A debate on the FERC proposal to put short-term capacity up for bid.
Last summer the Federal Energy Regulatory Commission truly outdid itself. In a move that left the gas industry speechless, the FERC proposed that it would remove all price controls or cost-based regulation for capacity rights shorter than one year's duration, and instead would resort to auctions for the purchase and sale of such "short-term" rights to transport natural gas on interstate pipelines.
The reason? The FERC said it wanted to level the field between short- and long-term contracts. The industry was showing less and less interest in longer-term deals, said the FERC. In fact, the Commission believed that shippers had found a way to have it all. Essentially, shippers could avoid the risk inherent in long-term deals and yet lock in some of the benefits by using rights of first refusal to renew their rights under short-term deals. The FERC called it an "asymmetry of risk."
Better Than Phone and Fax?
For pipeline rights of one day's duration, the FERC proposed a mandatory daily auction for all such "available" capacity. Pipelines would have little choice; they could not set a reserve price (a price below which they would not agree to sell). However, pipelines would not be required to sell capacity rights for a price below the minimum rate (variable cost) stated in their tariffs. For auction of rights of longer than one day, pipelines would be permitted to set a reserve price.
Moreover, the daily auction would apply to all available pipeline storage capacity, plus released capacity by shippers (who would be permitted to set reserve prices).
As the FERC explained in its 190-page proposal, "[a] well-structured auction can assure that pipeline capacity is allocated to the party placing the greatest value on the capacity and can assure fairness in the allocation process by preventing price discrimination or favoritism." As the FERC added, "[a]n electronic auction, designed properly, can be efficient and can operate faster than the current process of sending facsimiles and using telephones to arrange deals." Regulation of Short-term Natural Gas Transp. Servs. (Notice of Proposed Rulemaking), RM98-10-000, July 29, 1998, 84 FERC ΒΆ61,985.
A Proper Design?
How to create "properly designed" auctions?
The FERC soon discovered that it had walked into a hornet's nest. Pipelines, shippers and distributors pleaded that they needed more time to consider the idea. Bowing to industry requests, the Commission soon extended its deadline for comments until Jan. 22, 1999, then went on the offensive.
On Oct. 20, the staff of the FERC's Office of Economic Policy convened a technical conference to discuss how auctions might work. It released a series of staff papers, discussing the merits of first- and second-price auctions, market-clearing auctions, iterative auctions, reverse auctions, ad hoc and sequential auctions, English and Dutch auctions, and single- and double-sided auctions.
But that wasn't enough. The October conference did little to assuage industry skepticism. The industry was puzzled over many things. What happens if a shipper holds gas to move but loses his bid for pipeline capacity? What if the shipper wins the capacity auction but can't come up with the "molecules?" And then, what good does it do to win a bid on an upstream segment if another shipper comes away with the downstream rights? Should pieces of capacity be sold sequentially? What about auctioning off receipt and delivery points, as well? Then there's another whole set of problems concerning the sharing of information.
Meanwhile, in early November, the FERC announced a second conference, to be held on Dec. 8, with all issues open for discussion:
How do auctions affect pipeline cost recovery?
Can auctions accommodate pre-arranged deals for capacity release?
How do auctions affect transaction costs?
How would auctions coordinate with risk management through spot and futures commodity markets?
How would the amount of capacity "available" and open to auction be determined?
With these and other questions hanging in the air, we asked two industry experts - each was present at the October conference - to offer some thoughts.
- B.W.R.
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