The authors asked pipelines
and LDCs how they used storage.
Leasing activity proved a surprise.
Since deregulation, the natural gas industry has seen tremendous changes in every sector. Competitive pressures have reorganized business strategies so much that only those firms that adapt will survive. One area that stands ripe for change is the natural gas storage market.
Why build gas storage fields?
For the local distribution company (LDC), gas storage fields grew in part from the obligation to serve. Utilities have taken this obligation seriously: Customers have relied on it, state legislators and regulators have enforced it. In some northern states, storage backs up a pipeline's ability to meet supply demand during extended sub-zero weather. Storage also prepares for a possible freeze-off in the production area, sub-zero weather in the market area, or facility-related outages in general. Certainly, no regulator would want to explain to the General Assembly why an LDC could not meet gas-supply demand on a cold winter day. No reason would suffice.
Since few transportation customers existed prior to 1984, most LDC storage fields were built to serve sales customers. In the "old" days, producers produced; pipelines took title to the gas in the production areas and transported it to the city gate where LDCs took title.
The Current Environment
Times have changed. Today LDCs are searching for ways to expand their business ventures. Nonregulated businesses stand high on the priority list. We found that leasing storage to generate cash currently occupies a low priority, but appears to be growing in importance. LDCs often do provide limited-duration storage and balancing as an integral service to transportation customers.
The current environment is dramatically different for pipelines as well. Prior to FERC Order 436,1 interstate pipelines used storage in production areas to ensure supply deliverability in case of weather-related interruptions in the production areas. Before the advent of open transportation, pipelines served only sales customers (em that is, LDCs. A pipeline's obligation to serve differs substantially from an LDC's. Pipelines do not have to provide service to all who request service (em however, a transportation contract imposes an obligation to serve. To meet this obligation, pipelines built storage fields in both production and market areas.2
But in Order 436, the Federal Energy Regulatory Commission (FERC) turned the comfortable world of the pipeline industry upside down. Pipelines have lived through open access, take-or-pay, transition costs, and capacity release. Today competitive pressures force pipelines to be more efficient and aggressive marketers. Storage fields can help ensure reliability, balance gas with gas demands, and increase revenues through leasing. LDCs are learning that they can reduce transportation costs by contracting for interruptible, rather than firm service, and use market storage to backstop deliveries on days when interruptible service is curtailed.
LDC efforts to reduce costs to sales customers by purchasing lower-priced natural gas and storing it for use when prices are higher also impacts gas operations, since interruptible service is less reliable. If enough transporters chose interruptible over firm service, revenue risk should rise.
This article takes a look at the current state of affairs in the gas storage market. Why do LDCs and pipelines own storage and what do they use it for? New storage fields, especially market area storage, are being considered. If constructed, customers will benefit. But when will a saturation point be reached? Economists will answer "The market will decide." Hopefully, however, the decision will be made before we create stranded investment in natural gas.
Survey Results: A Few Surprises
We developed a questionnaire to analyze the characteristics of the natural gas storage market. The questionnaire was distributed to companies identified in the October 1994 and January 1995 issue of Gas Daily's Gas Storage Report as having working gas in storage.3 A total of 47 companies were identified, and 32 responded (em a response rate of 68 percent. Of the 32 that responded, 15 were pipelines, 16 were LDCs, and one was a storage company that was eliminated from the survey. The data were tabulated according to responses by totals, pipelines, and LDCs.
Type of gas storage facilities owned? As Table 1 indicates, depleted gas fields tend to be the storage facility of choice, followed by aquifers, depleted oil, salt caverns, and liquefied natural gas (LNG). Differences in type of gas storage facilities owned between pipelines and LDCs do not appear significant. LDCs own depleted oil, salt caverns, and LNG to the same degree, while pipelines possess an equal amount of salt caverns, and LNG facilities. One interesting finding is the higher-than-expected ownership of LNGs. However, although 16 percent of the pipelines and LDCs in the sample indicated that they own LNG, we do not know the capacity.
