I hear and agree with you Bearcatbob, its getting messy in CA.
Power Woes Raise Questions Over Control of Gas Pipelines
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." |
