Presumed Power

Deck: 

Growing gas storage depends on fair regulatory treatment.

Fortnightly Magazine - September 2010

Customers of natural gas storage facilities use them to stockpile a lower-cost gas supply inventory when demand weakens. Later, they draw down the inventory to avoid higher, spot-market gas commodity prices when demand strengthens. That mitigation of gas commodity price volatility by storage facilities and storage-related services confers a vital macroeconomic benefit on the nation.

The Federal Energy Regulatory Commission (FERC) seeks to promote more storage facility construction by offering storage providers the carrot of what-the-market-will-bear, market-based rates in appropriate circumstances. The important role of market-based rates in the development of new storage infrastructure and related capacity and services has been obvious for years. For example, interstate natural gas pipeline companies have declared that new gas markets are attracted and retained by the ratemaking flexibility provided by market-based storage rates.1

FERC authorizes market-based rates both for new, green-field caverns, reservoirs, or aquifers, and for new expansions or enhancements of existing storage facilities. Besides promoting storage facility construction, FERC protects consumers against any anticompetitive or illegally discriminatory exercise of market power by storage providers in interstate commerce. FERC defines market power as the ability to maintain prices above competitive levels for a significant period of time.2 To prevent unmitigated market power, FERC’s traditional regulatory approach since 1992 has been to require storage provider applicants to include a lack-of-market-power analytical study in their market-based rate application filings at the agency.3

In 2005, Congress amended the Natural Gas Act (NGA) to supplement FERC’s traditional, lack-of-market-power study approach with a more inclusive, additional approach.4 Under Congress’s additional approach, even a storage provider unable to demonstrate that it lacks market power may receive market-based rate authorization for any storage service it proposes to provide. For the additional approach to be effective, the two approaches should team up to promote storage facility construction whether a storage provider files a lack-of-market-power study (i.e., FERC’s traditional approach) or not (i.e., Congress’s additional approach).

Congress’s additional approach hasn’t replaced FERC’s traditional approach for NGA entities, like interstate pipelines, or for Natural Gas Policy Act (NGPA) intrastate pipelines5 or other intrastate entities6 providing interstate storage services. Far from it. In fact, after implementing the additional approach in 2006, FERC has used it only for four interstate pipelines. That is, the additional approach hasn’t been used for any NGPA intrastate pipelines or other intrastate storage providers. Moreover, all four of those interstate pipeline cases involve expanding or enhancing existing facilities. Thus, no new, independent storage providers or projects have been authorized.

The gas storage industry has made surprisingly light use of Congress’s additional approach. Applicants possibly are wary of FERC’s implementation of the additional approach because the agency’s implementing rule added a presumption of applicant market power that Congress didn’t include in its statute.

FERC and Congress

To foster investment in new or expanded storage facilities, Section 312 of the Energy Policy Act of 2005 (EPAct 2005) permits FERC to authorize storage and storage-related services at market-based rates “notwithstanding the fact that the company is unable to demonstrate that [it] lacks market power.”7 EPAct 2005 thus amended NGA §4, adding a new subsection (f). NGA §4(f) applies to specific new storage facilities, providing capacity and associated services, placed in service after Aug. 8, 2005, such as new storage caverns, reservoirs, or aquifers, or new facilities expanding or enhancing existing facilities. The new subsection further requires that: 1) market-based rates must be in the public interest and necessary to encourage storage capacity construction in the geographic area needing storage services; 2) customers must be protected adequately with reasonable terms and conditions in interstate tariffs or intrastate statements of operating conditions to protect consumers; and 3) FERC shall review the lawfulness of NGA §4(f) market-based rates periodically.

To implement NGA §4(f), FERC issued a final rulemaking order and adopted regulations in 2006 [NGA §4(f) final rule]. Asserting that it can’t rely on competition to ensure lawful rates under Congress’s additional approach, FERC recast Congress’s statutory description of an applicant as unable to demonstrate that it lacks market power, into an agency regulation declaring that an applicant “will be presumed by the Commission to have market power.”8

Congress could have written a market-power presumption into law, but it didn’t. Instead, Congress described NGA §4(f) applicants more inclusively as unable to demonstrate that they lacked market power. That was not a market-power presumption by another name. Potential storage providers may consider the distinction to be more than a quibble.

