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Date: Wed, 10 Oct 2001 09:16:34 -0700 (PDT)
From: issuealert@scientech.com
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Subject: El Paso Corp. Absolved of Manipulation Charges (For Now),
But Affiliate Abuse Allegations Linger
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October 10, 2001=20
El Paso Corp. Absolved of Manipulation Charges (For Now),=20
But Affiliate Abuse Allegations Linger=20
By Will McNamara
Director, Electric Industry Analysis=20
[News item from Reuters] El Paso Corp. (NYSE: EPG) was cleared on Oct. 9 of=
manipulating natural-gas prices in California, but the agency judge overse=
eing the case expressed impatience with company executives who engaged in w=
hat he described as "hanky panky" in arranging pipeline shipments. Curtis W=
agner, FERC's chief administrative law judge, ruled that El Paso did not un=
fairly drive up natural-gas prices on its four pipelines into energy-starve=
d California last year, but used blunt language in assessing the behavior o=
f two executives with the Houston-based energy giant. Wagner said telephone=
records of the conversations showed "blatant collusion" between company af=
filiates in booking pipeline space at a discounted rate for future shipment=
s.=20
Analysis: The best assessment of this ruling in the ongoing case against El=
Paso Corp. is that it is a mixed bag of judgments, and only one more step =
in what will continue to be a very long and drawn-out case. On one hand, th=
e FERC administrative law judge appears to be absolving El Paso Corp. of th=
e accusations that it intentionally manipulated conditions in California to=
gain market power over the state's natural-gas market. That is the good ne=
ws for El Paso Corp. However, on the other hand, the same judge has also in=
tensified lingering claims that El Paso exclusively shared market-sensitive=
information between its affiliates, violating a FERC standard of conduct t=
hat a pipeline must give information about natural-gas transportation to al=
l potential shippers as well as a company's own marketing affiliates. Furth=
er, as noted Judge Curtis Wagner has indicated that existing telephone reco=
rds from last year indicate "blatant collusion" between El Paso Corp. compa=
ny affiliates, potentially violating FERC rules that a pipeline's operating=
staff and the staff of its marketing affiliate function independently of e=
ach other. The next step in this case will be to determine any possible fin=
es that might be affixed by the full FERC commission on the basis of the al=
leged collusion or affiliate abuse issues.=20
The case against El Paso Corp. is a very complicated one, but it essentiall=
y comes down to one core issue. The case revolves around allegations that d=
uring the period of May to November 2000 El Paso improperly shared market-s=
ensitive information with one of its affiliates, which drove up natural-gas=
prices, pre-empted competition from non-affiliated companies and resulted =
in extra costs for fuel in the range of $3.7 billion for Californians. El P=
aso Corp. has consistently maintained that it engaged in no wrongdoing. The=
case has carried enormous significance for the energy industry as it impac=
ts not only the profits earned by El Paso Corp. but also the degree to whic=
h federal regulators may continue to intercede into wholesale markets. In a=
ddition, the other key aspect to this case is the extent to which FERC, und=
er the leadership of new Chairman Pat Wood, will exhibit strong regulatory =
oversight over these claims of market abuse and issue its own harsh financi=
al penalties against El Paso Corp.=20
What is critically new about this case is the information now available fro=
m transcripts of phone conversations between El Paso affiliates. First, let=
me establish some background that will help to explain the significance of=
the transcripts. El Paso Corp. is the parent of subsidiaries El Paso Natur=
al Gas and El Paso Merchant Energy, which are the companies in question reg=
arding the California transactions. El Paso Natural Gas, a regulated compan=
y, operates pipelines and El Paso Merchant Energy, which is unregulated, ma=
rkets natural gas. El Paso Natural Gas owns and manages the Western Divisio=
n pipeline, which includes 14,604 miles of interstate transmission pipeline=
, serving markets in California, the southwestern United States, northern M=
exico, and throughout the Rocky Mountains. In early 2000, El Paso Natural G=
as awarded approximately one-third of the capacity on this interstate pipel=
ine to El Paso Merchant Energy. This contract essentially gave subsidiaries=
of El Paso Corp. control over transporting about one-sixth of the state's =
daily demand in California. As such, this gave the El Paso affiliates betwe=
en 35 and 45 percent of the Southern California gas market, clearly positio=
ning it as the largest natural-gas provider in the state.=20
As subsidiaries, all of El Paso's operations fall under FERC's "arms-length=
" rule, which enforces a separation between affiliated production and pipel=
ine companies that exist within a corporate family. Since early 2001, FERC =
has been examining allegations that El Paso manipulated natural-gas prices =
