# Promotion of a More Efficient Capacity Release Market

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URL: https://www.frixlaw.com/law-library/documents/fr%3AE8-14444

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** June 30, 2008
- **Citation:** 73 FR 37058

## Text

DEPARTMENT OF ENERGY
Federal Energy Regulatory Commission
18 CFR Part 284
[Docket No. RM08-1-000; Order No. 712]
Promotion of a More Efficient Capacity Release Market
Issued June 19, 2008.

AGENCY:

Federal Energy Regulatory Commission, DOE.

ACTION:

Final rule.

SUMMARY:

In this Final Rule the Federal Energy Regulatory Commission revises its regulations governing interstate natural gas pipelines to reflect changes in the market for short-term transportation services on pipelines and to improve the efficiency of the Commission's capacity release program. The Commission permits market based pricing for short-term capacity releases and facilitates asset management arrangements by relaxing the Commission's prohibition on tying and on its bidding requirements for certain capacity releases. The Commission further clarifies that its prohibition on tying does not apply to conditions associated with gas inventory held in storage for releases of firm storage capacity. Finally, the Commission waives its prohibition on tying and bidding requirements for capacity releases made as part of state-approved retail open access programs.

DATES:

This rule will become effective July 30, 2008.

FOR FURTHER INFORMATION CONTACT:

William Murrell, Office of Energy Market Regulation, Federal Energy Regulatory Commission, 888 First Street, NE., Washington, DC 20426,
William.Murrell@ferc.gov
, (202) 502-8703.

Robert McLean, Office of the General Counsel, Federal Energy Regulatory Commission, 888 First Street, NE., Washington, DC 20426,
Robert.McLean@ferc.gov
. (202) 502-8156.

David Maranville, Office of the General Counsel, Federal Energy Regulatory Commission, 888 First Street, NE., Washington DC 20426,
David.Maranville@ferc.gov
, (202) 502-6351.

SUPPLEMENTARY INFORMATION:

Order No. 712

Final Rule

Table of Contents

Paragraph
Numbers

I. Background
2.

A. The Capacity Release Program
2.

B. The NOPR
15.

C. Comments
19.

II. Overview of the Final Rule
24.

III. Price Cap Issues
30.

A. Removal of Maximum Rate Ceiling for Short-Term Capacity Releases
30.

1. Maximum Rate Ceiling Interferes With Efficient Transactions
32.

2. Assurance of Just and Reasonable Rates
38.

a. Market Conditions Ensure Just and Reasonable Rates
39.

b. Recourse Rate Protection
48.

c. Short-Term Customers Are Not Captive
50.

d. Non-Cost Factors
51.

e. Oversight
55.

3. Comments
57.

a. Lack of Competition in Certain Areas
58.

b. Benefits From Removing the Price Ceiling
63.

c. Promotion of Construction
67.

d. Changed Circumstances
68.

e. Exemption From Bidding for Short-Term Releases at the Maximum Rate
72.

B. Removal of Price Ceiling for Long-Term Releases
74.

C. Removal of Price Ceiling for Pipeline Short-Term Transactions
81.

1. Removal of the Price Ceiling Is Not Justified
82.

2. Response to Specific Comments
87.

a. Evidentiary Record
87.

b. Infrastructure Incentives
90.

c. Competitive Market Structure
92.

d. Differences in Flexibility Between Pipeline Capacity and Released Capacity
95.

e. Bifurcation of the Markets
103.

IV. Asset Management Arrangements
109.

A. Background
110.

B. Discussion
118.

1. Tying
127.

2. Bidding
132.

3. Definition of AMAs
138.

a. NOPR Proposal
138.

b. Comments
141.

c. Modified Definition
144.

4. Supply AMAs
148.

5. AMA Profit Sharing Arrangements
154.

6. Exemption From Buy/Sell Prohibition
163.

7. Other AMA Terms and Conditions
170.

8. Posting and Reporting Requirements
172.

9. Part 157 Capacity
178.

V. Tying of Storage Capacity and Inventory
186.

VI. Liquefied Natural Gas
191.

VII. State Mandated Retail Unbundling
194.

VIII. Implementation Schedule
202.

IX. Information Collection Statement
203.

X. Environmental Analysis
216.

XI. Regulatory Flexibility Act
217.

XII. Document Availability
220.

XIII. Effective Date and Congressional Notification
223.

Before Commissioners:
Joseph T. Kelliher, Chairman; Suedeen G. Kelly, Marc Spitzer, Philip D. Moeller, and Jon Wellinghoff.

Order No. 712

Final Rule

Issued June 19, 2008.

1. In this Final Rule, the Commission revises its Part 284 regulations concerning the release of firm capacity by shippers on interstate natural gas pipelines. First, as proposed in its Notice of Proposed Rulemaking,
1

the Commission will remove, on a permanent basis, the rate ceiling on capacity release transactions of one year or less. Second, the Commission will modify its regulations to facilitate the use of asset management arrangements (AMAs), under which a capacity holder releases some or all of its pipeline capacity to an asset manager who agrees to either purchase from, or supply the gas needs of, the capacity holder. Specifically, the Commission will exempt capacity releases made as part of AMAs from the prohibition on tying and from the bidding requirements of section 284.8. Third, the Commission clarifies that its prohibition on tying does not apply to conditions associated with gas inventory held in storage for releases of firm storage capacity. Fourth, the Commission will modify its regulations to facilitate retail open access programs by exempting capacity releases made under state-approved retail access programs from the prohibition on tying and from the bidding requirements of section 284.8. This Final Rule is designed to enhance competition in the secondary capacity release market and to increase shipper gas supply options. This rule will become effective 30 days after publication in the
Federal Register
.

1

Promotion of a More Efficient Capacity Release Market
, 72 FR 65,916, FERC Stats. and Regs. ¶ 32,625 (November 26, 2007) 121 FERC ¶ 61,170 (2007) (NOPR).

I. Background

A. The Capacity Release Program

2. The Commission adopted its capacity release program as part of the restructuring of natural gas pipelines required by Order No. 636.
2

In Order No. 636, the Commission sought to foster two primary goals. The first goal was to ensure that all shippers have meaningful access to the pipeline transportation grid so that willing buyers and sellers can meet in a competitive, national market to transact the most efficient deals possible. The second goal was to ensure consumers have “access to an adequate supply of gas at a reasonable price.”
3

2

Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation; and Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol
, Order No. 636, 57 FR 13,267 (April 16, 1992), FERC Stats. and Regs., Regulations Preambles January 1991-June 1996 ¶ 30,939 (April 8, 1992),
order on reh'g
, Order No. 636-A., 57 FR 36,128 (August 12, 1992), FERC Stats. and Regs., Regulations Preambles January 1991-June 1996 ¶ 30,950 (August 3, 1992),
order on reh'g
, Order No. 636-B, 57 FR 57,911 (Dec. 8, 1992), 61 FERC ¶ 61,272 (1992),
notice of denial of reh'g
, 62 FERC ¶ 61,007 (1993);
aff'd in part, vacated and remanded in part, United Dist. Companies
v.
FERC
, 88 F.3d 1105 (DC Cir. 1996),
order on remand
, Order No. 636-C, 78 FERC ¶ 61,186 (1997).

3
Order No. 636 at 30,393 (citations omitted).

3. To accomplish these goals, the Commission sought to maximize the availability of unbundled firm transportation service to all participants in the gas commodity market. The linchpin of Order No. 636 was the requirement that pipelines unbundle their transportation and storage services from their sales service, so that gas purchasers could obtain the same high quality firm transportation service whether they purchased from the pipeline or another gas seller. In order to create a transparent program for the reallocation of interstate pipeline capacity to complement the unbundled, open access environment created by Order No. 636, the Commission also adopted a comprehensive capacity release program to increase the availability of unbundled firm transportation capacity by permitting firm shippers to release their capacity to others when they were not using it.
4

4
In brief, under the Commission's current capacity release program, a firm shipper (releasing shipper) sells its capacity by returning its capacity to the pipeline for reassignment to the buyer (replacement shipper). The pipeline contracts with, and receives payment from, the replacement shipper and then issues a credit to the releasing shipper. The replacement shipper may pay less than the pipeline's maximum tariff rate, but not more. 18 CFR 284.8(e) (2007). The results of all releases are posted by the pipeline on its Internet web site and made available through standardized, downloadable files.

4. The Commission reasoned that the capacity release program would promote efficient load management by the pipeline and its customers and would, therefore, result in the efficient use of firm pipeline capacity throughout the year. It further concluded that, “because more buyers will be able to reach more sellers through firm transportation capacity, capacity reallocation comports with the goal of improving nondiscriminatory, open access transportation to maximize the benefits of the decontrol of natural gas at the wellhead and in the field.”
5

5
Order No. 636 at 30,418.

5. In Order No. 636, the Commission expressed concerns regarding its ability to ensure that firm shippers would reallocate their capacity in a non-discriminatory manner to those who placed the highest value on the capacity up to the maximum rate. The Commission noted that prior to Order No. 636, it authorized some pipelines to permit their shippers to “broker” their capacity to others. Under such capacity brokering, firm shippers were permitted to assign their capacity directly to a replacement shipper, without any requirement that the brokering shipper post the availability of its capacity or allocate it to the highest bidder.
6

However, in Order No. 636, the Commission found “there [were] too many potential assignors of capacity and too many different programs for the Commission to oversee capacity brokering.”
7

6

See Algonquin Gas Transmission Corp
., 59 FERC ¶ 61,032 (1992).

7
Order No. 636 at 30,416.

6. The Commission sought to ensure that the efficiencies of the secondary market were not frustrated by unduly discriminatory access to the market.
8

Therefore, the Commission replaced capacity brokering with the capacity release program designed to provide greater assurance that transfers of capacity from one shipper to another were transparent and not unduly discriminatory. This assurance took the form of several conditions that the Commission placed on the transfer of capacity under its new program.

8
Order No. 636-A at 30,554.

7. First, the Commission prohibited private transfers of capacity between shippers and, instead, required that all release transactions be conducted through the pipeline. Therefore, when a releasing shipper releases its capacity, the replacement shipper must enter into a contract directly with the pipeline, and the pipeline must post information regarding the contract, including any special conditions.
9

In order to enforce theprohibition on private transfers of capacity, the Commission required that a shipper must have title to any gas that it ships on the pipeline.
10

9
Order No. 636 emphasized:

The main difference between capacity brokering as it now exists and the new capacity release program is that under capacity brokering, the brokering customer could enter into and execute its own deals without involving the pipeline. Under capacity releasing, all offers
must
be put on the pipeline's electronic bulletin board and contracting is done directly with the pipeline. Order No. 636 at 30,420 (emphasis in original).

10
As the Commission subsequently explained in Order No. 637, “the capacity release rules were designed with [the shipper-must-have-title] policy as their foundation,” because, without this requirement, “capacity holders could simply transport gas over the pipeline for another entity.”
Regulation of Short-Term Natural Gas Transportation Services and Regulation of Interstate Natural Gas Transportation Services,
Order No. 637, FERC Stats. & Regs. ¶ 31,091 at 31,300,
clarified,
Order No. 637-A, FERC Stats. & Regs. ¶ 31,099,
reh'g denied,
Order No. 637-B, 92 FERC ¶ 61,062 (2000),
aff'd in part and remanded in part sub nom. Interstate Natural Gas Ass'n of America
v.
FERC,
285 F.3d 18 (DC Cir. 2002),
order on remand,
101 FERC ¶ 61,127 (2002),
order on reh'g,
106 FERC ¶ 61,088 (2004),
aff'd sub nom. American Gas Ass'n
v.
FERC,
428 F.3d 255 (DC Cir. 2005).