(Given the multiple responses by respondents, the percentages do not add up to 100 percent. While information was not collected on the capacity of working gas in the facilities, one would expect a positive correlation between such a number and the data listed in Table 1.)
Reasons for owning gas storage facilities? The possible responses were: hedging (em purchasing and injecting gas when prices are lower, and withdrawing that gas when prices are higher; surrogate for reserves (em avoidance of curtailment and reduced reliability of gas service at peak periods; balancing gas supply (em better use of pipeline transportation facilities; deferring or cancelling new
transportation and distribution facilities; leasing storage to third parties; improved operating efficiency. Responses were prioritized by degree, with 1 representing "Most Important" (see Table 2).
We designed this question to investigate how gas storage is currently used, not why it was originally built. In fact, the decision to build may reflect different factors that no longer affect actual use (em regulatory change, for example. In addition, some of the responses are not mutually exclusive: Balancing gas supply and improving operational efficiency are similar functions, and were ranked second and third, respectively, for both LDCs and pipelines.
Pipelines cited the following reasons for owning storage facilities, in order of importance: leasing, balancing gas supply, improving operating efficiency, deferring new facilities, surrogate for reserves, and hedging. LDCs cited the following reasons, in order of importance: surrogate for reserves, balancing gas supply, improving operating efficiency, hedging, deferring new facilities, and leasing.
Pipelines and LDCs differed the most on leasing (em which shouldn't prove surprising, given the difference in their sales obligations. Leasing was the most important reason for pipeline ownership of gas storage facilities; the least important reason for LDCs. Thus, the evolution of the gas storage market and the increasing importance of leasing is driven primarily by the pipelines. However, since LDCs are providing and offering storage services, leasing is not necssarily an unimportant strategy for them.
Another significant difference between pipelines and LDCs is evident in their ranking of gas storage as a surrogate for reserves: That reason showed up as Most Important for LDCs, but second-to-least important for pipelines. While both sectors have an obligation to serve, most pipeline storage fields are located near production, giving them less need to use storage as a surrogate for reserves.
Hedging ranked last in importance for pipelines, and tied for third place for LDCs. Pipelines are not using gas storage as a hedging tool with much frequency; LDCs are somewhat more active in this area.
Does your company lease storage to third parties? What percent? Overall, 80.6 percent of respondents indicated that their company leases storage to third parties. While the pipelines' high response rate of 93.3 percent comes as no surprise, the LDCs' response rate of 68.8 percent is somewhat unexpected, given LDC responses on leasing in Table 2. However, Table 3 indicates that while a majority of LDCs responded that they leased storage, only one-fifth (20.6 percent) of facilities are actually used for that purpose.
Nevertheless, the data indicate that LDC leasing is nontrivial. One possible explanation: As distribution becomes more competitive, customers are demanding access to storage services from their LDCs. This answer suggests that to the extent that bundled retail sales fall in importance, LDCs will play an ever-larger role in developing gas storage markets, as bundled retail sales disappear.
How do you design rates for end users who lease gas storage? We posed this question to gauge the extent of competitive pressure, if any, in the gas storage market. The degree to which cost-of-service studies (COSS) dominate in determining rates charged to third parties would indicate lack of significant competitive pressure.
The data in Table 4 present mixed results. (Also, the rows do not sum to 100 percent because of multiple responses.) For pipelines, rate determination comes primarily from traditional rate-base regulation, through COSS. Of course, the FERC regulates storage service rates and requires a demonstration of lack of market power for price deregulation. Some of the pipeline respondents did indicate, however, that the FERC rate is used as a cap, while market pressures determine the final price. This fact is shown in Table 4, where 17 and 8 percent of pipelines responded that they employ negotiations and auctions, respectively, to determine final rates.
Interestingly, LDCs claim more experience with market rates, negotiations, and auctions. Seventy percent of LDCs say they use COSS to determine final rates; 40 percent use market rates; 30 percent, negotiations; and 40 percent, auctions.
