FERC makes it easier to charge market rates for gas storage

FERC makes it easier to charge market rates for gas storage

September 17, 2006

By David Schumacher

Owners of underground natural gas storage facilities should find it easier to charge unregulated, market-based rates for their services under new rules announced by the Federal Energy Regulatory Commission in June.

FERC hopes the new rules will lead to construction of more gas storage facilities. Additional storage sites are needed to meet increasing demand for natural gas and to help mitigate price volatility in the natural gas market.

Owners of storage facilities have had historically to charge cost-of-service rates for storing gas. In recent years, FERC has allowed them to charge market-based rates, meaning whatever they can negotiate with customers. However, to qualify for market rates, a storage provider must demonstrate that it lacks market power in the geographic and product markets in which it will provide services.

Even then, approval to charge market rates is not automatic. FERC has rejected a number of proposals on grounds that customers in the area have few alternatives but to use the storage facilities at issue. The agency has taken a narrow view of what qualifies as a practical alternative. The new rules represent a rethinking of this approach. The agency is concerned that its current market power test is inhibiting construction of new storage capacity because it is too restrictive.

Congress gave the agency a push. The new Energy Policy Act that was enacted in August last year amended the federal Natural Gas Act to allow anyone building a new gas storage facility to charge market-based rates without having to satisfy the FERC market-power test. The developer must merely demonstrate that market-based rates are in the public interest and are necessary to encourage construction of his or her project and consumers will be protected against the exercise of “market power” by a developer.

The new rules address two primary issues. First, they ease the evidentiary burden under the FERC market power test. This should make it easier for owners of existing facilities to receive authority to charge market rates. Second, they list criteria that owners of new storage facilities must satisfy to receive authority to charge market rates under the new energy law without having to pass the FERC market power test. The new rules apply to all types of services that underground storage providers make available, not just firm storage services.

According to the Energy Information Administration, there are more than 390 underground storage facilities in the United States. Estimates of working gas capacity at these facilities range up to 4.7 trillion cubic feet (tcf). More than half this capacity is subject to FERC ratemaking jurisdiction under the Natural Gas Act. FERC has jurisdiction over facilities that store gas moving across state lines.. The US consumes approx imately 22 tcf of natural gas per year.

Since 1989, available storage capacity has increased by only 1.4%. The demand for underground storage capacity is likely to increase due to the increases in LNG imports and continued growth in natural gas consumption. The National Petroleum Council estimates that an additional 0.7 tcf of working gas capacity will be needed by 2025.

Underground storage is important to the efficient operation of the US gas market. With storage, buyers can purchase gas during periods of low demand, when the market price is generally at lower levels. This gas can be injected into storage and used during periods of peak demand. Thus, storage can have the effect of dampening price volatility and allowing more efficient use of the infrastructure necessary to produce natural gas and deliver it to market.

Market Power Test

Under the market power test as currently administered, a storage owner seeking authority to charge market-based rates must show that there are good alternatives to its services in the relevant product and geographic markets and that these markets are not concentrated. FERC defines a “good alternative” as a service that is available soon enough, has a price that is low enough, and has a quality that is high enough to permit customers to substitute the alternative service for the services of the underground storage provider.

The new rules modify the market power test by expanding the types of service that FERC will treat as a “good alternative” to the services of the underground storage provider. Storage owners will now be able to demonstrate that non-storage services, such as pipeline transportation services (including released capacity), local gas production, services that a local distribution company provides, and even financial instruments like futures contracts are acceptable substitutes to the provider’s storage services.
The burden will still be on the applicant for market-based rates to demonstrate that non-storage services are a good alternative to its storage services. To meet this burden of proof, the applicant will have to demonstrate that the proposed non-storage alternative will be available during periods of peak demand, and will be available at a price and will have a quality to meet customer needs as well as the storage services of the applicant.

This revised market power test will apply literally not only to new underground storage capacity, but also to underground storage facilities that are currently in operation. (However, owners of new projects have two bites at the apple. If they flunk the market power test they can still seek authority to charge market rates under the new relaxed standards in the Energy Policy Act.)

Underground storage providers with market-based rate authority will not have to file a revised market power analysis every five years, as was originally feared. Instead, every underground storage provider offering services at market-based rates will have to notify FERC if there have been changes in circumstances that affect the provider’s ability to exercise market power. In addition, if an underground storage provider charging market-based rates has a market share greater than 10%, then FERC will consider on a case-by-case basis whether the provider should be subject to additional reporting requirements.

