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Regulation of Short-Term Natural Gas (Docket No. RM98-10-000 Transportation Services)

Regulation of Interstate Natural Gas (Docket No. RM98-12-000 Transportation Services)

COMMENTS OF THE NATURAL GAS SUPPLY ASSOCIATION

Pursuant to the Notice of Proposed Rulemaking ("NOPR") and Notice of Inquiry ("NOI") issued by the Federal Energy Regulatory Commission ("the Commission" or "FERC") on July 29, 1998, the Natural Gas Supply Association ("NGSA") hereby files comments in response to the Commission's request for comments on issues raised in both the NOPR and NOI regarding Commission regulation of short and long-term interstate natural gas transportation.

NGSA represents integrated and independent companies that produce and market domestic natural gas. Established in 1965, NGSA encourages the expanded use of natural gas and a regulatory climate that fosters competitive markets.

Communications regarding this docket should be sent to:

Philip M. Budzik Vice President, Federal Regulatory Affairs & Technical Analysis Natural Gas Supply Association 805 15th Street, N.W., Suite 510 Washington, D.C. 20005

(202) 326-9300

TABLE OF CONTENTS

SECTION I: EXECUTIVE SUMMARY 

SECTION II: ALTERNATIVE RATEMAKING APPROACHES 

A. The Commission Should Modify Its Existing Ratemaking Policies.

B. Without Periodic Rate Review, Pipeline Transportation Rates Become "Stale" And "Unjust And Unreasonable".

C. Pipeline Rates Are Higher Than They Need To Be.

D. Pipeline Capital Structures Are Inappropriately Weighted Toward Equity.

E. Pipelines Lack Sufficient Inducement To Be Efficient And Should Be Required To Implement A Rate Mechanism Encouraging Cost Savings And Timely Benefits To Shippers.

F. The Implementation Of The Alternative Ratemaking Mechanism Should Be Mandatory And Preceded By A General Section 4 Rate Case.

G. NGSA Urges The Commission To Review The Amoco And Exxon Proposals.

EXHIBIT II-1: 1997 Returns On Common Equity For 28 Major Interstate Natural Gas Pipelines (As Reported By Foster Associates, Inc.)

SECTION III: SHORT-TERM RATES: AUCTIONS

A. The Commission Should Not Remove The Rate Caps On Short-Term Transportation Unless Market Power is Effectively Constrained.

B. Market Power Remains; The Commission Should Not Approve Market-Based Rates.

C. The Commission May Remove Short-Term Rate Caps Only If It Adopts A Properly Designed And Effective Auction.

D. The Commission Should Consider Viable Auction Proposals.

E. If Rate Caps Are Removed And An Auction Is Implemented, The Auction Mechanism Should Contain Certain Basic Principles To Constrain Market Power.

F. All Available Pipeline Capacity Must Be Sold Through The Auction.

G. Rate Caps Should Only Be Removed For Transactions Of One Calendar Month Or Less. Under No Circumstances Should The Rate Caps Be Removed For More Than One Month.

H. Pipelines Should Not Be Able To Set Auction Reserve Prices Above Variable Cost.

I. Pre-Arranged Capacity Releases Should Be Disallowed For Transactions Of Less Than One Calendar Month. 

J. The Auction Must Provide A Non-Biased Allocation Of Capacity.

K. The Auction Must Be Commercially Efficient And Practical.

L. The Auction Must Be Mandatory For All Pipelines.

M. The Auction Should Provide A Daily, Intra-Day, Intra-Month, And Monthly Auction Process

N. The Auction Must Maintain The Operational Reliability Of Transportation.

SECTION III – ADDENDUM I 33 A. Outline Summary Of A Possible Auction Process. 33 B. Narrative Description Of A Possible Auction Process.

SECTION IV: OPERATIONAL ISSUES

A. There Should Be No Difference In Nomination Requirements For Released Capacity And The Pipelines' Short-Term Firm Service And Interruptible Service.

B. The Commission Should Clarify Its Intra-Day Nomination Regulations Regarding Bumping Of Already Scheduled Gas.

C. Creditworthiness Standards In Pipeline Tariffs Should Be More Reasonable So As To Promote Competition And Efficiencies In The Marketplace.

D. Additional Operational Information Is Needed From The Pipelines In Order To Promote Competition And Mitigate The Exercise Of Market Power.

E. NGSA Supports The Commission's Commitment To Take Remedial Action When Pipelines Or Shippers Exercise Market Power.

F. Pipelines Should Provide, And Shippers Should Be Able To Rely On, More Timely Imbalance And Overrun Information.

G. Transportation Penalties Should Be Imposed Only To The Extent Necessary To Protect System Operations And Should Not Be A Profit Center For The Pipelines.

H. Pipelines Must Provide Services, To The Extent Operationally Feasible, That Facilitate Imbalance Management.

I. Pipelines Must Adopt Incentives And Procedures That Minimize The Use And Adverse Impact Of Operational Flow Orders.

J. Shippers Should Have Both The Ability To Segment Their Capacity And The Flexibility To Use Alternate Receipt And Delivery Points To The Extent Operationally Feasible.

SECTION V: REGULATION OF NEGOTIATED TRANSPORTATION SERVICES OF NATURAL GAS PIPELINES

A. NGSA Opposes A Commission Policy Permitting The Negotiation Of Terms And Conditions Of Pipeline Service.

B. Current FERC Processes Provide Interstate Pipelines Adequate Flexibility To Offer Their Customers New Services Or To Modify The Terms And Conditions Of Existing Services

C. The Request For The Negotiation Of Pipeline Service Terms And Conditions Is Not Driven By An Inability To Fashion Pipeline Tariff Services That Are Responsive To Pipeline Customer Requirements.

D. Allowing The Negotiation Of Transportation Service Terms And Conditions Would Inevitably Result In Preferential Contracts, Especially For Contracts Between The Pipelines And Their Affiliates.

E. The Commission's Order No. 636 Regulations Should Not Be Compromised By A Commission Program Permitting The Negotiation Of Pipeline Service Terms And Conditions.

SECTION VI: SEASONAL RATES

A. Seasonal Rates Could Increase The Ability Of Pipelines To Exert Market Power And Should Be Implemented Only If Market Power Can Be Constrained.

B. The Commission Should Refrain From Any Implementation Of Seasonal Rates Unless A Specific Proposal Is Made And Approved Through A Generic Proceeding.

SECTION VII: TERM-DIFFERENTIATED RATES

A. Term- Differentiated Rates Do Not Properly Address Long-Term Capacity Subscription And Should Be Implemented Only After Appropriate Review.

B. The Need For Term-Differentiated Rates Is Currently Unproven, And Term-Differentiated Rates Can Already Be Implemented Under Current Policy.

C. The Commission Should Not Set Rates Based On The Value Of Capacity To Shippers.

D. Term-Differentiated Rates Can Potentially Increase The Ability Of Pipelines To Exert Market Power.

E. The Best Solution Is To Lower Rates For All Services.

F. The Commission Should Refrain From Any Implementation Of Term-Differentiated Rates Unless A Specific Proposal Is Made And Approved Through A Generic Proceeding.

SECTION VIII: MISCELLANEOUS ISSUES

A. The Commission Should Encourage Interstate Pipeline Competition By Conditioning Any New Pipeline Service Or Program With The Requirement That Pipelines Provide Interconnection Upon Request.

B. Whether The Commission "Should Adopt A Policy That Shippers With Long-Term Firm Contracts Should Be Guaranteed Fixed Rates?" (NOI at 14; 28 -30.)

C. Whether The Commission Should Permit Market-Based Rates For Unsubscribed or "Turned Back" Capacity? (NOI at 20 - 21; 30 -31.)

D. Whether The Commission Should Permit New Capacity Incremental Rates For "Turned Back" And Released Capacity? (NOI at 34.)

E. Whether The Commission Should Change Its Policies Regarding The Financial Depreciation Of Pipeline Assets? (NOI at 36 - 40) 

SECTION I

EXECUTIVE SUMMARY

The members of the NGSA commend the Commission for the rather considerable initiative undertaken in the NOPR and NOI, which together represent a complete review of its current natural gas transportation policies.

NGSA responds to the Commission's NOPR and NOI in these proceedings with one set of comments. NGSA did so because there are neither fundamental nor distinguishable differences between the short-term and long-term pipeline transportation markets. There is only one interstate natural gas transportation market, which starts at the present and extends into the future without discontinuity. As such, NGSA views the interstate natural gas transportation market as a whole, and consequently encourages the Commission to view the market in the same manner, so that Commission regulations are consistent between the short-term and long-term transportation markets.

Long-Term Rates In the NGSA's view, changes in the Commission's regulatory oversight of the interstate pipelines in the period since the issuance of Order No. 636 have produced what is assumed to be an unintended consequence. As a result of the elimination of the requirement that the pipelines file a periodic general NGA Section 4 rate case, the determinants that form the basis of the pipelines' rates have grown stale. As a consequence, current transportation rates are, on average, considerably higher than they need to be in order for the pipelines to recover their costs, realize a reasonable return on their investments and to attract additional capital for any needed expansions of capacity.

During the period since the issuance of Order No. 636 pipeline throughput has increased significantly. Interest rates have reached a near all time low, resulting in a lower cost of capital and, although some pipelines have reduced their costs, none of this has resulted in lower rates. On the contrary, all of the benefits of these and other improvements have gone to the pipelines' bottom line.

The most compelling evidence of this dysfunction can be found through an examination of the pipelines' Form 2 filings. On average, the pipelines' rate of return on equity authorized by the Commission is in the range of 12%, while the composite average 1997 return on equity of the 28 major interstate natural gas pipelines was 15.1%, with three of those pipelines' rates of return on equity exceeding 20%.

Another factor sustaining the pipelines' higher than need be transportation rates is that pipeline capital structures are unduly weighted with equity funds, displacing less expensive debt instruments. Neither the high rates of return, nor the high equity capitalizations can be justified in light of the relatively low risks faced by the pipeline segment of the industry, and both unnecessarily increase the costs of transportation to shippers.

The foregoing notwithstanding, the NGSA is not troubled by the success experienced by the pipeline segment of the industry. A successful pipeline community is essential to the success of the other segments of the industry and of the natural gas market as a whole. However, the NGSA is concerned that unnecessarily high transportation rates are distorting proper market signals between consumers and producers. Inappropriately high transportation rates result in higher prices to consumers, and/or lower netbacks to producers. In order to optimize those market signals, the Commission's regulatory oversight must ensure that an inordinate share of the natural gas value chain does not flow to the "middleman" pipeline. In this context, the Commission's regulatory model needs fixing.

It is the NGSA's position that these proceedings should undertake to achieve at least the three following things. First, existing pipeline rates need to be brought more into line with those current factors and data that form the basis of the Commission's cost-based pipeline rate calculations. Second, a procedure should be established for the periodic freshening of those rates so as to avoid the kind of over recovery on equity by the pipelines that has occurred with many since the elimination of the requirement for the filing of periodic general Section 4 rate cases. Third, the Commission's pipeline ratemaking model needs to be modified so as to induce behavior on the part of the pipelines that will result in greater overall operational efficiency, cost savings and a more balanced and equitable sharing of risks and rewards among all natural gas market stakeholders. This will not necessitate a departure from the Commission's traditional cost-based methodology in establishing and maintaining such rates.