To regulate market power by some or even most NGA §4(f) applicants, Congress substituted FERC’s public interest determinations, determinations of need to encourage storage capacity, and determinations of customer protections, for the lack-of-market-power studies filed under FERC’s traditional approach. An additional regulatory presumption of applicant market power therefore is unnecessary to ensure lawful rates, because Congress concluded that the important NGA §4(f) FERC determinations were sufficient whether or not market power is present.

Despite FERC’s disclaimer that its presumption isn’t a generic finding that would apply in other situations,9 there’s some reason for the industry’s underwhelming use of the NGA §4(f) final rule. The agency’s market-power presumption may be inhibiting storage providers from using Congress’s additional approach to an unanticipated degree. If that hypothesis is right, FERC could consider relaxing the inhibition by removing the presumption, and conforming its regulations more exactly to Congress’s statutory description of an applicant’s inability to demonstrate lack of market power.

Public Interest Determinations

To ensure lawful rates, FERC navigates between encouraging storage infrastructure and protecting competition. In its first four precedents under Congress’s additional approach, FERC generally determines whether: 1) a need to serve the public interest with new storage facility construction is shown in an auction for storage capacity; and 2) a fair and transparent auction protects customers by preventing capacity withholding, with a reserve price set only high enough to allow the applicant to recover its investment.10 If those answers are “yes,” FERC may authorize lawful market-based rates.

FERC’s important NGA §4(f) public interest determination requires consideration of: whether additional capacity is needed in the geographic area; the risk faced by project sponsors; and a showing that the facilities wouldn’t be built but for market-based rate treatment.11 Applicants can demonstrate need in the geographical area by showing general lack of storage, full use of existing storage capacity, other pipeline constraints into the market, projected increased gas demand, customer interest, high gas prices or volatility, or other information. While receptive to other showings, FERC explained that presenting the results of an open season offering capacity at cost-based rates, which was unsuccessful in obtaining long-term commitments, best demonstrates that cost-based rates are insufficient and market-based rates are needed.

• Southern Star: Need to expand existing storage: Despite the Order No. 678 observation that it might be more difficult for an existing storage provider to meet the public interest standard, all four storage providers that have received NGA §4(f) final rule market-based rates sought to expand or enhance their existing storage facilities. No new, independent projects were authorized for either interstate or intrastate applicants. For example, FERC determined on May 20, 2010, that market-based storage rates for Southern Star Central Gas Pipeline would be lawful rates in the public interest.12 This storage provider’s NGA certificate application to expand its facilities demonstrated need because its existing storage capacity, including previous expansions, had been fully subscribed since 1993. Need also was shown because, despite significant interest in new storage capacity, customers hadn’t contracted for it long-term. The applicant held three binding open seasons, with the first offering up to 5 Bcf of storage capacity at cost-based reserve rates. Customers weren’t willing to enter into long-term contracts needed to support cost-based rates. FERC thus found market-based rates necessary to encourage construction of the proposed storage capacity expansion.

• Columbia Gas: Under-recovery risk from cost-based rates: In 2009, FERC ensured that market-based rates were lawful and in the public interest for Columbia Gas Transmission, based on need and risk shown in its NGA certificate application for expanded storage facilities.13 A 2004 FERC staff report14 estimated a substantial need for incremental working gas capacity in the applicant’s markets. The applicant’s existing storage capacity was fully contracted. Customers showed significant interest in new storage capacity, but were unwilling to contract long-term under cost-based rates. A binding open season for up to 15 Bcf of storage capacity at incremental, cost-based recourse rates had elicited no acceptable, long-term bids. The applicant pointed to its risk in constructing and operating partially subscribed storage-capacity facilities under cost-based rates, due to inability to recover its cost-of-service, to earn a fair return, and to avoid cost overruns. Given the lack of response to its open season for 15 Bcf of working gas capacity, the applicant proposed to construct a total of only 6.7 Bcf of capacity. Moreover, it would construct the unsubscribed portion of that 6.7 Bcf only if allowed to charge market-based rates for that portion.

