The Gas Storage Conundrum

Deck: 

Congress allows market-based rates. How will FERC respond?

Fortnightly Magazine - November 2005

Under Natural Gas Act (NGA) Sections 4(a) and (b), and 5(a), natural gas companies engaged in interstate commerce must charge just and reasonable, non-discriminatory rates.1 When the Federal Energy Regulatory Commission (FERC) determines rates are unjust and unreasonable, § 5(a) requires that agency, either on its own motion or on complaint to it, to determine and order just and reasonable, non-discriminatory rates on a prospective basis.2

Because these laws are so critical to predictable interstate gas storage and transportation rate regulation, NGA §§ 4 and 5 are not amended every day. In fact, except for minor § 4(e) rewording in 1962, §§ 4 and 5 had not been changed from 1938 until the Energy Policy Act of 2005 (EPACT05), effective Aug. 8, 2005.

If only in that sense, as a rare amendment to a venerable statute, EPACT05 § 312, New Natural Gas Storage Facilities, made headlines by appending a new subsection (f) to § 4. But the new law also tells us of Congress's effort to meet today's national need for gas storage capacity and services.3

New NGA § 4(f) adds an option for interstate, market-based storage rate making. It would encourage new storage facilities by permitting FERC to authorize market-based storage rates, even when the applicant is unable to demonstrate it lacks market power. After authorizing such rates, FERC periodically must review them.

The problem with the new law is that it does not specify those review periods. To give gas storage providers more rate predictability and encourage investment in new storage facilities in the first place, FERC needs to define when it will carry out its new mandate to review § 4(f) authorized and effective market-based rates.

Navigating Between a Policy Rock And Hard Place

New § 4(f) first would encourage interstate gas storage project sponsors to build new infrastructure by providing for FERC market-based rate authorizations under a relaxed standard (no showing of a lack of market power). The new law also requires FERC to protect storage customers and consumers generally from storage-provider market power, and in no uncertain terms to review periodically new § 4(f) market-based rates. However, without FERC explanation of when it intends to exercise that rate-review power, the latter policy to prevent market power likely will inhibit the former policy to promote storage infrastructure.

The intention was to promote needed interstate storage infrastructure, but the statute's plain words authorize gas market-based rates absent a showing of a lack of market power only when those rates shall be subject periodically to plenary FERC rate review. New § 4(f) rates thus would be market-based storage rates constantly subject to legally-required, pro-active agency review of undefined periodicity.

New § 4(f)'s legislative history includes an earlier, rejected proposal, detailed below, that may have been considered to define such periodic rate reviews to mean periods not more frequent than triennially. Perhaps not to encumber FERC's ability to search for gas storage market manipulators, that three-year review period limit was not enacted.

From the storage provider's vantage, it is hard to see why the new § 4(f) game would be worth that undefined rate review candle, with reviews of rates launched as FERC determines. Absent FERC elucidation of how often it will review such market-based rates, no one should be surprised by a tepid gas-storage project sponsor response to the opportunity for such a rate option.

Promoting Infrastructure, Preventing Market Power

New § 4(f) did not appear suddenly. FERC long has appreciated the substantial role market-based rates play in promoting development of needed, new gas storage infrastructure and storage services. Interstate natural-gas pipeline companies have explained that the ratemaking flexibility that market-based storage rates provide attracts and retains new gas markets.4

For example, the gas share for new markets for electricity generation, subject to dampening effects from gas-cost increases, is projected to rise from 16 percent in 2003 to 24 percent in 2025.5 According to pipelines and electric generator shippers, growing electric markets require long-term price certainty to assure financing for such gas-intensive storage ventures, as well as specialized rate designs to meet daily electric generation swings in takes.6 Market-based rate-making flexibility helps meet those requirements.

Under NGA rate policy, lack of market power has been the sine qua non to permit market-based gas storage rates since FERC's 1992 Richfield ruling.7 Until new § 4(f), FERC forbade market-based ratemaking in the presence of market power. The two in combination were believed to fail in protecting storage-service customers from unjust, unreasonable, unduly discriminatory rates and charges.

FERC policy from 1996 requires an applicant for market-based rate authority to establish that it lacks significant market power before market-based rates become an option.8 FERC determines whether the applicant can withhold or restrict services and, as a result, increase prices by a significant amount for a significant time. FERC also determines whether the applicant can discriminate unduly in price, or terms and conditions, which is especially a concern when the market-based rate applicant can deal with affiliates.9

If not quite set in stone, market-based gas-storage rates that the FERC thus traditionally authorized at least were considered to retain their market-based status absent new developments.10 In its regulation of the electric industry, FERC also places a similar condition on public utilities making power sales at market-based rates. That is, utilities are to report within 30 days any change in status reflecting a departure from the characteristics FERC relied on in granting the market-based rate authority.11 FERC's market-based rates approvals rely on applicant-presented facts, and the commission may reconsider those approvals should circumstances change.

