FERC Hearing on Natural Gas Rates Refines a Complex Issue


Did a Texas energy conglomerate named El Paso gouge defenseless California electric utilities by charging many times the going rate for natural gas at a time when the utilities had nowhere else to turn?

For three weeks and counting, this question has generated mountains of testimony and exhibits in a trial-like hearing before the Federal Energy Regulatory Commission. "This case has proven to be much more complex than anyone imagined," FERC Chief Judge Curtis L. Wagner Jr. said in a letter Thursday to the agency's governing board.

The hearing has produced no smoking gun proving that two subsidiaries of the Texas energy company squeezed Southern California's gas supply to fatten their parent company's bottom line.

But the California regulators and utilities that brought the case do not have to prove that El Paso hatched a plot to game the market, lawyers in the case say. The standard of proof in civil proceedings--a preponderance of the evidence--is much lower than in a criminal trial. FERC usually relies on economic analysis and circumstantial evidence to determine whether a company behaved like a monopoly.

Three key questions have emerged in the El Paso case:

* Are Southern California natural gas prices performing as would be expected in a normal market?

* Was a March 2000 contract in which one El Paso subsidiary won the right to ship a large volume of gas through a pipeline system owned by another subsidiary in consumers' interest?

* Have the El Paso companies behaved like monopolists?

The market: At the end of March 2000, the average weekly price for immediate delivery of natural gas at the Arizona border was $2.86 per million British thermal units, 16 cents higher than at West Texas producing basins, according to Natural Gas Week. (A typical Southern California home consumes 1 million BTU in five or six days.)

Natural gas prices rose steadily around the country in 2000. In Southern California they surged to unprecedented levels. Around Christmas, the average weekly price was $12.71 per million BTU in Chicago and $11.89 in New York. In Los Angeles it stood at $19.13.

Economic theory says that higher prices provide an incentive for producers to increase supply, which in turn brings prices back down. Prices went down quickly around the country--except in Southern California, where they stayed high.

"There is a disconnect between economic theory and what has happened here," said Regina Speed-Bost, a lawyer monitoring the trial for the city of Los Angeles, which supports California regulators and electric utilities.

El Paso witnesses testified that one explanation for the continuing high prices in Southern California is a lack of pipeline capacity within the state. Interstate pipelines can deliver 7 billion cubic feet a day, but pipelines within the state can carry only 6.7 billion cubic feet. So some gas flowing to the border can't get through.

But the biggest price increases haven't occurred within California. Rather, the biggest markups were between El Paso's Texas gas wells and the California line. Last week, the price of gas was marked up $8.86 per million BTU between Texas and the California border but only 49 cents more from there to L.A.

The deal: The California Public Utilities Commission, Southern California Edison and Pacific Gas & Electric are pointing fingers at two El Paso subsidiaries: El Paso Natural Gas Co., which owns pipelines, and El Paso Merchant Energy, which sells natural gas.

In March 2000, El Paso Merchant bought the right to ship up to 1.2 billion cubic feet of natural gas a day through El Paso Natural Gas pipelines for $38.5 million. The volume represents about 17% of California's average daily consumption and about 30% of the flow on El Paso's system.

Patricia Shelton, president of El Paso's pipeline subsidiary, testified the pact was "a Plain Jane deal."

"We had an open [bidding] season in early 2000," she said.

FERC rules permit such contracts between affiliates, but some FERC officials call them invitations for price markups.

El Paso executives deny any withholding or insider dealing. "We never had any belief that we could manipulate a market as large and as complex as California," testified Ralph Eads, president of El Paso Merchant, the gas-selling arm.

William A. Wise, the chief executive of El Paso Corp., the parent company, acknowledged on the witness stand that he approved the contract. But he said he never immersed himself in its details.

Though FERC's board had earlier ruled that the contract between the El Paso companies was proper, Wagner has asked board members for guidance on reopening the question based on testimony at the hearings.

A question of conduct: FERC forbids the withholding of energy supplies to increase prices, but Southern California Edison and PG&E; allege that is precisely what El Paso did. The utilities analyzed El Paso business records and concluded that Merchant failed to ship gas on the El Paso pipeline even when prices at the California line would have guaranteed a profit.

Edison said that from June 1 to Nov. 30, 2000, Merchant withheld an average of 45% of its daily capacity to deliver Texas gas to pipelines owned by Southern California Gas at the Arizona border.

PG&E; compared Merchant's efforts to sell pipeline capacity it wasn't using with the efforts of other shippers on the El Paso system.

When shippers have space they don't intend to use, they typically offer it for sale. PG&E; found other shippers sold 98% of their unused capacity, while Merchant sold 7%. PG&E; concluded that Merchant made unattractive offers because it didn't want the capacity used.

But Eads, who oversees El Paso's energy marketing ventures, said Merchant entered into long-term, fixed-priced contracts called "hedges" for much of the shipping rights it bought from the El Paso pipeline. He said Merchant made a profit of $184 million on the contract with its sister company, but it could have made $700 million more if it hadn't hedged.

"It's certainly not rational to hedge if you think you can drive prices up," Eads testified.

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