Excerpts
Chapter 1
Credit of
Some Sectors Will Be Affected by SMD
Ellen Lapson
On July 31, 2002,
the Federal Energy Regulatory Commission published its NOPR
(Notice of Proposed Rulemaking) concerning a uniform tariff for
electric transmission service and a standard design for
electricity markets in the United States. The scope is profound,
amounting to a thorough redesign of the entire U.S. electricity
market. Although FERC states that it does not intend to impair any
preexisting contracts or arrangements, Fitch Ratings believes
that, in many cases, implementing SMD would reallocate profits
among market participants and result in both gains and losses.
Encouraged
by judicial decisions that upheld the commission’s authority in
Order 888, FERC now asserts its authority over the transmission
component of integrated utility bundled tariffs and seeks to
impose uniform market conditions on all U.S. electric markets.
FERC can count on strong opposition from the Pacific Northwest and
California as well as from a bloc of southeastern states that have
not restructured their integrated utility systems.
Congressional
backing for FERC’s initiative is weak. There are some obvious gaps
in the SMD initiative, including the lack of means to entice
utilities outside FERC’s jurisdiction to participate and potential
problems implementing the standard design in regions that have not
developed in the same manner as the Northeast. Consequently, Fitch
believes that FERC will have to phase in the implementation of SMD
by region and over time, focusing first on implementing the pure
form of SMD in a very large market area east of the Rockies and
accepting numerous adaptations if it wishes to impose at least
some aspects of the design in the West and Southeast.
Simplistically,
implementation of SMD is expected to impact companies’ longer-term
profitability, as indicated below. However, in reality, individual
companies have unique contracts and circumstances that will affect
the potential for gains and losses. In the near-to-intermediate
term, the consequences for individual companies will depend on the
provisions of the parties’ existing contracts, the location of
their loads or energy resources relative to transmission
constraints, the ease or difficulty of amending contracts to
incorporate changes in regulation, or transmission costs.
Table 1.1:
Credit Impact by Sector
Expected Long-Term Impact
Sector or Subsector
Positive
Power developers, merchant generators, and
merchant wholesale marketers
Neutral to Somewhat Positive Distribution
utilities with clear ability to recover
transmission and resource adequacy costs
from
consumers; independent transmission owners
Negative
Integrated utilities in states that have not restructured;
distribution utilities with frozen local tariffs
The impact on a load-serving utility
will depend on regulatory cost recovery provisions within its
state (such as frozen retail tariffs and automatic cost recovery
mechanisms). Under SMD, load-serving entities would be responsible
for ensuring future resource adequacy, a cost burden that
distribution utilities can only bear if they are guaranteed
reliable cost recovery from power consumers.
Integrated utilities in states that
have not yet restructured may now benefit from preferential
transmission access. However, under SMD, their generating capacity
may no longer earn such stable or protected profits on off-system
wholesale power sales and may become exposed to a more competitive
generation market.
Identifying these potential favorable
or unfavorable consequences will be incorporated in Fitch’s
individual company analyses and ratings in the months ahead. It
should be noted that many details of SMD’s implementation have not
been worked out yet or are subject to change, thus the exact
effects concerning any market participant are still speculative.
FERC HAS COURT CASES ON ITS SIDE
There were three
earlier FERC orders to foster competitive wholesale electric
markets:
-
Order 888:
Order 888, issued in 1996, required all utilities to file
open-access and nondiscriminatory transmission tariffs and
separate the functions of transmission access from generation
and distribution operations.
-
Order 889:
Order 889, also issued in 1996 as a companion to Order 888,
ordered utilities to implement codes of conduct to limit
communications between the wholesale power generation and
marketing functions and transmission network. Transmission
operators were required to post available transmission capacity
(ATC) on an electronic bulletin board, OASIS.
-
Order 2000:
Order 2000, issued in 1999, was meant to encourage utilities to
put their transmission assets under the direction of qualifying
RTOs or ISOs Order 2000 was not prescriptive, and it
acknowledged that there would be
Chapter 4
Standard Market Design
Undergoing Evolution from State Inputs
William H. Smith, Jr.
