Burnertip and Beyond

Fortnightly Magazine - September 15 1995

Erroll B. Davis, Jr.

President & CEO

Wisconsin Power & Light Co.

WP&L advocates that the following steps be taken to create a level playing field for merchants entering the retail market:

s Distribution rates should be fully unbundled from retail sales tariff rates. WP&L took this step years ago.

s Gas procurement, salaries, overhead, and gas storage working capital should be removed from distribution rates.

s Meter charges for transporters should be lowered to the true incremental cost to the LDC of providing transportation service versus "core" service, if any.

s LDCs should provide variable levels of firm backup to customers willing to pay for this service, anywhere from zero to 100 percent of full requirements.

Burnertip access will favor those entities most able to meet customer needs, regardless of where they currently operate in the gas business. LDCs that want to assume a retail merchant role, but are unwilling or unable to do so for risk and profit will be at a

severe disadvantage. Serious issues, such as whether utilities will be forced to provide gas as supplier of last resort, must be resolved for LDCs.

James A. Carrigg

Chairman, President, & CEO

New York State Electric & Gas Corp.

The retail gas distribution market is the most competitive aspect of the gas business. There is currently open access on most distribution systems. Several LDCs individually have more transportation customers than the entire pipeline industry. There is more customer choice beyond the city gate than anywhere else in the gas delivery chain. In addition to open access, gas LDCs compete against pipelines, local production, and alternative fuels.

Patrick J. Maher

Chairman & CEO

Washington Gas Light Co.

Distribution markets have been opening up for 10 years. Most LDCs have been transporting gas for end users and putting together negotiated, tailor-made deals for many customers. The wellhead market is clearly competitive, but the secondary market for interstate pipeline capacity is not there yet. The FERC needs to address that issue and needs to rethink rate design too.

At the retail level, other marketers seek assignment of interstate pipeline capacity from LDCs in order to offer full city-gate service. To make this happen, we need to find rules that work fairly for all concerned and ensure reliable service for even the smallest customer. It will also be vital to find ways to achieve other social objectives traditionally provided through utility service.

Beverly A. Wharton

President, Gas Division

MidAmerican Energy Co.

For the most part, there is effective open access and competition for large- and medium-sized gas customers across the United States. These services largely

involve interruptible customers who have alternative energy- consuming capability, like fuel oil. Competition in residential and smaller commercial firm retail markets will occur when reliability, pricing, and the obligation to serve are replicated by several qualified, creditworthy gas suppliers.

Fair burnertip access will not necessarily favor pipelines, distributors, marketers, or brokers. It will favor suppliers that provide the best combination of price, reliability, flexibility, and service. The only significant risks are the obligation to serve (supplier of last resort), which is mandated to remain with the gas utility without appropriate compensation, and the threat of physical bypass of the utility. Otherwise, the various entities can be effective partners with the gas distribution utilities in growing the natural gas pie for everyone.

Bernard J. Kennedy

Chairman, President, & CEO

National Fuel Gas Co.

Our industrial and commercial customers have had easy access to alternative gas supplies for several years now. In our Pennsylvania service area, residential customers have the ability to purchase gas supplies on the open market, although the demand has not yet materialized. In New York, the expansion of service unbundling to residential customers is being actively considered. Before long, we expect that any customer on our system will have the ability, if not the incentive, to buy gas from the supplier of his or her choice.

Ironically, the rate design policy mandated by the FERC in connection with pipeline unbundling under Order 636 hampers full retail unbundling. The sheer size of LDC demand-charge responsibility under straight-fixed-variable rates may frustrate initiatives to provide LDC customers with unlimited gas supply choices.

A total unbundling of gas utility services has the potential to benefit all segments of the industry, and more importantly, its customers, if it is taken on as a single, beginning-to-end, coordinated initiative. From our standpoint, the greatest risk is that utility service unbundling will proceed to a halfway point and then stall or stop completely. We are concerned about the further expansion of retail transportation if the utility is to remain the supplier of last resort. It would become increasingly expensive for us to provide a backup supply service for the benefit of a core market that can buy alternative supplies when they are available and attractively priced, and call on the utility when they are not. It will also perpetuate the current reluctance on the part of many utilities to make long-term commitments for gas supplies and upstream transportation and storage services.

