however, the changes are dependent, then the pipeline will need to impose penalties for unexpected changes to maintain the operational integrity of the system.

Diversification. Alliance allows shippers to ship wet gas for processing near Chicago, which can result in discounts on the cost of their firm shipments amounting to 16 percent. With this discount and approved overruns, shippers are expected to receive transportation service at a cost significantly below what competitors can offer.*

-J.H.H.

Profits from selling power onto the wholesale market using natural gas-fueled generators have been huge at times during the past few years. Such profits have been a driver for companies installing new gas-fueled generators to take advantage of the expected additional gas from Alliance and connecting pipes. Yet today, with the high gas prices, the outlook has become clouded for gas-fired merchant generation. Consider the downward trend in the Chicago area of days on which gas-fired merchant gen plants could earn high profits.

In 1999, in the Commonwealth Edison and Chicago market area, there were only 20 days—8 percent of the total number of trading days—when the spark spread exceeded $30 per million Btu. By contrast, this past summer in Chicago the number of such days fell to only ten. These are the days on which power producers with gas-fired plants would expect to earn their meal tickets.

Aux Sable: Achilles Heel?
The risk of adding ethane and propane to the product mix.

Alliance is not without possible threats. In addition to high natural gas prices working to undermine market growth, clear risks are associated with Aux Sable, part of the Alliance package.

The Venture. Aux Sable Liquid Products (Aux Sable) is a new, $365 million venture for extraction and factionation of natural gas liquids, to be constructed near Chicago, and supplied by Alliance. It will initially process up to 1.6 billion cubic feet of natural gas per day. It is expected to initially recover 70,000 barrels per day of natural gas liquids (ethane, propane, normal butane, iso-butane and natural gasoline), and become a significant propane supplier for the Midwest, particularly for Illinois and neighboring states.

Price Volatility. Nevertheless, the selling of such liquids is a risky business. Marketers must deal with volatile product price risk, which is influenced by international markets. They also must be able to hedge commodity price risk.

Examination of statistical characteristics of ethane and natural gas prices, the difference between which prices is the , a crude measure of profit potential, indicates the price volatility of ethane in recent years is much greater than the price volatility of natural gas. The correlation between changes in ethane prices and changes in natural gas prices also has been very small. Thus a natural gas company may be increasing its risk when it enters the ethane business, while a company that produces ethane may be reducing its risk by entering the natural gas business. The frac spread is very unstable, which indicates that earnings from being in both lines of business will vary greatly over time.

Stock Prices. Another way to view the risk of this business is to examine the stock price of NOVA Chemical. The Alberta-based chemical company several years ago was part of NOVA, the major pipeline company until TransCanada purchased it and shortly thereafter sold its chemical operations, which became Nova Chemicals. NOVA is a solid company, yet it has a price-to-earnings ratio of about 5 and a price-to-book ratio of 1.24, low values by any standards. -J.H.H.

Moreover, there were days during the summer of 1999 with enormous price spikes and spark spreads, as also occurred during 1998, when generators captured similar gains from significant spikes in wholesale power prices. Smaller but regular profits were also possible at times throughout 1998 and 1999 because gas prices stayed below $2.50 per million Btu. Thus, in 1998 and 1999, power prices could fall to $30 per megawatt-hour and still bring a gain from using natural gas to generate power. By contrast, the year 2000 saw far fewer gains from gas-fired generation, since gas prices had moved higher.

In fact, on many days this past summer and fall, it would have paid companies with rights to natural gas for power generation to release the natural gas to the wholesale gas markets and purchase the power needed on the wholesale power market. The spark spread in Chicago was only $5.18 per megawatt-hour on average from June through August. Between Sept. 1 and Oct. 15, the average spark spread was a negative $19.26 per megawatt-hour. Compare those figures with the full two-year period 1999-2000, when the daily average power price came in at $39.97, about 80 percent higher than the daily average gas price of $22.22.

As long as natural gas prices remain near or above $5/MMBtu, low spark spreads are expected because of the relatively low cost of generating power from coal and nuclear generation in the Chicago area. At these elevated natural gas prices, it takes a wholesale power price greater than $40 per megawatt-hour to yield a positive value for a spark spread. (That, again, assumes a heat rate of 8 MMBtu to generate a megawatt-hour of power.)

By contrast, the price of power generation from coal and nuclear plants is low and stable under stable weather conditions, but volatile when weather is unstable. These generators need to be ramped up to sell additional power into the wholesale market. Initially, the price of power rises. Then the market is flooded with power. The initial rise in the price of power and the eventual flooding of the market create significant price volatility. This price volatility provides opportunities for companies with operationally flexible natural gas-fueled generation in reserve to use this generation to produce power for highly profitable sales onto wholesale markets. However, there is no guarantee that a company with such a generator will be able to capture these returns regularly; regular returns require trading skill and intimate knowledge of the market.

The larger price volatility and spark spreads in wholesale power markets to the east of Chicago are reasons for extending and connecting pipe in this direction. Yet while spark spreads in these markets were higher this year than in the ComEd/Chicago market, those spark spreads also were low relative to year-earlier values in these markets because of high natural gas prices.

Investors also know that as an increasing amount of natural gas-fueled generation is installed in Illinois, Indiana, and Ohio, price volatility will fall, as will the gains from using these generators as a way to profit on the wholesale power market. In short, Alliance and connecting pipelines heading east will have a role in reducing price volatility. However, this trend for increased natural gas-fueled power generation will be weakened unless the natural gas price declines or the power price increases.

If the price of natural gas does not decline significantly, there will be fewer companies willing to take the risk of investing in natural gas-fueled generation. A steady negative spark spread in the Chicago market most likely will blow many investments out of the water, and reduce the full value that Alliance can deliver.

1 The chemical arm now is a separate company, NOVA Chemicals.

2 An expansion also occurred along the border in late December, bringing additional Canadian gas to the United States.

3 The company with the largest equity interest in Alliance is First Chicago, a limited liability company whose major equity holder (26 percent of the equity) is Gendis, a Manitoba-based company with interest in retail outlets and real estate.

4 The markets to be served by Alliance are near Chicago and to the east of Chicago. Thus Alliance connects with Vector, which also connects to such systems as NiSource (which signed up for 200 MMcf per day of firm service on Vector). Vector ships gas through Indiana and Michigan into Toronto, where it connects to Millennium West. Millennium West, in turn, will connect to the proposed Millennium pipe in New York state, which ships the gas into the New York City metropolitan area.

5 , FTEnergy, Feb. 11, 2000, p. 8.

6 See FERC Docket No. RP-00-241-000, filed Apr. 24, 2000. The California PUC filed a complaint against El Paso Natural Gas co., accusing the gas pipeline of anticompetitive conduct by awarding firm transportation rights in a capacity auction to two of its marketing affiliates, which won out over some 24 bids by other unaffiliated competitors. In August, the PUC asked the FERC to issue a summary ruling on the complaint, without a hearing, on the basis of evidence taken in discovery.

7 For a discussion of estimating conservation or price effects for natural gas use, see John H. Herbert, "Clean Cheap Heat-The Development of Residential Markets for Natural Gas in the United States," Praeger, New York, N.Y., 1992.

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