Power Woes Raise Questions Over Control of Gas Pipelines
NYTimes
March 26, 2001
nytimes.com
By RICHARD A. OPPEL Jr. and LOWELL BERGMAN
Early last year, the El Paso Natural Gas
Company took bids from two dozen
companies for the right to ship enough natural
gas through its pipeline from Texas and New
Mexico to meet one-sixth of the daily demand
of energy-starved California.
The winner: El Paso's sister company, the El
Paso Merchant Energy Company, which
buys, sells and trades natural gas. The bidding
was not close. El Paso Merchant offered
twice as much for the capacity as the other
companies bid, in total, for bits and pieces.
Why pay so much more? California officials,
who are pressing a complaint against El Paso
at the Federal Energy Regulatory Commission, say the answer is simple. The state
contends that El Paso Merchant, with help from its sister company, saw the
transaction as a way to manipulate the price of natural gas by using its control of
pipeline capacity.
According to sealed documents obtained by The New York Times that are part of
filings in the federal case, executives at El Paso Merchant said internally that the deal
would give them "more control" of gas markets, including the "ability to influence the
physical market" to benefit the company's financial positions.
El Paso executives called the accusations fanciful, and in a formal response to
California's complaint, said the state "grossly distorted" company documents by
quoting words and phrases out of context.
The dispute opens a window on an important debate about oversight of the natural
gas industry, which fuels a growing share of the nation's electric power plants.
At issue is whether current safeguards do enough to prevent anticompetitive abuses
in the marketing and trading of natural gas, and whether federal regulators
adequately enforce existing rules. In particular, many industry officials question
whether regulated pipeline companies are able to favor unregulated sister companies
that trade natural gas and are free to maximize profits.
More than 200,000 miles of interstate pipelines crisscross the country, moving
natural gas from Canada, the Southwest and other producing regions to fuel
factories, power utilities and heat houses.
Not long ago, many parts of the country had excess pipeline capacity. But experts
say that several regions, including California, New York and New England, now
face constraints as demand soars for gas to fuel power plants.
In California, state officials and utility executives said the documents in the federal
case, and El Paso's actions, were proof that the state's energy crisis stemmed not
just from an ill-conceived deregulation plan but from price manipulation and
profiteering.
"They are the market maker with this pipeline," said Loretta Lynch, the president of
the California Public Utilities Commission, which has struggled to cope with
skyrocketing power prices and supply shortages.
El Paso "sets the price in California," Ms. Lynch said, and what it did was
intentional. "It has affected the price," she said, "for everything related to heat and
electrical power prices in the state."
California's complaint to the federal agency contends that El Paso Merchant "has
hoarded capacity and refused to attractively price unused capacity" on the pipeline.
The state also charges that El Paso Natural Gas, the pipeline's owner, has had no
incentive to spur competition, by offering discounts to other users, because the two
companies are corporate siblings. The state said that El Paso had violated federal
natural gas statutes that prohibit anticompetitive behavior.
The sealed filings in the El Paso case indicated that the company expected to make
money by widening the "basis spread" — the difference between what gas can be
bought for in producing basins of Texas and New Mexico, at one end of the
pipeline, and its price on delivery to Southern California.
As it turned out, spreads widened enormously over the last year as the price of gas
soared in California, adding to costs for wholesale electricity that pushed the biggest
utilities near bankruptcy. California utilities paid $6.2 billion above competitive
prices for wholesale electricity over the last 10 months, state officials estimated. The
utilities are not allowed to recoup the costs from customers. While the cost of 1,000
cubic feet of gas typically is less than $1 higher at the California end of the pipeline,
spot prices in the state rose to almost $50 more than the Texas- New Mexico price
in December.
To executives of the parent company, the El Paso Corporation, the accusations of
market manipulation are ludicrous.
High gas prices in California, El Paso executives said in interviews, are easily
explained by soaring demand, the poor credit standing of the state's utilities and the
failure of the utilities to retain pipeline capacity or store enough gas for winter.
"The idea that anybody is holding back on California is really ridiculous," said Clark
C. Smith, president of El Paso Merchant's operations in North America.
Some El Paso customers, though, agreed with California officials. The Pacific Gas &
Electric Company, the San Francisco-based utility, condemned El Paso in a filing
with the federal agency after its lawyers reviewed the sealed company documents.
"It is now very clear from the business records of El Paso Energy Corporation," the
utility said in the filing, "that the business strategy El Paso Merchant was authorized
at the highest corporate levels to pursue involved manipulation of price spreads."
The agency has not ruled on California's complaint, which asks that the deal
between El Paso Natural Gas and El Paso Merchant be invalidated. Based on the
agency's history of policing energy providers lightly, many industry observers
predicted that the complaint would be dismissed, perhaps as soon as the agency's
public meeting on Wednesday.
Nonetheless, El Paso Merchant is feeling some pressure. The subsidiary said
recently that it planned to relinquish control of all but about 22 percent of the
capacity on the pipeline to California, rather than exercise an option that would have
allowed it to retain the entire capacity of 1.2 billion cubic feet of gas a day.