FERC will require companies providing storage services at market-based rates to account separately for all costs and revenues associated with the facilities used to provide market-based services. FERC wants to make sure that a company, such as a regulated pipeline, providing services at both cost-of-service rates and market-based rates is not using its cost-based services to subsidize its market-based services. Such cross-subsidization would provide a pipeline’s market-based services with an unfair rate advantage over the services of an independent storage developer.

FERC will not change other aspects of its market power test. Consistent with its current practice, FERC will not permit an applicant for market-based rates to include in its evidentiary case services of its affiliates, including services that are offered by an affiliated interstate pipeline, as examples of good service alternatives. Additionally, FERC will not change how it defines the relevant geographic market for its market power analysis. Finally, FERC will continue to consider a market concentration measurement of 1800 using the Herfindahl-Hirschman index as an indicator that the relevant markets are too concentrated to allow an underground storage provider to charge market-based rates.

Energy Policy Act

The Energy Policy Act allows FERC to authorize storage projects placed in service after August 8, 2005 to provide service at market-based rates even if the underground storage provider cannot demonstrate that it lacks market power.

Specifically, an underground storage provider could be given authority to charge market-base rates if such rates would be in the public interest, they are necessary to encourage the construction of storage capacity in the local area, and customers would be adequately protected. FERC must ensure that reasonable terms and conditions for storage services are in place to protect consumers, and it must review periodically whether the market-based rates of the provider are just, reasonable and not unduly discriminatory or preferential.

Intrastate storage providers seeking to provide interstate services also would be able to charge market-based rates under these new Energy Policy Act provisions.

The Energy Policy Act test applies only to underground storage providers that cannot otherwise demonstrate to FERC that they lack market power. Thus, an underground storage provider can obtain market-based rate authority either by demonstrating that it cannot exercise market power in the relevant markets or it can meet the requirements of the Energy Policy Act. If an underground storage provider opts for the Energy Policy Act test to obtain market-based rate authority, it is presumed to have market power.

In determining whether market-based rates are consistent with the public interest, FERC will consider, among other factors, the riskiness of the project and the investment necessary to fund its construction. A showing that the use of market-based rates is necessary to attract financing would indicate that market-based rates are consistent with the public interest. FERC believes that independent storage providers are more likely than existing pipeline companies to need market-based rates to attract investment in a new project. Thus, existing pipeline companies may have a hard time getting market rate authority if they have market power.

An underground storage provider’s use of an open season, through which capacity is offered to the market at cost-based rates, is one means through which the provider can demonstrate that market-based rates are necessary to encourage construction of storage capacity. If sufficient interest in the storage capacity at cost-based rates is not demonstrated through the open-season process, FERC will consider this as evidence that the provider must have market-based rate authority to attract market interest.

An underground storage provider can demonstrate that storage services are needed in a particular area if it can present evidence that there is a lack of storage capacity or existing capacity is fully subscribed. Additionally, the provider can show that its project is needed to alleviate pipeline constraints and high or volatile natural gas prices in the local area.

Whether customers are adequately protected, and whether reasonable terms and conditions for storage service are in place, could be demonstrated in different ways. For example, if an underground storage provider has conducted an open season for available capacity, this could demonstrate that interested customers are given non-discriminatory access to available storage capacity. Also, the underground storage provider must demonstrate that the Energy Policy Act authorization will not result in existing customers being subjected to additional costs, risks or degradation to their services. Finally, if the underground storage provider has on file with FERC a tariff or statement of operating conditions spelling out terms and conditions of the provider’s storage services, this will be an indication that there are in effect terms and conditions of service that will protect the provider’s customers.

FERC will not impose cost-based caps on the rates that could be charged by an underground storage provider obtaining the Energy Policy Act approval to charge market-based rates.

FERC will not impose specific requirements on these underground storage providers to ensure that they are not withholding capacity to drive up rates. However, the applicant must demonstrate that there are adequate protections in place to ensure that the underground storage provider cannot exercise market power by withholding capacity from the market. Such protections could include a reserve price for capacity and a commitment to provide available capacity to interested customers willing to pay the reserve price.

FERC will not require successful applicants to deliver to FERC any more information for purposes of future monitoring than regulated entities are currently required to provide