8. Second, the Commission determined that the record of the proceeding that led to Order No. 636 did not reflect that the market for released capacity was competitive. The Commission reasoned that the extent of competition in the secondary market may not be sufficient to ensure that the rates for released capacity will be just and reasonable. Therefore, the Commission imposed a ceiling on the rate that the releasing shipper could charge for the released capacity.
11

This ceiling was derived from the Commission-approved monthly maximum tariff rates, necessary for the pipeline to recover its annual cost-of-service revenue requirement.
12

11
Order No. 636-A at 30,560.

12
Order No. 637 at 31,270-71.

9. Third, the Commission required that capacity offered for release at less than the maximum rate must be posted for bidding, and the pipeline must allocate the capacity “to the person offering the highest rate (not over the maximum rate).”
13

The Commission permitted the releasing shipper to choose a pre-arranged replacement shipper who can retain the capacity by matching the highest bid rate. The bidding requirement, however, does not apply to releases of 31 days or less or to any release at the maximum rate. But all releases, whether or not subject to bidding, must be posted.
14

13
18 CFR 284.8(e) (2007) provides in pertinent part that “[t]he pipeline must allocate released capacity to the person offering the highest rate (not over the maximum rate) and offering to meet any other terms or conditions of the release.”

14
18 CFR 284.8(h)(1) provides that a release of capacity for less than 31 days, or for any term at the maximum rate, need not comply with certain notification and bidding requirements, but that such release may not exceed the maximum rate. Notice of the release “must be provided on the pipeline's electronic bulletin board as soon as possible, but not later than forty-eight hours, after the release transaction commences.”

10. Finally, the Commission prohibited tying the release of capacity to any extraneous conditions so that the releasing shippers could not attempt to add additional terms or conditions to the release of capacity. The Commission articulated the prohibition against the tying of capacity in Order No. 636-A, where it stated:

The Commission reiterates that
all
terms and conditions for capacity release must be posted and non-discriminatory and must relate solely to the details of acquiring transportation on the interstate pipelines. Release of capacity cannot be tied to any other conditions. Moreover, the Commission will not tolerate deals undertaken to avoid the notice requirements of the regulations. Order No. 636-A at 30,559 (emphasis in the original).

11. Subsequent to the Commission's adoption of its capacity release program in Order No. 636, the Commission conducted two experimental programs to provide more flexibility in the capacity release market. In 1996, the Commission sought to establish an experimental program inviting individual shipper and pipeline applications to remove price ceilings related to capacity release.
15

The Commission recognized that significant benefits could be realized through removal of the price ceiling in a competitive secondary market. Removal of the ceiling permits more efficient capacity utilization by permitting prices to rise to market clearing levels and by permitting those who place the highest value on the capacity to obtain it.
16

15

Secondary Market Transactions on Interstate Natural Gas Pipelines, Proposed Experimental Pilot Program to Relax the Price Cap for Secondary Market Transactions,
61 FR 41,401 (Aug. 8, 1996), 76 FERC ¶ 61,120,
order on reh'g,
77 FERC ¶ 61,183 (1996).

16
77 FERC ¶ 61,183 at 61,699 (1996).

12. In 2000, in Order No. 637, the Commission conducted a broader experiment in which the Commission removed the rate ceiling for short-term (less than one year) capacity release transactions for a two-year period ending September 30, 2002. In contrast to the experiment that it conducted in 1996, in the Order No. 637 experiment the Commission granted blanket authorization in order to permit all firm shippers on all open access pipelines to participate. The Commission stated that it undertook this experiment to improve shipper options and market efficiency during peak periods. The Commission reasoned that during peak periods, the maximum rate cap on capacity release transactions inhibits the creation of an effective transportation market by preventing capacity from going to those that value it the most and therefore the elimination of this rate ceiling would eliminate this inefficiency and enhance shipper options in the short-term marketplace.
17

17
Order No. 637 at 31,263. The Commission also explained why it was lifting the price cap on an experimental basis, instead of permanently, stating:

While the removal of the price cap is justified based on the record in this rulemaking, the Commission recognizes that this is a significant regulatory change that should be subject to ongoing review by the Commission and the industry. No matter how good the data suggesting that a regulatory change should be made, there is no substitute for reviewing the actual results of a regulatory action. The two year waiver will provide an opportunity for such a review after sufficient information is obtained to validly assess the results. Due to the variation between years in winter temperatures, the waiver will provide the Commission and the industry with two winter's worth of data with which to examine the effects of this policy change and determine whether changes or modifications may be needed prior to the expiration of the waiver. Order No. 637 at 31,279-80.

13. Upon an examination of pricing data on basis differentials between points,
18

the Commission found that the price ceiling on capacity release transactions limited the capacity options of short-term shippers because firm capacity holders were able to avoid

price ceilings on released capacity by substituting bundled sales transactions at market prices (where the market place value of transportation is an implicit component of the delivered price). As a consequence, the Commission determined that the price ceilings did not limit the prices paid by shippers in the short-term market as much as the ceilings limit transportation options for shippers. In short, the Commission found that the rate ceiling worked against the interests of short-term shippers, because with the rate ceilings in place, a shipper looking for short-term capacity on a peak day who was willing to offer a higher price in order to obtain it, could not legally do so; this reduced its options for procuring short-term transportation at the times that it needed it most.
19

Throughout this experiment, the Commission retained the rate ceiling for firm and interruptible capacity available from the pipeline as well as for long-term capacity release transactions.

18
Among other things, the data showed that the value of pipeline capacity, as shown by basis differentials, was generally less than the pipelines' maximum interruptible transportation rates, except during the coldest days of the year, and capacity release prices also averaged somewhat less than pipelines' maximum interruptible rates.

19
Order No. 637 at 31,280-81.

14. On April 5, 2002, the United States Court of Appeals for the District of Columbia Circuit, in
Interstate Natural Gas Association of America
v.
FERC,
20

upheld the Commission's experimental price ceiling program for short-term capacity release transactions as set forth in Order No. 637.
21

The court found that the Commission's “light handed” approach to the regulation of capacity release prices was, given the safeguards that the Commission had imposed, consistent with the criteria set forth in
Farmers Union Cent. Exch.
v.
FERC.
22

The court found that the Commission made a substantial record for the proposition that market rates would not materially exceed the “zone of reasonableness” required by
Farmers Union.
The court also found that the Commission's inference of competition in the capacity release market was well founded, that the price spikes shown in the Commission's data were consistent with competition and reflected scarcity of supply rather than monopoly power, and that outside of such price spikes, the rates were well below the estimated regulated price.
23

The Commission's experiment in lifting the price ceiling for short term capacity releases ended on September 20, 2002.
24

20
285 F.3d 18 (DC Cir. 2002) (
INGAA
).

21
Specifically, the court found that: “[g]iven the substantial showing that in this context competition has every reasonable prospect of preventing seriously monopolistic pricing, together with the non-cost advantages cited by the Commission and the experimental nature of this particular “light handed” regulation, we find the Commission's decision neither a violation of the NGA, nor arbitrary or capricious.”
INGAA
at 35.

22
734 F.2d 1486 (DC Cir. 1984) (
Farmers Union
) (finding that a move from heavy-handed to light-handed regulation can be justified by a showing that under current circumstances, the goals and purposes of the Natural Gas Act (NGA) will be accomplished through substantially less regulatory oversight.

23

Id.
at 33.

24

Regulation of Short-Term Natural Gas Transportation Services and Regulation of Interstate Natural Gas Transportation Services,
FERC Stats. & Regs., Regulations Preambles July 1996-December 2000, ¶ 31,091 (Feb. 9, 2000),
order on rehearing,
Order No. 637-A, FERC Stats. & Regs., Regulations Preambles July 1996-December 2000, ¶ 31,099 (May 19, 2000),
order on rehearing
, Order No. 637-B, 92 FERC ¶ 61,062 (July 26, 2000),
aff'd in part and remanded in part, Interstate Natural Gas Association of America
v.
FERC,
285 F.3d 18 (DC Cir. Apr. 5, 2002).

B. The NOPR

15. On January 3, 2007, the Commission, in response to petitions from various gas industry participants concerning issues related to capacity releases,
25

issued a request for comments on the operation of the capacity release program and whether changes in any of its capacity release policies would improve the efficiency of the natural gas market.
26

The Commission also included in its request for comments a series of questions asking whether the Commission should lift the price ceiling, remove its capacity release bidding requirements, modify its prohibition on tying arrangements, and/or remove the shipper-must-have-title requirement.

25
In August 2006, Pacific Gas and Electric Co. (PG&E) and Southwest Gas Corp. (Southwest) filed a petition requesting the Commission to amend sections 284.8(e) and (h)(1) of its regulations to remove the maximum rate cap on capacity releases. Subsequently, in October 2006, a group of large natural gas marketers (Marketer Petitioners) requested clarification of the operation of the Commission's capacity release rules in the context of asset (or portfolio) management services.

26

Pacific Gas & Electric Co.,
118 FERC ¶ 61,005 (2007).

16. After review of the petitions, comments, responses to its questions, and available data, the Commission issued a Notice of Proposed Rulemaking (NOPR), proposing two major changes to its capacity release regulations and policies. First, the Commission proposed to lift the price ceiling for short-term capacity release transactions of one year or less. The Commission determined that the traditional cost-of-service price ceilings in pipeline tariffs, which are based on annual costs recovered over twelve equal monthly payments, are not well suited to the short-term capacity release market, because they do not reflect short-term variations in the market value of the capacity. Therefore, removing the price ceiling for short-term capacity releases would permit more efficient utilization of capacity by allowing prices to rise to market clearing levels, thereby permitting those who place the highest value on the capacity to obtain it. The Commission determined that the data obtained by the Commission both during the Order No. 637 experiment and more recently indicated that short-term release prices reflect market value of the capacity as revealed by basis differentials, rather than the exercise of market power. Moreover, the Commission reasoned that shippers purchasing capacity would be adequately protected because the pipeline's firm and interruptible services will provide just and reasonable recourse rates limiting the ability of releasing shippers to exercise market power. Finally, the Commission stated that reporting requirements in Order No. 637 and the Commission's implementation of the Energy Policy Act of 2005, specifically with respect to market manipulation, give the Commission an enhanced ability to monitor the market and detect and deter abuses. The Commission did not propose to remove the price ceiling on either long-term capacity releases or the pipelines' sale of their own primary capacity.

17. Second, the Commission proposed to revise its capacity release policies to give releasing shippers greater flexibility to negotiate and implement AMAs, based on the Commission's findings that AMAs provide significant benefits to participants in the natural gas and electric marketplaces.
27

Recognizing that the linking of transportation capacity with gas supply arrangements would violate the Commission's prohibition against “tying” released capacity to any extraneous conditions, the Commission proposed to exempt pre-arranged capacity release transactions that met certain criteria
28

from the prohibition against tying.
29

This proposal would permit a releasing shipper in a pre-arranged release to require that the replacement shipper agree to supply the releasing shipper's gas requirements and take assignment of the releasing shipper's gas supply contracts, as well as released transportation capacity on one or more pipelines and storage capacity with the gas currently in storage.
30

27
NOPR at P 67-74.

28
The Commission's definition of AMA as proposed in the NOPR is discussed in detail below.

29
NOPR at P 75-82.

30
In addition, the releasing shipper could require that, upon expiration of the AMA, the replacement shipper must return storage capacity included in the release with an appropriate level of inventory,

e.g.,
to promise to replenish storage inventories to a mutually agreed upon level.

18. The Commission's second proposal to facilitate AMAs was to exempt pre-arranged releases to implement AMAs from competitive bidding.
31

The Commission stated that, because the asset manager will manage the releasing shipper's gas supply operations on an ongoing basis, it is critical that the releasing shipper be able to release the capacity to its chosen asset manager. Requiring releases made in order to implement an AMA to be posted for bidding would thus interfere with the negotiation of beneficial AMAs by potentially preventing the releasing shipper from releasing the capacity to its chosen asset manager. The Commission concluded that in the AMA context the bidding requirement creates an unwarranted obstacle to the efficient management of pipeline capacity and supply assets. The Commission emphasized that AMAs would remain subject to all existing posting and reporting requirements.
32

31

See
NOPR at P 83-90. Section 284.8 of the Commission's regulations require capacity release transactions to be posted for competitive bidding unless the transactions are at the maximum tariff rate or are for a term of 31 days or less.

32
While the NOPR originally required that any comments were due January 10, 2008, a number of entities filed for an extension of that deadline until February 8, 2008. On January 14, the Commission granted an extension of time for filing comments until January 25, 2008.

