Edison to Enron: Energy Markets and Political Strategies

Leave a comment

Book 2 Internet Appendices

Chapter 8: Florida Gas Company

8.1 Natural Gas and Florida Environmental Issues

Air pollution was not a lever for national energy policy in the 1950s, although air quality had become a major issue in certain regions such as the Los Angeles Basin (Bradley: 1242—44). In 1952, the first major stocktaking of energy issues by the federal government (President’s Materials Policy Commission) discussed the availability and competitive position of rival fuels. But the fuels’ relative emissions were not discussed. Federal concern about air emissions began with the Air Pollution Control Act of 1955, which earmarked funds to study the problems and recommend solutions (Bradley: 1244).

The original decision of Florida’s electric utilities to commit to natural gas was made for economic reasons. Natural gas entered the state more than a decade before the Clean Air Act of 1970 became law, and air quality was not yet a political issue in Florida. Stated one company veteran involved in gas sales and regulation issues for Florida Gas Company:

It is clear from the original contracts signed by Florida Power & Light Company and Florida Power Company that they would only burn gas if it was below the as-burned price of residual fuel oil. Some in our management liked to think that the customers would give you something for the environmental benefits of gas (and would say as much in customer meetings). But from my marketing experience to these customers in the 1960s, 1970s, and 1980s, they would not use gas unless it was cheaper. Their calculations actually would not give gas the deserved side benefits such as less maintenance and the saved energy from not having to heat or pump the gas (as was necessary with fuel oil). Also, no part of Florida was in nonattainment under the Clean Air Act until the late 1970s or early 1980s (Wiley Cauthen to author, e-mail communication, November 4, 2004).

Still, cleaner air allowed natural gas to wear a white hat from the beginning. Florida officials had to think twice about obstructing the introduction of a cleaner alternative to coal, coal gas, and fuel oil. As time went on and air quality grew in importance, coal and fuel oil faced environmental requirements that raised their costs relative to natural gas.

Florida Gas Company first emphasized the environmental advantage of natural gas in their 1970 Annual Report (3): “Natural gas is increasingly attractive as a partial solution to the problem of air pollution.” This comment was inspired by the creation of the federal Environmental Protection Agency (EPA) and enactment of the Clean Air Act Amendments in 1970, which set national primary ambient air quality standards for six pollutants: particulate matter (PM), sulfur dioxide (SO), carbon monoxide (CO), nitrogen oxides (NOx), ozone (O3), and lead (Pb). Natural gas emitted significantly less of PM, SO, NOx, and ozone precursors than either fuel oil or coal, and Florida Gas Company’s management saw an opportunity to play the environmental card in the public arena.

8.2 Wellhead Gas Price Regulation

In 1954, the U.S. Supreme Court (Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672) ruled that the “just and reasonable” rate standard for interstate gas transmission pursuant to the Natural Gas Act of 1938 (NGA) also applied to wellhead gas sold to the same pipelines (Bradley: 376—79). Legislative attempts at wellhead decontrol fell short, putting the Florida pipeline proposal in jeopardy. In response, 25 chambers of commerce in Florida passed resolutions urging congressional action to decontrol wellhead gas prices (Stanley, 1959: 6).

Still, Houston Corporation, later Florida Gas Company, secured enough gas to build its line in 1959. This was accomplished by working around the boundaries of regulation to allow enough volume to flow at an unregulated price on Florida Gas Transmission (FGT). This gas was a combination of gas transported for electric generation and gas sold to industrial users for final use. It was not a federally regulated sale-for-resale gas in interstate commerce.

“Sale for resale” regulation applied to gas sold by a producer to an interstate pipeline, which sold the gas to a gas utility or municipality for resale. The gas was sold three times: to the pipeline, to the utility, to the customer. But the sale-for-resale was to the utility, meaning that the utility or municipality could not escape a “sale for resale” by buying the gas from the producer and turning to the pipeline for transportation only.

Such regulation by the Federal Power Commission (FPC), and, later, the Federal Energy Regulatory Commission (FERC) did not, however,apply to an electric utility buying gas for its own powerplant, even if the facility was in another state. This is because the purchase was done at the wellhead, an intrastate transaction protected from federal jurisdiction under the commerce clause of the U.S. Constitution. In such cases, the pipeline was paid a transportation fee for moving the gas from the producer to the end-user, a fee that was regulated because the gas moved between states.