The Federal Energy Regulatory Commission’s most
significant activity of 2002 was the development of the Notice of
Proposed Rulemaking (NOPR) for Standard Market Design (SMD),
adopted on July 31, 2002. Receipt and analysis of comments on the
proposal and preparation of a final rule promise to be the
agency’s major activities of 2003. Not only will the SMD take up
the largest part of the agency’s effort, it will also be the focal
point for everyone connected with the electricity industry.
Generators, transmission providers, distribution systems, state
regulators, and marketers will all find their lives and businesses
reshaped by the SMD rule’s final form.
ORIGINS
The concept of SMD traces to two sources, one in
the FERC’s natural gas regulation and the other in its electricity
regulation. Besides these two inspirations, the FERC was pushed to
revamp the wholesale markets to facilitate the introduction of
retail competition in several key states.
Order 636
First, the FERC established a successful path to a
competitive energy market with its natural gas initiatives of the
1990s embodied in Orders 436 and 636. The natural gas experiment
involved several features that the FERC thought it could replicate
in the electricity industry. Most importantly, by separating the
business of commodity marketing from the movement of the
commodity, the agency could allow market-based pricing of the
commodity and encourage competing commodity providers.
FERC considers these natural gas developments
an unqualified success. They have opened markets for suppliers,
reduced the role of regulation in controlling the markets, and
saved customers billions of dollars. The first initiatives in
restructuring wholesale electricity markets unabashedly borrowed
both inspiration and details from the FERC’s previous natural gas
restructuring.
Orders 888 and 2000
Despite the existence of a successful template, the
FERC and those who urged it to transfer the template clearly
understood that the natural gas solution could not be transposed
onto the electricity markets without some refitting to recognize
the peculiarities of the two industries. They simply are not alike
in some critical respects.
Ownership patterns are different. In most
cases, natural gas distributors are separate companies from the
pipelines that supply them and from the producers and marketers of
natural gas commodities. Even the historic pattern reflected this
distinction when pipelines performed a merchant service as well as
transportation. This division was usually consistent with the
jurisdictional boundary between states’ jurisdiction over retail
transactions and the FERC’s jurisdiction over wholesale markets.
Thus when the FERC felt the need to separate the pipeline merchant
service from the transportation service, both parts of the problem
were neatly within its jurisdiction.
The electricity picture is different. Most
electric utilities were vertically integrated. That is, each
company owned the three main sectors of its business: generation,
transmission, and distribution. Because of the common ownership,
there were no intermediate transactions to provide FERC
jurisdiction. Thus, for most electric utilities, well over 90
percent of the costs and assets were within the retail
jurisdiction, regulated by the state commissions. Applying the
natural gas template requires that the FERC transfer costs and
assets from state jurisdiction, invoking concerns for changes in
cost level and control.
Other differences are physical. Electricity
production and consumption must be matched at every instant,
because it cannot be stored. As usage changes, even by the simple
act of turning on a light switch, some generator’s output must
adjust instantaneously to the increased load. On the other hand,
natural gas can be conveniently stored, allowing production and
consumption to vary from each other according to hourly, daily,
and yearly schedules. Storage and balancing are important services
in the natural gas industry, but they can be provided in many ways
by competing firms or by transportation and distribution
companies. Transposing the natural gas template requires finding
new ways to provide ancillary services that provide this matching.
Electric transmission in particular is
governed by physical rules that differ from those that govern the
movement of gas molecules. Gas flow can be directed and controlled
by valves. Electricity flows over every available parallel path.
Generation intended to go from Source A to Sink B will in fact
affect several transmission lines, many not in close proximity to
the straightest path between A and B. This physical reality
demands system control broader than the assets of any single firm
for the transmission system to support an active market of bulk
power transactions.
Nevertheless, recognizing these differences, the principles of
Orders 436 and 636 could be applied to electricity markets. The
first step was to require open-access transmission service.
Open-access requires that a transmission provider
Chapter
5
Meltdown in the Trading and Marketing
Industry
Benjamin
Schlesinger
“It ain't pretty.”
—Ron Barone, Standard & Poor’s.