Alternative ratemaking proposals have been developed by Amoco Energy Trading Corporation, et. al. and Exxon that will accompany their respective filings in these Dockets. The NGSA respectfully directs the Commission's attention to these proposals as providing a possible framework for achieving the foregoing ends.

Short-Term Rates: Auctions As the Commission acknowledges, the interstate natural gas transportation market is not effectively competitive. Consequently, meaningful regulatory oversight is necessary in order to protect against the exercise of market power in both the long-term and short-term markets, to ensure just and reasonable rates, and to protect against undue discrimination. Thus, the NGSA is concerned with any suggestion that the Commission abandon rate caps and its traditional cost-based regulation of short-term transportation services.

Under no circumstances should the Commission abandon rate caps applicable to the short-term or secondary transportation markets unless a showing of a competitive market has been made, or sufficient regulatory procedures are implemented to effectively constrain market power.

The Commission, having conceded the foregoing, proposes new regulations that purportedly focus on balancing the improvement of efficiency and competition in the short-term transportation market and effective protection against the exercise of market power. The auction is the centerpiece of that proposed policy change.

If rate caps are removed, the NGSA believes that a properly structured auction would be essential in order to provide transportation customers with an effective means to acquire capacity, while preventing pipelines or releasing shippers from exercising inherent market power.

If rate caps are removed, all available pipeline capacity that is not subject to a rate cap should be sold through an auction. However, rate caps should only be removed for those capacity transactions that are for a period of one calendar month or less, with the pipeline being permitted to set a reserve price limited to no more than its variable cost of the service. Further, the auction should be mandatory and standardized across all pipelines. To optimize the effectiveness of the auction, pre-arranged capacity release transactions should be disallowed, for periods of one calendar month or less.

The NGSA notes that Amoco Energy Trading Corporation, et. al. has filed an extensive auction proposal that deserves the Commission's thoughtful attention. Further, the NGSA has attached to the text of its comments herein, as an addendum, the description of a general auction concept that, like the Amoco proposal, could form the basis for the development of a generic auction concept.

Operational Issues The NGSA welcomes and supports the several operational reforms suggested by the Commission that would enhance competition and increase efficiency, particularly those relating to receipt and delivery point rights and priorities, segmenting of capacity, imbalance management, and greater access to pipeline transportation information.

Negotiated Terms and Conditions NGSA opposes a policy that grants pipelines the authority to negotiate terms and conditions of service. Throughout the text of the NOPR and NOI the Commission repeatedly acknowledges the fact that the pipelines are possessed of market power and acknowledges that they will exercise it if given the opportunity. The NGSA agrees.

Current Commission procedures are designed to protect pipeline customers from the exercise of such market power. Should a pipeline seek to provide a new and innovative service it can do so after notice and the opportunity for protest under applicable Commission regulations. This procedure affords shippers on the system the opportunity to examine the potential for the degradation of basic service, whether undue discrimination will occur, and whether costs will be appropriately allocated should the tailored service be implemented. It is argued by some parties that such procedures result in undue delay and limit needed flexibility. However, recent Commission experience under existing procedures decries this assertion. Regardless, the Commission should not abandon the protection of pipeline customers in return for an improved implementation schedule. An after-the-fact complaint process is not an acceptable alternative. The commercial damage to those complainants may be past redemption.

Further, the need for such flexibility in the negotiation of terms and conditions of service has yet to be demonstrated. Future growth in the demands of the electric generation market is often cited as requiring such flexibility. Pipelines have successfully served the variable consumption loads of that market for decades. Further, since 1990 the electric generation market has shown the greatest growth of any natural gas consumption segment, without such flexibility. Decontracting by distributors may reduce the proportion of the pipelines' throughput moving under long-term contracts in the future, but not total throughput, which by all counts is expected to increase. Nonetheless, if maintaining sufficient pipeline revenue is an issue, flexibility in the negotiation of the terms and conditions of service is not the answer.

Allowing the negotiation of terms and conditions of transportation service will inevitably result in preferential contracts, especially for contracts between the pipelines and their affiliates, whether they be in the business of producing, processing, gathering, marketing, distribution of gas or the generation of electricity. Each of these affiliate activities would be competitively advantaged by negotiated terms and conditions of service that are not made available to non-affiliated competitors, which could convey significant financial returns to the pipeline's parent company.

Further, the "comparability" of service achieved through the unbundling of the pipeline merchant service under Order No. 636 would be severely compromised should pipelines be granted "flexibility" in the negotiation of terms and conditions of service, which should not be permitted.

Seasonal Rates When discussing the option of seasonal rates, the Commission rightfully concludes that "if the price cap is raised high enough to accommodate peak period competitive prices, this approach is little different than simply removing the rate cap, since it would afford firms with market power substantial latitude to exercise that power at prices below the price cap." (NOPR at 43 - 44.) The NGSA agrees.

The Commission must ensure continuing, effective protection against recognized market power before seasonal rates for transportation services can be contemplated. The NGSA's primary concern is that without either the suggested market power test or an effective means to protect against market power, such as the short-term auction process, seasonal rates would likely result in unjust and unreasonable rates.

The Commission should not consider the implementation of any seasonal rate design until a specific, fully articulated proposal has been made, and all parties have had the opportunity to review and comment on it in a generic Commission proceeding.

Term-Differentiated Rates It is the NGSA's belief that the justification for term-differentiated rates has not yet been demonstrated. In any event, such rates can be effectively implemented under the Commission's negotiated rates policy. Term-differentiated rates would, as with seasonal rates, increase short-term rate caps and serve to effectively increase the potential for the exertion of market power.

To a large degree the Commission's concerns regarding the potential bias against long-term contracts under the current regulatory regime and its potential negative impact on pipelines are at best premature. There is simply insufficient empirical information to conclude that there is an industry-wide problem that requires such a departure. The best solution to this problem is to lower the cost of both long and short-term capacity. Further, should the promise of the projections of a 30 TCF market be realized, it is totally reasonable to expect that the current pipeline infrastructure will be completely utilized.

When establishing cost based rates for a service provided by a transporter possessed with unquestioned market power, the relative value or related risks associated with a particular service to a potential shipper are not relevant. Both long-term and short term capacity perform the same basic transportation function, which has been and should remain cost based. Thus, the Commission should not establish any rate design that specifically transfers costs between long and short-term customer classes, based on the perceived value or risk of that capacity to shippers. Most certainly, such a rate design should not be implemented in the absence of a fully defined term-differentiated rate proposal that has been reviewed and commented upon by the entire industry in a generic Commission proceeding.

Miscellaneous Issues A. Pipelines should be required, as a condition to the implementation of any new service or program, to provide interconnections upon request. Such a policy would promote greater competition among pipelines, enhance the efficiency of the pipeline grid, and create the impetus for additional market centers and hubs.

B. The Commission has asked whether shippers with long-term firm contracts should be guaranteed fixed rates. (NOI at 14;28-30.) The Commission's negotiated rates policy has given certain pipelines authority to enter into such contracts and provides guidance regarding the over or under recovery of revenues. Thus, the Commission's existing policy provides both sufficient contracting flexibility and appropriate regulatory guidance regarding such contracts.

C. The Commission has asked whether pipelines should be permitted to charge market-based rates for unsubscribed or turned back capacity. (NOI at 20-21; 30-31.) The NGSA submits that they should not. The presence of unsubscribed capacity does not, in and of itself, assure that a pipeline is without market power and unable to extract monopoly rates from its customers. The Commission concedes as much at page 25 of the NOPR. D. The Commission has asked whether pipelines should be permitted to charge incremental rates for customers contracting for new or turned back capacity. (NOI at 34.) The NGSA fully supports the Commission's Pricing Policy Statement issued May 31, 1995. The NGSA believes that the Policy Statement strikes an equitable balance between the interests of new and existing pipeline customers regarding the pricing of new facilities and that the Commission should not deviate from that policy. As to turned back capacity, the NGSA opposes price discrimination between new and existing customers.

E. The Commission has asked whether it should change its policies regarding the financial depreciation of pipeline assets. (NOI at 36-40.) The NGSA believes that the Commission's current depreciation methodology is appropriate and should not be changed. The NGSA urges the Commission to determine the appropriate asset life of facilities when they are constructed and to adhere to that determination through the life of that asset.

SECTION II

ALTERNATIVE RATEMAKING APPROACHES

A. The Commission Should Modify Its Existing Ratemaking Policies.

Cost-based rates constitute a fundamental customer protection against the exercise of pipeline market power. As noted by the Commission, "An important aspect of the regulatory regime proposed in the NOPR is the continued use of cost-based ratemaking in the long-term market as a protection against the pipelines' exercise of market power." (NOI at 8.) Because "pipelines are permitted to price discriminate at rates below the maximum rate" (NOPR at 25 & 36), excessive transportation rates enhance a pipeline's market power. Thus, the Commission has a Natural Gas Act responsibility to pipeline customers to ensure that pipeline rates are as low as possible and that the underlying costs truly reflect a pipeline's cost of operating its business.

In the NOI, the Commission seeks comment on whether the fundamental aspects of its pricing for long-term transportation service and for new facilities should be modified to be more effective in today's environment. (NOI at 2.) The NGSA agrees with the Commission that cost-based regulation should be retained and that rate caps should not be removed. NGSA, however, believes that certain modifications to the Commission's existing ratemaking policies are necessary to ensure that pipeline rates are as low as possible and constrain the exercise of pipeline market power.

Current pipeline rates have become stale due to the lack of periodic review. As a result, pipeline rates are higher than they ought to be. Further, pipelines lack sufficient inducement to be efficient. To correct these problems, NGSA recommends the following modifications to the Commission's ratemaking policies which would be implemented on all pipelines:

• a general Section 4 rate case to establish an initial baseline for rates;

• an annual "refreshment" of rates based on prior period costs and throughput;

• the implementation of a rate mechanism encouraging cost savings and timely benefits to shippers; and

• a periodic Section 4 rate case at least every five years.

These modifications would result in a more balanced sharing of risks and rewards among all participants in the natural gas marketplace.

The NGSA is increasingly concerned with the excessive rates being charged for interstate pipeline transportation services. NGSA believes that these modifications to the Commission's existing ratemaking policies will lower pipeline transportation rates, thereby resulting in a national pipeline grid that operates more efficiently and equitably. NGSA sees several reasons why such modifications are necessary.

B. Without Periodic Rate Review, Pipeline Transportation Rates Become "Stale" And "Unjust And Unreasonable".

Under current Commission regulations, there is no requirement for pipelines to file a general Section 4 rate case. This makes it impossible to determine with any reasonable accuracy the current cost of service for pipelines that have not recently filed a rate case. Even for those pipelines that have recently filed a rate case, rates can become "stale" in a relatively short period of time. As a result, the pipelines can significantly over recover their costs. Absent a periodic Section 4 rate case, the pipelines have little incentive to reduce rates and improve service. The lack of periodic rate review allows pipelines to retain any cost savings as shareholder profits rather than passing those savings onto their customers.

In order to have true cost-of-service rates, the rates must directly reflect pipeline costs and allowed rates of return. In the absence of periodic rate review, the rates being charged pipeline customers bear less of a relationship to a pipeline's cost structure as time goes forward. Under the Commission's current ratemaking policy, rates that are not periodically reviewed and revised can become "unjust and unreasonable" because they do not bear any direct relationship to the costs actually being incurred by the pipeline. Consequently, NGSA believes that the Commission has a responsibility to pipeline customers to require pipelines to submit to full Section 4 rate case filings on a periodic basis.