C. Comments

19. Over 60 entities from all segments of the natural gas industry filed comments on the NOPR. The vast majority of those who filed comments regarding the Commission's proposal to permanently remove the price cap for short-term capacity releases of one year or less support the proposal, generally agreeing with the Commission's reasoning in support of removing the cap. Many of the local distribution companies (LDC), marketers, producers, and end-users who support lifting the price cap on short-term capacity releases also support retaining the price cap on long-term capacity releases
33

and/or primary pipeline capacity.
34

These parties generally view retention of these price caps as providing valuable safeguards in preventing the exercise of market power in the uncapped short-term capacity release market.

33
Those commenters include Direct Energy Services, LLC (Direct Energy), New Jersey Natural Gas Company (NJNG), Oklahoma Independent Petroleum Association (OIPA), Reliant Energy Inc. (Reliant), Statoil Natural Gas, LLC (Statoil), and Weyerhaeuser Company (Weyerhaeuser).

34
Such commenters include Edison Electric Institute (EEI), NJNG, NJR Energy Services Company (NJR), Nstar Gas Company (Nstar), OIPA, Piedmont Natural Gas Company, Inc. (Piedmont), Statoil, Weyerhaeuser, and the Wisconsin Distributor Group (WDG). American Gas Association (AGA), American Public Gas Association (APGA), and Independent Petroleum Producers of America (IPAA) oppose lifting the price cap for primary capacity, arguing that doing so would undercut a major premise for lifting the price cap in the short-term secondary market, namely, that the availability of recourse rates from the pipeline will constrain the exercise of market power in the secondary market.

20. Two commenters oppose the Commission's proposal to lift the price cap for the short-term capacity release market, arguing that the Commission has not supported its proposed rule and that the proposed rule would fail a cost-benefit test.
35

Other commenters express concern over the potential for capacity owners to exercise market power under the proposed rule.
36

For example, some end-users of gas express concerns about the concentration of capacity ownership on lateral pipelines and therefore argue that the Commission should either not remove the price cap for laterals or do so on a case-by-case basis.
37

Other parties generally urge the Commission to carefully monitor markets to ensure that they are functioning properly. Some suggest a final test period before permanently removing the cap, periodic reassessments of the uncapped market, or a process to revisit the determination if the market becomes dysfunctional.
38

35
Tenaska Marketing Ventures (Tenaska) and National Energy Marketers Association (NEM).

36

See
Comments of NEM.

37
Weyerhaeuser, Northwest Industrial Gas Users (NWIGU), and Process Gas Consumers (PGC).

38
Direct Energy, OIPA, Honeywell International, Inc. (Honeywell), Arizona Public Service Company (APS) (arguing that the market currently served by El Paso Natural Gas Pipeline east of California is not competitive). Commerce Energy Group, Inc. (Commerce Energy) suggests including a contingency for replacing the price cap in “exceptional capacity situations.”

21. In general, commenters also overwhelmingly supported the Commission's efforts to facilitate the development of AMAs.
39

Those commenters agree with the Commission's assessment that AMAs provide value and benefits to market participants and to natural gas markets overall. Virtually all who commented support the steps proposed by the Commission to facilitate AMAs, though many of those that support the Commission's proposal regarding AMAs request that the Commission modify or clarify the proposal in various ways in order to permit broader use of AMAs and greater flexibility in the terms of permitted AMAs. They request, for example, that the Commission permit uncapped AMA releases of a year or less to be rolled over without bidding, clarify that profit sharing arrangements in an AMA do not violate any applicable price cap, relax the requirements concerning the replacement shipper's obligation to deliver gas to the releasing shipper, exempt AMAs from the Commission's prohibition against buy/sell arrangements, and allow supply side AMAs. Williston Basin commented that exempting AMAs from the tying prohibition and bidding requirements would encourage discrimination against pipelines and provide preferential treatment to asset managers.

39

See e.g.
, Comments of the AGA at 1-2, Comments of APGA at 2-4; Comments of Atmos Energy Corporation (Atmos) at 2-4, Comments of BG Energy Merchants (BGEM) at 1-2, Comments of BP Energy Company (BP) at 2, Comments of Direct Energy at 3-4, Comments of Duke Energy Corporation (Duke Energy) at 3, Comments of the EEI at 6, Comments of the Electric Power Supply Association (EPSA) at 2, Comments of Florida Cities at 2, Comments of the Interstate Natural Gas Association of America (INGAA) at 6, Comments of Marketer Petitioners at 2, Comments of National Grid Delivery Companies (National Grid) at 2, Comments of NJNG at 1, Comments of the Natural Gas Supply Association (NGSA) at 3, Comments of NJR at 1, Comments of NWIGU at 6, Comments of Nstar at 1-2, Comments of the Ohio Gas Marketers Group (OGMG) at 1, Comments of Piedmont at 1, Comments of PPM Energy, Inc., (PPM) at 1-3, Comments of PGC at 5, Comments of the Public Utilities Commission of Ohio (PUCO) at 5-7, Comments of Puget Sound Energy, Inc. (Puget Sound) at 8-9, Comments of Sequent Energy Management, L.P. (Sequent) at 5-6, Comments of the Financial Institutions Energy Group (FEIG) at 6-7, Comments of Turlock Irrigation District (Turlock) at 5, Comments of Ultra Petroleum Corporation (Ultra) at 4, Comments of the WDG at 3, and Comments of the Wyoming Pipeline Authority at 5.

22. The Commission also received favorable comments on whether it should clarify its prohibition against tying agreements to allow a releasing shipper to include conditions in a storage release concerning the sale and/or repurchase of gas in storage inventory outside the AMA context. All comments that addressed this issue supported removing this prohibition for storage services. They assert that a shipper releasing storage capacity should be permitted to require the replacement shipper to take assignment of any gas that remains in the released storage capacity at the time the release takes effect; and/or to return the storage capacity to releasing shipper at end of the release with a specified amount of gas in storage.
40

Commenters note that tying storage capacity with storage inventory will enable transactions to be consummated more readily and that the nature of the relationship between storage capacity and storage inventory calls out for a waiver of the tying rule. Others add that the ability of releasing shippers to “tie” storage capacity with storage inventory such that releasing

shippers would be permitted to require that replacement shippers take inventory as a condition of release, even in circumstances outside the AMA context, will provide benefits to the marketplace similar to those provided by AMAs.
41

40
Public Service Commission of New York (PSCNY) comments at 20-21.

41
Comments of Marketer Petitioners.

23. The Commission also received numerous comments on its inquiry whether pre-arranged capacity release deals necessary to implement retail access programs should be treated as similar to releases made as part of an AMA, and thus accorded the same exemptions. The majority of comments on this issue advocated affording capacity releases under state retail choice programs the same blanket exemptions from the tying prohibition
42

and bidding requirements as those granted to asset managers.
43

AGA, for example, recommends that the Commission add an exemption from the bidding requirements for any prearranged, recallable capacity release from an LDC to a natural gas marketer in accordance with the terms of a retail choice program approved by a State commission. AGA also asks that the Commission clarify that LDC releases to retail choice marketers would be entitled to the same partial exemption from the tying prohibition as would be releases under AMAs. The SPSCNY would extend the AMA exemption from the tying prohibition to releases of storage capacity conducted according to state retail access programs.

42
Those commenters include AGA, Commerce Energy, Duke Energy, Hess Corporation (Hess), Interstate Gas Supply (IGS), NJNG, New York State Electric and Gas Corporation (NYSEG), Rochester Gas & Electric Corporation (RG&E), OGMG, the Public Service Commission of North Carolina (PSNC), South Carolina Electric and Gas Company (SCE&G), SCANA Energy Marketing (SEMI), PSCNY, and Sequent.

43
Those commenters include the AGA, Boardwalk Pipeline Partners (Boardwalk), BP, Commerce Energy, Direct Energy, Duke Energy, FPL Energy, LLC (FPL Energy), Hess, IGS, NJNG, NYSEG, RG&E, Nstar, OGMG, Peoples Gas System, a Division of Tampa Electric Company (Peoples), PG&E, PSCNY, PUCO, SEMI, Sequent, and the WDG.

II. Overview of the Final Rule

24. In this Final Rule, the Commission is modifying its policies and regulations concerning the release of capacity by firm shippers on interstate pipelines in order to enhance the efficiency and effectiveness of the secondary capacity release market. The Commission's capacity release program has created a successful secondary market for capacity.
44

As a result, natural gas markets in general, and the secondary release market in particular, have undergone significant development and change in the sixteen years since Order No. 636 and the inception of the capacity release program. As this market has developed, shippers and potential shippers have sought greater flexibility in the use of capacity. They seek to better integrate capacity with the underlying gas transactions, and are looking for more flexible methods of pricing capacity to better reflect the value of that capacity as revealed by the market price of gas at different trading points. They also seek to implement AMAs, in which capacity holders release their capacity to asset managers (generally marketers) that have greater expertise in maximizing the value of pipeline capacity and negotiating beneficial transactions in the gas commodity markets.

44
As the Commission observed in 2005, the “capacity release program together with the Commission's policies on segmentation, and flexible point rights, has been successful in creating a robust secondary market where pipelines must compete on price.”
Policy for Selective Discounting by Natural Gas Pipelines
, 111 FERC ¶ 61,309, at P 39-41,
order on reh'g
, 113 FERC ¶ 61,173 (2005).

25. In this Final Rule the Commission is taking actions to respond to the industry's request for greater flexibility in the capacity release market and to revise its policies and regulations to reflect the changes and developments in the marketplace. The first major revision is the removal of the price ceiling on short term capacity releases. The permanent elimination of the price ceiling for short term releases will enable shippers to offer competitively-priced alternatives to pipelines' negotiated rate offerings and will permit short-term capacity release prices to rise to market clearing levels, thereby allocating capacity to those that value it the most. It will also provide more accurate price signals concerning the market value of pipeline capacity.

26. The Commission is also revising its regulations and policies to accommodate and facilitate AMAs, a relatively recent development in the industry. AMAs provide significant benefits to many participants in the natural gas and electric marketplaces and to the secondary marketplace itself. They maximize the utilization and value of capacity by creating a mechanism for capacity holders to use third party experts to both (1) manage their gas supply arrangements and (2) use that capacity to make gas sales or re-releases of the capacity to others when the capacity is not needed to serve the releasing shipper. AMAs result in ultimate savings for end-use customers by providing for lower gas supply costs and more efficient use of the pipeline grid.
45

The Commission's goal in facilitating AMAs in this rule is to make the capacity release program more efficient by bringing it into line with the realities of today's secondary gas marketplace.

45

See Comments of BGEM at 2, Comments of BP at 5, Comments of Nstar at 8
, Comments of Piedmont at 4-5, Comments of PUCO at 7, Comments of WDG at 3.

27. To that end, the Commission in this rule is adopting its NOPR proposal to exempt capacity releases made to implement AMAs from the prohibition on tying and the bidding requirements of section 284.8. The Commission is also making several revisions to the definition of AMAs as proposed in the NOPR. The Final Rule modifies the definition of AMAs proposed in the NOPR to relax the delivery obligation of the replacement shipper to the releasing shipper and to permit supply side AMAs. The Final Rule also clarifies that short term AMAs may be rolled over without bidding. Further, the Final Rule clarifies that the price ceiling does not apply to any consideration provided by an asset manager to the releasing shipper as part of an AMA. These steps, requested by many industry commenters that support the Commission's efforts in the NOPR to facilitate AMA's, will further enhance the efficiency of AMAs by allowing greater flexibility for parties to customize arrangements to meet unique customer needs while at the same time ensuring that capacity releases that qualify for the exemptions from tying and bidding granted in this rule are
bona fide
AMAs. The rule also extends the benefits of AMAs to sellers of natural gas, creating an even greater diversity of potential suppliers and participants in the secondary market.