The U.S. energy
industry is now one year into its “transition”—a journey to points
unknown. It's more of an upheaval.
Following Enron's bankruptcy in 2001, shock after shock roiled the
energy trading and marketing community. Today, only five of 1999's
top dozen energy marketers are still actively trading gas and
electricity, and the remaining traders are operating at reduced
levels. Gone from trading
are 1999 leaders Enron, Aquila, Dynegy, El Paso Merchant, Mirant,
PG&E, Reliant, Engage and TransCanada. Still trading, but at
reduced levels, are BP, Duke, Coral (Shell), Sempra, and Koch.
In this
chapter, we portray the status of the trading and marketing
industry through its current turmoil.
GAS SURPLUS ENDS AND
CALIFORNIA PROBLEMS BEGIN THE SLIDE
Both gas and
electricity are of major importance to the U.S. economy. Figure
5.1 shows that, apart from mobile (transportation) uses of energy,
natural gas and electricity account for five-sixths (83 percent)
of all stationary energy use in the United States.
Figure 5.1: U.S. Primary
Energy Demand in 2001
For its
part, natural gas is being counted on to supply most of the fuel
in new electricity generating in this decade (the 2000s) and well
into the next. As Figure 5.2 shows, the Energy Information
Administration forecasts that U.S. natural gas markets will have
to grow by 2025 to some 35 trillion cubic feet in order to
accommodate growth in gas use as a fuel for power generation.
Figure 5.2: Projected Growth in Power Plant Gas Demand
Chapter 12
Prospects Strong for Global LNG Trade
Ralf
Dickel and Sylvie Cornot-Gandolphe
As by
means of water-carriage a more extensive market is opened to every
sort of industry than what land carriage alone can afford.
—Adam Smith, The Wealth of Nations
Since 1776, this
axiom has held true for wood, wool, coal, and other dry goods, but
I doubt Adam Smith had thought about squeezing six hundred liters
of gas into a one liter steel bottle and shipping it around the
world. Perhaps he was more prescient than he could know.
Gas
transport costs easily exceed half of its market value and thus
far only 22 percent of gas crosses borders, whereas 57 percent of
oil does so. The equivalent transport costs for oil and coal
equate to less than 20 percent of their market value.
Today, we
probably would not be talking about liquefied natural gas if oil
prices had not departed from their cost base some thirty years
ago, giving gas the leeway to cover its higher transportation
costs in competition with coal. However, these advantages will be
challenged over time as gas prices are gradually being decoupled
from oil. Gas increasingly has to compete with coal and other gas
or even with nuclear and hydro, as gas will be increasingly used
in base-load generation.
THE LONG TERM PROSPECTS
FOR GAS
The
following chapter describes the long term prospects of natural gas
as reflected in the World Energy Outlook (WEO 2002).
Every second year, the International Energy Agency (IEA) produces
a projection of Energy Supply and Demand by region and energy
based on enacted policies. WEO 2002 for the first time addressed a
time horizon until year 2030.
INCREASINGLY ABUNDANT
GAS RESERVES
The U.S.
Geological Survey confirms an abundance of gas reserves and
resources. Proven gas reserves were estimated at 165 trillion
cubic meters at the beginning of 2002, representing sixty years of
current production. In addition, proven gas reserves increased
almost continuously over the last thirty years. Proven gas
reserves increased from about 40 billion tonnes
of oil equivalent in 1971 to about 140 billion tonnes of oil
equivalent in 2000, a factor of 3.5, while primary energy supply
of gas increased by a factor of 2.3 from 895 million tonnes of oil
equivalent in 1971 to 2.085 billion tonnes of oil equivalent in
2000.
Figure 12.1:
Gas Reserve/Production Ratio by Region
Gas reserves
are more widely distributed among regions than are oil reserves.
Nonetheless, as with oil, a few regions dominate the global
picture for gas. Two regions, the Former Soviet Union (FSU) and
the Middle East account for more than two thirds of global gas
reserves. On a country-by-country basis, Russia ranks first with
30 percent of worldwide reserves and Iran second with 16 percent.