• Texas Gas: Poorly-subscribed open season shows risk: In 2008, in Texas Gas Transmission, LLC,15 FERC approved market-based rates relying on need, risk, and the 2004 FERC staff report. The applicant’s NGA certificate application showed that its existing storage capacity, including two previous expansion projects, was fully contracted, and it had received requests for additional firm storage. Also, the placement of the proposed, expanded storage facilities could mitigate impacts of certain existing pipeline constraints into the storage provider’s market. Texas Gas was FERC’s first occasion to determine that insufficient customer open-season subscriptions showed cost-based rates didn’t encourage storage capacity construction, making way to ensure lawful market-based rates. Only one bid was received, for some 2 Bcf of the project’s proposed 8.25 Bcf of capacity for a 10-year term. Despite a later 10-year agreement for approximately 3 Bcf of additional capacity, the applicant indicated it hadn’t found a sufficient number of customers willing to make long-term contracts for the full, proposed project capacity. Arguing it lacked an opportunity to earn a fair, cost-based rates return on investment, the applicant was willing to incur the risk to construct all the proposed capacity under market-based rates.

• Northern Natural: Public interest without an open season: Unlike the more recent Southern Star, Columbia Gas, and Texas Gas orders, the first order under FERC’s NGA §4(f) final rule, for Northern Natural Gas in 2006,16 didn’t determine market-based rates in the public interest based on insufficient storage capacity open-season subscriptions. Rather, market-based rates were authorized as lawful due to the geographic area’s need for storage and the project’s substantial engineering risks. Despite the fact that its proposed expansion project was subscribed fully with long-term contracts, some with a 20-year term, and that shippers desired more aquifer storage capacity, the applicant still sought a declaratory order authorizing market-based rates. FERC found those facts showed additional storage was needed in the geographic area, while observing that its NGA §4(f) final rule doesn’t require an applicant to pursue cost-based rates in an open season before being allowed to seek market-based rates. FERC determined whether market-based rates are in the public interest by focusing on the applicant’s significant engineering risks, including unknown but likely large gas treatment costs to remove hydrogen sulfide, the costs of possible additional treatment facilities to maintain pipeline quality specifications, the costs for additional wells to be drilled to maintain deliverability at approximately $2 million each to develop, and difficult determinations of base gas volumes and prices. Given those risks, the applicant had declared that the expansion wouldn’t proceed without market-based rates. FERC concluded, if cost projections were incorrect, that market-based rates would provide rate security during long-term shipper contracts, with the applicant assuming the amply demonstrated risks of cost increases, thereby protecting customers instead of subjecting them to future rate increases under cost-based rates.

Customer Protection Determinations

FERC’s important NGA §4(f) customer protection determination can be accomplished in various ways.17 Customers of interstate pipelines like those discussed here, and of intrastate entities for which no FERC authorizations have been made, should be given non-discriminatory access18 to new storage capacity and services through a fair and transparent open season auction. Open season proposals should prevent capacity withholding, which creates artificial scarcities that can allow storage providers to exercise market power to increase prices by a significant amount for a significant time.

A reserve price, or minimum acceptable bid, should be set only high enough to allow the applicant to recover its investment in the proposed storage facilities. Because a FERC-mandated reserve price would amount to indirect cost-based ratemaking, applicants may propose reserve prices that are reasonable prices in the market to be served, balancing the need to prevent capacity withholding19 with the applicant’s revenue needs. Examples of reserve pricing include competing storage seller rates, the applicant’s total costs in an appropriate ratemaking context, or already-agreed, highest arms-length prices to a non-affiliate in an initial open season. New storage services shouldn’t cause existing customers additional costs, risks, or service degradations. Costs, services, and commitments should be accounted for separately, with records retained under FERC’s Uniform System of Accounts.20 Customers should be protected by an applicant’s generally applicable, FERC-approved, open access transportation tariff or statement of operating conditions, declaring the general terms and conditions (GT&Cs) for the service.