28. The Commission is also revising its policies to reflect the realities of today's marketplace by allowing a releasing shipper to include conditions in a release concerning the sale/and repurchase of gas in storage inventory, even outside the AMA context. Allowing such arrangements reflects the fact that in the storage context, storage capacity is inextricably linked to storage inventory. By permitting the tying of releases of storage capacity to conditions on storage inventory, the Commission will enhance the efficient use of storage capacity while at the same time ensuring that releasing shippers will have adequate storage inventories for the winter.

29. The Final Rule also extends the blanket exemptions from the prohibition against tying and from bidding granted to AMAs to capacity releases made to a

marketer participating in a state approved retail access program, finding that such programs provide benefits similar to AMAs.

III. Price Cap Issues

A. Removal of Maximum Rate Ceiling for Short-Term Capacity Releases

30. In this Final Rule, the Commission amends section 284.8 of its regulations to eliminate the price ceiling for short-term capacity release transactions of one year or less. The Commission finds that this action will improve shipper options and market efficiency, particularly during peak periods, by allowing the prices of short-term capacity release transactions to reflect short-term variations in the market value of that capacity. This will enable shippers to better integrate capacity with the underlying gas transactions, and will permit more flexible methods of pricing capacity to better reflect the value of that capacity as revealed by the market price of gas at different trading points. The Commission has previously provided pipelines with the flexibility to enter into negotiated rate transactions which are permitted to exceed the maximum rate ceiling, and this rule will permit releasing shippers similar flexibility in pricing release transactions.

31. At the same time, we are convinced that the rates resulting from removal of the price cap for capacity release will be just and reasonable. The data collected over many years shows that the value of short term capacity only exceeds the price ceiling in times when capacity is scarce. These data are confirmed by the data gathered during the experimental release of the price ceiling which showed that capacity release prices exceed the price ceiling only for brief periods of constraint. Moreover, we are not relying solely on competition to ensure just and reasonable prices. We are maintaining the rate cap on pipeline services that will provide the same protection for capacity release transactions as it now does for pipeline negotiated rate transactions. Further, we have required informational postings of capacity release transactions that will provide transparency and facilitate the filing of complaints if circumstances warrant. The Commission will also continue to actively monitor the release market.

1. Maximum Rate Ceiling Interferes With Efficient Transactions

32. As we explained in Order No. 637,
46

the traditional cost-of-service maximum rates in pipeline tariffs are not well suited to the short-term capacity release market.
47

Under the traditional ratemaking methodology, the Commission develops a maximum annual transportation rate for each pipeline that, when applied to the pipeline's contract demand and throughput levels, will enable the pipeline to recover its annual cost-of-service revenue requirement. Each pipeline's maximum rates for services of less than a year are simply the maximum annual rate prorated over the shorter period.

46
Order No. 637 at 31,271-75.

47
While the Commission offered pipelines the opportunity to propose other types of rate designs, such as seasonal and term-differentiated rates, only a very few pipelines have sought to make such rate design changes, although many pipelines have taken advantage of negotiated rate authority.

33. Such prorated annual rates bear no relationship to the competitive rates that would be established in the short-term capacity market, particularly during peak periods. The market value of transportation service from the production area to the downstream market may be inferred by comparing the downstream delivered gas price in bundled sales to the market price at upstream market centers in the production area.
48

As the DC Circuit recognized in
INGAA
, “if the difference between field prices and city gate prices in a particular pathway is only $.07, people will not pay more than $.07 for the unbundled transportation.”
49

As discussed in more detail below, the data set forth in Order No. 637 and the updated data in Figures 1 through 3 below concerning the implicit value of transportation in the bundled sales market demonstrates the variability of transportation value in the short-term market and the divergence between the transportation value and cost-of-service rates. This data shows that during most of the year, the value of transportation service is significantly less than the pipelines' annual cost-of-service maximum transportation rates, but during brief, peak demand periods, the value of transportation service is measurably greater than the maximum transportation rates.

48
In Order No. 637, the Commission explained “gas commodity markets now determine the economic value of pipeline services in many parts of the country. Thus, even as FERC has sought to isolate pipeline services from commodity sales, it is within the commodity markets that one can see revealed the true price for gas transportation.” Order No. 637 at 31,274 (
quoting
M. Barcella,
How Commodity Markets Drive Gas Pipeline Values
, Public Utilities Fortnightly, February 1, 1998 at 24-25).

49

INGAA
at 31.

34. Because the existing capacity release price ceiling does not reflect short-term variations in the market value of the capacity, the price ceiling inhibits the efficient allocation of capacity and harms, rather than helps, the short-term shippers it is intended to protect. The price ceiling operates to prevent the shipper most valuing short-term capacity on a peak day from being able to obtain it, because that shipper cannot offer a releasing shipper the full value the shipper places on that capacity. The price ceiling may also reduce the amount of released capacity available during peak periods. As the Commission explained in Order No. 637, “As a result of the maximum rate, firm capacity holders may not find it sufficiently profitable to make their capacity available for release. For instance, a dual fuel industrial customer might determine that it would be more economic not to use gas, and to substitute a different fuel, if it could obtain a sufficiently high price for its released capacity.”
50

Thus, during a peak day the price ceiling may only serve to limit a purchasing shipper's capacity options, with the result that it must purchase gas in a bundled transaction in the downstream market at a price reflecting the market-determined value of the transportation.

50
Order No. 637 at 31,279.

35. The increased use by pipelines and shippers of negotiated rate transactions based on gas price differentials demonstrates that buyers and sellers value the ability to calibrate the price of transportation to its value in the market. The maximum rate ceiling applied to capacity release transactions denies releasing and replacement shippers the same ability to negotiate transactions that reflect the market value of capacity at all times. As the Commission has found, providing the ability to negotiate capacity release transactions based on price differentials will help in providing short-term capacity to replacement shippers, such as gas-fired electric generators.
51

With the price ceiling in effect, releasing shippers are unable to effectively use price differentials as a measure of capacity value because they are denied the ability to recover the value of capacity during peak periods when that value exceeds the maximum rate cap.

51

Standards for Business Practices for Interstate Natural Gas Pipelines
, Notice of Proposed Rulemaking, 71 FR 64,655 (November 3, 2006), FERC Stats. & Regs. Proposed Regulations ¶ 32,609, P 17 (Oct. 25, 2006), Order No. 698, 72 FR 38,757 (July 16, 2007), FERC Stats. & Regs. Regulations Preambles ¶ 31,251 at P 51 (Jun. 25, 2007).

36. The price ceiling also harms captive customers holding long-term contracts on the pipeline. Those customers pay maximum rates for both peak and off-peak periods. During off-

peak periods, they can only recover a small portion of the capacity cost through capacity release because of the low market value of off-peak capacity. However, during peak periods, the price ceiling prevents those customers from releasing their capacity for its full market value.

37. Finally, the price ceiling reduces the dissemination of accurate capacity pricing information. That is because the price ceiling causes transactions to move to the bundled sales market during peak periods, so that there is no separate capacity transaction to be reported.

2. Assurance of Just and Reasonable Rates

38. As the court stated in
INGAA
, the Commission may depart from cost of service ratemaking upon:

A showing that * * * the goals and purposes of the statute will be accomplished ‘through the proposed changes.’ To satisfy that standard, we demanded that the resulting rates be expected to fall within a ‘zone of reasonableness, where [they] are neither less than compensatory nor excessive.’ [citation omitted]. While the expected rates' proximity to cost was a starting point for this inquiry into reasonableness, [citation omitted], we were quite explicit that ‘non-cost factors may legitimate a departure from a rigid cost-based approach,’ [citation omitted]. Finally, we said that FERC must retain some general oversight over the system, to see if competition in fact drives rates into the zone of reasonableness ‘or to check rates if it does not.’
52

52

INGAA
at 31.

Accordingly, we analyze below (1) the extent to which market conditions and other factors may be expected to keep short-term capacity release prices within a reasonable zone despite the removal of the price ceiling, (2) the non-cost factors supporting a removal of the price ceiling, and (3) our oversight of the short-term capacity release market after removal of the price ceiling.

a. Market Conditions Ensure Just and Reasonable Rates

39. The Commission finds that the short-term capacity release market is generally competitive. Therefore competition, together with our continuing requirement that pipelines must sell short-term firm and interruptible services to any shipper offering the maximum rate, and the Commission's ongoing monitoring efforts will keep short-term capacity release rates within the “zone of reasonableness” required by
INGAA
and
Farmers Union
.

40. In Order Nos. 636 and 637, the Commission instituted a number of policy revisions which have enhanced competition between releasing shippers as well as between releasing shippers and the pipeline. These revisions provide shippers with enhanced market mechanisms that will help ensure a more competitive market and mitigate the potential for the exercise of market power. The Commission required pipelines to permit releasing shippers to use flexible point rights and to fully segment their pipeline capacity. Flexible point rights enable shippers to use any points within their capacity path on a secondary basis, which enables shippers to compete effectively on release transactions with other shippers. Segmentation further enhances the ability to compete because it enables the releasing shipper to retain the portion of the pipeline capacity it needs while releasing the unneeded portion. Effective segmentation makes more capacity available and enhances competition. As the Commission explained in Order No. 637:

The combination of flexible point rights and segmentation increases the alternatives available to shippers looking for capacity. In the example,
53

a shipper in Atlanta looking for capacity has multiple choices. It can purchase available capacity from the pipeline. It can obtain capacity from a shipper with firm delivery rights at Atlanta or from any shipper with delivery point rights downstream of Atlanta. The ability to segment capacity enhances options further. The shipper in New York does not have to forgo deliveries of gas to New York in order to release capacity to the shipper seeking to deliver gas in Atlanta. The New York shipper can both sell capacity to the shipper in Atlanta and retain the right to inject gas downstream of Atlanta to serve its New York market.
54

53
In the example used in Order No. 636, a shipper holding firm capacity from a primary receipt point in the Gulf of Mexico to primary delivery points in New York could release that capacity to a replacement shipper moving gas from the Gulf to Atlanta while the New York releasing shipper could inject gas downstream of Atlanta and use the remainder of the capacity to deliver the gas to New York.

54
Order No. 637 at 31,301.

41. In addition to enhancing competition through expansion of flexible point rights and segmentation, the Commission in Order No. 637 also required pipelines to provide shippers with scheduling equal to that provided by the pipeline, so that replacement shippers can submit a nomination at the first available opportunity after consummation of the capacity release transaction. The change makes capacity release more competitive with pipeline services and increases competition between capacity releasers by enabling replacement shippers to schedule the use of capacity obtained through release transactions quickly rather than having to wait until the next day.

42. The data accumulated by the Commission during the Order No. 637 experiment, as well as review of more recent data, confirm that capacity release prices reflect competitive conditions in the industry. On May 30, 2002, the Commission issued a notice of staff paper presenting data on capacity release transactions during the experimental period when the capacity release ceiling price was waived.
55

The staff paper provided analysis of capacity release transactions on 34 pipelines during the 22-month period from March 2000 to December 2001.
56

55
On May 30, 2002, a staff paper was posted on the Commission's web site presenting, and analyzing data on capacity release transactions relating to the experimental period when the rate ceiling on short-term released capacity was waived.

56
Many of these release transactions would have occurred prior to completion of the pipeline's Order No. 637 compliance proceedings and the implementation of the changes to flexible point rights, segmentation and scheduling described above.

43. In brief, the data gathered during the 22-month period show that without the price ceiling, prices exceeded the maximum rate only during short time periods and appear to be reflective of competitive conditions in the industry. The following table shows the distribution of above ceiling price releases among the pipelines studied.