C. Pipeline Rates Are Higher Than They Need To Be.

The realized return on equity (ROE) for many pipelines has been creeping up steadily over and above the return on equity used to establish rates. This fact is apparent in the 1997 edition of the Foster Associates, Inc. report entitled: "Foster Financial Reports: 28 Major Interstate Natural Gas Pipelines" (See Exhibit II-1). The Foster analysis shows that in 1997 the "composite" pipeline return on equity was 15.1 percent. Many pipelines, however, realized ROEs above 15%, including three above 20%.

Another unbiased source, Standard & Poor's ("S&P") confirms that the pipelines have earned healthy returns on equity. At the January 30, 1998 public conference on the financial outlook for interstate natural gas pipelines (Docket No. PL98-2-000), Mr. Barone, Director of S&P's Utility Group stated that:

"Standard & Poor's believes that the pure interstate pipeline business is a strong cash generator, and the cash returns have been equally healthy. Cash equity returns are more important than the actual book returns and highlight the good financial performance that is capable when viewing the pipelines on a completely stand alone basis separate from all other activities within the corporate entity. ...Historically, these adjusted or cash equity returns have averaged more than 17 percent..." (January 30, 1998 Public Conference Transcript at 104.)

These high realized pipeline returns on equity exceed the 12 to 13 percent returns that have been allowed by the Commission to establish rates. These excessive rates of return are due to Commission regulations that do not require either periodic Section 4 rate cases nor any annual adjustment to pipeline rates.

D. Pipeline Capital Structures Are Inappropriately Weighted Toward Equity.

Debt is a less expensive form of capital than equity. Therefore, it is important that pipeline capital structures and the rates based on those structures, reflect an appropriate mix of debt and equity which minimizes pipeline customer rates while also reflecting the appropriate level of risk faced by the pipeline. As regulated monopolies, the risk confronting interstate natural gas pipelines is relatively low.

The FERC has generally established current pipeline rates based on a book value capital structure of 40 percent debt and 60 percent equity. Because pipelines are low risk enterprises, the proportion of equity in their capital should be lower than that for debt. This suggests that the FERC's capital structure guidelines for designing transportation rates have been excessively weighted toward equity. Therefore, NGSA urges the Commission to consider modifying its policies on pipeline capital structures as part of a broader inquiry which would consider the implementation of alternative ratemaking mechanisms.

E. Pipelines Lack Sufficient Inducement To Be Efficient And Should Be Required To Implement A Rate Mechanism Encouraging Cost Savings And Timely Benefits To Shippers.

In the absence of competition, the Commission needs to lower transportation rates and require pipelines to implement a program that periodically refreshes those rates and induces efficiency. As pointed out in the NOI, incentive regulation is "intended for markets where the continued existence of market power prevents the Commission from implementing light handed regulation without harm to consumers." (NOI at 17.) A properly designed alternative ratemaking mechanism would give pipelines the inducement to operate their systems more efficiently and thereby provide for a more equitable sharing of cost savings between pipelines, their customers, and consumers.

NGSA supports the adoption of such an alternative ratemaking mechanism; a key element of which is that pipeline rates would be refreshed annually based on each pipeline's actual costs and throughput for the prior year. An annual rate refresher mechanism would be administratively more efficient because it would require pipelines to enter certain data, already available in Form 2 and from other sources, into a spreadsheet model from which the new rates would be derived. This proposed mechanism would help to ensure that rates would be current, predictable, fair and rational, and eliminate the base and test period gaming that occurs today when pipelines can pick and choose when to file a rate case. A new general Section 4 rate filing would be required for each pipeline no less than once every five years to thoroughly review a pipeline's cost of service, cost allocation, and rate design in order to determine if the rates accurately reflect the pipeline's operations and business conditions.

F. The Implementation Of The Alternative Ratemaking Mechanism Should Be Mandatory And Preceded By A General Section 4 Rate Case.

There are two other important aspects to a properly designed alternative ratemaking mechanism. One aspect is that participation in the mechanism must be mandatory to ensure that all interstate gas pipelines are subject to the same ratemaking policies and that their costs are reviewed and updated annually in order to keep rates current for all pipelines.

The other important aspect is that prior to implementation of the mechanism, each pipeline must file a new Section 4 rate case in order 1) to establish a baseline for the magnitude of costs incurred by the pipeline, 2) to properly categorize, functionalize and allocate pipeline costs, and 3) to calculate the appropriate initial rates from which subsequent annual adjustments would be made. Under these approach, each component of a pipeline's historic cost of service must be established. These initial Section 4 rate filings could be staggered over a period of a few years in order to reduce the administrative and financial burden of reviewing a large number of rate cases at the same time. After this initial Section 4 rate filing, a pipeline would be required to file a Section 4 rate case no less than once every five years.

G. NGSA Urges The Commission To Review The Amoco And Exxon Proposals.

The NGSA has not developed its own alternative ratemaking mechanism but proposals do exist and have been filed separately by Amoco Energy Trading Corporation, et. al., and Exxon in these proceedings. NGSA urges the Commission to review these proposals and modify its existing ratemaking policies to ensure that pipeline rates are refreshed on an annual basis, that pipelines are provided with the inducement to reduce costs and improve operational efficiency and that there is a balanced sharing of risks and rewards among all natural gas market participants.

EXHIBIT II-1

1997 RETURNS ON COMMON EQUITY FOR 28 MAJOR INTERSTATE NATURAL GAS PIPELINES (As Reported By Foster Associates, Inc.)

1. Algonquin Gas Transmission Company 15.1% 2. ANR Pipeline Company 18.6% 3. CNG Transmission Corporation 16.0% 4. Colorado Interstate Gas Company 20.4% 5. Columbia Gas Transmission Corporation 10.9%

6. El Paso Natural Gas Company 18.5% 7. Florida Gas Transmission Company 10.8% 8. Great Lakes Gas Transmission Company 13.6% 9. K N. Interstate Gas Transmission Company 7.3% 10. Koch Gateway Pipeline Company 2.2%

11. Midwestern Gas Transmission Company 16.6% 12. Mississippi River Transmission Corporation 9.4% 13. National Fuel Gas Supply Corporation 16.5% 14. Natural Gas Pipeline Company of America 22.9% 15. NorAm Gas Transmission Company 9.0%

16. Northern Border Pipeline Company 18.8% 17. Northern Natural Gas Company 21.7% 18. Northwest Pipeline Corporation 13.2% 19. PGE Gas Transmission Co. NW Corp. 13.0% 20. Panhandle Eastern Pipe Line Company 17.4%

21. Southern Natural Gas Company 13.2% 22. Tennessee Gas Pipeline Company - 3.0% 23. Texas Eastern Transmission Corporation 16.9% 24. Texas Gas Transmission Corporation 9.9% 25. Transcontinental Gas Pipe Line Corporation 12.5%

26. Transwestern Pipeline Company 15.9% 27. Trunkline Gas Company 16.1% 28. Williams Natural Gas Company 10.0%

Mean 13.7% Median 14.4% Composite 15.1%

Used with the permission of Foster Associates, Inc.

SECTION III

SHORT-TERM RATES: AUCTIONS

A. The Commission Should Not Remove The Rate Caps On Short-Term Transportation Unless Market Power is Effectively Constrained.

The NGSA strongly believes that despite all the recent improvements in the natural gas marketplace, the interstate transportation market is not effectively competitive, and that the Commission must continue to have a significant regulatory presence in order to protect against the exercise of market power in both the long-term and short-term transportation markets. Meaningful regulatory oversight is necessary in order to ensure just and reasonable rates and to protect against undue discrimination. Therefore, the NGSA is very concerned that the Commission's proposed policy changes will increase interstate pipeline transportation rates, reduce wellhead prices, and severely impede domestic exploration and production. Moreover, in light of the increase in interstate pipeline merger combinations (e.g., El Paso Natural Gas' acquisition of Tennessee and Sonat), and the excessive interstate pipeline returns on equity, the Commission must act with even greater vigilance against the further exertion of market power. Any new regulatory policies that could allow the extraction of additional transportation monopoly rents cannot be tolerated.

The Commission's statutory obligation under the Natural Gas Act to ensure just and reasonable rates can only be accomplished when a fully competitive market exists (which has not been shown) or when sufficient regulatory safeguards are in effect to fully constrain pipeline market power. The NGSA fully supports the Commission's stated goal of creating a "balance between achieving the objectives of preventing the exercise of market power and creating a regulatory environment that fosters a competitive, efficient commodity market that is fair to all shippers." (NOPR at 44.) However, as the Commission itself recognizes: "the ability to exercise market power still exists in the short-term market and, therefore, any regulatory approach it adopts must continue to provide effective protection against the exercise of market power." (NOPR at 28.) In this regard, the NGSA cannot endorse the Commission's sweeping proposal to fundamentally abandon rate caps and its traditional cost-based regulation of short-term transportation services. Under no circumstances can the NGSA support the elimination of rate caps in the short-term or secondary transportation markets unless a showing of a competitive market has been made, or sufficient regulatory procedures are implemented to effectively constrain market power.

B. Market Power Remains; The Commission Should Not Approve Market-Based Rates.

Because the Commission concedes that the interstate transportation market is not fully competitive, it has chosen not to make a blanket determination that a fully competitive marketplace exists as a justification to lift the rate caps. To do so would require that a complete market power analysis as outlined in the Commission's Alternative Rate Design Policy Statement be performed on each service considered for rate cap removal. Instead, the Commission proposes new regulations that purportedly focus on improving efficiency and competition in the short-term transportation market. The Commission supports this course of action by stating that: "Maximum rate regulation may not provide shippers with the most effective protection against the exercise of market power. Moreover, the protection it does provide may come at too great a cost in efficiency." (NOPR at 20; underlining added.)

The NGSA advises against any regulatory policy that abandons maximum rates solely to achieve additional, perceived efficiencies in the short-term transportation market. Any policy that advocates efficiency gains through the elimination of rate caps, without concurrent consideration of the associated risks to short-term shippers is misplaced and potentially unlawful. In no event can improved efficiencies come at the expense of just and reasonable rates to all shippers. Hypothetically, if the Commission simply desired an efficient marketplace, a perfect monopoly would present a highly efficient outcome. However, a monopolistic market also produces consequences that are economically, socially, and legally unacceptable. Therefore, the Commission's proposal is more properly and broadly intended to create a balance between achieving the objectives of preventing the exercise of market power and creating a regulatory environment that "fosters a competitive, efficient commodity market that is fair to all shippers". (NOPR at 44.) The Commission proposes to accomplish this balance through regulations that will purportedly: (1) maximize competition in the short-term market, (2) minimize the potential for the exercise of market power, and (3) monitor the marketplace for the continuing exercise of market power. ( NOPR at 30.) The Commission, thus, offers a three-legged stool upon which to support its statutory obligation to ensure just and reasonable rates. NGSA endorses these laudable goals, but cautions that (as with all tri-legged stools) their effectiveness depends at all times upon the existence of all three equally-supporting, separate legs. A single missing or faulty leg renders the entire stool useless.

