The FERC's latest idea throws pipelines for a loop, with implications for power markets, too.

Transmission and distribution (em the business they call "pipes and wires" (em can't last much longer with rates set by cost of service. Contrary to the myth, these services deserve no special status due to their high embedded costs. They carry no intrinsic value apart from the electrons and molecules they deliver.

Imagine Exxon ferrying crude from Japan, where it is valuable, to the Persian Gulf, where it is not, and then asking to "recover our investment." Intuitively, we see that oil tankers earn their keep only on the per-barrel price spread between the drilling platform and the consumer. Why can't utilities figure that out? Commoditization is coming to pipes and wires, with prices set in the trading pit, just as surely as for electric generation and wellhead gas.

That much rang clear from the technical workshop on natural gas pipeline capacity auctions, held on Oct. 20 in Washington, D.C., at the Federal Energy Regulatory Commission. However, the lawyers, traders, and association CEOs in attendance may have been slow in getting the message.

The meeting was widely anticipated. A few weeks earlier, at the DOE/NARUC Natural Gas Forum Pittsburgh, I had spent time with several reps from the American Gas Association. They talked of virtually nothing else, but of how the FERC's proposal to introduce a mandatory auction to allocate short-term transportation rights on interstate natural gas pipelines, issued in July, had thrown the gas industry for a loop. When asked at the Pittsburgh meeting how the FERC could force auctions on the pipelines, chairman James Hoecker replied, "Bring your question to the conference."

Two weeks later they came in droves, loaded for bear, but found no target to shoot at. Hoecker and the commission were nowhere to be seen. Instead it was FERC staffer Kevin Madden, director of the Office of Pipeline Regulation, who led the meeting. He entertained only those questions addressed to technical and operational points (em not the underlying policy.

So hunting season was called off. But FERC Commissioner Curt Hébert, known to climb over the mountain from time to time (and to question FERC authority) , was seated in the audience, to see what he could see.

ON THE SURFACE, THis Latest move RESEMBLES any other natural gas rulemaking proposal. In its notice of nearly 200 pages, the FERC talks of market power, firm and interruptible service, capacity release, nominations (day-ahead and intra-day) Order 636, the "gray market" and prearranged deals, the price cap in the secondary market, GISB standards, primary and secondary receipt and delivery points, and negotiated terms and conditions. All of these issues should sound familiar. Citing the right of first refusal enjoyed by shippers holding rights to firm pipeline capacity, and how they can retain those rights by matching competing offers, the FERC admits that its policies may have skewed the balance of risks, favoring short-term contracts over longer firm rights. To redress the balance, the FERC would consider ending or restricting the right of first refusal. It would put released capacity on an even keel with pipeline firm by making intra-day noms possible and preserving primary receipt and delivery rights for releasing shippers. It would end cost-based tariff regulation for pipeline transportation rights for terms of one year or shorter, instead forcing all such short-term capacity to trade through auctions. (See, FERC Docket No. RM98-10-000, July 29, 1998.)

A raft of issues emerged at the conference. Many fell under the heading of "chicken or the egg." Must a bidder commit in a market-wide pipeline auction without first knowing if he can line up all the other elements required for a deal? Kathy Patton and Ed Ross of Dynegy described their current practice, implying that traders still appear more comfortable with one-on-one, phone-and-fax trading. "Normally," said Ross, "if we're long on the molecules, we rely on interruptible transportation. So if we are scheduled on IT and then we don't flow, we don't generally have to pay. The market will take up the capacity."

Other questions involved the ins and outs of the gas day and other sorts of technical, operational concerns:

• Price. Do winners pay what they bid or match a single, market-clearing price?

• Fungibility. How to throw capacity rights into one pot when they differ in kind (recall conditions, firm vs. IT, different receipt/delivery points, etc.)?

• Sequence. Auction all rights at once, even though a bidder might win midstream rights but lose on bids for upstream and downstream zones?

• Storage. Auction that too?

• Privacy. What information to reveal in bids?

• Gaming. How to force pipelines to put all "available" capacity up for bid?

• Timing. Integrate auction schedule with NYMEX futures positions?

One obvious stumbling block is how to coordinate capacity auctions with retail unbundling programs imposed by state regulators, which may reassign short-term pipeline capacity from the utilities leaving the merchant business to the marketers picking up their retail customers. Richard O'Neill, Director of the FERC's Office of Economic Policy, noted the problem:

"You have to recognize that some state unbundling plans will be inconsistent with each other. Some state plans stipulate the price at which LDC-owned capacity is transferred to marketers. That may be inconsistent with auction rules."

WHAT I FOUND MOST INTERESTING was how the gas pipeline auction proposal dovetails so neatly with the FERC's electric industry experience with independent system operators and power exchanges. Nothing happens in a vacuum. The knowledge the commission has gained from the PJM, Midwest ISO, and other cases (em about spot markets, coordinated dispatch, congestion contracts, pancaking, and locational marginal pricing (em it now seeks to impart to a gas industry more accustomed to distance-based pricing.

The FERC's electric experience became particularly obvious when staffers presented a "four-node" example with multiple pipeline paths, showing how in this particular case, an gas pipeline auction would produce a market-clearing price for transportation between a pair of receipt and delivery points that was much lower than that offered by one of the bidders. The example recalled the technical conference I attended a while back on transmission pricing in PJM (em and the notion that transmission can sometimes sell virtually for free in a condition of zero constraint under these newfangled ISO pricing schemes. Yet, at the gas conference, some of the pipeline reps in the audience asked why such mysterious auction mechanics should force them to take a lower price for their "bottleneck assets" than they might otherwise get through a straight-up bilateral deal.

It was not so long ago that the FERC floated but then abandoned a proposal (the CRT plan, or "Capacity Reservation Tariffs") to price electric transmission capacity on a commercial basis. Is the commission now using the gas pipeline industry as a "stalking horse" for electricity, to resurrect CRT, as economist Robert Blohm suggested to me a few days after the conference?

Comments are due January 22, 1999. You can expect to hear a lot more on this.

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