Table I.—Above Cap Releases by Pipeline
[Releases Awarded Between March 26, 2000 and December 31, 2001]

Pipeline

Releases above max rate
(number of transactions)

% of total
releases

Release
quantity above
max rate
(MMBtu/day)

% of total
release
quantity

Algonquin
1
0.1
18,453
0.2

ANR Pipeline
1
0.1
30,000
0.2

CIG
19
6.5
109,984
4.4

Dominion (CNGT)
21
1.0
65,789
0.7

Columbia Gas
101
4.4
374,727
2.7

Columbia Gulf

East Tennessee

El Paso
135
13.3
631,683
12.5

Florida Gas
25
1.7
43,526
1.4

Great Lakes
3
1.3
15,000
0.6

Iroquois

Kern River
2
3.9
55,000
2.5

KMI (KNEnergy)
3
1.0
1,409
0.0

Gulf South (Koch)

Midwestern
1
0.6
50,000
2.3

Mississippi River

Mojave Pipeline Co
1
2.6
40,000
4.7

Natural Gas Pipeline Co
16
3.2
270,489
2.3

Reliant (Noram)

Northern Border

Northern Natural
12
1.6
23,273
0.5

Northwest Pipeline
24
1.8
139,850
4.1

Paiute Pipeline

Panhandle Eastern
1
0.4
1,000
0.1

Southern Natural
7
0.3
24,101
0.2

Tennessee Gas
11
0.4
36,421
0.2

TETCO
122
3.8
645,856
3.3

Texas Gas
6
0.5
103,237
1.0

Trailblazer
3
25.0
15,000
10.0

Transco
183
3.3
1,540,885
4.1

Transwestern
11
4.5
64,058
6.5

Trunkline

Williams
4
0.4
16,500
0.3

Williston Basin

Total
713
2.2
4,316,241
2.1

44. These data show that during periods without capacity constraints, prices remained at or below the maximum rate. The staff paper does identify 713 releases above the ceiling price, representing an average total capacity release contract volume of 4.3 billion cubic feet (Bcf) per day. However, the staff paper reflects that these above-ceiling price releases represented only a small portion of the total releases on these pipelines, comprising approximately two percent of total transactions on the pipelines studied for the entire period, and two percent of gas volumes. Further, above ceiling releases accounted for no more than six or seven percent of transactions during any given month of the period. As one would expect, the percentages of releases occurring above the ceiling increased during peak periods. However, average release rates were higher by only one cent per MMBtu per day or five and one-half percent higher than they would have been with the price ceiling in place. Of the 34 pipelines in the study, 10 reported no releases above the ceiling price, and 20 pipelines reported fewer than 25 above-ceiling price releases. The data gathered during this 22-month period reflects the Commission's expectations and affirms the Commission's findings in the Order No. 637 proceeding. As the court stated in
INGAA:

The data represented in the graph [ ] do support the Commission's view that the capacity release market enjoys considerable competition. The brief spikes in moments of extreme exigency are completely consistent with competition, reflecting scarcity rather than monopoly. * * * [citation omitted] A surge in the price of candles during a power outage is no evidence of monopoly in the candle market.
57

57

INGAA
at 32.

45. The Commission has gathered additional current data and has replicated the evidence presented in Order No. 637. The current data shows that the conditions that existed at the time of Order No. 637 and during the past experimental period continue in today's marketplace.

46. For example, Figure 1 illustrates the fluctuations in the market value of transportation service, as shown by the basis differentials between Louisiana and New York City. This graph compares the daily difference in gas prices between Louisiana and New York City to Transcontinental Gas Pipe Line Corporation's maximum interruptible transportation rate, including fuel retainage, during the 12 months ending July 31, 2007. This graph shows that for most of the year, the value of transportation service, as indicated by the basis differentials, is less than the maximum transportation rate. However, during brief, peak demand periods, the value of transportation service is measurably greater than the maximum transportation rate. For example, on

February 5, 2007, the basis differential between Louisiana and New York City was in excess of $27.00 per MMBtu, while the maximum tariff rate plus the cost of fuel was approximately $1.08 per MMBtu.
58

58
In Order No. 637, the Commission presented similar data in figure 6 showing the implicit transportation value between South Louisiana and Chicago. Order No. 637 at 31,274.

BILLING CODE 6717-01-P

ER30JN08.020

47. Figures 2 and 3 below reflect that a similar pattern of transportation value is evident in other areas of the country. Focusing on fluctuations in the market value of transportation service as shown by basis differentials between Louisiana and Chicago and between the Permian Basin and the California border, respectively, these figures show that for most of the year, the value of transportation service is less than the maximum transportation rate of Natural Gas Pipeline Company of America and El Paso Natural Gas Company, respectively. However, similar to figure 1, these figures also reflect that during brief peak-demand periods the value of transportation service is measurably greater than the maximum transportation rate.

ER30JN08.021

ER30JN08.022

BILLING CODE 6717-01-C

The data in all three of the above figures reflect similar market conditions to the data that the Commission relied upon in lifting the price ceiling for short-term capacity releases in Order No. 637, with the market value of capacity generally below the pipeline's maximum rate except for relatively brief price spikes.
59

In affirming the Commission's actions, the court in
INGAA
found that the data presented by the Commission constituted a substantial basis for the conclusion that a considerable amount of competition existed in the capacity release market. Further, the
INGAA
court concluded that the price spikes reflected in the data were consistent with competition and that such spikes reflected scarcity rather than monopoly power.
60

59
Order No. 637 at 31,273-75.

60

INGAA
at 31-32.

b. Recourse Rate Protection

48. Moreover, the Commission is not relying only on a competitive market to ensure just and reasonable rates. The pipeline's maximum rates for short-term firm and interruptible services serve as recourse rate protection for negotiated rate transactions,
61

and will provide the same protection to replacement shippers by giving them access to a just and reasonable rate if the releasing shipper seeks to exercise market power.
62

As the Commission explained in Order No. 637:

61

Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines
, 74 FERC ¶ 61,076,
reh'g denied
, 75 FERC ¶ 61,024 (1996),
petitions for review denied sub nom., Burlington Resources Oil & Gas Co.
v.
FERC
, 172 F.3d 918 (DC Cir. 1998).
See also Natural Gas Pipelines Negotiated Rate Policies and Practices; Modification of Negotiated Rate Policy
, 104 FERC ¶ 61,134 (2003),
order on reh'g and clarification
, 114 FERC ¶ 61,042, order
dismissing reh'g and denying clarification
, 114 FERC ¶ 61,304 (2006). As the Commission explained in its negotiated rate policy statement, “[t]he availability of a recourse service would prevent pipelines from exercising market power by assuring that the customer can fall back to traditional cost-based service if the pipeline unilaterally demands excessive prices or withholds service.” 74 FERC ¶ 61,076 at 61,240 (1996).

62
The pipeline is obligated to sell capacity at the just and reasonable rate.
Tennessee Gas Pipeline Co.
, 91 FERC ¶ 61,053 (2000),
reh'g denied
, 94 FERC ¶ 61,097 (2001),
petitions for review denied sub nom., Process Gas Consumers Group
v.
FERC
, 292 F.3d 831, 837 (
DC
Cir. 2002).

The Commission is continuing to protect against the possibility that, in an oligopolistic market structure, the pipeline and firm shipper will have a mutual interest in withholding capacity to raise the price because the Commission is continuing cost based regulation of pipeline transportation transactions. The pipeline will be required to sell both short-term and long-term capacity at just and reasonable rates. In the short-term, a releasing shipper's attempt to withhold capacity in order to raise prices above maximum rates will be undermined because the pipeline will be required to sell that capacity as interruptible capacity to a shipper willing to pay the maximum rate. Shippers also have the option of purchasing long-term firm capacity from the pipelines at just and reasonable rates.
63

63
Order 637 at 31,282.

49. The court in
INGAA
similarly recognized the value of the pipeline's recourse rate protecting against possible abuses of market power by releasing shippers stating that:

[i]f holders of firm capacity do not use or sell all of their entitlement, the pipelines are required to sell the idle capacity as interruptible service to any taker at no more than the maximum rate—which is still applicable to the pipelines.
64

64

INGAA
at 32.

c. Short-Term Customers Are Not Captive

50. The releasing shippers' ability to exercise market power in the short-term capacity release market also is limited because short-term customers are not captive, even if only connected to one pipeline. Short-term customers, those using interruptible or short-term firm pipeline service or relying on capacity release transactions, are by the very nature of the service for which they are contracting, expressly taking the risk that they may have to forgo the use of gas entirely if short-term capacity is too expensive, or not available, when they need it.
65

Thus, short-term shippers always have the option simply not to take service, if the price demanded is above competitive market levels.

65
Order No. 637 at 31,285, 31,336-42.

d. Non-Cost Factors

51. Removal of the price ceiling on short-term capacity release transactions provides a number of advantages which “offset whatever harm the occasional high rate might entail.”
66

Most importantly, removal of the price cap permits more efficient utilization of capacity by permitting prices for short-term capacity releases to rise to market clearing levels, thereby permitting those who place the highest value on the capacity to obtain it. Removal of the price ceiling also will provide potential customers with additional opportunities to acquire capacity. Without the price ceiling, firm capacity holders will have a greater incentive to release capacity during times of scarcity, because they will be able to obtain the full market value of the capacity.
67

Therefore, a shipper needing gas on a peak day will have a greater opportunity to obtain the capacity it needs from a firm capacity holder, instead of having only the choices of purchasing a bundled sale or taking gas out of the pipeline and paying the pipeline's scheduling or overrun penalties.
68

Thus, removal of the price ceiling benefits short-term shippers because the shipper placing a high value on the capacity has a greater assurance of obtaining the capacity it needs than it does under a price cap where that shipper may be unable to obtain any capacity.

66

INGAA
at 33.

67
For example, an LDC shipper may hold capacity on one or more pipelines and have access to storage and peak shaving facilities. Using these facilities may cost the LDC more to deliver gas than purchasing gas in the upstream markets and using its transportation capacity to transport that gas to the city gate. However, the LDC might be willing to release its transportation capacity and use its peak shaving device instead if it could receive a price above the maximum rate for its transportation capacity so that the price it receives will cover the costs of the peak shaving device. Order No. 637 at 31,277.

68
Order No. 637 at 31,280;
INGAA
at 34.

52. Second, even if replacement shippers do end up paying higher prices for capacity during peak periods than they did with the regulated rate in effect, it is appropriate for shippers using the system only during peak periods to pay higher prices reflecting the greater demand on the system. Short-term shippers currently receive the benefit of paying reduced capacity release prices during off-peak periods but face a cap on the market price during peak periods. Removal of the price ceiling on short-term capacity releases will ensure that those shippers that receive the benefit of lower market prices during off-peak periods face the higher market prices during peak periods.

53. Third, removing the price ceiling on short-term capacity releases should benefit the “primary intended beneficiaries of the NGA—the `captive' shippers”
69

by removing the regulatory bias built into the current rate structure. Those shippers typically have long-term firm contracts with the pipeline. Long-term shippers pay the same rate for capacity during both peak and off-peak periods. During off-peak periods they can recover only a small portion of their capacity cost through capacity release, because the market value for release capacity is generally quite low due to the reduced demand for capacity and the increased availability of released capacity. But during peak periods, the price cap limits long-term captive customers (who cannot make bundled sales) from receiving the full market value of their capacity. Long-term shippers pay for the largest proportion of the pipeline's fixed costs through their annual reservation charges, and

permitting them to receive more revenue from capacity release during peak periods will help them defray those costs. In short, the captive customers will “continue to receive whatever benefits the rate ceilings generally provide,” while also “reaping the benefits of [the] new rule, in the form of higher payments for their releases of surplus capacity.”
70

69

INGAA
at 33.

70

Id
.

54. Finally, by providing more accurate price signals concerning the market value of pipeline capacity, removal of the price ceiling for short-term capacity releases will promote the efficient construction of new capacity by highlighting the location, frequency, and severity of transportation constraints. Correct capacity pricing information will also provide transparent market values that will better enable pipelines and their lenders to calculate the potential profitability and associated risk of additional construction designed to alleviate transportation constraints.

e. Oversight

55. The reporting requirements in Order No. 637 and the Commission's implementation of the Energy Policy Act of 2005, specifically with respect to market manipulation, provide the Commission with enhanced ability to monitor the market and detect and deter abuses.

56. Order No. 637 improved the Commission's and the industry's ability to monitor capacity release transactions by requiring daily posting of these transactions on pipeline Web sites.
71

This has increased the information available to buyers while at the same time making it easier for the Commission to identify situations in which shippers are abusing their market power.
72

Further, the Commission will entertain complaints and respond to specific allegations of market power on a case-by-case basis if necessary. Furthermore, the Commission directs staff to monitor the capacity release program and, using all available information, issue a report on the general performance of the capacity release program, within six months after two years of experience under the new rules.