Red Lake vs. FERC Standoff

Market-based storage rate proposals can fizzle out. An applicant can claim that its storage infrastructure project will not proceed without market-based rates. If the applicant is not exaggerating, and if FERC is unable to find a lack of market power, a standoff can result.

One such impasse occurred in 2003. A FERC order denied market-based rate authority for Red Lake Gas Storage L.P.'s proposed Arizona gas storage facility.12 Red Lake's project would have helped develop the region's gas infrastructure by providing high deliverability service to meet growing market demand, giving customers increased ratemaking flexibility in those markets. FERC nevertheless decided to preclude exercise of what it found to be unmitigated market power in the relevant storage market during peak periods for the foreseeable future, and to require Red Lake to file cost-based, § 4 rate proposals instead.13

Observing Red Lake's storage market to be highly concentrated and lacking in alternatives, the commission nevertheless left a door open for a more favorable future outcome. It did so by denying market-based rates without prejudice to re-application if Red Lake could show changed circumstances, such as new entrants placed in service and direct competition.

On rehearing, the clash between promoting infrastructure and preventing market power intensified. Red Lake repeated that its project would not go forward absent market-based rate authorization.14 It argued that its assumption of revenue loss risk in the event of insufficient business justified market-based rates. Red Lake also insisted that failure to grant it market-based rates would discourage other companies from providing gas-storage market infrastructure.

FERC did not budge. Rehearing was denied, and the proceeding terminated, shutting the door on further movement in the docket. The agency said the price for promoting gas-storage infrastructure was "too high":

We believe rather that our orders in this proceeding send the appropriate message, , that customers must be protected from the exercise of market power, even in an incipient market like this, and that the price of market development demanded by Red Lake (market-based rates) is too high.15

Policy to prevent market power, in one sense, may be understood to have prevailed when FERC does not act and the application languishes. But, the fact remains that new storage capacity is not being constructed and new storage services are not being provided. New § 4(f) should provide the agency a middle ground with its novel twist that FERC, after making certain required determinations, now may authorize market-based rates despite the fact that the applicant cannot show lack of market power.

Devil in the Details

Promotion of needed storage infrastructure through new § 4(f) may not prove efficacious. What the statute gives on one hand, as an additional FERC option to permit market-based rates, it complicates on the other hand with newly required periodic rate review.

New § 4(f) provides for FERC exercise of NGA or National Gas Policy Act of 1978 (NGPA) authority to allow a natural-gas company, or any individual or corporation that will be a natural-gas company on completion of proposed infrastructure construction, to provide storage or storage-related services at market-based rates, even if the applicant's lack of market power has not been demonstrated. The new law applies to new storage capacity related to a specific facility placed in service after Aug. 8, 2005.

New § 4(f) market-based ratemaking, even absent demonstrated lack of market power, is authorized if FERC determines it is in the public interest, and is necessary to encourage storage capacity construction in an area needing storage services. Customers are to be protected adequately. The agency shall ensure reasonable terms and conditions are in place to protect consumers. Also, after the market-based rate is authorized and effective, FERC periodically shall review the rate's ongoing justness and reasonableness.

Rates Reviewed as FERC Sees Fit

The just and reasonable, anti-discriminatory legal standards FERC now must use to review new § 4(f) market-based rates periodically are declared in the NGA's §§ 4(a) and (b), and 5(a). Pre-EPACT05, market-based rates were authorized under those standards and, after FERC review on the agency's own motion or on complaint, they were subject to determination and order under § 5(a). Post-EPACT05, storage providers with new § 4(f) market-based rates, after storage construction is complete and storage-related services have begun, constantly would have to plan against the day such FERC periodic rate review gears up.

As the basic power for FERC review of all rates and charges made in the first instance by natural gas companies,16 § 5(a) allows the agency to review rates, and to order lawful rates into prospective effect, either on its own motion or on complaint. The commission now is to review new § 4(f) market-based rates periodically and, using its § 5(a) basic power, determine and order any necessary lawful rates into similarly prospective effect.17

A possible model for timing such periodic rate review is FERC's requirement that NGPA intrastate pipelines providing interstate storage and transportation services must petition for new fair and equitable rates every three years.18 In another possible model, look to the commission's orders authorizing market-based rates for the sale of power. They routinely direct applicants to file an updated market-power analysis within three years, while reserving the right to require such analysis at any intervening time.19

Those familiar triennial rate reviews may have served as ultimately unsuccessful prototypes for the new § 4(f)(3) requirement for periodic FERC review. Indeed, the EPACT05 legislative history includes both an unenacted Senate bill,20 and a Congressional Record entry,21 with each presenting the same proposed version of a § 4(f)(3) using the triennial rate review limit, thus:

(3) If the commission authorizes a natural-gas company to charge market-based rates under this subsection, the commission shall review periodically (but not more frequently than triennially) whether the market-based rate is just, reasonable, and not unduly discriminatory or preferential.