C. The Commission May Remove Short-Term Rate Caps Only If It Adopts A Properly Designed And Effective Auction.

The auction is the linchpin to the Commission's proposed policy change, and to the continued restraint of recognized market power. In that regard, the auction provides the means by which the Commission seeks to eliminate the traditional cost-of-service rate caps and allow both pipelines and capacity holders to sell short-term capacity at prices above maximum rates. A properly structured auction would provide transportation customers with an effective means to acquire capacity, while preventing pipelines or other releasing shippers from exercising market power. However, to the extent that the Commission ultimately concludes that an auction is impractical or otherwise undesirable, then irrespective of the other desirable goals suggested in the NOPR, one of the three regulatory legs that supports the proposal is missing, and the Commission must abandon any plan to remove the rate caps.

While some will undoubtedly oppose the implementation of any auction, while still calling for the elimination of the rate caps, such a proposition would obviously fail to restrain pipelines and other sellers of short-term capacity from exerting established market power and extracting transportation rates above just and reasonable levels. The Commission should summarily reject any proposal to lift the rate caps in the primary and secondary transportation markets, that does not also include a corresponding proposal to effectively constrain market power, such as a fully functioning auction.

D. The Commission Should Consider Viable Auction Proposals.

Although the NGSA does not support the removal of cost-based rate caps, if the Commission proceeds to institute an auction, the NGSA suggests that the Commission seriously review those comments filed in this proceeding that present viable auction proposals. In this regard, the NGSA notes that Amoco Energy Trading Corporation, et. al. has filed an extensive auction proposal that deserves the Commission's thoughtful attention. Further, the NGSA also attaches herein (as Addendum I) the description of a general auction concept that, like the Amoco Energy Trading Corporation et. al. proposal, could form the basis for the development of a generic auction mechanism.

E. If Rate Caps Are Removed And An Auction Is Implemented, The Auction Mechanism Should Contain Certain Basic Principles To Constrain Market Power.

The primary purpose of the auction is to constrain and control inherent transportation market power. In order to accomplish this goal, the auction process should be designed to: (1) yield market prices, (2) prevent capacity hoarding, (3) minimize gaming, and (4) provide a transparent and verifiable process. First, market prices are a fundamental prerequisite to the guarantee of effective competition without discrimination. Second, auction procedures that would allow hoarding of pipeline capacity should be rejected because hoarding tends to concentrate market power and prevent capacity from being used by parties that value it. Third, any specific auction mechanism must be structured in a manner that would eliminate the ability of any party (pipeline, releasing shipper, or bidding party) to manipulate the system in a fashion that prevents the free and competitive allocation of capacity to the highest willing bidder. Fourth, as the Commission recognizes, the capacity auction process must be transparent in order to curb abuse and potential gaming. In that regard, the results of the auction process should also be auditable and easily reproduced by all participants so that instances of potential abuse or discrimination can be quickly discovered.

F. All Available Pipeline Capacity Must Be Sold Through The Auction.

In order to constrain the market power that can be exercised through the withholding of capacity from the marketplace, any regulatory policy that eliminates the short-term rate caps must require that all available pipeline short-term capacity be sold through an auction. Pipelines should be required to post all available operational capacity (FT and IT) and to place that capacity into the auction process. Any other FT capacity holders that wish to release capacity for a period of a calendar month or less must utilize the auction process. Although capacity release shippers would not be required to sell any of their unused, available short-term capacity in the auction, the obligation for pipelines to place all their available capacity in the auction would, however, provide a strong incentive for capacity release shippers to do so, as well. The requirement that all available short-term pipeline capacity be auctioned would also serve to maximize the utilization of total pipeline capacity, increase access and competition in the secondary market, improve auction liquidity, and increase transaction transparency.

G. Rate Caps Should Only Be Removed For Transactions Of One Calendar Month Or Less. Under No Circumstances Should The Rate Caps Be Removed For More Than One Month.

The Commission proposes that all available short-term capacity be sold in an auction, and that the corresponding rate caps be removed for any capacity transaction with a term of less than one year. To the extent that the Commission decides to lift the rate caps, the NGSA believes that the rate caps should be limited to capacity transactions of one calendar month or less. Removal of the rate caps for more than one calendar month would reduce liquidity, inhibit a competitive market, and increase the exercise of market power. This is due to the fact that: (1) on many pipelines, capacity is fully subscribed so that pipelines have little or no short-term capacity to auction, (2) on constrained pipelines, capacity holders will possess substantial market power, and (3) a very large portion of existing short-term capacity transactions are for one month or less, thus limiting demand for longer-term transportation capacity transactions. Further, removing the rate caps for periods of longer than one month would induce the current holders of FT to hoard capacity rather than to permanently release it to the marketplace.

H. Pipelines Should Not Be Able To Set Auction Reserve Prices Above Variable Cost.

The Commission proposes two different auction processes. For capacity sold for more than one day, pipelines would be permitted to establish a reserve price. For capacity sold in the daily auction, the pipelines could not establish a reserve price and would be required to sell all capacity at any auction-determined price above their minimum tariff rates. (NOPR at 70.) The NGSA believes that the inability of pipelines to set a reserve price above the variable cost should be extended for the full auction period of one month. First, reserve prices provide the means for pipelines to artificially remove capacity from the auction in order to exert market power. Second, as a matter of equity, the pipelines should not be able to set a reserve price during any period that they can also receive prices higher than their maximum rates. Third, if reserve prices are disallowed only in the daily auction, the corresponding gas commodity sales market may be driven away from the preferred monthly market, because the daily auction may be the only market where non-discriminatory access to transportation can be assured (particularly in the off peak). Any Commission regulatory policy that has impractical or unwanted consequences (such as driving gas commodity sales to a daily transactional basis) should be strictly avoided. Thus, in order to provide equity and to forestall a regulatory policy that inherently drives the gas commodity market to favor daily transactions, the Commission should limit the removal of price caps to capacity with the term of one month or less and extend the prohibition on reserve pricing to the full monthly auction period. However, in order to provide other FT holders the ability to better manage their own capacity needs, the NGSA would propose to allow capacity release shippers to set reserve prices for any released capacity sold in the auction.

I. Pre-Arranged Capacity Releases Should Be Disallowed For Transactions Of Less Than One Calendar Month.

The Commission proposes that all available short-term capacity must be sold in an auction. The NGSA agrees that pipelines should be required to sell all of their available short-term pipeline capacity in the auction process, but suggests that capacity holders not be forced to sell their available, unused capacity. But, if the capacity holder desires to sell any capacity for a period of one month or less, that capacity must be sold in the auction process. Allowing monthly pre-arranged capacity release transactions to occur outside of the auction process would only serve to remove a large portion of short-term transportation capacity from the very auction process which is intended to constrain market power. This would reduce the capacity available in the auction process, diminish the corresponding auction liquidity, reduce effective competition, and confuse meaningful pricing signals. Finally, if the Commission ultimately allows pre-arranged capacity release transactions to be conducted during the auction periods, the results of such release transactions must be made subject to competitive bidding, subject to the right of first refusal for the original acquiring party.

J. The Auction Must Provide A Non-Biased Allocation Of Capacity.

A well designed auction process should allocate capacity on a non-discriminatory basis that prevents abuse, discrimination, or favoritism by the capacity seller. It should provide all bidding parties with an equal opportunity to acquire capacity and should allocate that capacity to those parties that are willing to place the highest value on the available capacity. It is possible, however, for a releasing shipper to effectively manipulate the auction process by having an affiliate, or other aligned party, place a bid on capacity that is higher than the going market price. Such a "false bid" could be effectively used to either: (1) drive up the capacity's market price to other bidders, or (2) entirely remove the capacity from the marketplace if the "false bid" is sufficiently high. Therefore, in order to effectively constrain market power, an appropriately designed auction process would need to include rules that constrain this type of abuse.

K. The Auction Must Be Commercially Efficient And Practical.

The auction process should be understandable, straightforward, and easy to use. In this regard, the auction mechanism should be standardized, consistent, and user friendly in order to allow all market participants, small and large, equal access and simple utilization. To the greatest extent possible, the specific auction process should also be incorporated into, and made compatible with, the pipelines' existing commercial business procedures. Transaction costs should be minimized in order to induce the maximum number of large and small shippers to participate in the auction, thus increasing liquidity, competition, and market transparency. Conversely, to the extent that the auction process is not easy to use, simple, and low cost, potential shippers will avoid the auction process, thereby inhibiting liquidity and competition. Finally, market efficiencies would be greatly enhanced, and the transaction costs would be reduced, if the auction process could be largely standardized across all pipelines.

L. The Auction Must Be Mandatory For All Pipelines.

The auction process must be implemented on all interstate pipelines in order to fully achieve the Commission's goals. The auction process and the lifting of the rate caps should not be mutually exclusive. Under no circumstances should the pipeline's current maximum rates be eliminated unless a means to control market power is also instituted, such as an auction process. Correspondingly, such an auction program should not be made voluntary. If left to the discretion of individual pipelines, each pipeline will inherently institute an auction when it advantages the pipeline, and not necessarily when it advantages its shippers. A voluntary program would likely result in a Balkanized interstate transportation industry, with constrained pipelines choosing to participate in an auction process (which can provide higher-than-maximum rates) and less-utilized pipelines choosing to remain under existing, cost-based rate caps. Such an event would very likely increase shippers' transportation costs on some pipelines without a commensurate rate reduction on others. Further, a Balkanized transportation system would present shippers with a potentially confusing multitude of differing capacity allocation methodologies (auctions vs. non-auction), which would also serve to undermine the Commission's goal of creating a uniform national pipeline grid. For these reasons, the Commission must find the means to uniformly institute any auction program on a national, industry-wide basis.

M. The Auction Should Provide A Daily, Intra-Day, Intra-Month, And Monthly Auction Process.

Any auction program must be consistent with current gas market demands and with other ongoing Commission initiatives, such as the standardization of interstate pipeline operational practices. Moreover, any auction mechanism must be configured in a manner that supports the gas commodity market's preferred operational needs and structures. For example, a large portion of the gas commodity market is currently conducted on a monthly sales basis, with an increasing amount being conducted on an intra-month basis. Therefore, at a minimum, the NGSA proposes that any auction process should incorporate a daily, an intra-day, an intra-month, and a monthly auction mechanism.

N. The Auction Must Maintain The Operational Reliability Of Transportation.

An important and necessary criterion for the Commission to judge any suggested auction process is whether the interstate pipelines' current safety, reliability, and operational levels and standards will be maintained. The underlying goal is to enhance the efficiency and productivity of the natural gas marketplace through improvements in the allocation and pricing of short-term interstate transportation capacity. To the extent that an auction process either inhibits the ability to purchase short-term capacity or degrades the transportation service itself, shippers will avoid using the auction process, thus limiting liquidity, reducing competition, and frustrating the Commission's goals. Therefore, the auction process should be configured in a manner that does not degrade the pipelines' existing physical, operational, or accounting systems.

SECTION III

ADDENDUM I

A. Outline Summary Of A Possible Auction Process.

1. "Short-term" Auction Definition: The maximum term that capacity could be sold without price caps should be one calendar month or less.

