How Commodity Markets Drive Gas Pipeline Values


Has rate regulation become obsolete for natural gas pipelines?

Has rate regulation become obsolete for natural gas pipelines?

Fortnightly Magazine - February 1 1998

On Jan. 30, the Federal Energy Regulatory Commission will hold a public conference to review the financial health of the pipeline industry. It will ask whether its regulatory framework still works; whether pipelines can still attract new capital for investment. %n1%n Does rate policy threaten the financial integrity of the pipeline industry? That very question may come before the Commission. %n2%n

Nevertheless, the FERC need not look far for an answer. If the pipeline industry should lie at risk, the cause may go no farther than the Commission itself. In fact, FERC ratemaking policy for gas transportation service now appears to jeopardize the ability of pipelines to recover costs.

Today's competitive markets increasingly prevent pipelines from achieving full cost recovery. During periods when the market places a lower value on pipeline services than the FERC's maximum allowed rate, cost recovery is impossible to the extent that shippers simply decline to purchase long-term firm transportation service. In the case of released capacity, and short-term firm and interruptible service, rates will be discounted to market levels. Studies by the U.S. Energy Information Administration and the Interstate Natural Gas Association of America have found that released capacity and interruptible transportation have been discounted by 60 to 65 percent less than maximum rates in the past three years. %n3%n

Similarly, during peak periods, when the market value of pipeline services exceeds the allowed rate, FERC regulation prevents the pipeline from collecting prices that will recover the full value of its services, in order to make up for losses sustained during the off-peak season. Buyers and sellers receive incorrect price signals. Shippers lack price incentives to use alternative resources, such as storage or fuel-switching. Bottlenecks ensue, creating the illusion of capacity shortages.

All this has come as the FERC has restructured the pipeline industry on the principle of unbundling (em separating pure transportation service from the sale of gas as a physical commodity. The new FERC framework has brought about two related results. First, natural gas now trades in competitive commodity markets that are consolidating into a single, unified U.S. market. Second, gas commodity markets now determine the economic value of pipeline transportation services in many parts of the country. Thus, even as the FERC has sought to isolate pipeline services from commodity sales, it is within the commodity markets that one can see revealed the true price for gas transportation.

Two examples (winter and summer) illustrate how today's gas market works and how FERC ratemaking policy has failed to recover costs in an environment that has become increasingly competitive.

A WINTER EXAMPLE. During a cold week, suppose the gas price is $2.50 in Texas, and $7.00 at the city gate in Chicago. In other words, the pipeline adds $4.50 to the value of the gas by transporting it to market from the production area. But suppose the shipper has firm capacity rights on the pipeline, for which the regulated