71
18 CFR 284.8 (2007).

72
Order No. 637 at 31,283; Order No. 637-A at 31,558.

3. Comments

57. The vast majority of comments support the removal of the price ceiling for capacity release transactions. But some commenters have raised limited concerns.

a. Lack of Competition in Certain Areas

58. A few commentors have alleged that certain discrete portions of the short term capacity release market may not be competitive at all times. For example, Arizona Public Service states that the transportation markets served by El Paso Natural Gas Company (El Paso) located east of California are not currently competitive. It asserts that during the 2000-2002 California energy crisis, when the Commission had lifted the price cap on short term capacity releases, prices of releases of El Paso capacity spiked to levels in excess of $20 per Dth. Honeywell similarly argues that the Commission has failed to address the fact that many geographical areas do not operate as a free market and that areas in the Northeast, East, and Southwest portions of the country faced constrained capacity and difficulties in building new pipeline facilities. Honeywell argues that lifting the price cap on short term capacity release will only exacerbate prices while not addressing the underlying problem of these constrained markets. In addition, some end-users of gas express concerns about the concentration of capacity ownership on lateral pipelines and therefore argue that the Commission should either not remove the price cap for laterals or do so on a case-by-case basis, after a review of market concentration and a demonstration that the releasing shipper does not have market power on the lateral.
73

73
Weyerhaeuser, NWIGU, and PGC.

59. While the Commission has not conducted a detailed market analysis for each discrete area of the interstate pipeline grid, the data previously discussed shows that the short-term capacity release market is generally competitive. Indeed, with respect to the El Paso market, the data in Table 1 shows that during the period March 26, 2000 to December 31, 2001, which included the California energy crisis referred to by APS, only 12.5 percent of the total volume of capacity released on El Paso was released at prices above the maximum rate. Moreover, the updated data in Figure 3 for August 2006 through July 2007 shows that the market value of transportation service from the Permian Basin to the California border was less than El Paso's maximum transportation rate, except during brief, peak-demand periods when the value of transportation service was somewhat greater than the maximum transportation rate. Similar data for deliveries to East of California markets on El Paso's South Mainline reflects the same overall pattern, as shown in the following graph.
74

74
The data for this chart comes from ICE, an on-line electronic trading platform. The El Paso South Mainline area is described on ICE as: El Paso-South Mainline—buyers' choice west of Cornudas.

BILLING CODE 6717-01-P

ER30JN08.023

BILLING CODE 6717-01-C
60. Similarly, while Honeywell suggests that capacity is constrained in areas in the East and Northeast, the data in Figure 1 shows that for most of the year the value of transportation service from Louisiana to New York City is less than the maximum transportation rate on Transco, with only brief spikes above that level during peak demand periods.

61. These data are consistent with the proposition that prices will exceed the maximum rate only during periods of constraint. Moreover, it is precisely for these reasons that the Commission is continuing to insist on the maintenance of the pipeline's recourse rate as protection against the exercise of market power. Even on laterals or other parts of the pipeline grid where all firm capacity may be held by only a few or one firm shipper, those shippers cannot withhold their capacity in order to charge a price above competitive levels. The pipeline's cost-based interruptible rate is always available as an alternative when a releasing shipper attempts to withhold its capacity. For example, assume that a releasing shipper with available capacity on a little used lateral seeks to exercise market power by withholding capacity unless a potential replacement shipper pays a higher than justified rate. If market demand for capacity at that rate does not exist,
75

the replacement shipper has the option of turning down the deal and purchasing the capacity from the pipeline at the just and reasonable interruptible rate.

75
In other words, the market is not constrained.

62. NEM remains concerned that in spite of the Commission's finding that the short term capacity release market is competitive, market power may exist for some market participants resulting in historically high natural gas prices reaching even higher levels. However, the data reflects the competitive nature of the short term capacity release market and the safeguards that the Commission employs in the instant Final Rule to mitigate any residual market power. The Commission accordingly finds that NEM's speculative concerns are unwarranted.
76

76
NEM also posits that the lifting of the short term capacity release market price ceiling in states where LDCs are required to release their capacity to marketers as part of a state retail unbundling program will place the marketer in a position where they would no longer be guaranteed the same underlying capacity costs as if the capacity had remained with the utility, and this could increase the costs the marketers must pass on to their state retail customers. To the extent that this feature causes problems in states where capacity release assignments are a mandatory part of a state retail unbundling program, the Commission would expect that the State would consider this in its policies.

b. Benefits From Removing the Price Ceiling

63. Tenaska contests some of the benefits the Commission has cited for removing the price ceiling. It argues there will be no overall increase in allocative efficiency from removal of the short term release price cap. It asserts that capacity that is in excess to the current capacity holder's needs already finds it way to those who value it more by a variety of means, including bundled downstream sales, short and long term capacity releases, and pipeline sales of short-term firm and interruptible service. It also argues that releasing shippers with excess capacity are more likely to release that capacity over a longer term, perhaps multiple years, rather than speculate that it could profit by making very short-term releases during peak period price spikes. It states that releases over relatively long term with few exceptions allow the releasing shipper to realize its full market value without being constrained by maximum pipeline rates.
77

77
Tenaska explains, “[c]apacity that basis markets show to be worth more than the applicable pipeline maximum rate in the prompt month will almost always drop in value to a level below that maximum rate at some future point. Such capacity can be sold for its full value within the pipeline maximum rate cap simply by extending the term.” Tenaska comments at 4-5.

64. Rather than undercutting the removal of the price cap, Tenaska's argument that releasing shippers can now avoid the price ceiling by making gas sales (in effect bundled sales of gas and transportation) supports our determination. Shippers may well find that releasing transportation alone is far more efficient than making a bundled sales transaction, and therefore, removal of the price ceiling will serve only to promote efficiency with negligible effect, if any, on price levels. Similarly, requiring shippers to execute long-term contracts in order to effectuate short-term transactions is inefficient, and would mask more accurate short-term price signals. Moreover, as discussed earlier, releasing and replacement shippers want to contract based on price differentials between markets even when such differentials exceed the maximum rate, and executing long term contracts at some approximate capped rate would not achieve that goal.

65. Tenaska also argues that holders of long term pipeline contracts, that are “net long” compared to their actual capacity needs will be the only shippers to benefit. Market participants that are “net short” hold less capacity than they need and choose to match some portion of their demand with short term services and delivered gas purchases rather than to rely exclusively on long term pipeline contracts. Tenaska argues that the effect of the removal of the short term release rate cap, if there is any effect on reallocation of capacity at all, will be a transfer of value from net short companies to net long companies and states that there will be no net market benefit of the type the Commission must show to justify the proposed removal of the cap.

66. Tenaska ignores the fact that “net short” holders of capacity under its scenario will benefit from the removal of the price cap from short term capacity release because they may be able to gain access to capacity in a constrained market that they could not if the price cap remained. A releasing shipper, subject to a rate ceiling, may well hold onto capacity if the maximum rate is less than its opportunity cost, such as using an alternative fuel, using expensive storage, or conservation of gas.
78

Moreover, the fact low load factor “net long” holders of capacity of the type described by Tenaska can profit from above-cap short term releases is one of the benefits of removing the short-term price cap.

78
Order No. 637 at 31,554.

c. Promotion of Construction

67. Honeywell argues that the Commission has failed to show that more accurate price signals concerning the value of pipeline capacity will, in fact, promote construction of needed capacity. First, higher prices should serve as price signals indicating where capacity shortages exist and where potentially profitable construction can take place. If prices are “exacerbated” as Honeywell argues, replacement shippers paying such prices have every incentive to go to the pipeline and support economically efficient construction to rectify the shortage. While political and environmental obstacles are also a factor in construction, this factor has not stymied construction. The Commission has processed a large number of certificate applications for new construction of capacity, storage, and liquefied natural gas terminals in every region.
79

Third, providing incentives for new construction is not the only benefit of removing the price ceiling. As discussed earlier, removal of the price ceiling will benefit the market even in the short term by providing for a more efficient allocation of capacity to those who value that capacity.

79
In 2007 alone, approximately 34 major pipeline projects were authorized by the Commission which was comprised of approximately 2,782 miles of pipeline, 850 thousand horsepower of compression and the capacity to transport some 23,000 million MMd/t of gas. See the “2007” data at
http://www.ferc.gov/industries/gas/indus-act/pipelines/approved-projects.asp.
See similar data for storage at
http://www.ferc.gov/industries.asp
and liquefied natural gas terminals at
http://www.ferc.gov/industries/lng.asp.

d. Changed Circumstances

68. Tenaska and APS argue that even if the Commission's conclusion that all pipeline capacity release markets are competitive is supportable at this time, circumstances could change dramatically in this industry. As a result, they assert that the Commission must include a process for promptly revisiting its determination that the market is competitive if there is evidence that the market is dysfunctional. Honeywell also states that the Commission also proposes to blind itself for almost three years to any problems in the capacity release market by directing its staff to issue a report within six months after gaining two years of experience under the new rules.

69. As set forth above, we are maintaining oversight over the market and can act if market power is being abused in particular circumstances. Order No. 637 improved the Commission's and the industry's ability to monitor capacity release transactions by requiring daily posting of these transactions on pipeline Web sites.
80

This has increased the information available to buyers while at the same time making it easier for the Commission to identify situations in which shippers are abusing their market power.
81

Such information allows the Commission to monitor, with the assistance of all industry participants, the overall competitiveness of the market including discrete portions of the market that may not be competitive at all times. Moreover, the Commission will entertain complaints and respond to specific allegations of market power on a case-by-case basis if necessary. This action will also guard against the use of market power by any market participant.

80
18 CFR 284.8 (2007).

81
Order No. 637 at 31,283; Order No. 637-A at 31,558.

70. Further, Honeywell misreads the Commission's directives and intent when it claims the Commission has voluntarily blinded itself to market forces for some three years. While the Commission directs its staff to monitor the capacity release program and issue a report on the general performance of the capacity release program within six months after two years of experience under the new rules, nothing in this directive precludes staff from alerting the Commission to any irregularities in the capacity release market before it issues its general report.

71. Moreover, while Tenaska refers to the Commission lifting of the short term price cap as permanent, and notes that the
INGAA
court reviewed a proposal by the Commission to lift the price ceiling only on a temporary basis, it is important to note that, although the Commission will remove the price ceiling on short term capacity releases it will monitor the capacity release market and review its staff's report on the effects of the new rule and the overall functioning of the capacity release market.

e. Exemption From Bidding for Short-Term Releases at the Maximum Rate

72. The NGSA and others request that the Commission continue to allow market participants to enter into a pre-arranged capacity release transaction without bidding for releases of capacity with a term of a year or less as long as those releases are made at the pipeline's maximum tariff rate. NGSA asserts that prearranged releases at the pipeline's maximum rate without the competitive bidding requirement have been proven to provide significant market benefits and should not be eliminated, solely

because the Commission removes the rate cap on short-term capacity release transactions.

73. The reason for the prior exemption from bidding for pre-arranged capacity release transactions at the maximum rate was based solely on the fact that with the rate cap in place, no one could submit a higher bid and win the capacity. As discussed earlier, one of the reasons for removing the price ceiling for short-term releases is to ensure that capacity is allocated to the shipper that values it the most. NGSA has not provided a sufficient justification for permitting shippers to consummate a capacity release at the maximum rate when another potential shipper places a greater value on that capacity.

B. Removal of Price Ceiling for Long-Term Releases

74. Several commenters to the NOPR request that the Commission remove the price ceiling on long-term capacity releases in addition to eliminating the price ceiling on short-term capacity releases.
82

These commenters assert that the same arguments that support removal of the price cap for short-term capacity releases apply equally to lifting the price cap for long-term capacity releases. For example, commenters argue that lifting the price ceiling on long-term capacity releases would increase liquidity and competition in the market for capacity release and primary pipeline capacity, thereby promoting the goals of allocative efficiency. Moreover, commentors assert that lifting the price cap on long-term capacity releases will promote the construction of additional pipeline capacity by providing more accurate price signals reflecting the value of such capacity.