in California by blocking competitors' access to the interstate pipeline. C=
alifornia officials have claimed that El Paso subsidiaries secretly shared =
information about the pipeline that was not available to other companies. S=
pecifically, the transcripts of phone conversations between executives at E=
l Paso Merchant and Mojave Pipeline Co., an El Paso affiliate, reportedly i=
nclude comments from El Paso Merchant that inquire about a delay in publish=
ing information about the pipeline's available capacity to all potential co=
mpetitors.=20
The existence of these phone records gave some credence to ongoing claims t=
hat El Paso had shared what should have been public information only with i=
ts affiliates. According to Reuters, the executive at El Paso Merchant aske=
d the executive at Mojave Pipeline to hold off on posting competitive data =
about the capacity on the pipeline for a week. This allegation has importan=
t ramifications. First, the sharing of this non-public information might me=
an that El Paso's subsidiaries had provided preferential treatment to affil=
iated subsidiaries, which gave the company as a whole an unlawful advantage=
over competitors. Any potential abuse of affiliate standards could include=
the unlawful exchange of classified information between subsidiaries or th=
e extension of discounted prices between two affiliated companies. Yet, acc=
ording to Judge Wagner this sharing of information among affiliates did not=
contribute to a clear case of market power abuse, and in fact should be di=
smissed outright, which is why the ruling is such a mixed bag for El Paso C=
orp.=20
Nevertheless, the California Public Utilities Commission (CPUC), Pacific Ga=
s & Electric Co. and Southern California Edison may continue to fight the c=
ase with an appeal on the ruling that could be launched within 30 days. Acc=
ording to the California parties, this alleged manipulation cost California=
ns an extra $3.7 billion in unnecessary power purchase costs that the two u=
tilities are still attempting to recover. It is important to note that San =
Diego Gas & Electric, California's third IOU, purchases all of its natural-=
gas supply from Southern California Gas and is therefore not a participant =
in this case against El Paso.=20
In response, El Paso has repeatedly denied any wrongdoing, including market=
manipulation or inappropriate sharing of information between its affiliate=
s, and thus has not violated any standards set out by FERC in its "arms-len=
gth" policy applied to affiliates. Instead, El Paso claims that the seeming=
ly high prices that it charged in California resulted solely from nationall=
y high gas prices. However, according to the Energy Information Administrat=
ion, delivery prices for natural gas in California during the October 2000 =
to January 2001 timeframe were considerably higher than other national mark=
ets. For instance, during this time period, natural-gas prices in Californi=
a were running near $23/MMBtu, while prices at Henry Hub and in Florida wer=
e at around $7/MMBtu.=20
El Paso says the sudden drop in natural-gas prices once its contract on the=
pipeline expired is the result of constraints that are inherent in Califor=
nia's distribution system. In addition, the company claims that mild weathe=
r in the region and increased storage levels of natural gas have also drive=
n the dramatic price swing. Further, El Paso says that it hedged most of it=
s gas capacity into California to protect itself from potential losses, cut=
ting potential profits in the process. The significance of this, El Paso co=
ntends, is that the company's hedging indicates that it had no foreknowledg=
e that gas prices would be higher than normal. In other words, El Paso hedg=
ed on its gas supply because the company thought that prices would be flat =
or go down. On the other hand, hedging is a common practice among seasoned =
traders and gas traders have countered that hedged contracts are often reso=
ld at higher multiples before the gas is ultimately delivered.=20
It will be interesting to see where this case goes from here. As noted, the=
"new" FERC that has emerged under the leadership of Pat Wood may demonstra=
te a decidedly lower tolerance for any allegations of affiliate abuse and c=
onsequently issue stiff penalties. In addition, it is interesting to note t=
hat other pending affiliate abuse cases have recently been launched by FERC=
, indicating that the commission is increasing its efforts to investigate s=
uch abuse. For instance, last week FERC ordered an inquiry into whether Exe=
lon Corp., PECO Energy and their affiliates improperly manipulated Northeas=
t power markets in 1999 by possibly sharing non-public information. Further=
, Wood has made no bones about the fact that he embraces a market philosoph=
y that includes regulatory intervention when necessary. Consequently, Wood =
could very well spearhead a re-examination of FERC's methodology regarding =
market-based rates in markets that become deregulated, along with how merch=
ant plants calculate their rates, and the ruling on potential fines against=
El Paso Corp. could be the first indication of this policy change.=20
An archive list of previous IssueAlerts is available at
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