2. Auction Period: Four auctions could be held each month: (1) a monthly auction held three days before the NYMEX close, which would auction capacity for the next month (unsubscribed pipeline FT and capacity release FT), and gas would commence flowing at 9:00 am on the first day of the month; (2) an intra-month auction that would be held daily throughout the month to auction capacity that would be available for periods through the remainder of the month; gas would commence flowing at 9:00 am two days after the auction closes; (3) a daily auction that would be held each morning to auction capacity that could flow at 9:00 am the following day; and (4) an intra-day auction for capacity that would be available for a partial day (the remainder of the gas day). A further narrative description of each of these auctions is described in Section B, below.

3. Product: The auction product would be the specific transportation service being offered, as identified in the pipeline's tariff (i.e. FT service, FT-2 Flexible Firm, IT etc.). Storage and storage related services (parking, lending, etc.) should not have the price caps removed, nor would they be subject to an auction. The auction/rate cap removal would only be applicable to transportation service.

4. Pipeline Participation: All available short-term pipeline transportation capacity would be sold in the auction. Pipeline participation to sell unsubscribed FT and IT capacity would be mandatory. The pipelines could not set a reserve price (other than variable cost) during the auction process. Pipeline firm capacity would not be recallable; but interruptible capacity would still be recallable.

5. Capacity Release Participation: The sale of unused capacity by shippers would be optional; however, any shipper releasing capacity for one calendar month or less must use the auction process. Releasing shippers may set a reserve price for the minimum bid they will accept. Released capacity would be recallable under stated conditions.

6. Pre-arranged Releases: Pre-arranged capacity release deals could not be permitted during the auction period. All other pre-arranged deals done for terms longer than one calendar month would continue to be handled under current procedures (i.e., subject to price caps).

7. Type of Bidding: Open, interactive bids would be used in all auctions. However, the bidder's name would be withheld during the bidding process. Bids could not be withdrawn or reduced during the bidding process. Bids could be increased. The length of each bid period would be appropriate for the type of auction, i.e., a longer bid period for longer-term capacity purchases. Contingent bidding would not be permitted.

8. Price Paid: Winning bidders would pay the price they bid (not the lowest market clearing price). Bids could be made on discrete offers to sell capacity, or bids could be made into pools of identical offers to sell capacity. The winner of tie bids could be determined by the bidder's time stamp, with the earlier bid winning the capacity (i.e., not necessarily pro-rata).

9. Pipeline Offer Information: When a pipeline posts unsubscribed capacity for any auction, at a minimum, the following information should be provided: a. Path / Receipt: Identification of the most upstream point for which capacity is available, identified by: receipt meter, node, zone, compressor station, MID, interconnect, Pool, point, basin or some other ODS (Operationally Distinct Segment). b. Delivery: Identification of the most downstream point for which capacity is available, identified by: delivery meter, node, city gate, etc. c. Available time period (monthly or applicable days) d. Available capacity (MDQ) at all receipt and delivery points along the path.

10. Capacity Release Offer Information: When a releasing shipper posts FT capacity for any auction, at a minimum, it should provide the following: a. Path: Identification of the applicable primary receipt and delivery meters from which the capacity is being released. b. Available time period (monthly or applicable days) c. Available capacity (MDQ) at applicable primary receipt and delivery points d. Recall rights e. Reserve price f. Name of releasing shipper (and whether it is an affiliate of the pipeline) g. Other release terms/conditions (i.e., all or nothing, volume options, pricing terms, - i.e., usage vs. demand, etc.)

11. Transparency: All bidder information, including the bidder's name, would be posted after the auction is complete. The parties to whom capacity was awarded would also be provided in the post-auction public information.

12. Auctioneer: The pipeline should be required to administer its own auction (FERC staff should periodically audit the procedures and results). An independent auctioneer is not needed at this time.

B. Narrative Description Of A Possible Auction Process.

1. The Monthly Auction:

This auction would cover all available pipeline FT for an entire month, and any voluntary shipper-released capacity. Shipper-released capacity could be recallable based on specific conditions (e.g., capacity could not be recalled less than 24 hours before the beginning of a gas day. The winning bidder could not amend the terms of the underlying bid contract except for primary receipt/delivery points, which could be changed, on the condition that the changes revert to the original points when the release term ends. The monthly auction should commence three business days before the monthly NYMEX close. The NYMEX close is currently established at three business days prior to the first of the following month. Capacity should be posted for auction by 11:30 am central time three business days prior to NYMEX close. Open, interactive bidding could start as soon as the capacity is posted. Auction bidding would close promptly at 2:00 p.m. on the same day. Bids could not be withdrawn or reduced, but could be increased in the interactive process. Reserve prices could not be increased but could be reduced. Offers to sell capacity in the auction could not be withdrawn. Capacity auction winners would be subject to reservation charges beginning on the first day of the month. It is possible that additional monthly auction rounds could be constructed to occur subsequent to the initial award of monthly capacity. Such additional auctions (up to two) would serve to allocate capacity that did not sell (due to excessive reserve prices) during the initial monthly auction.

2. The Intra-Month Auction

This auction would cover all pipeline FT capacity available for more than one day, but less than the entire calendar month, and any voluntary shipper-released capacity. Shipper-released capacity could be recallable based on specific conditions (e.g., capacity could not be recalled less than 24 hours before the beginning of a gas day). The winning bidder could not amend the terms of the underlying contract except for primary receipt/delivery points, which would revert to the original points when the release term ends. The intra-month auction (which would be held each day for the remaining days of the month) should commence two business days prior to the first day gas is to flow. Capacity should be posted for auction by 11:30 am central time two business days prior to gas flow. Open, interactive bidding could start as soon as the capacity is posted. For example, an intra-month auction for flow to commence on the first day of a month would be held two days prior to the first. Auction bidding would close promptly at 2:00 p.m. on the same day. Bids could not be withdrawn or reduced, but could be increased in the interactive process. Reserve prices could not be increased but could be reduced. Offers could not be withdrawn. Capacity winners would nominate on the day before for gas flow with flow to commence at 9:00 am the beginning of the next gas day. Capacity auction winners would be subject to reservation charges beginning on the effective date of gas flow.

3. The Daily Auction:

This auction would cover all pipeline FT capacity available for only one day, and all IT capacity, and any voluntary shipper-released capacity. No auction capacity would be recallable. The winning bidder could not amend the terms of the underlying contract. The daily auction would be to auction one-day capacity. Capacity should be posted for auction by 8:00 am central time one business day prior to the gas flow. Open, interactive bidding could start as soon as the capacity is posted. Auction bidding closes promptly at 10:00 am on the same day. Bids could not be withdrawn or reduced, but could be increased in the interactive process. Reserve prices for daily released capacity could not be increased but could be reduced. Offers could not be withdrawn. Capacity winners could nominate by 11:30 am for gas flow to commence at 9:00 am (beginning of the gas day) the next day. Capacity auction winners of FT capacity would be subject to reservation charges beginning the next day. The bid price for IT capacity is established through the daily IT auction. The IT queue establishes the priority queue position for next day IT flow. Shippers willing to bid the highest price flow ahead of those bidding lower rates. If there are no capacity restrictions, all IT could flow. All IT bids in the auction would be assumed to be nominated, with actual scheduling of flow subject to availability (after all FT is scheduled).

4. The Intra-Day Auction:

This auction covers all pipeline FT capacity available for a partial day, IT capacity, and any FT shipper-released capacity. Shipper-released capacity is not recallable. The winning bidder could not amend the terms of the underlying contract. The intra-day auction would auction capacity today for flow later today. Capacity would be posted for auction by 10:00 am central time on the day of gas flow. Open, interactive bidding could start as soon as the capacity is posted. Auction bidding would close promptly at noon on the same day. Bids could not be withdrawn or reduced, but could be increased in the interactive process. Reserve prices for released capacity could not be increased but could be reduced. Offers could not be withdrawn. Capacity winners could nominate by 1:30 p.m. for gas flow to commence at 4:00 p.m. (at a pro-rated flow rate) the same day. The bid price for IT capacity made through the Intra-Day IT auction process establishes the IT priority queue position. Shippers willing to pay the highest price flow ahead of those bidding lower rates. If there are no capacity restrictions, all IT could flow. Intra-day IT could not bump flowing IT awarded in the daily auction. Nominated FT could bump flowing IT. All bid IT would be assumed to be nominated, but flow is subject to capacity availability.

SECTION IV

OPERATIONAL ISSUES

A. There Should Be No Difference In Nomination Requirements For Released Capacity And The Pipelines' Short-Term Firm Service And Interruptible Service.

NGSA supports the Commission's proposal to provide nomination equality between primary and secondary capacity. (NOPR at 51.) Replacement shippers should have the same opportunities to nominate gas as do shippers nominating primary capacity. Allowing replacement shippers to acquire released capacity at any of the nomination or intra-day nomination synchronization times and submit a nomination at the earliest available nomination opportunity will provide more competition for the pipeline's short-term firm and interruptible capacity and help to mitigate the pipeline's inherent market power.

B. The Commission Should Clarify Its Intra-Day Nomination Regulations Regarding Bumping Of Already Scheduled Gas.

The Commission's current regulations covering intraday nominations provide for firm capacity to bump already scheduled interruptible capacity during the first two intraday nomination time periods. However, NGSA seeks clarification on two points regarding the bumping issue.

First, NGSA requests that the Commission order that an interruptible shipper bumped by an intra-day nomination will not be subject to bump-related pipeline penalties for that gas day, irrespective of whether the pipeline notifies the interruptible shipper. Interruptible shippers should not be held financially liable for actions over which they have no control. Second, NGSA requests that the Commission order that an already scheduled interruptible shipper flowing gas cannot be bumped by an intraday nomination submitted by another interruptible shipper at a higher rate.

C. Creditworthiness Standards In Pipeline Tariffs Should Be More Reasonable So As To Promote Competition And Efficiencies In The Marketplace.

The NGSA also supports the Commission's desire to ease the burden of credit-worthiness requirements found in many pipeline tariffs. (NOPR at 52.) The Commission's proposed regulation that the requirement for contracting must not inhibit the ability to submit a nomination at the time the capacity release transaction is complete is most welcome. As the Commission points out, pipelines can institute procedures under which replacement shippers receive pre-approval of their creditworthiness or receive a master contract permitting the shipper to nominate under such contract at any time. With the availability of these procedures, creditworthiness can be resolved well before secondary capacity is awarded. The proposed regulations would encourage pipelines to set up pre-award creditworthiness procedures, thereby eliminating the original problem.

D. Additional Operational Information Is Needed From The Pipelines In Order To Promote Competition And Mitigate The Exercise Of Market Power.

NGSA fully supports the Commission's proposals to increase the amount of information made available by pipelines to shippers. (NOPR at 79 - 86.) Requiring pipelines to provide more information will help to mitigate pipeline market power, assist shippers in planning for their transportation needs and promote efficiencies in the market place. NGSA submits the following comments on the three categories of reporting requirements identified by the Commission in the NOPR.

a. Information on Available Capacity - NGSA agrees with the Commission that requiring pipelines to post the total design capacity of each receipt and delivery point and pipeline segments, along with daily scheduled volumes, is needed to determine if all of a pipeline's capacity is being utilized. This information should be posted with the operationally available and unsubscribed capacity information that is already required under Commission regulations. The requirement that all pipelines post information on planned and actual maintenance or system outages is also necessary to allow shippers to make informed decisions about capacity availability and value.

b. Information on Market Structure - NGSA supports the Commission's proposals that would require pipelines to post more information with respect to the structure of the marketplace. This includes, in the Index of Customers, the receipt and delivery points held under contract, the zones or segments in which the capacity is held and the shipper's contract number. This information would be helpful in evaluating capacity rights held by shippers, especially in the context of procuring secondary capacity.