82

See, e.g.,
Comments of Allegheny Energy Supply Co. (Allegheny), Duke Energy, Dynegy Marketing and Trade (Dynegy), and Southwest .

75. Commentors also point out that the Commission's concern over replacement shippers being “locked in” to high price long-term contracts is misplaced because such releases of capacity would likely be priced using basis differentials at different price index locations.
83

Other commentors such as Duke assert that the Commission's concerns are misplaced because replacement shippers accepting such multi-year deals are sophisticated market participants capable of negotiating fair agreements.

83

See e.g.,
Comments of Southwest at 10; Allegheny at 6-7.

76. Allegheny argues that the pipelines' recourse rates will serve as a check on over-priced long-term capacity releases because replacement shippers would have the ability to negotiate for capacity from a pipeline at the recourse rate if the releasing shippers were seeking excessive prices. Allegheny also points to the Commission's reporting requirements, complaints process, and enhanced civil penalty authority as additional safeguards against the exercise of market power.

77. Several commenters support the retention of the price ceiling on long term capacity releases and argue that it protects customers from being locked into a long term contract without price cap protection, that the price cap provides protection against possible abuse of market power and that removal of the price cap for long term capacity releases does not provide the efficiency gains provided by the removal of the price ceiling on short term capacity release.
84

84

See, e.g.,
Comments of NJNG at 33, OIPA at 3, Statoil at 14, Weyerhaeuser at 11.

78. In this instant Final Rule, the Commission will not extend the removal of price ceilings to long term releases as urged by these commentors. The data discussed above indicate only that removal of the price cap for short-term releases is needed to reflect market values. The Commission removed the price ceiling to permit shippers to quickly align their capacity prices with the fluctuating short term market for capacity releases. Such flexibility is not relevant to long-term releases.

79. Limiting this rulemaking to short-term transactions is a reasonable response to the circumstances the Commission is trying to address,
i.e.,
short term price spikes. Only under these conditions do Commission-approved maximum rates prevent the market from rationally allocating scarce capacity to those shippers who value it most. Removing the price cap only for short-term transactions allows a more efficient market-driven allocation of capacity during those brief peak demand periods, and provides more detailed price signals to the market on the value of peak capacity, while retaining valuable consumer protections provided by the price ceiling for longer term transactions. The Commission's policy emphasis in this rule is on short-term transactions, because that is where there is a problem to be solved. No commenter has made a convincing argument that price ceilings on longer term transactions create significant allocative inefficiencies or market failures. Accordingly, the Commission concludes that the current record does not warrant removal of the price ceiling on long-term capacity releases.

80. Moreover, as we said in the NOPR,
85

limiting the release to one year will not prevent the releasing and replacement shipper from continuing an index-based release past one year, because they could repost the release for another year, and the price ceiling would not apply to the release. However, such reposting provides additional assurance to the market that capacity will be allocated to those who value it the most. Any transaction in which the parties want to continue the release past one year would have to be re-posted for bidding to ensure that the capacity is allocated to the highest valued use.
86

This bidding process could provide an opportunity for re-determining the current market value of the capacity.

85
NOPR at P 44-45.

86
As discussed below, however, short term capacity releases made in context of an AMA need not be re-posted for bidding at the end of their term.

C. Removal of Price Ceiling for Pipeline Short-Term Transactions

81. Pipelines request that the Commission remove the price ceiling for short-term primary pipeline capacity whether firm or interruptible. In sum, the Interstate Natural Gas Association of America (INGAA) and the commenting pipelines argue that if the Commission lifts the price cap for short-term capacity releases, it should also lift the price cap for primary pipeline capacity.
87

87

See e.g.,
Comments of Boardwalk, Spectra Energy Transmission, LLC and Spectra Energy Partners, LP (Spectra), and Williston Basin Interstate Pipeline Co. (Williston Basin).

1. Removal of the Price Ceiling Is Not Justified

82. The Commission declines to remove the ceiling from short-term pipeline capacity. In the Alternative Rate Design Policy statement, we offered the pipelines the flexibility to exceed the price cap in one of two ways: either pipelines can make a filing with appropriate information to establish the market is competitive or pipelines can negotiate rates as long as the shipper has the option of purchasing capacity at the recourse (maximum) tariff rate.
88

These two approaches assured shippers that the pipelines were not exercising market power. The pipelines request for lifting the maximum rate on short-term releases would effectively negate the recourse rate protection we included in the negotiated rate program.

88

Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines and Regulation of Negotiated Transportation Services of Natural Gas Pipelines,
74 FERC ¶ 61,076 (1996).

83. Our action here is designed to permit releasing shippers some of the

same flexible pricing authority the Commission has already granted pipelines through the negotiated rate program. But, as discussed earlier, the Commission is retaining the maximum rate ceiling on pipeline capacity because it acts as the recourse rate for both pipeline transactions as well as release transactions. Removing the rate ceiling for pipeline transactions would therefore remove an important protection both for pipeline customers and for replacement shippers on capacity release transactions.

84. In addition, pipelines are the principal holders of capacity. As the court recognized in
INGAA
:

There seems every reason to suppose that [releasing shipper] ownership of such capacity (in any given market) is not so concentrated as that of the pipelines themselves—the concentration that prompted Congress to impose rate regulation in the first place.

Here, the distinction between pipelines and other holders of unused capacity, based on probable likelihood of wielding market power, seems to us to pass muster.
89

89

INGAA
at 35.

85. Unlike releasing shippers, the pipeline holders of primary capacity have a greater ability to exercise market power by withholding capacity and not constructing facilities. Because pipelines are in the best position to expand their own systems, cost-of-service rate ceilings help to ensure that pipelines have appropriate incentives to construct new facilities when needed. As the Commission found, “the only way a pipeline [can] create scarcity to force shippers to accept longer term contracts would be to refuse to build additional capacity when demand requires it.”
90

As long as cost-of-service rate ceilings apply, however, “pipelines [will] have a greater incentive to build new capacity to serve all the demand for their service, than to withhold capacity, since the only way the pipeline could increase current revenues and profits would be to invest in additional facilities to serve the increased demand.”
91

Similarly, as long as pipeline short-term services are subject to a cost of service rate, the pipelines will not limit their construction of new capacity to meet demand in order to create scarcity that increases short-term prices. Indeed, releases at prices above the maximum rate will indicate that pipeline capacity is constrained and demonstrate that constructing additional capacity could be profitable.

90

Regulation of Short-Term Natural Gas Transportation Services,
101 FERC ¶ 61,127, at P 12 (2002),
aff'd, American Gas Ass'n
v.
FERC,
428 F.3d 255 (
DC
Cir. 2005).
See also Tennessee Gas Pipeline Co.,
91 FERC ¶ 61,053 (2000),
reh'g denied,
94 FERC ¶ 61,097 (2001), aff'd, 292 F.3d 831 (
DC
Cir. 2002).

91

Id.

86. Further, pipelines already have significant pricing discretion. As discussed above, pipelines can enter into negotiated rate transactions above the maximum rate. Pipelines also may seek market-based rates by making a filing with the Commission establishing that they lack market power in the markets they serve.
92

In addition, pipelines have the ability to propose seasonal rates for their systems, and therefore, recover more of their annual revenue requirement in peak seasons.
93

The proposed rule is designed solely to give releasing shippers some of the same flexibility enjoyed by the pipelines, subject to the same recourse rate protection. But removing the ceiling price from the release market does not justify removing all regulatory protections applicable to the primary capacity holder.

92

Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines and Regulation of Negotiated Transportation Services of Natural Gas Pipelines,
74 FERC ¶ 61,076 (1996).

93

See
Order No. 637 at 31,574-81.

2. Response to Specific Comments

a. Evidentiary Record

87. INGAA states that the same evidentiary record relied upon by the Commission to propose lifting the ceiling on capacity releases reflects that the entire market, including short-term pipeline services, is competitive, and therefore contends that the Commission should lift the rate ceilings on the entire short-term market. Spectra adds that the evidence cited by the Commission supports the existence of competition by all participants in the single market for short-term capacity, not just competition in the capacity release sector of the overall market. INGAA asserts that if the market is competitive, the identity of the seller should be irrelevant.

88. As we have explained above, while the data indicates that the short-term secondary market is competitive in general, we have not made a finding that every segment of every pipeline is competitive; we retained the recourse rate as a protection against the potential exercise of market power by both pipelines and releasing shippers in those cases in which the market may not be competitive. While the purpose of capacity release, segmentation, and flexible point rights is to encourage competition between the pipeline's sale of its own capacity and capacity release, and those policies have successfully created a robust secondary market as demonstrated by the data discussed earlier in this rule, that does not necessarily mean that every pipeline faces competition in the sale of its short-term capacity on all segments of its system. For example, the Commission's selective discounting policy permits pipelines to restrict a shipper's discount to specific points, so that the shipper must pay the pipeline's maximum rate if it releases the capacity to a replacement shipper who uses different points where the pipeline faces less competition.
94

This may reduce that shipper's incentive to release its capacity to a replacement shipper who will use points on a segment with less competition.
95

Retaining the recourse rate helps protect against the pipeline's abuse of market power in the sale of capacity on any such segments of its system.

94

Williston Basin Interstate Pipeline Co.,
110 FERC ¶ 61,210 at P 22,
order on reh'g,
112 FERC ¶ 61, 038 (2005). These orders responded to a decision by the United States Court of Appeals for the District of Columbia Circuit in
Williston Basin Interstate Pipeline Co.
v.
FERC,
358 F.3d 45 (
DC
Cir. 2004) (
Williston
), vacating orders in an Order No. 637 compliance proceeding permitting releasing shippers to retain primary point discounts when their replacement shippers used different points. The
DC
Circuit held that the policy could undermine the benefits of selective discounting, stating that “economic theory tells us price discrimination, of which selective discounting is a species, is least practical where arbitrage is possible—that is, where a low price buyer can resell to a high price buyer * * * yet this is precisely what the Commission's policy would appear not only to allow but to encourage.” 358 F.3d at 50 (cite omitted).

95
In addition, a particular shipper's incentive to release capacity in competition with the pipeline could be reduced, if its discounted or negotiated rate agreement contains a provision, as permitted by Commission policy, providing that the pipeline will share any revenues the shipper receives from a capacity release in excess of its discounted or negotiated rate.
See LSP Cottage Grove, L.P.
v.
Northern Natural Gas Co.,
111 FERC ¶ 61,108 at P58-59 (2005), and cases cited.

89. Further, the repercussions of removing price ceilings for pipeline transactions are more serious than for released capacity, because the exercise of market power by pipelines could reduce the total amount of primary pipeline capacity available to the market. Finally, to the extent pipelines believe their markets are competitive, they have a full opportunity to make a filing with the Commission to obtain market based rates based on a showing of lack of market power.
96

96
Pipelines so far have not been successful in demonstrating that their major markets are competitive.
See e.g., Gas Transmission Northwest Corp.,
119 FERC ¶ 61,288 (2007);
Koch Gateway Pipeline Co.,
85 FERC ¶ 61,013 (1998),
order on reh'g,
89 FERC ¶ 61,046 (1999).

b. Infrastructure Incentives

90. INGAA alleges that maintaining cost-based recourse rates for pipelines is not required to preserve an incentive for pipelines to construct needed pipeline infrastructure. It asserts this runs counter to the general presumption that market-based rates send the proper signals as to whether new pipeline construction is needed and can be constructed economically. In their comments, INGAA and Spectra argue that pipelines actually compete to build new capacity, and that there is no reason to assume that non-pipeline investment will not fill any void caused by pipelines withholding capacity.
97

97
Spectra also argues that the Commission should remove the price caps for pipeline short-term firm and interruptible capacity, and suggests that to the extent the Commission retains its concerns regarding withholding of capacity, the Commission could retain the price caps for interruptible service. Spectra further argues that this action would provide shippers with a recourse alternative that would be available if the pipeline attempted to withhold short-term firm capacity or the releasing customer tried to withhold short-term release capacity.

