Some Challenges from the May Conference about the Industry Future

n May 27 and 30, the Commission heard 0 from a broad range of gas industry partici- pants as to the future shape of the industry and what that shape means for Commission policy. As one would expect, the public conference in Docket No. PL97-1 was wide-ranging and con- fusing, but several themes were apparent. Many nonpipeline market participants urged the Com- mission to undo just about everything except Order 636, on the basis that pipelines had too much market power. Pipeline market partici-

~ pants urged the Commission to move forward, rather than back, in reliance on market forces and a loosening of constraints concerning how pipelines compete. LDCs varied between urg- ing some more flexibility and trying to reargue ordinary rate-case issues. Overall, at the end of the thing, I was tired, so I am sure the Commis- sioners and Staff were exhausted.

What will or should happen now? Can the Commission move forward concerning some of the initiatives that were suggested? This month, because I am a speaker for pipeline interests, I will pick a couple of our recommendations and try to explore them.

Two, Interrelated Initiatives Two courses of action recommended by

various pipelines and groups of pipelines are directly related to each other and are fundamen- tally related to the economic world in which we now find ourselves. These are the development of a workable scheme of negotiable terms and conditions (“FlexTerms”) and the deregulation of certain types of pipeline transactions, espe- cially short-term services. How are these initia-

tives related to each other and what value would they add to the industry? What pitfalls do they present for pipeline customers, and are there ways of dealing with those pitfalls?

Recourse Service Has Become Regular Service

As things have evolved since the Commission’s January 31, 1976, policy state- ment, “recourse service” has become the term for regular pipeline service pursuant to an approved tariff. In other words, it is just what we have always done. Any customer or potential customer has a right to service under those tariff terms, and neither terms nor rates may be adjusted beyond the specific limits defined in the tariff. We used to call this regulated pipeline service, now we call it recourse service. The obvious reason for the semantic change is that now it is a “recourse” from something-but from what? Both FlexTerms and pricing flexibility for short-term services represent a new definition of what “recourse service” means: to what do customers have a right under our tariffs, and to what should they have a right?

FlexTerms-Who Likes Them and Who Doesn’t?

There has been much discussion over the last year as to some of the basic controls and constraints that might be necessary for nego- tiable terms of service to work. Complaint-

Richard G, Smead is senior vice president of Colo- rado Interstate Gas Company, a subsidiary of The Coastal Corporation. He is past chairman of the Rate Committee of the American Gas Association.

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procedure protection (and notice requirements) might be impaired for some customers. More- over, protection against undue discrimination in negotiating a specific term with one customer versus another customer has absorbed a lot of brain cells and meeting time. However, more recently, in a couple of public venues, what I think may be the most basic questions as to negotiable terms have become clearer.

First, as a senior Commission official asked me recently, “You guys keep saying you have to have this flexibility to serve new loads and meet your customers’ needs. However, all I hear from pipeline customer groups is that they hate the idea. How do you explain that.?’ Certainly when one reads the discussion of the issue by some of the producer and end-user representa- tives, there is less-than-universal acclaim for the concept.

I have explained this phenomenon two ways. Probably most importantly, there often seems to be a disconnect between the Washing- ton positions taken by many companies, through their trade associations, and the opinions or desires of their commercial representatives who deal with us day-to-day. It may be a communi- cation problem, or it may simply be the disparity between large, national organizations and spe- cific, more parochial commercial dealings, but the disconnect is there. The gas buyer for an industrial company will say, ‘‘I could use natural gas if you could find a way for me to swing a lot more than your tariff limits.” At the same time his Washington voice is saying, “No one should ever be allowed to deviate from tariff stan- dards.” Go figure.

me of the

The other reason I have heard quoted (but not observed myself) for there being strong opposition to negotiable terms in the regulatory arena, among parties who could benefit from them, is that some players seem to believe that they individually have enough market power to get what they need anyway. A general scheme

of negotiable terms, with some sort of FERC standards, would tend to impair the exercise of this market power. Indeed, it might result in the benefits being spread thinly enough that the big guy could not get as much as before.

However, for the most part, the challenge of the industry is to use the FlexTerms debate to find a way to trust each other again and to make some new services available. That is up to us, the pipelines.