The Commission's proposal to require posting of pipeline affiliate relationships and pipeline affiliate transactions in capacity release transactions should be approved. This information, as well as requiring posting on the Internet of organizational charts, names of senior employees, shared operating personnel and facilities, marketing affiliates, and gas sales operating units will enable shippers and the Commission to more effectively monitor affiliate transactions. The posting of this affiliate information would also deter pipeline/affiliate abuses.

NGSA also supports the Commission's proposal to require that pipelines disclose the identity of agents or asset managers that control 20% or more of the capacity in a pipeline rate zone as well as the rights of the agent or asset manager with respect to managing the transportation service. This information would be helpful in determining market concentration and the potential for the exercise of monopoly power.

c. Transactional Information - NGSA supports the Commission's proposal to require pipelines to post, and provide downloadable files of, information regarding pipeline capacity transactions, just as they do now for capacity release transactions. The pipelines should post this information contemporaneously with the execution of their contracts and update that information as changes occur. This requirement will provide shippers with more transportation market information on a real-time basis and will allow them to make more informed decisions about capacity purchases, and to detect and deter preferential treatment.

E. NGSA Supports The Commission's Commitment To Take Remedial Action When Pipelines Or Shippers Exercise Market Power.

The Commission should use its authority to take the remedial action that is necessary to deter, detect and punish the exercise of market power. NGSA strongly supports the Commission's proposals for mitigating pipeline market power, especially a requirement for pipelines to install interconnects up request, on a non-discriminatory basis, in order to increase access to alternative transportation service providers.

NGSA also encourages the Commission to conduct periodic audits of pipeline operations to ensure that certain customers (especially affiliates) are not receiving preferential treatment from pipelines. Commission audits should also focus on the pipelines' use of and need for operational flow orders ("OFOs") and the levying of imbalance penalties in order to ensure that OFOs are not being invoked to artificially constrain capacity and increase its value. Audits would also be important in determining whether pipeline operating practices permit shippers to trade imbalances on an efficient and timely basis.

In those instances where the exercise of market power has been demonstrated, NGSA requests that the Commission exercise its authority to impose significant financial penalties on the responsible party. Such penalties should be sufficiently large to deter improper activities, in much the same way that pipeline tariffs impose imbalance penalties to deter shipper "gaming". Moreover, NGSA applauds recent Commission Order No. 602, which provides for the possibility of complainants receiving interim relief from inappropriate pipeline behavior.

F. Pipelines Should Provide, And Shippers Should Be Able To Rely On, More Timely Imbalance And Overrun Information.

NGSA agrees with the Commission that each pipeline should provide to each shipper on its system, on a confidential and timely basis, as much information as possible about the imbalance and overrun status of that shipper. (NOPR at 96 - 99.) NGSA suggests that the Commission take an additional step and provide that each shipper should be able to rely on this information from the pipeline and not be penalized if, after the month has ended, the pipeline revises its numbers and the result reflects a larger imbalance. This policy would be more equitable for shippers striving to stay in balance during the month and would provide an incentive for the pipelines to post accurate information. Pipelines should provide real time flow data at as many meters as is feasible and post the best data available to enable shippers to stay in balance. NGSA supports the Commission's suggested option that would forbid a pipeline from imposing a penalty for an overrun/imbalance that does not threaten system reliability unless the pipeline has metering equipment to measure the overrun/imbalance and notifies the shipper in a timely manner of the overrun/imbalance.

G. Transportation Penalties Should Be Imposed Only To The Extent Necessary To Protect System Operations And Should Not Be A Profit Center For The Pipelines.

As stated in the NOPR, the Commission has authorized extremely high overrun and imbalance penalties for several pipelines in recent years and now questions whether the higher penalties are necessary to ensure system reliability. (NOPR at 99 - 105.) NGSA commends the Commission for reviewing this issue and believes that such penalties are indeed excessive and unnecessary for the purpose of protecting pipeline system operations. NGSA believes that a reasonable alternative was proposed by the Commission; specifically, penalties should be set based on a published commodity index price that is agreed to by the pipeline and its customers, plus an "adder". (NOPR at 100 - 101.) The additional amount represented by the adder should effectively deter any gaming on a pipeline because it would be cheaper for a shipper to procure or sell gas at the commodity rate to stay in balance than to pay the commodity rate plus the "adder". Consequently, the Commission need not set the "adder" at an exorbitant level to achieve the desired effect.

NGSA does not believe that this is an issue that can or should be standardized by the Gas Industry Standards Board. NGSA, however, believes that the Commission policy on this matter would be more appropriately resolved through a generic Commission proceeding.

NGSA also supports the Commission's suggestion to provide an automatic credit to shippers of penalty revenues collected by the pipelines. (NOPR at 103.) This policy would prevent penalties from becoming a profit center for pipelines and would give the pipeline an incentive to match the level of the penalty to the severity of the problem. As long as pipelines can collect penalties during periods of constrained capacity, NGSA believes that the current regulatory treatment of penalties encourages pipelines to constrain current capacity and to defer the construction of new capacity which would alleviate system constraints. With respect to how the collected penalties are distributed, NGSA believes that penalty revenues should be refunded to non-offending shippers.

The Commission solicited comments on the desirability of revising the manner in which a shipper's cash-out payment is determined. (NOPR at 104.) NGSA does not believe there is a need to change the way a shipper's cash-out payment is determined. The current system of using a monthly average price is working well for both the pipelines and their customers.

H. Pipelines Must Provide Services, To The Extent Operationally Feasible, That Facilitate Imbalance Management.

NGSA agrees with the Commission that pipelines should strive to provide services that would reduce the need for imbalance penalties and the imposition of unnecessary penalties. (NOPR at 108 - 111.) NGSA believes that recent Commission initiatives requiring intra-day nominations, operational balancing agreements at all pipeline to pipeline interconnects, permitting shippers to offset imbalances across contracts and to trade imbalances with each other are important tools that can reduce pipeline imposed penalties. NGSA agrees with the Commission's proposal that pipelines revise or eliminate any tariff provision that gives preference to their storage or balancing services over such services that are provided by a similarly situated third party. (NOPR at 106.)

NGSA supports the Commission suggestion to require that each pipeline adopt a "no harm, no foul" policy whereby a shipper who has an imbalance that is actually helping the system (one that runs in the opposite direction of the system imbalance) would not be penalized. (NOPR at 99.) This policy can be especially beneficial to the pipeline system during critical times.

Another service that can facilitate imbalance management and promote administrative efficiency is pool to pool transfer service. This service is already offered by a few pipelines. NGSA requests that the Commission make pool to pool transfer service required on all pipelines because it would facilitate shipper efforts to stay in balance and because it is not administratively burdensome on the pipelines.

I. Pipelines Must Adopt Incentives And Procedures That Minimize The Use And Adverse Impact Of Operational Flow Orders.

NGSA supports the Commission's proposal that would require each pipeline to revise its tariff with the objective to reduce the frequency and adverse impact of OFOs. (NOPR at 108 - 111.) NGSA also supports the Commission's suggestion of requiring automatic rate crediting of OFO penalties to non-offending shippers. In contrast, NGSA opposes the Commission's suggestion of using financial incentives for pipelines that never impose OFOs. Never having to impose OFOs should be the standard. NGSA is in favor of instituting a procedure that monitors on a periodic basis the frequency of OFOs imposed by each pipeline. Those pipelines that frequently issue OFOs should be audited by the Commission to ensure that OFOs are not being invoked to generate additional profits through the imposition of unnecessary penalties.

J. Shippers Should Have Both The Ability To Segment Their Capacity And The Flexibility To Use Alternate Receipt And Delivery Points To The Extent Operationally Feasible.

The issue of segmenting capacity has been addressed before in the Commission's proceeding on secondary market transactions in Docket Nos. RM96-14-000 and RM96-14-001. In that proceeding, NGSA supported the Commission's proposal to allow all shippers to segment their own capacity for their own use to the maximum extent feasible. NGSA continues to support that proposal. Capacity segmentation increases the availability of transportation capacity, improves the value and fungibility of capacity, and provides for a more competitive and flexible transportation market.

NGSA also supports the Commission's suggestion that pipelines be required to provide all shippers with firm capacity rights over the mainline with equal rights to flow gas past a mainline constraint point along the shipper's path. (NOPR at 64.) This policy would make released capacity flowing to secondary points more comparable and competitive with other firm capacity flowing past the constraint. The Commission's suggestion that all shippers with firm capacity have equal rights to receive or deliver gas at all points along their path would work only if there was available capacity at the particular point in question.

NGSA does not support the Commission's suggestion that shippers could acquire from pipelines unsubscribed primary capacity rights at receipt and delivery points independent of mainline transportation. (NOPR at 64.) This would invite speculators and/or hoarding of such rights that could create bottlenecks and abuse of the system.

With regard to confirmation practices across interconnects (NOPR at 65.), the NGSA believes that when the capacity restriction is on the upstream pipeline, that pipeline's priority rules should control, and vice-versa. If the capacity restriction is at the interconnect meter, the priority rules of the pipeline that is responsible for measurement at that meter should control. The party responsible for measurement at an interconnect meter should be posted on the Internet web page of each pipeline upstream and downstream of the interconnect.

SECTION V

REGULATION OF NEGOTIATED TRANSPORTATION SERVICES OF NATURAL GAS PIPELINES

A. NGSA Opposes A Commission Policy Permitting The Negotiation Of Terms And Conditions Of Pipeline Service.

The Commission's proposal for negotiated terms and conditions of pipeline service could have a far-reaching impact on the entire U.S. natural gas industry. The Commission's current negotiated rate policy (Docket No. RM95-6) already provides pipelines flexibility in designing and setting rates. The Commission proposal in Docket No. RM98-10 to permit negotiated terms and conditions of service heightens the already significant concern about the ability of pipelines to exercise market power.

The Commission's stated purpose for permitting negotiated terms and conditions is to provide pipelines and their customers with additional flexibility to design terms and conditions that, it hopes, will result in increased market efficiency to the benefit of all industry participants. NGSA believes that pipelines already have the ability to create more flexible, market responsive services through the development of new tariff services. The benefits of any incremental flexibility afforded by the negotiation of terms and conditions of service do not outweigh the risks and costs of the pipelines exercising their monopoly power. Consequently, NGSA opposes the Commission's proposal to permit the negotiation of the terms and conditions of pipeline service.

B. Current FERC Processes Provide Interstate Pipelines Adequate Flexibility To Offer Their Customers New Services Or To Modify The Terms And Conditions Of Existing Services.

It has been argued that a pipeline must have the ability to tailor its services to the needs of individual customers without the delays associated with traditional filing requirements in order to achieve and maintain maximum throughput. For example, the Commission speculates that "conventional tariff procedures may inhibit the development of innovative services, since the need for such services may be immediate and may arise quickly". (NOPR at 112) NGSA does not agree. Pipelines already have the flexibility they need through the current regulations to provide new, innovative services on a timely basis. Recent examples of new, innovative pipeline services include parking, loaning, seasonal billing flexibility (e.g., Texas Eastern), and flexible firm service.

