Make gas pipeline rights more fungible, but draw the line at contingent bidding.
Last July the Federal Energy Regulatory Commission proposed mandatory auctions to allocate all capacity rights shorter than one year's duration on interstate natural gas pipelines. (See RM98-10-000, Regulation of Short-term Natural Gas Transportation Services, FERC, July 29, 1998.) At a technical conference held Oct. 20, staff members of the commission's Office of Pipeline Regulation and its Office of Economic Policy suggested at least two auctions-a daily auction to clear one-day rights and a second process for rights longer than one day but shorter than 12 months.
In theory, a capacity auction process can create a fully functioning market in pipeline capacity. Other processes may work as well.
In any case, before auctions can make capacity trading more efficient, at least a handful of problems stand in the way:
1. Should there be pre-arranged deals, and if so, what's
2. Should shippers bid separately on point and
3. How do shippers compare firm transportation prices when products are so different, and some rights might be contingent?
4. For daily rights, how much flexibility do pipelines and shippers enjoy to change offers and bids on auction day or the day before?
5. Must traders learn different rules for each auction?
Problem 1: Should there be Prearranged Deals?
Answer: Pre-arranged deals should remain available, even with auctions of firm transportation rights.
Until 3 p.m. two days before flow (the day before timely nominations are due), any party (including pipelines) should be able to make a pre-arranged deal to sell all or a portion of its capacity rights to any other party for any duration up to one year. The price should be open to negotiation, without any mandatory cap or floor. However, the price for any pre-arranged transactions of greater than a year (or a series of transactions with the resulting effective capacity rights being equal to or greater than a year) would be capped at the then-effective maximum annualized rate.
In addition, after 5 p.m. two days before day of flow and until 3 p.m. the day of flow, anyone, including the pipeline, should be permitted to make a pre-arranged deal to sell all or a portion of its capacity rights at any price to any other party for the day of flow. These transactions are intended for the duration of one day or a part of a day.
By contrast, when a pre-arranged deal for capacity is executed after the timely nominations deadline for the subject gas day, the capacity must be "un-nominated" by the releasing shipper. There are, of course, complications associated with determining what capacity has been un-nominated. Equally, the benefits of partial-day releases may not outweigh these complications. However, to the extent a pipeline can sell firm transportation (FT) capacity on the day of flow, releasers should be able to compete.
Parties may establish their own capacity exchanges to compete with the pipeline's auction process. The pipeline may subcontract the administration of the auction process. Transaction results of the independent or subcontracted exchanges should be communicated to the pipeline and listed as pre-arranged deals.
Problem 2: Separate Bids on Which Rights?
Answer: To increase fungibility of capacity rights, accept separate bids for individual point and zone FT rights.
Primary receipt, delivery and path capacity rights by zone or operational area of pipeline should be sold separately and offered independently during the auction process. Buyers would be able to purchase what they need, place the rights into a master contract, and use them interchangeably within the boundaries of that contract. This idea also makes the auction process easier to participate in and administer. The ease would come from pipelines not having to predetermine which receipt rights should be offered with which delivery rights and which of either/both should be offered with which path rights-not to mention the quantity denominations that might be appropriate with respect to any of the above. Likewise, unless their constituent parts were offered separately and alongside the pipeline's offering of the same constituent parts, releasers offering capacity would not be able to have it considered interchangeably with that of the pipeline.
A significant feature of such a structure is that the ability to effectuate deliveries off of any FT contract could remain with the local distribution company. Concerns as to loss-of-pressure rights, flow rates and the like would be eliminated, as the LDC could retain these point rights. These rights exist only on the transportation agreements. Providing for their "separate release and sale" overcomes the problem of such rights becoming alienated, as they often are today, through the current release process.
Problem 3: Comparing Prices
Answer: Hold two FT auctions-Monthly and Two Days Out-as a check against market power.
There should be two firm capacity auctions: a monthly capacity auction and a two-day-out capacity auction.
In the monthly capacity auction, all unsubscribed capacity available in the same quantity for each day during the next month would be made available. A seller of capacity (the pipeline or releaser) could, but would not be required to, auction off more than the next month's capacity.
In the two-day-out auction, no less than two days before the date of flow, all pipeline unsubscribed receipt, delivery and path capacity must be made available for auction. Sellers (the pipeline and releasers) would be permitted to offer capacity for any individual days before the next monthly capacity auction (and the pipeline should be required to support such releaser choice). Any seller of capacity could, but would not be required to, offer to auction off more than the "at least two-day-out" capacity.
In the monthly capacity auction, bidding would occur between 1 p.m. and 2 p.m. CST on the day that the New York Mercantile Exchange closes the prompt month's gas futures (i.e., ends trading of the next calendar month's futures contracts).
Allow no contingent bidding. But allow owners to set reserve prices for each capacity right (i.e., receipt, delivery or path). Reserve prices would not be considered "bids," as that would not yield the intended results outlined below. Releasers could break up their capacity into its constituent primary receipt, delivery and path rights (offering only components for sale while retaining the rest) to be put up for auction along with the identical components of the pipeline's unsubscribed capacity. All capacity is considered to be in separate "pots" of identical capacity. All capacity in each auction pot is auctioned and proceeds split pro rata based upon quantity placed in the pot and reserve prices set, met and exceeded. Capacity for which there is no bid exceeding the lowest reserve price is returned to the party and may be sold through pre-arranged deals.