The marketing companies stand to benefit most from a piecemeal approach to utility unbundling, because they will be able to capitalize on short-term opportunities without having to worry about long-term service obligations. If unbundling is undertaken comprehensively, and state regulatory agencies offer a balanced risk/ reward profile to the utilities, no single segment of the industry should be unfairly advantaged or disadvantaged. Thenceforth, the market will reward the companies that best meet the diverse needs of gas customers, and our customers will enjoy the benefits of this competition.

James Schretter

Senior Vice President

C.C. Pace Resources, Inc.

True burnertip competition will occur when multiple competitors of the same approximate size and market share, armed with the same information, compete for multiple customers with a minimum of regulations. This environment may take a lifetime to create. Currently, many gas LDCs have the upper hand, and true competition does not exist.

However, as the electric utilities "functionally unbundle" supply from distribution, the gas industry should look at separating inherently regulated from unregulated businesses. The physical distribution of gas is probably a regulated entity, with one operator of one pipeline system to your house or business. Similarly, the supply of gas and the sale of pipeline transportation capacity is probably an unregulated business. If a transition period can be established to protect existing LDC shareholders, customers will ultimately benefit from having suppliers compete fairly for their business.

The challenge to true burnertip competition is in the transition to a competitive marketplace. Information technology and the momentum of current marketer and brokers will influence this transition. The risk is in not trying and, as a result, weakening competition and harming customers fundamental position.

Gary G. Ely

Vice President, Natural Gas

Washington Water Power Co.

Customers in gas distribution markets have had alternative choices in other fuel energy options for a significant period of time. Burner access would not necessarily favor pipelines, distributors, or marketers. Price competitiveness and service, including reliability, will give the edge once burnertip access is available. The risks for each industry segment lie in their respective abilities to develop competitive alternatives and services to customers, and to do so in a timely manner.

R.E. Terry

Chairman & CEO

The Peoples Gas Light and Coke Co.

State regulatory commissions need to ensure that distributors have the incentives to open up markets, and the tools needed to compete on the same footing as marketers, brokers, and pipelines.

A significant part of our market is already open to gas supply competition. Peoples Gas and North Shore have offered end-user transportation to all but their small

residential customers since the mid-1980s, with significant unbundled service options since 1991. In addition, Peoples Gas and North Shore have each proposed, in pending rate proceedings, completely unbundled rates for large commercial and industrial customers as well as additional transportation, storage, and balancing service options for end-users and pooling, storage, and balancing services for marketers that provide services to those end users. We are also replacing our existing electronic bulletin board with a state-of-the-art interactive system.

As for expanding these services to include small residential customers, Peoples Gas and North Shore are investigating how best to achieve burnertip sales competition for this class of customers. This effort demands a different approach than for larger customers and must resolve how to 1) avoid making transaction costs prohibitively high; 2) operate simply without unneeded and unwanted complexity; and 3) resolve supplier-of-last-resort, system

reliability, and social program and cost issues so that ratepayers, the utility, and third-party service providers are treated equitably.

If burnertip access is fairly implemented, and the difficult issues I have identified are resolved, any party able to provide competitive services should benefit. Clearly, consumers would benefit.

D. Louis Peoples

Vice Chairman & CEO

Orange and Rockland Utilities, Inc.

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A fundamental requisite to fostering real competition is a truly level playing field. O&R is reluctant to support a regulatory environment in which marketers and brokers can skim a portion of firm customers, for whom long-term costs were incurred, stranding remaining LDC customers with new transition costs. The obligation to serve, the recovery of capital outlays, and the burden of taxes on distribution facilities must be balanced among all suppliers to the retail market.