The current Commission procedures protect pipeline customers from monopoly behavior by requiring both full disclosure and Commission approval before new services go into effect. These traditional procedures for implementing new services provide the Commission and interested parties the opportunity to scrutinize proposed pipeline services prior to their going into effect and to assess the potential for preferential treatment and/or the degradation of other pipeline services. These current procedures allow for the creation of new services without the risks of having the pipeline exercise its monopoly power through the negotiation of service terms and conditions. Moreover, the Commission can approve new pipeline services on a timely basis, often within 30 days. Consequently, NGSA sees no benefit to leaving pipeline customers open to the exercise of pipeline monopoly power in return for a slightly faster schedule for implementing new services. The Commission should not abandon the protection of pipeline customers in return for a slightly improved implementation schedule.

In contrast, under a negotiated terms and conditions policy, pipeline customers would have to rely on the Commission's after-the-fact complaint procedures to redress any harm resulting from a particular negotiated contract. This shifts the "burden of proof" to complainants to demonstrate not only that they have been harmed, but also that a specific negotiated contract is the cause of that harm. Because a complainant will never have as intimate an understanding of a pipeline's operations as the pipeline itself, the complainant's "burden of proof" constitutes an almost insurmountable hurdle for real damage being redressed.

Because NGA Sections 4 and 7 processes provide interstate pipelines adequate flexibility to structure their transportation services to meet customer needs, NGSA is baffled when parties state, for example, that: "Currently, out-dated tariff and contract provisions restrict the flexibility of all parties to meet customer requirements..." as a justification for permitting the unfettered negotiation of pipeline services. If an interstate pipeline views its tariff as "out-dated", then it should initiate either a Section 4 or Section 7(c) procedure to restructure its tariff or offer new services to better meet the needs of its customers.

C. The Request For The Negotiation Of Pipeline Service Terms And Conditions Is Not Driven By An Inability To Fashion Pipeline Tariff Services That Are Responsive To Pipeline Customer Requirements.

Current Commission procedures provide pipelines with a sufficient ability to change their tariffs in a timely fashion, as their customer needs change. If there is any serious impediment to future gas consumption growth, it is the existence of excessive pipeline transportation rates due to exorbitant pipeline costs and rates of return.

Even though pipeline transportation service to the electric generation industry is often cited as a compelling reason for permitting the negotiation of terms and conditions of pipeline service, gas consumption in electric generation has shown the greatest growth of any gas consumption segment. Moreover, the interstate pipeline industry has successfully served the variable gas consumption loads of the electric generation market for many decades. These realities belie any notion that current pipeline regulation is somehow artificially constraining gas use either by electric generators or by any other group of energy consumers.

Pipelines also often point to the LDC "decontracting" of pipeline capacity as another circumstance that justifies the negotiation of terms and conditions of pipeline service. Pipelines claim that the negotiation of service terms and conditions is necessary to maintain sufficient pipeline throughput and revenues as LDCs "decontract" for firm pipeline capacity.

Even though LDC decontracting might reduce the proportion of the pipelines' throughput moving under long-term transportation contracts, it will not necessarily reduce total pipeline throughput. Gas market participants expect aggregate pipeline throughput and capacity utilization to increase as total gas consumption increases, a phenomena that is readily apparent. For example, the growth in gas consumption between 1990 and 1996 increased lower-48 interstate pipeline capacity utilization from 68 percent to 75 percent. Thus, the real issue for the Commission is not the proportion of pipeline capacity purchased under long-term contracts, but rather how pipeline services are priced so that pipelines have an adequate opportunity to recover their revenue requirements. Maintaining sufficient pipeline revenue recovery is not an issue of pipeline negotiating flexibility.

With respect to the pipelines' responsiveness to customer "needs", there appears to be a fundamental disagreement between what the LDCs and pipelines envision regarding the purpose for additional pipeline negotiating flexibility. The pipelines apparently see themselves providing "premium" services at a rate exceeding current tariff rates. In contrast, the LDCs apparently see additional pipeline negotiating flexibility as a means for obtaining "stripped down" transportation services at a lower rate. The LDC request for lower-cost "stripped down" services can be viewed as a request for the further unbundling of pipeline transportation services. This LDC request can be accommodated through the traditional Commission processes. Finally, the Commission's speculative discussion of the "need" for negotiated terms and conditions is undermined by the hypothetical examples discussed in the NOPR.

"Allowing pipelines and shippers to negotiate terms and conditions of service, as well as rates, may permit greater flexibility in the allocation of the shipper's risk inherent in long-term capacity contracts. Such negotiation of rates and services could permit more flexible contracts for higher rates. Other options for negotiation could include lower rates for longer term contracts, different rates for the right to reopen the contract in specified contingencies, or varying rates for different payment schedules." (NOPR at 114)

Each of these customer "needs" can either be accommodated through current Commission policy (e.g., the negotiation of rates, which includes the pipeline's ability to: a) discount rates, b) charge rates in excess of the maximum tariff rate, and c) sign fixed rate contracts) or can readily be accommodated by changing pipeline tariffs (e.g., flexible firm service, which currently exists in some offshore pipeline tariffs; tailored payment schedules, as in the Texas Eastern tariff). Finally, NGSA is not aware of any regulatory barriers that preclude parties from signing transportation agreements with re-opener clauses.

The Commission also speculates that state retail unbundling, capacity turn-back, and greater competition from the electric industry "may" be accommodated through negotiated terms and conditions of pipeline service. (NOPR at 114 - 115.) However, the Commission declines to speculate how the pipelines' ability to negotiate terms and conditions alleviates these "problems" in a manner that cannot be accommodated either through current Commission policy or through pipeline tariff changes. In this regard, NGSA is alarmed that the Commission might willingly forsake current customer protections against the exercise of pipeline market power based on a vague and highly speculative "need" that has never been demonstrated. Indeed, the Commission is well aware of the dangers inherent in a negotiated terms and conditions policy when its states:

"Pipelines will exercise market power if they can. ...the negotiation of rates and services, by its nature, gives pipelines the ability to treat customers differently, and thereby could facilitate a pipeline's ability to segregate customers and exercise market power." (NOPR at 115)

Again, NGSA does not believe that the unsubstantiated benefits of a negotiated terms and conditions policy outweighs the real and likely harm resulting from a greater exercise of pipeline monopoly power.

D. Allowing The Negotiation Of Transportation Service Terms And Conditions Would Inevitably Result In Preferential Contracts, Especially For Contracts Between The Pipelines And Their Affiliates.

NGSA believes that the negotiation of pipeline service terms and conditions would inevitably result in preferential treatment. These contracts would provide select customers with an undue competitive advantage. For example, suppose that there are two gas-fired electric generators located on the same pipeline and selling into the same wholesale power market. If one of those generators is able to negotiate more advantageous terms and conditions relative to its competitor, then it could have such a significant competitive advantage as to tip the competitive balance so that its facility is profitable whereas the other generator loses money. The preference problem is particularly nettlesome when a pipeline affiliate is involved. In these circumstances, preferential treatment of an affiliate can convey significant financial returns to the pipeline's parent company.

In most cases, pipeline parent companies are engaged in a host of business activities that are outside the jurisdiction of the Commission. These non-jurisdictional business activities include, but are not confined to: gas production, gas processing, gas gathering, gas marketing, the local distribution of natural gas, and gas-fired electric generation. Each of these non-jurisdictional affiliate activities would be competitively advantaged by negotiated terms and conditions that are not made available to non-affiliated competitors.

The granting of preferential treatment to pipeline affiliates could have the serious consequence of diminishing competition in non-jurisdictional businesses, such as electric generation. For example, pipeline-affiliated electric generators could gain sufficient competitive advantages from negotiated terms and conditions to preclude effective competition from non-affiliated generators. In other words, negotiated terms and conditions could give pipeline affiliates overwhelming economic benefits not available to non-affiliated parties so as to preclude the non-affiliated competitors' presence in certain non-jurisdictional markets. Thus, NGSA expects that contracts between the pipelines and their affiliates would seriously diminish competition both within and outside the gas industry.

The Commission should not assume that its "similarly situated" policy will prevent the pipeline-affiliate abuse problems presented by a negotiated terms and conditions policy. It is highly probable that the pipelines and their affiliates will structure negotiated term and condition contracts that preclude the eligibility of other parties for "similarly situated" status. For example, a contract designed to serve an affiliated gas-fired electric generator could effectively preclude the applicability of that contract to "similarly situated" parties by referring to a unique delivery point that can serve only one customer, i.e., the pipeline affiliated gas-fired electric generator. Even if such contracts were unable to completely preclude the existence of other "similarly situated" customers, the availability of such services to non-affiliated parties could be frustrated by a lengthy regulatory process intended to determine the eligibility of other pipeline customers for a negotiated pipeline service. Again, for these reasons alone, the Commission should not permit pipelines to negotiate the terms and conditions of service.

E. The Commission's Order No. 636 Regulations Should Not Be Compromised By A Commission Program Permitting The Negotiation Of Pipeline Service Terms And Conditions.

The primary objective of Order No. 636 was the promotion of economic efficiency in the natural gas industry through the equalization of transportation services provided to all sellers of gas by removing the pipelines' competitive advantage over other sellers of natural gas. The Commission sought to achieve this goal through, among other things, unbundling pipeline services and requiring implementation of capacity release programs. The negotiation of terms and conditions of pipeline service could contravene the Commission's Order No. 636 intention of creating a viable secondary capacity market, if a pipeline, for example, required that its negotiated contracts effectively deny or severely limit a firm capacity holder's release of capacity. Allowing pipelines to negotiate their terms and conditions of service would undoubtedly impact most if not all the changes brought about by Order No. 636.

SECTION VI

SEASONAL RATES

A. Seasonal Rates Could Increase The Ability Of Pipelines To Exert Market Power And Should Be Implemented Only If Market Power Can Be Constrained.

Throughout the NOPR the Commission expresses its concern that parties can continue to exercise market power. Therefore, the Commission expresses the intent that "any regulatory approach that it adopts must continue to provide effective protection against this exercise of market power." (NOPR at 28.) Furthermore, the Commission contemplates that there may be an administratively easier means to determine whether market power is a problem. In that regard, the Commission suggests that another option would be a seasonal rate design, which purportedly "would better approximate pricing activity during peak and off-peak periods." (NOPR at 43.) However, in the next breath, the Commission rightfully concludes that "if the price cap is raised high enough to accommodate peak period competitive prices, this approach is little different than simply removing the rate cap, since it would afford firms with market power substantial latitude to exercise that power at prices below the price cap." (NOPR at 43 - 44.) The NGSA agrees. Moreover, in the absence of a fully defined proposal that has been reviewed by all parties, the NGSA believes that the Commission should refrain from any generic approval of seasonal rates.

Given that a seasonal rate design can effectively remove the current maximum caps, the Commission must ensure continuing effective protection against recognized market power before any such seasonal rate design can be contemplated. As discussed in the NOPR, there are two means by which the Commission can provide such assurances. First, a full market power test can be conducted pursuant to the Commission's Alternative Rate Design Policy. (NOPR at 41 - 43.) Alternatively, the Commission may choose to institute some other regulatory means to constrain market power, such as the proposed short-term auction process. The NGSA's primary concern is that without either a market power test or an effective means to protect against market power, seasonal rates would likely result in unjust and unreasonable rates, and, thus, would be unlawful. Hypothetically, to the extent that (as proposed) the Commission does lift short-term rate caps and institute an effective auction process, it is unclear what the additional implementation of seasonal rates would add to the Commission's stated policy goals. Therefore, to the extent that the Commission does not properly constrain recognized market power (through the implementation of an auction process), it should be very cautious in lifting the rate caps or allowing seasonal rates.