This data should be interpreted with care. Companies may vary in how they define concepts. A slight change in LDC response greatly affects the magnitude of the
estimates. Also, the amount of capacity involved is unknown. Nevertheless, the data do show that LDCs are involved in leasing. In addition, market rates, negotiations, and auctions are not mutually exclusive, but, in fact, similar. Taking this into account, LDCs still reported higher responses for each category than did pipelines, indicating greater experience.
Is storage provided as a bundled or unbundled service? As storage becomes more competitive, one would expect to find unbundled storage services ever more available.
According to Table 5, 100 percent of pipelines and 80 percent of LDCs offer an unbundled storage service. While they do not tell us what percent of all storage service is involved, these figures reveal the possible beginnings of a competitive storage market. FERC Order 636 explains the 100-percent response of the pipelines, but the high response from LDCs indicates that they, too, are unbundling storage services. Customer demand for access to these services is probably the driver for new and innovative arrangements of services, including unbundled rates.
The LDC response of 60 percent for bundled service refers to transport customers and not necessarily retail sales services (em otherwise, we would expect a 100-percent response.
Unbundling is a natural phenomenon in the transformation from monopoly to competive markets. Thus, competitive pressures may help explain, in part, the increase in unbundling. However, regulatory changes may also play a role. In fact, history has shown that unbundling must sometimes be mandated, which then leads to more competition.
On the Horizon
Care must be taken in drawing broad conclusions regarding the development of the natural gas storage market. Pipelines and LDCs differ substantially; no single LDC or pipeline is like the next. Nevertheless, the survey data do provide a snapshot of the current state of affairs and offer some insights into where the market is heading.
Clearly, LDCs and pipelines use the gas storage market for different purposes. LDCs use gas storage primarily as a surrogate for reserves (em no surprise, given their obligation to serve. However, the data also indicate that leasing storage may play an increasingly important role for LDCs, one in which they are currently gaining valuable experience. LDCs will require time to develop the expertise and efficiency they needed to succeed.
For their part, pipelines employ gas storage primarily for leasing. Although currently restricted to pricing leasing at cost of service, pipelines may enjoy greater flexibility as the market becomes more competitive and the FERC permits more market-based rates. Leasing should continue to play a dominant role, and pipelines will begin to see more competition as time develops.
While it is always difficult, if not impossible, to predict the course of events, gas storage seems likely to continue to gain in importance on both the demand and the supply side. LDCs will see storage as an opportunity to supply a profitable service; customers will see additional choice in their overall consumption. Both will benefit. t
Ruth Kretschmer has served on the Illinois Commerce Commission (ICC) since 1983. Commissioner Kretschmer serves as chair of the ICC's Gas Policy Committee, and is a member of the Electric and Transportation Committees. She is also chair of NARUC's Committee on Gas. Agustin Ros is an advisor to the ICC's chairman. Dr. Ros received his BA in economics from Rutgers University, and his MS and PhD in economics from the University of Illinois at Urbana-Champaign.
A New Lease on Storage
Northern Illinois Gas Co. leads the crowd as the first Illinois LDC to lease storage space to end users. The LDC's Standard Rider 26 provides for auctioned bidding of seasonal storage capacity. Auction revenues are split 50/50 between shareholders and the company's jurisdictional revenues.
From the Rider:
"Rider applicable to any Customer transporting Customer-owned gas under the Company's Rate Schedules...to store Customer-owned gas in the Company's storage facilities.
Contract specifies (1) the Seasonal Storage Capacity (not to exceed 120 times the Customer's Maximum Daily Contract Quantity) the Customer requests, and (2) the Capacity charge the Customer bids for the capacity in cents per therm per month.
Allocation of Seasonal Storage Capacity will be determined by bid, with the highest bid being accepted first and so forth until all eligible requests for Seasonal Storage Service are accepted or until available capacity is exceeded.
* * *
Seasonal Storage Capacity Charge: The Amount per therm for each therm of Seasonal Storage Capacity determined and awarded by Auction Bidding, with minimum being .08 cents per month."
From the First Auction:
Total Capacity Awarded
Total Monthly Capacity Cost
Average Cost per Capacity
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