Southern Star: Order No. 637 auction principles followed: Most recently, FERC found that Southern Star had protected customers, thus ensuring lawful rates.21 A transparent process set forth and available in the applicant’s open access transportation tariff met FERC principles for proper interstate pipeline capacity auction design.22 The applicant appropriately designed a cost-based reserve price using storage facility construction costs and FERC-approved cost-of-service determinants. Failing agreement on a price, the cost-based reserve price would be the minimum acceptable bid for firm and interruptible storage. The applicant proposed to post all available market-based rate storage capacity on its electronic bulletin board prior to auctions initiated either by the storage provider for available excess capacity, or by a customer requesting available firm service. Existing customers weren’t subjected to additional costs, risks, or service degradations. NGA §4(f) facilities would be paid for only by those customers contracting for the new capacity. Existing customers wouldn’t subsidize construction, operation, or maintenance of the storage facilities expansion, because market-based costs and revenues would be isolated from future rate proceedings concerning the existing cost-based services. Storage injections, withdrawals, and inventory balances related to market-based rate expansion customers would be identified and tracked separately. Separate books and records would be kept with applicable cross references under FERC regulations.23

Columbia Gas: Arms-length auction price and term: In the next most recently issued order, FERC determined that Columbia Gas’s open seasons ensured lawful rates by protecting customers adequately.24 FERC modified and conditioned the applicant’s proposal for customer-initiated auctions by suggesting firmly that both price and term be set by arms-length negotiations. Absent a negotiated agreement, the applicant would set the reserve price up to the cost-based rate for the expansion storage field, with the auction-initiating customer setting the term. To avoid undue discrimination, the applicant may not accept a bid below the auction reserve price. The applicant must design a cost-based reserve price using estimated project costs and existing, FERC-approved, cost-of-service components from its other rates. FERC found reserve prices to be reasonable if based on arms-length prices between the applicant and its customer, or between a competing storage seller and its customer, excluding affiliate transactions in both situations. Further, such prices should occur within a reasonable time prior to the auction, i.e., 12 months. The auction term should match the contract term used to set the reserve price, and tariffs should delineate the geographic area where sellers are considered competitors. The applicant proposed to account separately for its market-based and cost-based storage services, which FERC required to be cross-referenced under its regulations. Sufficient protections were in place to protect cost-based storage service customers, whose capacity would remain subject to the applicant’s tariff and cost-based rates when their contracts expired. Only customers using the newly-created storage capacity would pay the costs associated with the new facilities. The applicant bore the risks of any cost overruns or revenue under collections.

Texas Gas: Tariff GT&Cs protect customers: With exceptions that were resolved after a later compliance filing, FERC found that Texas Gas had protected customers adequately with an open season, including an incremental, cost-based reserve price.25 When contracts for existing, cost-based storage services expire, that capacity would continue to be posted for sale under the applicant’s current tariff subject to cost-based rates. The storage expansion was incremental to the existing storage services, and the level and quality of the existing services were unchanged, with the applicant bearing the risks of any cost overruns or revenue under-collections. Storage expansion facilities’ costs and revenues received separate accounting. Only customers using the expansion facilities would pay the associated costs, and the market-based storage services were governed by the applicant’s FERC tariff GT&Cs.

Before Texas Gas’s filing of its revised proposal, FERC had disagreed that the proposed auction would protect customers. The revised proposal ensured lawful rates26 by meeting FERC’s Order No. 637, et al. requirements for a transparent auction, initiated either by the applicant or a customer. The reserve price for the initial, unsubscribed capacity auction was the price agreed to by a non-affiliated customer in the project’s open season. For later auctions, the reserve price was either that agreed to in arms-length negotiation with a non-affiliated customer, or a price no higher than the storage expansion facilities’ cost-based rate using previously vetted FERC ratemaking components. The applicant couldn’t exercise market power when it initiated an auction or when there was no price agreement because it had to post a reserve price no higher than the cost-based reserve price. FERC also rejected the applicant’s proposal to offer, in addition to its existing, cost-based interruptible storage service, a new, market-based rate interruptible storage service without an auction. Distinguishing the NGA §4(f) final rule and its market-power presumption from the traditional approach for market-based rates, FERC saw no consumer safeguards to prevent physical or economic withholding of storage capacity. Finally, capacity available for existing, cost-based interruptible service wouldn’t be affected adversely because nomination, scheduling, and allocation procedures were separate for market-based storage and cost-based storage services, and because volumes of storage capacity and deliverability available for market-based storage service were limited.