In July, the A.G.A. reported that the nation's overall natural gas demand is likely to grow 2.6 percent in 1995, with a 5.1-percent growth within the industrial market sector alone. If this projection holds, growth opportunities in the gas market will be open to distributors committed to competitive pricing and quality performance.

A level playing field (em offering open access and customer choice (em requires all distributors to assume risks and hold themselves accountable to the same standards of equity, environmental responsibility, service reliability, and other aspects of regulatory compliance.

Michael Baly

President & CEO

American Gas Association

The extent to which unbundling has already taken place is often understated. About three-quarters of industrial gas demand and nearly one-quarter of commercial gas demand are already delivered by LDCs under transportation arrangements. Nearly all LDCs offer at least some of their customers unbundled services, and in a number of jurisdictions, general-service transportation tariffs are available to any customer willing to purchase the metering equipment required to operate under such service. Unbundling is continuing, and while few residential customers are currently eligible for transportation services today, they may well be eligible in the future if the issues of standby service, scheduling, balancing, and market aggregation rules can be fairly established.

Unbundling does not inherently favor any segment of the industry. It favors companies that can use technology to control costs and react quickly in the marketplace.

Dean T. Casaday

President & CEO

Pennsylvania Gas and Water Co.

Mirroring the unbundling of the pipelines mandated by FERC Order 636 would open up retail gas-distribution markets to real competition, open access, and customer choice. However, making this work would generate new transition costs (em paid once again by the retail customers. These costs would include 1) installation of remote meter-reading devices at each retail customer location as well as a software system to collect data or the hiring of additional meter readers; 2) daily balancing and monthly cash out, setup costs, and administration; 3) abrogation of long-term supply and transportation contracts; and 4) any other costs incidental to the unbundling. An alternative would be to have a third party's personnel read the meters on a monthly basis and implement a mandatory standby charge systemwide to all customers in the form of a transition cost.

Burnertip access would favor marketers and brokers, since they are already shipping on the LDCs system and are unregulated. The main risk involved in open access is the utility's loss of control over the distribution system. Subordinate risks are the potential for runaway costs and loss of regulatory protection for the former residential core customers.

Jerald V. Halvorsen

President, Interstate Natural Gas Association of America

Individual states would have to take action to bring open access to the retail distribution market. If done correctly, open access will help pipelines, distributors, marketers, and customers, because there will be customer choice and good information that will lead to real competition, fair market pricing, and efficient services. However, all players must understand the service and contract obligations of an open-access delivery system. Further, the issue of cross-subsidization must be resolved to avoid unfairly penalizing any segment of the retail gas market.

Michael G. Morris

President & CEO, Consumers Power Co.

It will take major regulatory changes to allow access as proposed in this question. Such regulatory change can only come from market-driven pressure; such demand on the part of the customer simply does not exist today. The reason is that natural gas companies all across the country continue to deliver lower and lower costs to their customers and, therefore, natural gas service consumes less of the customer's disposable income.

Allowing residential and small commercial customers the same choices may seem intriguing, but usually fails upon further analysis. Obligation to serve, notwithstanding cost-effectiveness, may limit the sellers, and uncollectible accounts will surely cause most sophisticated sellers to shy away from that market. Curtailment plans based on need rather than cost will also chill the market for many sellers. A gas marketer or broker that fails to perform for a small customer may find regulatory oversight a bit more than it bargained for.

John E. Hayes, Jr.

CEO, Western Resources

Many believe the next logical step in the deregulation of the natural gas industry is restructuring of local retail gas distribution companies. In this way, LDC customers, for the most part a captive market, would gain access to pricing opportunities that are available to interstate pipeline

customers. Depending upon individual interests, restructuring of LDCs clearly offers owners and operators distinct challenges and opportunities.

If our industry is to give customers the opportunity to reap advantages that an increasingly competitive marketplace can bring, we must be prepared to sign on to the reality of open access (em a total unbundling of services (em at the LDC level. In five to 10 years, open access at the LDC level could be a reality. As an industry, that is something we need to be planning now. A variety of concerns must be addressed: firm supply issues, long-term contracts, special handling requirements for transporters, service responsibilities, peak-period supply reliability and accountability, "obligation to serve," and shutoff rules.