B. The Commission Should Refrain From Any Implementation Of Seasonal Rates Unless A Specific Proposal Is Made And Approved Through A Generic Proceeding.

Although seasonal rates are only tangentially addressed in the NOPR, there may be parties to this proceeding that propose a comprehensive seasonal rate design. In that regard, the Commission should not consider the implementation of any seasonal rate design until a specific, fully articulated generic proposal has been made, and all parties have had the opportunity to review and comment. To date, there is simply insufficient information on which to consider, much less approve, a reasoned seasonal rate policy. Given the potentially harmful impact that could result from an inappropriate and/or inconsistent implementation of seasonal rates, the Commission should institute a generic regulatory proceeding that would provide a forum for thorough discussion, and if approved, a consistent and uniformly applied concept for all interstate pipelines.

SECTION VII

TERM-DIFFERENTIATED RATES

A. Term-Differentiated Rates Do Not Properly Address Long-Term Capacity Subscription And Should Be Implemented Only After Appropriate Review.

In the NOPR the Commission suggests that its current regulatory policies create a bias in the natural gas market toward the contracting of short-term capacity. The Commission cites the use of the same maximum rate for service under short-term and long-term contracts as a major cause of this bias, and suggests that the corresponding financial risks and rewards are not linked, and that this risk asymmetry favors short-term contracts. The Commission then concludes that this imbalance in risk and reward may cause financial harm to the pipelines through capacity turn-back and the discounting of long-term contracts. (NOPR at 150 - 151.)

As a solution to this perceived problem, the NOPR proposes that term-differentiated rates be implemented, which would increase the maximum lawful rates for short-term contracts and lower the rates for long-term contracts. (NOPR at 157 - 158.) However, before the Commission can seriously consider term-differentiated rates, it must ensure that: (1) there is a real and compelling problem, (2) that a proposed cure is necessary, and (3) that any proposed remedy does not cause other, unintended harm. In the absence of a fully defined proposal that has been reviewed by the entire industry, the NGSA believes that these conditions have not yet been fully met and that term-differentiated rates could be both unnecessary and potentially harmful.

In this regard, there are several reasons why the Commission should be very cautious in approving any form of term-differentiated rate design. First, a new term-differentiated rate policy has not yet been shown to be necessary, and (in any event) such rates can already be effectively implemented under the Commission's current policies. Second, the Commission's apparent assumption that short-term services should be priced higher because they inherently have greater value to shippers should not form the basis for setting a cost-based rate. Third, because term-differentiated rates would increase the short-term rate caps, as with seasonal rates, they can serve to effectively increase the potential for the exertion of market power. Fourth, the best solution for any possible contract term bias is to reduce the cost of all rates, both long and short-term.

B. The Need For Term-Differentiated Rates Is Currently Unproven, And Term-Differentiated Rates Can Already Be Implemented Under Current Policy

In basic form, term-differentiated rates are already permitted under the Commission's current negotiated and discount rate policies. There is nothing that precludes the pipelines and their customers from voluntarily entering into contracts of any term, and at rates that either above or below the current cost-based maximum rates. Furthermore, the Commission's discounted and negotiated rates policies already sufficiently and properly address how and who should bear the relative costs and risks of these alternate contract forms. The Commission need not, in this proceeding, create new policy out of whole cloth. The work is already done; the industry has already adapted.

To a large degree the Commission's concerns regarding the potential bias against long-term contracts and the resulting negative financial impact on pipelines are premature. There is simply insufficient empirical information to conclude that there is an industry-wide problem that requires the introduction of a completely new regulatory policy that moves away from historic cost-of-service ratemaking. The very few examples that exist at this time, which have dealt with a stranded cost problem, do not by any means prophesy an eminent flood of such cases before the Commission. On the contrary, the few cases that have occurred are more likely the exception, rather than the rule. Furthermore, to the extent that the natural gas industry is positioning itself to supply a 30 TCF market, it is reasonable to expect that the current pipeline infrastructure will be completely utilized in the achievement of that goal. Therefore, the NGSA cautions against any fundamental change in current rate policies that are, as of yet, unproven and which may actually be contra-indicated in light of the future expectations of higher pipeline capacity utilization.

C. The Commission Should Not Set Rates Based On The Value Of Capacity To Shippers.

The Commission seems to justify the implementation of term-differentiated rates, and the corresponding higher short-term rates, on the conclusion that: "a short-term contract provides greater flexibility and less risk to the shipper, and the higher short-term rate would recognize, and require payment for, these benefits." (NOPR at 158.) This conclusion is, however, based on the faulty presumption that maximum rates should be set higher for short-term services because short-term capacity somehow has a greater intrinsic worth to shippers than long-term capacity. Both long-term and short-term capacity perform the same basic gas transportation function, which has been, and should remain, cost-based. The relative value, or related risk, of a particular service to a potential shipper is not relevant to the pricing of pipeline capacity, because, among other things, the financial risks and rewards are different for each individual shipper and each specific service. Fundamentally, the concept of value and risk is something that should be left to the commercial marketplace; it cannot, and should not, form the basis for the pricing of a cost-based service. Thus, the Commission should not establish any rate design that specifically transfers costs between long and short-term customer classes based on the perceived value or risk of that capacity to shippers.

D. Term-Differentiated Rates Can Potentially Increase The Ability Of Pipelines To Exert Market Power.

Term-differentiated rates are designed to raise the maximum lawful cap for short- term capacity above the current cost-based rate. As the Commission rightfully concluded regarding seasonal rates, when the short-term rate caps are raised in the peak period (as term-differentiated rates would provide), the increased risks become high enough to create a result that is little different than simply removing the rate caps. (NOPR at 43.) This, in turn, raises the possibility that parties may then exert their inherent market power, and thus, the Commission is bound by its stated intention to institute regulatory policies that continue to constrain such market power. Without an effective means to control market power, such as the proposed auction, just as with seasonal rates, term-differentiated rates could result in unjust and unreasonable rates. Therefore, to the extent that the Commission does not constrain recognized market power (through the implementation of an auction process), it should refrain from either lifting the rate caps or allowing term-differentiated rates.

E. The Best Solution Is To Lower Rates For All Services.

The Commission's concern that shippers are biased in favor of short-term capacity contracting is predicated on the assumption that long-term capacity is priced too high relative to short-term capacity. Stated another way, the Commission is concerned that the price of short-term capacity is too low, and that this induces shippers to participate in the short-term market. The NGSA suggests that the best means to motivate shippers to subscribe to long-term capacity is not to create a negative incentive towards short-term capacity (by artificially increasing short-term rates), but to lower the cost of both long-term and short-term capacity. Lowering the cost of all rates will serve to stimulate both long and short-term markets, to increase pipeline utilization, and to better balance overall risks and rewards. Lower long-term rates and the corresponding associated lower risk will inherently induce shippers to maintain their existing long-term capacity, which will also serve to reduce the pipelines' risk of under-subscription and stranded costs. The lowering of all pipeline rates provides beneficial results, which accrue to the entire natural gas industry. Therefore, the NGSA proposes that the Commission actively pursue a policy to lower all pipeline rates through the implementation of a mechanism as detailed in these comments in Section II.

F. The Commission Should Refrain From Any Implementation Of Term-Differentiated Rates Unless A Specific Proposal Is Made And Approved Through A Generic Proceeding.

Finally, as with seasonal rates, there may be parties to this proceeding that propose a comprehensive term-differentiated rate design. In that regard, the Commission should not consider the implementation of any term-differentiated rate design until a specific, fully articulated generic proposal has been made, and all parties have had the opportunity to review and comment. To date, there is simply insufficient information on which to consider, much less approve, a reasoned term-differentiated rate policy. Furthermore, given the potentially harmful impact that could result from an inappropriate and/or inconsistent implementation of term-differentiated rates, the Commission should institute a generic regulatory proceeding, which would provide a forum for thorough discussion, and if approved, a consistent and uniformly applied program for all interstate pipelines.

SECTION VIII

MISCELLANEOUS ISSUES

A. The Commission Should Encourage Interstate Pipeline Competition By Conditioning Any New Pipeline Service Or Program With The Requirement That Pipelines Provide Interconnection Upon Request.

If the Commission is really serious about enhancing interstate gas transportation competition, then it should look for every opportunity to condition new pipeline services and programs on the requirement that these pipelines provide requesting parties with interconnections upon request. One regulatory means for reducing the interstate pipelines' market power is for the Commission to provide shippers with the greatest number of transportation alternatives. Such transportation alternatives are available only to the degree that there are interconnections to these alternatives. A Commission policy to promote pipeline interconnections would not only promote greater competition among the pipelines, it would also enhance the efficiency of interstate transportation by further integrating the national gas grid by facilitating movement of gas over multiple pipelines and by creating additional gas market centers and "hubs". Consequently, NGSA strongly urges the Commission to promote pipeline interconnections by conditioning its approval of any pipeline request for new services and programs with the requirement that such pipelines provide interconnections with their system upon request. Of course, use of that interconnect will depend on the availability of unused capacity on both transmission systems.

NGSA's proposed interconnection policy would facilitate the development of new market centers and would provide buyers and sellers of gas with more efficient access to other pipeline systems in the transportation grid. This would enhance competition and enable parties that perceive they are competitively disadvantaged by a particular pipeline's rates to seek alternative transportation providers. Moreover, by providing shippers with more transportation alternatives, greater efficiency in gas transportation is likely to result. This greater transportation efficiency could take the form of lower transportation rates for gas shippers and the removal of capacity constraints on pipelines operating at close to full capacity. To the degree that capacity constraints would be reduced or eliminated by shippers using alternative routes, a Commission policy of interconnection on demand would reduce the need for future facility construction, which in turn, would lower gas transportation costs.

B. Whether The Commission "Should Adopt A Policy That Shippers With Long-Term Firm Contracts Should Be Guaranteed Fixed Rates?" (NOI at 14; 28 -30.)

The Commission has already given certain pipelines and their customers the authority to sign long-term, fixed price contracts under its negotiated rate policy. The Commission's negotiated rate policy gives appropriate guidance regarding the over or under recovery of pipeline revenues, relative to the prevailing tariff rates. Moreover, the Commission's negotiated rate policy permits parties to pay above or below the then current tariff rate based on an assessment of whether the parties expect future rates to rise or fall. Thus, the Commission's policy provides both sufficient contracting flexibility and appropriate regulatory guidance regarding fixed price contracts.

The Commission's negotiated rate policy should apply to both new and existing pipeline capacity. For example, the Commission asks "whether and how to encourage pipelines and customers to negotiate pre-construction risk and return-sharing agreements" (NOI at 32). NGSA's response is that both parties to a new facility agreement have a natural self-interest to negotiate a risk-sharing agreement. NGSA also believes that such risk-sharing agreements would be appropriate and can be accommodated under the Commission's negotiated rate policy. Consequently, the Commission need not provide any additional, artificial regulatory "encouragement" for such risk-sharing agreements.

C. Whether The Commission Should Permit Market-Based Rates For Unsubscribed or "Turned Back" Capacity? (NOI at 20 - 21; 30 -31.)

NGSA