That no-more-often-than-three-years definition for § 4(f)(3) periodic rate review was not enacted. Instead, new § 4(f) market-based rates are to be reviewed periodically as FERC chooses. Rate review without defined timing marks a striking change from traditional, after-the-fact review of market-based rate authorizations, where the applicant shows lack of market power. In those situations, FERC merely requires a successful market-based rate applicant to notify the agency within 10 days if future changes in circumstances significantly affect the applicant's present market power status.22

A New Puzzle

Possibly designed to mitigate standoffs when a storage project will not go ahead without market-based rates and market power has not been shown lacking, new NGA § 4(f) provides for market-based rates, but with the consideration that FERC shall review such rates as periodically as it wants. Even if enacted to encourage unencumbered agency review for Enron-style market-power excesses, rate review of such an undefined extent prompts the question whether this new market-based rate option will help promote gas storage infrastructure to any significant degree.

Storage project sponsors instead may prefer to proceed traditionally, removing or mitigating any market power identified in their proposals to the regulator's satisfaction. Confronted with new NGA § 4(f)(3)'s undefined periodic rate review, that seems the simpler course to achieve more storage rate predictability. Better still, FERC action could make the puzzle go away by explaining and defining just how often it will choose to use its new § 4(f)(3) review power. Storage providers would gain predictability, encouraging them to propose needed gas storage infrastructure.


Endnotes

  1. 15 U.S.C. §§ 717c(a) & (b), 717d(a); see also NGA definition of a natural-gas company, 15 U.S.C. § 717a(6).
  2. Section 5(a) applies of its own force to all natural-gas company rates, whether prospectively to rates long established or, under § 4 (c), (d) and (e), retroactively to rates a natural-gas company newly changes. , 350 U.S. 332, 341 (1956). Initial rates for new facilities construction or expansion are established under § 7 certificate authority. 15 U.S.C. § 717f.
  3. Congress shows further concern with needed gas storage infrastructure in EPACT05 § 1801, which requires the secretary of energy to present Congress by Aug. 8, 2006, a study on gas storage capacity nationwide and by major geographical regions, addressing historical and projected gas storage capacity trends. Also, EPACT05 changes other NGA sections, including a new 4A Prohibition on Market Manipulation.
  4. , 74 FERC 61,076, 61,225, reh'g denied, 75 FERC 61,024 (1996)(Policy Statement).
  5. U.S. Energy Information Administration, Annual Energy Outlook 2005 at 6 (gas share of electricity generation including end use sector generation).
  6. , 74 FERC 61,076, 61,225; see generally J.M. Marcoux, "Moving Gas To Generate Power: An Encore For Hrehor/Sytsma," 140 Pub. Util. Fort., No. 8, 14-16 (Apr. 15, 2002).
  7. , 59 FERC 61,316, 62,166-68.
  8. , 74 FERC 61,076, 61,227.
  9. at 61,230. Analysis of ability to exercise market power includes defining relevant product and geographic markets, measuring market share and market concentration, and evaluating other relevant competitive factors such as ease of entry, presence of buyer power, sufficient quantities of good alternatives, or various mitigating changes, conditions, or agreements. . at 61,230-36.
  10. , at 61,236; see also n.22, infra.
  11. 18 C.F.R. § 35.27(c).
  12. , 102 FERC 61,077, at Paras. (PP) 4 & 40 (2003).
  13.  
  14. 103 FERC 61,277, P 2 (2003).
  15. , at P 6.
  16. , 350 U.S. at 341.
  17. That periodic review would not involve rates newly changed by a storage service provider through § 4(c) and (d) filing requirements, for § 4(e) retroactive effect.
  18. , 112 FERC 61,268, Ordering P (D) (2005).
  19. , 112 FERC 61,248, P 19 (2005).
  20. S. 10, 109th Cong. § 382 (Jun. 9, 2005).
  21. . Rec. S6496 (daily ed. Jun. 14, 2005)(text of amendment submitted by Sen. Domenici).
  22. , 111 FERC 61,105 at PP 42-43 (2005) (significant changed circumstances include the applicant or an affiliate adding storage capacity, an affiliate linking storage facilities to applicant, or either applicant or affiliate acquiring an interest in, or being acquired by, an interstate pipeline connected to applicant), reh'g denied, 111 FERC 61,484 (2005); see also n.10, .