Natural Gas Firm’s Tactics Focus of Trial
It’s the closest thing yet to a public trial in the California energy crisis.
This morning, in a chilly hearing room about a mile from the U.S. Capitol, an administrative law judge will begin proceedings whose outcome could be critical to the future of energy deregulation in America.
The defendants are two units of El Paso Corp., a Houston energy conglomerate. They are accused of using monopolistic muscle to pump up the price of natural gas, allegedly adding $3.7 billion to the energy bills paid by Californians since March of last year.
The plaintiffs are the California Public Utilities Commission and the state’s two largest utilities. The companies--Pacific Gas & Electric, which is now in Chapter 11 bankruptcy proceedings, and Southern California Edison--went billions into debt as wholesale prices of electricity, much of it generated from natural gas, skyrocketed.
Acting as judge and jury is the Federal Energy Regulatory Commission, which is responsible for policing the interstate natural gas and electricity markets.
The issues in the case cut to the heart of public concerns about the wild new world of energy deregulation:
Are price spikes of 20 times the norm the result--as El Paso contends--of market forces shaped by the independent decisions and actions of many players? Or has California’s energy market fallen--as the plaintiffs allege--into the hands of modern-day pirates who traffic in British thermal units rather than bars of gold?
“It’s sort of a bellwether--a first on this market power issue,” said Curtis L. Wagner Jr., FERC’s chief administrative law judge. The silver-haired Tennessean, with 27 years as an agency judge, will preside over the weeklong hearing and render an initial decision to FERC’s governing board. The commission may accept, reject or amend his conclusions.
The corporate whodunit comes with secret evidence: a Valentine’s Day 2000 document in which an El Paso executive allegedly touts the benefits of acquiring power over the market.
If the allegations are proved, FERC could order El Paso to disgorge hundreds of millions in allegedly ill-gotten profit.
More broadly, however, a finding that monopolistic power was exercised could stifle deregulation across the country, leading to stricter controls and a less sanguine view of the benefits of unrestrained markets by lawmakers and regulators.
“The most important issue in this case is public confidence,” said Paul Joskow, an economist at the Massachusetts Institute of Technology who has written extensively on electricity deregulation. “FERC has to restore the confidence of the states, the public and the market participants that it has rules and regulations in place to ensure that both the natural gas and wholesale electricity markets perform competitively.”
The case arises from a March 2000 contract between El Paso Natural Gas Co., which owns pipelines, and El Paso Merchant Energy, which markets natural gas, for 1.2 billion cubic feet a day of space on pipelines from Texas and New Mexico into California. That represents about 17% of the total interstate pipeline capacity serving California.
The plaintiffs allege that El Paso Merchant withheld shipping capacity during a critical period from March through November of last year. That nudged prices higher, they say, and contributed to a shortage that set the stage for prices to take off when last winter turned out to be colder than predicted.
As recently as 1999, there was as much as 2 billion cubic feet a day of excess pipeline capacity into the state, which helped keep prices low.
El Paso counters that it did not engage in market manipulation--and in fact passed up opportunities to profit even more. The basic problem, the company says, is that there are not enough pipelines within California to carry all the gas that can be shipped to the border.
California border prices for immediate delivery of bulk natural gas on El Paso’s pipelines have risen from less than $3 per million British thermal units in March 2000 to more than $14 currently. (One million BTU is enough gas to serve a typical Southern California home for five or six days.)
FERC has already ruled that the contract between the El Paso units was proper, because it was awarded through standard notice and bidding procedures. The contract will expire at the end of this month, and about 30 companies will take over the pipeline capacity now controlled by El Paso Merchant.
Internal Memo Cited as Evidence
The central issue before Wagner is whether El Paso Merchant took advantage of the situation to create monopolistic conditions in which it could drive up the price of natural gas.
The answer is locked in the details of myriad transactions so convoluted that the litigants have retained Harvard and MIT economists--and sharp-tongued Washington litigators--to battle it out with econometric and behavioral studies.
Perhaps the most tantalizing detail in the case is a sealed Feb. 14, 2000, document in which an El Paso Merchant executive allegedly acknowledges that a deal between the two affiliates would give them the ability to influence gas markets.
Excerpts of the so-called “Valentine’s Day memo” have been quoted in the New York Times, but the document remains under seal. El Paso continues to oppose its release, arguing that it would compromise its future business strategy. Bill Sherman, a former FERC general counsel who now represents El Paso Merchant, said that “the snippets that have been used were taken out of context and do not accurately portray what was said.”
Countered Harvey Morris, lead lawyer for the California PUC: “Any commercial sensitivity has dissipated and is clearly outweighed by the public’s right to know. It’s really just embarrassment that they are trying to hide from the public.”
California Utilities Scrutinize Testimony
The strongest evidence against El Paso comes from Southern California Edison. Its consultants--economists Paul Carpenter and Matthew O’Loughlin of the Brattle Group in Cambridge, Mass.--analyzed reams of El Paso data during pretrial discovery.
In pretrial testimony, Carpenter said El Paso Merchant was able to “game” the California market by withholding a chunk of the pipeline capacity it acquired from El Paso Natural Gas.
For example, from last June through November, El Paso Merchant used only 53% of its capacity for deliveries to Southern California Gas Co., Carpenter testified.
Carpenter charged that El Paso Merchant’s actions caused prices to rise. That, in turn, prompted companies that store gas within California to put off building up their inventories in hopes that the price rise would be temporary. As a result, the state was unprepared for a cold winter. When demand for natural gas shot up in November, prices skyrocketed. And El Paso had even greater opportunity to profit, he said.
O’Loughlin testified that El Paso Merchant overcharged its customers by at least $864 million on sales of natural gas at the California border from March 2000 to March of this year.
Sherman, the lawyer for El Paso Merchant, said such figures are “absurd.”
Harvard economist Joseph Kalt, a consultant to the company, said El Paso Merchant shipped much of its gas under long-term, fixed-price contracts as a hedge against the possibility that gas prices might drop. By doing that, it passed up more profit when prices spiked last winter. That’s not the behavior typical of a company that wants to game the market, Kalt said.
According to Kalt, the contract between El Paso Natural Gas and El Paso Merchant has been misconstrued by the plaintiffs to buttress their allegation that El Paso Merchant withheld supply.
Gas--like mail--has several levels of priority delivery. Kalt said the contract was really a series of different arrangements rolled into one. A portion was for low-priority shipping rights that could get bumped.
Kalt compared El Paso Merchant to a travel agent who can only sell standby airplane tickets--not very attractive to most consumers. So it’s not surprising there would have been unused pipeline capacity.
Another portion of the contract, however, gave El Paso Merchant a block of high-priority shipping rights. Kalt said the company consistently used 90% or more of those rights.
“You have to do an apples-to-apples look,” he said.
Wagner has promised to render a decision by June 30.