In the monthly capacity auction, a seller of capacity (the pipeline or releaser) could, but would not be required to, auction off more than the next month's capacity. The pipeline would be required to offer the next month's quantities, and releasers may include theirs as well.
There are recognized means of handling pro rata revenue sharing, accounting for reserve prices. Thus, once the Commission has set the basic parameters of the auction, it should provide a six-month period for the industry to set uniform operating rules for the auction (probably through the Gas Industry Standards Board). Auction parameters should include: 1) what is to be auctioned, 2) when it is to be auctioned, 3) who may provide capacity to be auctioned, 4) who must provide capacity to be auctioned, and 5) policies governing reserve prices.
Problem 4: Flexibility on Eve of Auction
Answer: Allow only IT Rights for "day-before" and "day-of" auctions, to avoid double-booking and dilution of FT rights.
On nomination day, a shipper interested in unsold capacity should use its IT (interruptible) service agreement and submit a bid rate as part of its IT nomination. Submitting an IT nomination without a bid rate would be the same as submitting a nomination with a default bid. The default bid would be the 100-percent load factor rate of the long-term FT rate for the same haul.
A pipeline could set a reserve price for IT transactions where the pipeline has unsubscribed capacity for a zone of haul. An example would be where a pipeline has three zones in a path. The first zone has some unsubscribed capacity, but the second two zones have no unsubscribed capacity. The pipeline could set a reserve price for hauls using any part of the zone with unsubscribed capacity, but may not set a reserve price in fully subscribed zones. In addition, the pipeline should be permitted to maximize revenue (i.e., accept lower rate, shorter hauls that in aggregate generate greater revenue than higher rate, longer hauls).
This auction mechanism would suffice as the day-before/day-of auction process, and would pertain to any unconfirmed firm capacity (by definition, un-nominated capacity is unconfirmed capacity). The rate submitted by a shipper at the 11:30 cycle would be deemed that shipper's minimum bid for all pertinent cycles. Thus, parties would be able to bid a higher price in a subsequent cycle to get capacity.
A party would not have to submit another nomination just to retain space; however, if they were out-bid later they would face interruption. An IT shipper would have the right to reduce the quantity of a nomination but would pay transportation charges based on what was scheduled. In addition, all existing rights of parties with FT would continue.
Thus, excluding the 5 p.m. cycle, any lower priority or lower priced IT could be "bumped" by higher priority (i.e., FT) or a higher priced IT bid. There should be no sale by pipeline of un-nominated FT as anything other than IT.
Problem 5: Learning the Rules
Answer: Make rules uniform for all auctions.
The rules for all auctions should be uniform with respect to posting capacity offered for sale, accepting and processing bids and awarding winning bids. In addition, they should be uniform with respect to setting bidding rules, times for market openings and closings, minimum increments of pricing, minimum bid quantities and numbers of bids per item of capacity by a bidder. That goes double for contingent bidding-don't allow it in any auctions.
In addition, all rights for auction should be offered on a stand-alone basis (i.e., no tying of receipt to delivery or of either to path rights). Likewise, all bids should be made on a stand-alone basis (i.e., each right is to be bid upon separately and separately awarded to the highest bids). Uniform auction rules make it possible for companies to play on the national stage.
Gregory M. Lander is president of TransCapacity, based in West Peabody, Mass., a developer and provider of transaction and information computer systems and software for the natural gas industry. See the TransCapacity website, at www.transcapacity.com, for more proposed rules and procedures for implementing gas pipeline capacity auctions.
Setting the Stage
Auctions can't work without standardization-in path rights, point rights, segmentation, scheduling and confirmations.
Auctions can not make capacity trading more efficient without first satisfying 10 conditions to standardize the market.
1. Points and Paths. First, eliminate restrictions on the use of receipt and delivery points and clarify use of secondary points on primary paths.
Shippers should be able to use every point on every contract as a receipt point or as a delivery point. On firm contracts, if the point right is a primary receipt right, then the delivery rights at the point would be secondary only. Likewise, if the point right is a primary delivery right, then the receipt rights at the point would be secondary.
Similarly, a path should be purchased directionally on a primary basis, but could be used to nominate a back-haul (contra-flow) transaction on a secondary basis. This design makes capacity more fungible because more rights are available to more parties to contest markets at locations that may not have unsubscribed forward-haul path capacity. In addition, secondary, within-path point rights should be continued. However, use of secondary receipt or delivery points along a primary path should not cause the path capacity to have a lower (i.e., secondary) priority.
2. Segmentation. Self-releasing should be used to segment existing capacity. Excluding those presently in place, limits should not be permitted that might reduce the capability to segment capacity rights. Segmentation should be allowed at least by zone. Preferably, segmentation should be carried out to the level of individual links between locations covered by operational balancing agreements.
