Gas Market Restructuring in the 21th Century trading old for new - PowerPoint PPT Presentation

Gas Market Restructuring in the 21th Century trading old for new shibboleths Richard O’Neill Chief Economic Advisor Federal Energy Regulation Commission Regulation, Industry Structure, and Market Power Conference Gold Coast, Australia 31 July 2003

The paradigm shift problem The paradigm shift problem of Urban VIII of Urban VIII 1543: Copernicus publishes a book claiming the earth revolves around the sun then dies. Church doctrine: earth is the center of the universe Early 1600s: Bruno burned at the stake Galileo develops telescope, observes the universe and irritates the Jesuits Cardinal Barberini supports Galileo 1632: Dialogue is published; bubonic plague 1633 Urban orders Inquisition of Galileo Urban probably agrees with Galileo, but will be seen as weak if he supports him. Guilty! December 11, 2008 2

Post Galileo: Post Galileo: the quantum mechanics the quantum mechanics Cardinal Barberini was Urban: where you stand depends on where you sit. 1642: Galileo dies; Newton is born Newton discovers gravity and the calculus continuity and certainty rule 1835: Dialogue removed from the Index 1992: John Paul II accepts to Galileo’s empirical approach to science December 11, 2008 3

does science get it right the first time? ( Paradigm shifts we have no-ed and loved ) � History books don’t always document the mistakes � 2000+ years of Aristotelian logic � geocentrism: Aristotle, Ptolemy, Church, � heliocentrism: Copernicus, Galileo � Galileo’s telescope provides damaging evidence � ether: Aristotle, Maxwell � atom: Democratius, Aristotle, Thomson (plum pudding), Bohr, Heisenberg, Pauli (spin) � phlogiston/oxygen: Priestley, Lavoisier � 1905: Albert E introduces relativity � quantum mechanics � Albert E: God does not play dice with the universe � discontinuity and uncertainty rule December 11, 2008 4

The politics of paradigm shifts � “there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its outcome, than to take the lead in introducing a new order of things” Niccolo Machiavelli � Marx, Hayek, Keynes, Schumpeter � Lenin, Thatcher, Reagan, Gorbachev � Tipping point: Do you need a crisis? December 11, 2008 5

It is about choice socialism capitalism State Many: heavy Few: roads, monopolies industries airports cooperatives many Allowed but few planning Central Collusion is illegal December 11, 2008 6

Transitioning from Transitioning from planning and cost- - planning and cost based regulation to based regulation to markets and market- - markets and market based regulation based regulation December 11, 2008 7

All markets are regulated the policy question is how? ☯ Contracts and Property rights : common law ☯ eminent domain ☯ Institutional rules: SEC, CFTC, … ☯ Antitrust (monopoly): collusion ☯ Does Nash behavior violate antitrust law? no ☯ Utility regulation: just and reasonable prices ☯ Punishments for illegal behavior ☯ Restrictions on behavior ☯ disgorgement of profits ☯ compensation of harm ☯ Fines and jail time December 11, 2008 8

Market structure dictates efficient regulation ☯ Concentration ☯ Supply functions depend weather, e.g., storms in Gulf Coast ☯ Demand functions depend on weather, heat and cold ☯ Market mechanisms ☯ Contracts structure ☯ credit December 11, 2008 9

The Evolution of Natural Gas Market Structure � Joint ventures between producers and local distribution companies � Producers exit joint ventures � Some LDCs sell pipelines � Some don’t: Dominion Resources, Nicor, National Fuel Gas December 11, 2008 10

BIRTH OF U.S. FEDERAL REGULATION Pre-1930s: State and local regulation � Fair value principle as in tax value or eminent domain value (Smyth v. Ames 1898) � inflation: history of deflation; inflation < 1% � Cost-of-service (Sam Insull's answer) THE 1930s ENERGY LAWS: Regulation to Fill Gaps � Public Utility Holding Company Act (1935): repealing � Federal Power Act (1935) and Natural Gas Act (1938) � Set just and reasonable rates � Change rates is found not just and reasonable � Monitor with systematic reporting � Certificate pipelines (NGA) December 11, 2008 11 � Approve mergers (FPA)