Northern Natural: Cost-based rate customers unaffected: FERC held that Northern Natural had provided adequate protection both to expansion shippers bidding on new capacity and to existing customers, ensuring lawful rates.27 An open season including all estimated storage project capacity protected the expansion shippers, with any additional capacity given to the highest bidder not receiving capacity in the open season auction. A maximum ceiling price and a ceiling term were set, such that greater bids would be considered made at those ceiling levels. The new storage service was offered under the applicant’s FERC open access tariff GT&Cs. All market-based storage facilities costs and revenues were accounted for in separate records, and existing customer cost-based rates weren’t affected. However, because the applicant had advanced no customer protections for future remarketing of its market-based rate storage expansion capacity, FERC didn’t decide the authorization of market-based rates for any such future capacity resales.28

Ending Market-Power Presumption

EES North America

FERC’s NGA §4(f) final rule appears substantially underemployed. Four interstate pipeline authorizations since 2006 aren’t very many, even against a backdrop of national economic fluctuation. Congress hardly expands FERC’s statutory authority cavalierly.29 It’s thus unlikely that the NGA §4(f) final rule, which also declares new FERC NGPA authority, has escaped the attention of the gas storage industry, including other interstate and intrastate and green-field storage providers.

Perhaps more likely, the community of storage providers willing to swallow a FERC presumption that they have market power is smaller than anticipated. If that hypothesis is correct, then to help satisfy today’s vital national need for gas storage capacity and services, FERC should consider lessening the inhibition by removing its market power presumption and revising its regulations to reflect more exactly Congress’s statutory description of an applicant’s inability to demonstrate its lack of market power. Important NGA §4(f) determinations sufficiently ensure lawful rates whether or not market power is present.

 

Endnotes:

1. Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines, 74 FERC ¶ 61,076, 61,225 (1996), reh’g denied, 75 FERC ¶ 61,024 (1996).

2. 74 FERC ¶ 61,076, at 61,230.

3. 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. 74 FERC ¶ 61,076, 61,230-36. The traditional approach under Natural Gas Act (NGA) rate policy requires showing an absence of market power in order for FERC to authorize market-based storage rates. Richfield Gas Storage Sys., 59 FERC ¶ 61,316, 62,166-68 (1992). Lack-of-market-power studies filed in FERC proceedings also can support market-based storage rate authorizations to Natural Gas Policy Act of 1978 (NGPA) intrastate pipelines and to Hinshaw intrastate entities [15 U.S.C. § 717(c)], including local gas distributors. J. Michel Marcoux, “Too Easily Overlooked: Three Rivers Intrastate Pipeline Exemption,” 16 Natural Gas, No. 11, 25-28 (June 2000).

4. H.R. Rep. No. 109-190, at 97 (2005) (Conf. Rep.), as reprinted in 2005 U.S.C.C.A.N. 448; S. Rep. No. 109-78 (2005), 2005 WL 6486104, at *26.

5. Bay Gas Storage Co., 66 FERC ¶ 61,354, 62,189-90 (1994); Bay Gas Storage Co., 131 FERC ¶ 61,034, text para. (P) 2 (2010).

6. New York State Elec. & Gas Corp., 81 FERC ¶ 61,020, 61,133-37 (1997).

7. 15 U.S.C. § 717c(f)(1).

8. 18 C.F.R. § 284.505(b); accord Rate Regulation of Certain Natural Gas Storage Facilities, Order No. 678, Final Rule, 71 Fed. Reg. 36,612 (June 27, 2006), FERC Stats. & Regs. ¶ 31,220, P 186, order denying reh’g & granting clarification, Order No. 678-A, 117 FERC ¶ 61,190 (2006). Order No. 678 confirms that the NGA §4(f) final rule extends to NGPA intrastate pipelines and other intrastate entities providing interstate storage services. PP 102 & n.54, 156, 158 n.70.