91. Neither INGAA nor Spectra have shown that the entry barriers to constructing capacity on existing pipeline rights of way are so low that there is effective competition. Moreover, they have the opportunity to present any such detailed evidence in a proceeding seeking to show that they do not have market power, and other parties would have an opportunity to challenge such evidence. This is not a finding we can make on a generic basis in this proceeding.

c. Competitive Market Structure

92. INGAA asserts that the Commission's concern that pipelines own more pipeline capacity than their firm shippers is based on a pre-restructuring, pre-open access view of the industry, and not based on any empirical study of pipeline market power. Moreover, INGAA and Spectra assert that control of the short-term market is now primarily in the hands of pipelines' firm shippers, which have substantial rights such as capacity release, flexible point rights and segmentation rights. These shipper rights produce a competitive short-term market that cannot reasonably be bifurcated based on the identity of the seller. INGAA and Spectra state that the Commission should focus its concern not on formal ownership, but rather on the entity that controls access to or use of the capacity.

93. Spectra points out that a check on prices is not needed to prevent the exercise of market power because sufficient safeguards—in the form of competition between shippers seeking to release or acquire capacity in the short-term markets, as well as the competition between shippers and pipelines themselves—will protect the market from abuse. Further, Spectra asserts that construction of new capacity, the open access tariff, reporting and posting requirements, and the Commission's oversight and enforcement authority will also serve as added safeguards.

94. However, as the Court of Appeals found, these arguments are comparing “apples and oranges.”
98

First, the available capacity of the pipeline is on hand and ready to be sold, whereas the capacity held by releasing shippers is not necessarily available, since much of it may be needed to serve its native loads:

98

INGAA
at 24.

The petitioning pipelines assert that pipelines hold only about 7% of pipeline transportation capacity, while shippers hold the remaining 93%. This is classic apples and oranges. The Commission points out that whereas the uncontracted capacity of a pipeline is presumptively available for the short-term market, no such presumption makes sense for the non-pipeline capacity holders: they presumably contracted for the capacity in anticipation of actually using it.
99

99

Id.
In addition, as previously discussed, there may be circumstances in which shippers' discounted or negotiated rate agreements contain provisions that have the effect of reducing competition from capacity release on some segments of the pipeline.

Second, using the market shares for already existing capacity does not reflect the more important relationship of the price ceiling to construction of new capacity infrastructure which is far more critical to ensuring that the pipeline grid is expanded to meet demand. Because the pipelines are the principal parties constructing additional capacity, it is crucial that their incentive to build is not diluted by the ability to earn scarcity rents in the short-term market.

d. Differences in Flexibility Between Pipeline Capacity and Released Capacity

95. INGAA and the pipelines argue that the pricing flexibility available to the pipelines does not allow pipelines to compete with shippers offering short-term capacity releases without a price ceiling. They argue that market-based pricing for pipelines is subject to a strenuous market-power test that involves lengthy and costly administrative proceedings. They argue that the Commission rarely finds that a pipeline meets this market-power test, and therefore it is impractical for pipelines to engage in competition with capacity releases.
100

100

INGAA
at 12
(citing, KN Interstate Gas Transmission Co.,
76 FERC ¶ 61,134 (1996); and
Rendezvous Gas Services, LLC,
112 FERC ¶ 61,141, at 61,792-94 (2005)). Spectra notes that the Commission has never approved market based rates for a major natural gas pipeline. Spectra comments at 24.

96. In regard to negotiated rates, the pipelines argue that their flexibility is limited because the maximum rate is always subject to the shipper's right to elect the recourse rate, and implementation is subject to regulatory delays. INGAA and Williston also argue that the negotiated rate program offers pipelines very little, if any, opportunity to employ market-based pricing to efficiently allocate capacity to those who desire it most.

97. Third, INGAA asserts that seasonal rates do not provide the flexibility necessary to address the pipelines' competitive disadvantage under the Commission's proposal because seasonal rates result in new recourse rates, capped at the pipeline's annual revenues, not the ability to charge rates in excess of recourse rates. Spectra adds that seasonal rates do not allow pipelines to award the capacity to the customers who value it most because there is still a maximum rate. In addition, Spectra notes that pipelines are unable to respond to market signals in the short-term market using seasonal recourse rates. Williston asserts that seasonal rates are not a substitute for the removal of a price ceiling because they do not necessarily align prices with what the market will bear.

98. We agree that the flexibility offered to pipelines and releasing shippers is not identical, due to the differences already noted between the primary and secondary markets. The recourse rate, for example, may operate somewhat differently in the two markets by virtue of the design of these markets; but as we have found, the retention of the recourse rate is necessary to provide an effective check on both markets. Thus, we have sought to provide both pipelines and shippers with reasonably comparable flexibility consistent with the differences between these entities and the need to provide protection against market power.

99. For example, the commentors assert that the Commission has rarely granted a pipeline authority to price its capacity upon market based rates. INGAA and the pipelines make this allegation to show that it is administratively difficult to obtain market-based rates from the Commission and that is a difference from the pricing authority the

Commission grants capacity releases in this rule. On the other hand, the fact that the pipelines have not been granted market based rates based on their factual showings is strong evidence that the recourse rate is still needed to protect shippers against the exercise of market power.
101

This fact also leaves the Commission reluctant to find that it should remove the ceiling from primary short term pipeline capacity.

101

See e.g., Gas Transmission Northwest Corp.,
119 FERC ¶ 61,288 (2007);
Koch Gateway Pipeline Co.,
85 FERC ¶ 61,013 (1998),
order on reh'g,
89 FERC ¶ 61,046 (1999).

100. Spectra argues that the Commission uses a stricter market power analysis to determine whether to grant a pipeline market based rates than it did to conclude that it would remove the price caps for short term capacity releases. Spectra asserts that the Commission, in removing the price ceiling from short term capacity releases, did not define the relevant product market and the relevant geographic market, nor did it calculate a Herfindahl-Hirschman Index to measure market concentration of the releasing shippers and other competing sellers in the market. Spectra argues that the Commission should remove the price caps on short-term pipeline capacity on the same basis it used for removing the caps on short-term capacity releases.

101. The Commission is not using the same analysis to remove the price ceiling from short term capacity releases as it does to determine whether a pipeline lacks market power and should therefore be permitted market based rates. As we have explained, one of the principal reasons for removing the price ceiling on released capacity is the existence of the pipeline's service as recourse in the event market power is exercised.
102

As the court in INGAA observed:

102

Tennessee Gas Pipeline Co.,
91 FERC ¶ 61,053 (2000), reh'g denied, 94 FERC ¶ 61,097 (2001),
petitions for review denied sub nom., Process Gas Consumers Group
v.
FERC,
292 F.3d 831, 837 (
DC
Cir. 2002).

If holders of firm capacity do not use or sell all of their entitlement, the pipelines are required to sell the idle capacity as interruptible service to any taker at no more than the maximum rate—which is still applicable to the pipelines. [footnote omitted] Even though interruptible service may not be as desirable as firm service, the Commission concluded that it would provide an adequate substitute, whose availability would place a meaningful check on whatever anti-competitive tendencies the resellers might have.
103

103

INGAA
at 22.

102. The analysis we have employed in removing the price ceiling for released capacity is therefore more comparable to that used for pipeline negotiated rates than for the market power analysis under the Alternative Rate Design Policy statement. The continuation of the recourse rate provides sufficient protection to enable us to remove the price ceiling for short term capacity releases without doing a more detailed market power analysis.
104

The Commission finds, however, that there are sufficient concerns about the ability of pipelines to exercise market power in short-term transactions on at least some segments of their systems, that a blanket removal of the price cap on all such pipeline transactions in this rulemaking proceeding, without consideration of specific circumstances on individual pipeline systems, would be inappropriate.

104
Moreover, the Commission's use of stricter standard in reviewing petitions by a pipeline for alternative pricing authority for its primary transportation is not a new concept and is based upon the different risks of abuses of market power. In
Koch Gateway Pipeline Co.,
89 FERC ¶ 61,046 (1999), the Commission stated:

As reflected in the market power analysis set forth in the Policy Statement, the Commission has taken a conservative and cautious approach concerning the showing a pipeline must make in order to justify a finding that it lacks market power in its primary transportation market, i.e., the pipeline's own sale of its transportation capacity. In fact, many commenters asserted that it would be unlikely that the pipeline's primary market would meet the proposed criteria for market-based rates. The Commission recognizes that it has taken a more relaxed and light-handed approach toward market-based rates in other contexts, including for example, the pipeline's sales of storage service and unbundled sales of the gas commodity. Purchasers of such other services are more likely to have good alternatives to purchasing from the pipeline; for example, barriers to entry in the storage and gas commodity markets are likely to be less. The Commission also recognizes that its Short-Term Transportation NOPR proposed a different approach for justifying removal of the price cap on short term (less than one year) transportation services in both the pipeline's primary transportation market and the secondary, capacity release market. That proposal included the establishment of mandatory capacity auctions to control market power.
Id.
at 61,129 (footnote omitted).

e. Bifurcation of the Markets

103. The pipelines maintain that continuing the price ceiling on pipeline short term services will create a bifurcated market with higher market prices in the uncapped release market. The premise of this argument is that if shippers that place a lower value on transportation are able to acquire the capped pipeline service, the prices in the uncapped market will be higher than if all capacity were sold without a price ceiling. In the NOPR, the Commission responded to similar arguments.
105

The Commission pointed out that interruptible service has lower priority than firm service so that even if a shipper placing a relatively low value on the capacity has a higher position on the pipeline's queue for price-controlled interruptible transportation, it is not guaranteed that it can acquire that capacity, leading to the supposed higher market clearing price. A firm shipper could always release its unused firm capacity to a replacement shipper who places a higher value on that capacity, thereby displacing the lower-value interruptible shipper.

105
NOPR at P 51.

104. With respect to short-term firm service, the Commission stated that higher market clearing prices would not occur as long as arbitrage exists. Any shipper with a higher queue position that acquires the pipeline capacity at the lower capped rate would have an incentive to resell that capacity to another shipper who places a higher value on the capacity, thus ensuring that the market clearing price will reflect all relevant demand.

105. INGAA asserts that the Commission's observation that pipeline short-term capacity is interruptible and inferior to firm released capacity is a partial answer to its argument that a bifurcated market will produce higher prices in the regulated portion of the market than would otherwise be the case. But INGAA and Spectra assert that short-term pipeline capacity is not always interruptible—unsubscribed pipeline capacity can be sold on a firm basis during periods of peak demand, and would, if treated on a par with released capacity, compete on a head to head basis. INGAA and Spectra argue that if the rate for that short-term firm pipeline capacity is capped, the pricing inefficiencies will occur because the arbitrage opportunities relied upon by the Commission in the above-quoted text often entail high costs, making reliance on such opportunities inefficient. For example, Spectra cited articles for the proposition that arbitrage opportunities “often entail high costs, making the reliance on them also inefficient.”
106

106
Spectra comments at 12,
citing
, Stephen J. Choi and A.C. Pritchard,
Behavioral Economics and the SEC,
56 Stan. L. Rev. 1, n. 11 (2003) (discussing that “arbitrage is costly, which may limit its effect”). See also Lynn A. Stout,
The Mechanics of Market Inefficiency: An Introduction to the New Finance,
28 J. Corp. L. 635, 655 (2003) (observing that “arbitrage is costly and imperfect”) and Andrei Shleifer & Robert W. Vishny,
The Limits of Arbitrage,
52 J. Fin. 35 (1997) (explaining why the capital costs required to engage in arbitrage opportunities can hamper market efficiency).

106. The only arbitrage costs at issue in this case are the costs of releasing that capacity, which is precisely the same cost releasing shippers must incur and we have sought to reduce the costs

of capacity release over the years. In particular, the Commission's action in Order No. 637, where the Commission instituted a number of policy revisions that were designed to enhance competition and improve efficiency across the pipeline grid should reduce arbitrage costs. There the Commission required pipelines to permit releasing shippers to use flexible point rights in order to compete effectively on release transactions with other shippers and to fully segment their pipeline capacity which permits the releasing shipper t

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3AE8-14444. Public record. Not legal advice.