1. ECO 436 Natural Gas

2. ECO 436 David Loomis 309-438-7979 Pipeline regulation 25 pipelines account for 90% of volume (1987) Most LDCs served by 3 or fewer pipelines Pipelines bought gas from field producers on LT contracts 20 yrs. or more ROR regulated

3. ECO 436 David Loomis 309-438-7979 Pipeline regulation (cont’d) 2 pt. tariff - demand charge - subscribed for a certain max level of consumption per period commodity charge - based on quantity actually consumed Pipelines buy gas from producers and resell to distributor

4. ECO 436 David Loomis 309-438-7979 Pipeline regulation (cont’d) 1985, FERC order 436, did not require pipelines to offer transportation - only services, but if they did, access rates must not be not discriminatory. Some pricing flexibility

5. ECO 436 David Loomis 309-438-7979 Pricing –Peak load pricing problem –Solution 1storage 2interruptible tariffs

6. ECO 436 David Loomis 309-438-7979 Pipeline regulation (cont’d) April 92 FERC 636, mandates pipelines to separate gas sales from transportation and allowing open access to pipeline transportation for gas producers and customers Gas shortages in 70’s, surplus in 80’s 1987 Natural gas provided 22% of total US primary energy requirement –45% of all delivered residential energy

7. ECO 436 David Loomis 309-438-7979

8. Problem of Differentials Max. price was capped for transportation Value of service (shown by price differentials) exceeded cap Marketers that owned capacity would only sell bundled service

9. ECO 436 David Loomis 309-438-7979 FERC 637 Passed Feb 2000 waived the price ceiling for short-term released capacity (less than one year) until September 30, 2002. Effectiveness of this unregulated secondary market for short-term capacity will be assessed after the trial period. permitted pipelines to propose contracts for capacity with peak/off-peak and term differentiated rate structures.

10. ECO 436 David Loomis 309-438-7979 LDC Regulation from city gate to burner tip ROR regulated by state gas price is pass thru PGA – purchased gas adjustment clause

11. ECO 436 David Loomis 309-438-7979 IL LDCs 14 investor-owned gas public utilities in IL in 1999 NICOR 2,266,470 customers 42.27cents/therm Peoples Gas (Chicago) 813,200 customers 64.09 cents/therm Illinois Power 399,871 customers 52.27 cents/them North Shore 141,806 customers 56.43 cents/therm

12. ECO 436 David Loomis 309-438-7979 PGA Clause Peoples & North Shore proposed eliminating the PGA clause and include gas charges in base rates in 1999. Commission ordered set fixed gas charge Companies rejected the set rate and elected to maintain PGA

13. ECO 436 David Loomis 309-438-7979 PGA Clause (cont’d) NICOR proposed an alternative regulation scheme. Proposal was approved in November, 1999.

14. ECO 436 David Loomis 309-438-7979 Armstrong & Leppel - combination gas and electric –No statistically significant indications of cost complementarity or economies of scale in the combination gas and electric

15. ECO 436 David Loomis 309-438-7979 Lyon & Hackett Bottleneck or essential facilities - facilities with relatively large economies of scale, substantial asset specificity, initially linking isolated buyers and sellers.

16. ECO 436 David Loomis 309-438-7979 Bottleneck facilities characteristics: 1feature extremely large quasi-rents and require protection like vertical integration. 2governed by regulatory policies that protect both investors and customers. 3Began as providers of a service that tied upstream supply with transportation of that supply. 4Networks tend to grow in scope and complexity overtime creating greater competition upstream of the bottleneck facility.

17. ECO 436 David Loomis 309-438-7979 Reasons for using long-term governance structures in transactions with upstream suppliers: 1quality differences that can only be verified thru experience. 2If spot prices are not free to adjust instantly, shocks many cause the markets not to clear. 3Began as providers of a service that tied upstream supply with transportation of that supply. 4Networks tend to grow in scope and complexity overtime creating greater competition upstream of the bottleneck facility.

18. ECO 436 David Loomis 309-438-7979 Transactional Characteristics 1heterogeneity of customers –residential - no storage - can’t switch to other fuels –industrials - dual fuel boiler technology 22 forms of reliable service –instantaneous service - allows buyer to take gas out of pipeline as soon as buyer as gas put in –“no notice” peak service - allows buyer to take as much gas as needed without advance warning to the pipeline 3Reliability costs –inventory costs of holding excess gas deliverability –pipeline costs - holding excess transportation capacity maintaining extra system pressure (line pack) and monitoring suppliers.

19. ECO 436 David Loomis 309-438-7979 Critique of order 636 FERC focuses on benefits of unbundling, but rejects the possibility of degraded service reliability. Some pipelines argued that bundling was necessary for reliable no notice service (later refuted) “We predict the cost of internalizing externalities in the unbundled system will be greater than in the bundled system.” p. 390 FERC 636 should have left bundling as an option.