Russian and
Iranian gas reserves lay along what economist Jim Jensen calls the
gas seam, residing in about 10 degrees of longitude. A large part
of that gas
Chapter 18
Natural Gas II: Intense Activity in
Pipeline Security Plans
Richard G. Smead
Despite the
financial market and regulatory turmoil that has pervaded the
energy industry during 2002, those entities who are responsible
for the nation’s basic energy infrastructure have united around
one important theme: national security. The tragic attacks of
September 11 led, among other things, to a widespread concern that
our energy infrastructure could be one of several future targets
for terrorist activity. This concern has been based to some degree
on rumors released from time to time by the intelligence
community. It is also based on the obvious observation that the
United States is critically dependent on its enormous networks of
electric and natural gas delivery systems. The protection of our
energy infrastructure is a relatively small subset of the broad
national defense against an elusive, dangerous enemy, but it is an
important subset.
In the
natural gas pipeline industry, the level of concern has spurred a
thorough, ongoing reexamination of security issues as they apply
to our facilities, and of the possible approaches to dealing with
the impact of a major incident. This review has been conducted by
individual companies, by multiple state and federal agencies, and
among trade associations representing the various industry
sectors. It has resulted in multiple changes in security
protocols, in pending and potential changes in regulatory
policies, and in numerous proposals as to how the industry and its
regulators can work together to be prepared for any eventuality.
This degree of cooperation is unprecedented, in an industry that
is well known for its often fractious participants and for the
frequent and fairly nasty legal sparring among industry sectors,
among individual companies, and between regulated companies and
their regulators. However, as industry participants and government
agencies have come together to deal with security and
disaster-recovery issues, there has been a very clear view that we
are all in this together. As a result, the review of industry
security issues has turned out to be a good forum for an open,
results-oriented dialogue as to how the industry operates, a
dialogue that has so far been relatively free of private agendas.
Three Broad Areas of Security Review
The
security-driven review of industry and agency practices has
centered around three broad areas:
(1)
Access to sensitive
information regarding critical facilities
(2)
Actual security measures
to be taken to protect and back up critical facilities
(3)
Measures that can and
should be in place to preserve or recover needed levels of service
if a critical facility were disabled
This last
element, preservation and recovery of service, could apply equally
well in the case of a natural disaster, such as an earthquake. In
addition, the very definition of a “critical facility” has been in
a state of flux, subject to differing evaluations by various
parties and agencies and, to some degree, becoming redefined by
the individual areas of examination themselves.
The
information issue has so far been difficult to resolve in an
industry that has been pushed by the market and by regulators, for
more than a decade, to be steadily more transparent to the public.
Any initiative to protect major areas of facility and operating
information from full public disclosure represents some reversal
of this long-term trend and is thus viewed with suspicion by
parties who rely on the information for commercial or legal
purposes. Some facility and operating information that has
routinely been fully available to the public, either directly from
companies or from the files of regulators, could potentially be
useful to a terrorist planning an attack. However, there is a
natural tension between restricting the availability of such
information and the legitimate needs of a public that has come to
expect easy access to that information.
At least
potentially, facility security itself is also subject to some
tension. Security—whether it be in the form of hardware,
personnel, or redundant facilities—costs money that will
ultimately be paid by customers, through a pipeline’s rates. Thus,
achieving the proper balance between an adequate level of facility
protection and backup, as balanced against the costs to be borne
by consumers, could ultimately be a tricky business. To date,
however, this has not been a significant issue. The incremental
improvements in facility security that the industry has developed
in concert with safety regulators have not been costly enough to
raise much concern. Problems should only arise if too broad an
area of the pipeline industry were defined as “critical,” or if
significant redundancies of pipeline facilities, beyond those
already in place or planned, were to be required.
Last, any
scheme of disaster recovery (if an incident were to happen)
is characterized by implicit tensions with interests other than
national security. There are two aspects of disaster recovery as
it relates to meeting service needs: (1) keeping the gas flowing
where it is most needed, and (2) constructing emergency
replacement facilities to restore lost capacity. Planning in
advance to respond to an emergency in either area necessarily
raises significant concerns among those parties who might be
disadvantaged by the response. For instance,