1970s ORIGINAL COST-OF-SERVICE RATEMAKING BREAKS DOWN � Increasing energy prices lead to cost trackers (PGAs and FACs) � Over regulation leads to shortages and curtailments � Bad forecasting and Resource depletion theories: Chicken Little theory/ contrary empirical evidence � High inflation: 7% per year National Security and Resource Depletion Laws: � Fuel Use Act (1978): repealed � Natural Gas Policy Act (1978): only Title 3 is active � Public Utility Regulatory Policies Act (1978): December 11, 2008 12 cogeneration and renewables -> stranded costs

1980s: PUNCTUATED EVOLUTION Natural Gas Open Access Making an aquarium from fish soup � Order 380 (1983): take-or-pay/min bills eliminated � Order 436 (1986): training wheels for competition � Spot market development � commodity markets and interruptible transportation � Regulated commodity markets as a recourse � Decreasing energy prices lead to take-or-pay � Deregulation and the non-fly-up (1985) � New resource non-depletion theories: technological progress � � Lower inflation: 5% per year � Bad forecasting December 11, 2008 13 � The Wellhead Decontrol Act (1989): easy

Wellhead Gas Price Forecasts from 1980 to 1990 (1995 $/Mcf) Forecast Forecast Forecast 15 Years Out 10 Years Out 5 Years Out Forecast for 1995 for 1990 for 1995 for 1985 for 1990 for 1995 in 1980 in 1980 in 1985 in 1980 in 1985 in 1990 EIA 5.98 5.19 5.90 3.45 4.11 2.65 DOE 8.06 6.72 5.95 5.60 3.82 2.74 DRI 15.46 11.23 4.28 5.60 2.80 2.39 AGA -- 6.34 3.63 7.65 3.27 2.42 9.84 7.37 4.94 5.57 3.50 2.67 Average 1.59 1.96 1.59 3.44 1.96 1.59 Actual Avg/Act 6.19 3.76 3.11 1.62 1.79 1.68 Sources: Energy Information Administration (EIA), Department of Energy (DOE), Data Resources Incorporated (DRI), American Gas Association (AGA) and Gas Resources Institute (GRI). December 11, 2008 14

1990s: electric open access market evolution for gas � Order 636's strong comparability (full unbundling) � Energy Policy Act (1992): wholesale electric access � 1993-1997 (Post-636/pre-LDC open access): � Active in the market � Less active at FERC: where have all the rate cases gone? � secondary markets: capacity release and gray markets � Downstream market centers � Order 636 contracts � Full pipeline open access; weak comparability � Canadian imports grow from 1 to 3 Tcf (1985 to 95) � Order 888 (1996): open access in electric markets � Order 637(1999): greater tradability for trans � O2K(1999): RTO Rule separation and larger markets December 11, 2008 15 � retail access: electric and gas; were they ready?

Order 637 @ e-commerce @ EBBs become Web sites: still MtoM @ posting of daily transactions and capacity � efficient primary rates: � term differentiated,seasonal � equality of secondary market � no max rate for release � encourages voluntary e-auctions with MBR � segmentation if operationally feasible � imbalance trading December 11, 2008 16

Virtual pipelines Virtual pipelines = segmentation equality = nomination and confirmation equality = more primary firm = full tradability = better information = imbalance markets = no harm/no foul penalties = incentives to limit OFOs � efficient markets December 11, 2008 17

MARKET CENTERS ENHANCE EFFICIENCY AND RELIABILITY � Increasing access to sources of gas and capacity � pipelines often have highly correlated demand � makes short-term deals and long-term deals easier � creates deeper markets � Lowering transactions costs � reduced search costs and faster market response � real price information � simplifying multiple pipeline exchanges � Lowering reaction time in emergencies � Using multiple system responses � greater aggregation through market centers � one storage facility can serve many pipelines December 11, 2008 18