FlexTerms-Who Gets To Go How Fast? Probably the more difficult question is one

that was raised recently by another senior Commission official. It involved the issue of whether recourse customers are entitled in any way to a preservation of service that exceeds tariff standards. The way it was put to me was this: “We all know the speed limit out there on the highway is 55, but we all just drove 70 to get here.” (This is why I did not name this Commis- sion official.) “Do you really think you can just suddenly enforce 55, telling everyone that’s because you negotiated a deal with some other guy to go 90? I don’t think so.”

It is a difficult question. Reducing everyone’s service to tariff standards in order to provide a negotiated service to another party can only work if anyone who wants the enhanced service can get it on a nondiscriminatory basis. That is the plan. However, as far as the basic question goes of whether there is a right to supra-tariff service, simply because it has been available before, I do not have a lot of sympathy. An empty system has a lot of flexibility, but a full system does not. Thus, simply contracting for some more regular, re- course, firm transportation can have the effect of pulling everyone back to tariff standards of service. If the effect of FlexTerms is merely to add business that fills empty space or sells previously free flexibility, recourse customers should not have a basis to complain.

Meanwhile, the market is reconfiguring rap- idly, and the identities and needs of pipeline customers are shifting much faster than the

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ability of the regulatory system to adjust. Thus the ability to match services to individual situa- tions is perhaps the most critical challenge facing us as we approach the year 2000.

Short-Term Service Must Be Addressed Speaking of filling niches of available capac-

ity, one of the most rapidly evolving phenom- ena in the industry is the shortening of market cycles. Shippers and the Commission speak in terms of shorter and shorter firm contractual commitments, sometimes getting as short as a day or less. There is a basic concern this raises for pipelines, in that our facilities are built for 20 or 30 years, and we will be lucky to get a five- year commitment. The result is a mismatch between risk and reward that is increasingly troublesome.

However, a more significant, immediate problem is the impact of transactions lasting less than a year. The Commission’s whole rate- making model centers on an assumption of year-round service. Once a piece of pipe is in the ground, its cost of service goes on all year, even if its purpose was just to serve a few peak days. If someone can tie up the capacity on those peak days, without paying more than a few days’ worth of the 12-month cost of service of the capacity, something is just not right. This becomes clear if we compare two customers getting the same service: 30 days’ worth of coverage in a winter month. Customer A pays for the capacity the old-fashioned way, in 12 equal, monthly installments over the course of a year. Customer B signs up only for the single month. If they pay the same rates, Customer A is paying 12 times as much as Customer B for the same service. This is simply not fair, and the customer to whom it is not fair is the classic recourse, captive customer.

Looking at this dilemma in more current terms, Customer A has taken a commodity

position in the value of the capacity, assum- ing the risk that the capacity will be needed on peak. Customer B has not. Yet the cur- rent system of rate making gives Customer A no reward for assuming that risk. When this disparity between customers is coupled with the real cost of the capacity tied up by Customer B, a full year’s worth of cost of service, it is clear to me that we have a situation we need to fix.

The way to fix it would be to allow short- term rates to be set by the market, to remove cost-based regulation from them. If a customer wants the protection of cost-of-service rates set according to a year’s worth of volumes in the denominator, let that customer take a year’s worth of service. Thus, the upper limit concern- ing what could be charged for short-term service would always be set by the market at what a year’s worth of regulated service would have cost.

One of the benefits of unchaining short- term rates, especially if more flexible, individu- alized terms of service are allowed, will be to encourage creativity in pricing and service pack- aging. This will undoubtedly produce a lot of service selections none of us have really con- templated yet. At the same time, recourse cus- tomers would be protected, shielded from the massive cost shifts that can result from other customers shedding a lot of off-peak billing determinants.

__ I tremendous opportunity to let the industry catch up with a

rapidly changing world I - .

Overall, if it can entertain some contained experiments in letting the market work, the Commission has a tremendous opportunity to let the industry catch up with a rapidly chang- ing world and to solve problems in real time instead of procedural time, without giving up any appropriate protection of the captive cus- tomer. We can only hope that the next steps after the May conference will move us in that direction, rather than back to somewhere in the 1980s. W

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