Critics said they believed El Paso made the move in hopes of lessening the chance
of government action. El Paso executives deny that but do say that their decision
was influenced by the backlash over the arrangement.
Surrendering the pipeline capacity made for a "gut-wrenching" decision, Mr. Smith
said, but was "a first- class gesture" to California. El Paso Merchant paid $38.5
million to control the pipeline capacity from March 1, 2000, until May 31, 2001.
While Mr. Clark said he did not know the return on that investment, he
acknowledged that it was lucrative.
"No doubt about it," Mr. Clark said, "we made good money."
The question of whether El Paso's conduct has driven gas prices higher is expected
to be scrutinized by legislators in Sacramento this week. The company also faces
several lawsuits, including one by the city of Los Angeles, that accuse it of
conspiring with other companies to prevent pipeline projects that could have eased
California's energy crisis. El Paso denied the accusation.
With pipeline capacity and gas supplies tighter, concerns about anticompetitive
behavior have increased as price volatility has created soaring profits for energy
marketers and traders.
Dynegy Inc., a Houston-based energy trader, was once the target of complaints to
federal regulators that it had artificially raised prices by abusing capacity that it
controlled on El Paso's pipeline to California.
In a filing with regulators in January, Dynegy contended that pipeline companies
routinely favored affiliates. "Abuses abound because of financial windfalls, difficulty
of detection, lengthy investigations and increased complexity of the market," the
company said.
"There are some red flags right now," said William L. Massey, a member of the
Federal Energy Regulatory Commission since 1993. Mr. Massey said he was
troubled by the potential for abuses when pipeline companies own gas and power
marketing subsidiaries as well as electric plants fueled by natural gas. El Paso is in all
those businesses.
"What the commission ought to be serious about is: What are the forces at work? Is
it simply robust markets responding to true supply-and-demand signals, or is it a
market defined by market power and some measure of affiliate abuse?" he said.
Many in the industry do not believe changes are needed.
"There are rules in place today that protect against affiliate abuse," said Stanley
Horton, chief executive for gas pipeline operations at the Enron Corporation and
chairman of the Interstate Natural Gas Association of America, the industry's trade
group, referring to the rules under which California has brought its complaint about
El Paso.
To its critics, El Paso epitomizes competitive concerns. It operates the nation's
largest network of interstate pipelines and owns one of the largest reserves of natural
gas. With its recent acquisition of the Coastal Corporation, another large pipeline
operator, El Paso has a market capitalization of $32 billion.
At a conference at El Paso headquarters in Houston in February, analysts heard
executives predict net profits of $1.7 billion this year. El Paso's much better known
rival, Enron, with its headquarters a few blocks away, is expected to earn about
$1.4 billion.
El Paso Merchant provides the strongest growth. Two years ago, the unit's profits,
before interest payments and taxes, were $99 million; this year, it is expected to
have $700 million in North America alone. In its latest quarterly report, El Paso
attributed those profits, in part, to "commodity market and trading margins" that
were enhanced by "power price volatility, particularly in the Western United States."
Critics contend that El Paso set out to exploit those conditions. According to the
sealed filings, on Feb. 14, 2000, the day before El Paso Merchant was awarded the
pipeline capacity, executives made a presentation to William A. Wise, chief
executive of the parent company, laying out the rationale for the bid.
The presentation outlined what it termed "strategic advantages," including "more
control of total physical markets" and the "ability to influence the physical market to
the benefit of any financial/hedge position," according to the sealed filings. The
passages suggested that El Paso expected the deal to give it sway over the market
for trading actual volumes of gas and to support financial transactions it had entered
into with other parties to limit its risk.
For every one-cent increase in the spread on gas prices, the presentation said, El
Paso Merchant stood to make an additional $2.4 million.
Under the heading "Challenges," according to the sealed filings, the presentation
stated that storage was needed "to help manipulate physical spreads, adding to the
overall transport/storage cost."
On April 14, according to the sealed filings, El Paso Merchant's president at the
time, Greg G. Jenkins, wrote a memorandum to Mr. Wise involving an update for
directors meeting later that month. The memorandum stated: "We will make money
two ways: 1) increase the load factor, 2) widen the basis spread."
The language appears to suggest that El Paso Merchant would profit by increasing
the gas flow in the pipeline — the load factor — while increasing the difference
between what gas could be bought for at one end and what it could be sold for at
the other end — the basis spread.
In an interview, Mr. Smith, the El Paso Merchant executive, said that the unit's
prices, and profits, on bulk gas sales in California were locked in months in advance,
so that the company could not benefit from rising prices in the spot market.
Otherwise, Mr. Smith declined to provide any details about money made on the
pipeline deal or about financial terms of the transactions that locked in prices ahead
of time. In addition, Mr. Smith said that nearly all of El Paso Merchant's pipeline
capacity was used every day when prices spiked late last year, with no capacity
withheld to increase prices.
The company did not respond last week to a request to discuss information in the
sealed documents. But El Paso Merchant, in a filing with federal regulators, said
California's complaint had "misconstrued and incorrectly interpreted" what it termed
"snippets of data." |