9. Order No. 678, FERC Stats. & Regs. ¶ 31,220, P 186.

10. The NGA §4(f) Final Rule added a new subpart “M” to Part 284 of FERC’s regulations: “Applications for Market-Based Rates for Storage,” which includes 18 C.F.R. §284.505(a).

11. Order No. 678, FERC Stats. & Regs. ¶ 31,220, PP 127-29, 131.

12. Southern Star Cent. Gas Pipeline, Inc., 131 FERC ¶ 61,154, PP 8, 36-39 (2010).

13. Columbia Gas Transmission Corp., 126 FERC ¶ 61,237, PP 25-30 (2009).

14. FERC Staff, Current State of and Issues Concerning Underground Natural Gas Storage, Docket No. AD04-11-000 (Staff Report, Sept. 30, 2004), accessible at http://www.ferc.gov/EventCalendar/Files/20041020081349-final-gs-report.pdf.

15. Texas Gas Transmission, LLC, 122 FERC ¶ 61,190, PP 24-31; order denying reh’g & granting clarification, 123 FERC ¶ 61,198; order on compliance filing, 125 FERC ¶ 61,189 (2008).

16. Northern Natural Gas Co., 117 FERC ¶ 61,191, PP 13-18 (2006), reh’g denied, 119 FERC ¶ 61,072, PP 9-17 (2007); accord Northern Natural Gas Co., 122 FERC ¶ 61,227, P 7, Ordering P (E) (one Commissioner dissented as to FERC’s public interest and customer protection determinations), order granting reh’g & clarification, 122 FERC ¶ 61,270 (2008).

17. Order No. 678, FERC Stats. & Regs. ¶ 31,220, PP 153-59, 163-65.

18. Storage service providers must comply with the non-discriminatory access requirements of FERC’s transportation service regulations found at Part 284. 18 C.F.R. §284.7(b), 284.7(c), 284.9(b).

19. FERC open access regulations in Part 284 require non-discriminatory service only to the extent capacity is available. Order No. 678, FERC Stats. & Regs. ¶ 31,220, PP 163-65; 18 C.F.R. §284.7(f).

20. 18 C.F.R. Part 225, “Preservation of Records of Natural Gas Companies.”

21. 131 FERC ¶ 61,154, PP 40-47.

22. Regulation of Short-Term Natural Gas Transp. Servs. & Regulation of Interstate Natural Gas Transp. Servs., Order No. 637, FERC Stats. & Regs. ¶ 31,091, 31,294-96 (2000) (later FERC & Court rulings didn’t concern auction design).

23. 18 C.F.R. § 154.309, “Incremental expansions.”

24. 126 FERC ¶ 61,237, PP 31, 35-43, 45-47.

25. 122 FERC ¶ 61,190, PP 32-40.

26. 125 FERC ¶ 61,189, PP 20-25, 33.

27. 117 FERC ¶ 61,191, PP 19-22; 119 FERC ¶ 61,072, PP 18-29.

28. On July 9, 2010 (Docket No. RP10-841-000) FERC suspended until Dec. 12, 2010, Northern Natural tariff sheets filed to govern re-sales of any market-based rate storage capacity. FERC issued that suspension order subject to a technical conference on whether to rely on the Southern Star, Columbia Gas, and Texas Gas NGA §4(f) precedents to include cost-based rates to set reserve prices, among other issues. Northern Natural Gas Co., 132 FERC ¶ 61,021, PP 10-11 (2010). Six days later, a FERC Commissioner discussed the filing as an “interesting question of first impression,” stating that the technical conference “will … provide further guidance to the industry in terms of the very important issue of natural gas and natural gas storage.” Marc Spitzer, Comm’r, Remarks at FERC Open Meeting, Wash., D.C. (July 15, 2010).

29. Marcoux, “The Gas Storage Conundrum,” 143 Public Utilities Fortnightly, No. 11, November 2005, pp. 42-46.