Experience has shown that once open access arrives, customers will seek the most complete and reliable service available at the most reasonable price. To meet this challenge, LDCs should review current service offerings and determine from their customers what services should be expanded, modified, or added.

Value takes many forms for the customer, but we can be sure it includes basic components such as responsiveness to customers' needs, reliability and safety of service, and cost. Beyond basic components, LDCs can demonstrate added value through sensitivity to customers' needs and by helping them develop uniquely tailored solutions to meet those needs.

Open access does not mean we will see a proliferation of new local distribution systems. It does mean LDCs will have opportunities to price and package separate services they now bundle together at a set fee. Preparing now to identify, package, and price these options will determine how easily LDCs transition to the new marketplace and how well they can develop solutions that will improve their bottom-line revenues.

LDCs should also begin developing regulatory options that will support transition to this new marketplace. Flexible pricing and service options are two areas where we can work together to facilitate the transition. At the same time, "obligation to serve" and "no shut-off" issues must be addressed in a consistent, constructive, and beneficial way.

Charles E. Zeigler, Jr.

Chairman, President, & CEO

Public Service Co. of North Carolina, Inc.

This question seems to infer that there is currently no competition in the retail energy markets served by natural gas LDCs. However, natural gas is in fierce competition against the electric heat pump, fuel oil, and other energy sources on a daily basis.

Changes in regulation or legislation will probably be required for widespread open access and customer choice to be achieved within the natural gas portion of the retail energy markets. Two factors will determine the winners of this contest: a) the final rules and regulations, and b) the ability to provide the required service at the lowest possible cost. This last point includes the best use of new technology in conjunction with the best work processes. The most significant associated risk is that cost could be driven up and the level of service reduced in order to provide customers a choice. Higher cost and lower service are not what our customers want, and would hinder the growth opportunities our industry should be able to create under FERC Order 636 and its market-based successors.

William E. Davis

Chairman and CEO

Niagara Mohawk Power Corp.

The first step toward real distribution company competition will be for each state to go through a restructuring/unbundling proceeding similar to the one currently underway in New York State. Each state commission must take a fair and objective look at the whole process.

The unbundling should be managed so that the customer will be given a choice as to supplier, but the LDCs will not be stuck with the stranded costs.

One of the inherent risks may be less reliable service, especially if the LDC is no longer obligated to serve. Each commission must consider who is going to plan for the future. Will competition and an open market provide for future facility expansion to meet new load (em as have regulated entities in the past? If the new market entrants are not willing to take those risks, growth in the industry may be stymied.

Corbin A. McNeill, Jr.

President & CEO, PECO Energy Co.

The natural gas industry has seen many years of structural change, starting with the deregulation of wellhead prices in 1978. Now, large industrial consumers have direct access to gas supplies and can make transportation arrangements with pipelines and utilities. Utilities have direct access to gas supplies, with transportation by pipelines, and use that access to competitively source and

aggregate gas supplies for the core market.

Because it is unclear what real efficiency gains would follow from restructuring the natural gas utility industry, it is questionable whether the core market is better served by marketers than by utilities. Any theoretical efficiency gain involves major issues that stem from consumers buying from multiple suppliers out of a commingled gas stream. A supplier might be able to offer lower prices from greater efficiency, or from reduced reliability during periods of extreme demand. If emergency conditions developed due to unreliable suppliers or inadequate upstream capacity, it is unlikely that utilities and regulators would be absolved from responsibility.

Any potential efficiency gains must be weighed against the long-term reliability risks. These risks are substantial because competing suppliers to firm customers would have the incentive to be short on capacity and thereby raise margins.

Finally, without real efficiency gains, the residential customer is likely to see costs increase as marketers take higher load factor customers out of retail service. For all these reasons, PECO Energy is cautious about aggressive restructuring proposals. t

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