In practice, a segmentation down to the level of OBA location segmentation would permit division of rights from interconnect to interconnect and the establishment of segments between market center locations. However, it would be appropriate for network pipelines with postage-stamp rates to bar segmentation, as there is nothing to segment.
3. Back-Hauls. Back-hauls on FT contracts from primary delivery points to primary receipt points should be priced at the pipeline's minimum usage rate. That allows markets with no available primary forward-haul capacity to be contested on a back-haul basis. Back-hauls involving secondary points should be priced at the usage component of the FT rate. There should be no compressor fuel on back-hauls. Shippers should be able to release their back-haul rights without having to forfeit their forward-haul rights. Permitting in-stream transfers between contracts allows different parties with contiguous rights the benefit of their individual rights.
4. Capacity Expansion. The construction of taps for third parties helps preclude situations in which a pipeline might refuse to expand capacity in order to extract scarcity rent. Pipelines should permit third parties with FERC certificates to construct receipt and delivery taps upon request, provided they agree to reimburse the pipeline for the costs of construction and incremental operation. A receipt tap coupled with an upstream delivery tap and connected by a third party's pipeline can constitute a third-party constructed "loop," providing increased capacity.
5. Confirmation of Transactions. First, interconnected parties should confirm with each other the matches of their respective nominated transactions. Once the universe of confirmed transactions is identified, the pipelines should allocate their available point capacity to these confirmed transactions. If that process reduces or eliminates certain confirmed quantities, the pipeline with the reduction should seek to re-confirm with the other. The resulting "re-confirmed" quantities using the current "lesser-of rule" would then become the scheduled quantities. The process encourages parties to coordinate their transactions.
6. Streamline Confirmation of Capacity. Priorities in capacity allocation must accommodate interconnections between system operators. Divide these interconnect transactions into four categories, by order of priority: primary to primary, mixed firm, mixed interruptible and IT to IT.
In primary-to-primary transactions, the parties on each side of the interconnect nominate primary delivery and receipt point rights, respectively. Mixed firm transactions occur where both parties have some sort of firm point capacity but at least one of the parties has nominated secondary point capacity at the location. Mixed IT transactions are where one of the parties has nominated IT capacity at the location regardless of what kind of firm the other party has on its side of the interconnect. IT-to-IT transactions are where both parties have nominated IT capacity rights at the location.
Prioritization according to these categories would encourage parties to join firm with firm, in order to obtain the highest flow priority. It also would make firm rights more valuable, and thus provide an underpinning for the whole FT market.
In addition, once points are resolved, capacity allocations along paths wholly within one system should follow these categories, in order of priority: primary (within path or on the mainline), then secondary (outside the path), then interruptible. The "secondary" category would not apply for network pipelines with postage-stamp rates. Once transactions are confirmed and the universe of confirmed transactions at points is established, the mainline is scheduled according to the path distinctions above (i.e., categorized as primary, secondary and IT).
7. Daily Reconciliation. Even where monthly measurement continues, the after-the-flow gas allocation process (distinct from the before-the-flow capacity allocation process) should be daily-or even hourly, if possible. Monthly allocations in a daily market make no sense and decrease transaction certainty due to ex post facto adjustments and re-allocation. Nothing should inhibit finer granularity in the allocation process.
8. Post It. Post all available capacity and all capacity transactions according to format rules set by the GISB. This posting should include the index of customers, pre-arranged deals (short-term FT), recalls, reputs and scheduled IT bids. As for timing, all transactions, including IT, should be posted by the close of business on the day of the award.
As for how much capacity is "available," post two types: First, "real-time operationally available capacity"; second, "real-time unsubscribed available capacity."
The first category represents the amount of capacity that remains available to be nominated at the location (and along the path or through the zone) following the last scheduling cycle-not a "prediction." The second denotes the capacity existing through the location or zone for purchase from the pipeline under a pre-arranged deal or through the proposed auctions. All such real-time available capacities should identify locations, paths and time intervals.
9. Master Contracts. Each shipper should be afforded the opportunity to have one or more "master" contracts for firm and interruptible service. A master contract would be able to accept new purchased capacity; capacity would be removed from it once released, for the duration of the release.
For FT, the individual component rights could be added to the contract as they are auctioned. For IT, all points and paths are considered part of these contracts. At any given time, a winning bid for a transaction would add the rate and locations/paths for the specified service to the contract for the duration of the scheduled transaction.
10. Imbalance Penalties. Have the FERC set uniform national standards for penalties and treatment of penalty revenues, and encourage state regulators to follow suit. Pipelines could charge less to all shippers uniformly, but could not charge more. Penalty tolerances should also be uniform across pipelines (i.e., 0 to 5 percent, 5 to 10 percent, 10 to 20 percent, and 20 percent) to eliminate cross-system arbitrage and dumping/drafting to avoid market behavior driven by disproportionate penalties or penalty thresholds.
Finally, the party levying the penalty should not retain penalty revenues. Penalty revenue should be rebated within two months of collection to non-offending parties in proportion to their scheduled quantities at the time and in the zone or operational area subject to the penalty.
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