Gas sold to industrial users was more complicated. Originally, sales-for-resale to a utility or municipality where the final user was an industrial customer was not regulated under the NGA as was the same gas sold to residential and commercial customers. Thus, FGT was able to attract this (unregulated) gas for the interstate market. But a 1962 amendment to the NGA made all sales for resale, even “direct sale” gas from pipelines to industrials, regulated (Bradley: 883—884). But if an industrial company bought the gas at the wellhead (an intrastate transaction) and did not resell the gas in interstate commerce, then the sale was not regulated, just like an electric utility buying gas for its powerplant. Thus industrials began this practice to remain unregulated after 1962.

The FPC, knowing the Florida pipeline hung in the balance, allowed the project to escape regulation by certificating the transportation contracts involving unregulated wellhead gas. The FPC, however, would later block similar transportation-gas arrangements on other pipelines intended to circumvent regulation (Tussing and Tippee: 111—12). Only with gas shortages in the 1970s and then surpluses in the 1980s would federal regulators turn to transportation (called mandatory open access) to free commodity prices from regulation and bring order to the market.

Thus, FGT was able to attract enough gas post-Phillips because it supplied a large powerplant and industrial market relative to its sale-for-resale market. Other interstate projects in the cold-weather states with larger sales-for-resale markets were stymied for want of gas. And it was their cancelled or deferred pipe orders that allowed Republic Steel Corporation—whose mills had originally been booked from 1957 until 1960—to supply the pipe for the Florida line (Stanley, 1959: 14—17).

8.3 Revenue Risk at Florida Gas Transmission

Rates approved by the FPC allowed FGT to achieve its allowed rate of return at a volume that was below the capacity of the line. If higher throughput was achieved, the pipeline could “beat its rate case” and make extra revenue. The downside was that the next rate case could set a higher bar for earning incremental earnings, for projected throughput was typically set according to historical throughput. On the other hand, throughput that was below the rate-case level could result in undercollection of the authorized rate of return, although the next rate case might be easier to meet and beat as a result. It was an egalitarian system with the inefficiencies thereof.

A particular incentive for FGT—if it could attract federally regulated gas—was to maximize sales-for-resale gas, which provided a margin of $0.55 per thousand cubic feet versus a transportation margin of either $0.30 or $0.33/Mcf (The Houston Corporation, September 15, 1959: 3).

Transportation rates were another unique aspect of FGT. They were negotiated with its transport customers and generally tied to the market price of the alternative fuel that the electric utility could purchase and burn—number-two fuel oil. This created an incentive for the pipeline to reduce costs because the savings flowed to the bottom line, unlike cost-based regulated rates for which cost reductions would mean lower rates in the future. “Those of us who came from Florida Gas had always worked in a competitive environment,” Stan Horton stated (Interview: 3).

FGT’s original firm contracts totaled 270 MMcf/d, 96 percent of the pipeline’s rated capacity. Greater revenues depended on “interruptible” (nonfirm) gas flowing through the system. Low capacity factors hurt profitability at the start, but gas demand grew with the population and the state’s economy.

Interfuel competition to natural gas from coal and fuel oil has been significant since Florida Gas Company entered the state in 1959. In addition, natural gas competed with itself, meaning that lower prices introduced new uses. Effective October 1, 1963, for example, gas rates were reduced for the residential market “to attract new space-heating customers and to encourage present customers to install additional gas appliances” (1963 Annual Report: 8).

The first expansion of the Florida system occurred in 1962; in the next decades the system would be expanded 10 more times for a design capacity of 3.0 Bcf/d. In March 2011, the Southern Union subsidiary increased capacity by approximately one-third with the completion of the $2.5 billion Phase VIII expansion project.

In 2002, a second interstate natural gas line arrived in Florida, the first since FGT began service forty years before. Gulfstream was a 1.1 Bcf/d project of Duke Energy Gas Transmission and Williams Companies, with a 240-mile line originating from the Gulf of Mexico that began deliveries in May 2001. After several expansions, capacity today is 1.3 Bcf/d. Williams (the owner of Transcontinental Gas Pipe Line) operates Gulfstream, which remains half-owned by Spectra Energy (the renamed Duke Energy Gas Transmission).

The offshore-to-onshore project, the first of its kind, introduced pipe-to-pipe competition in addition to gas-on-gas competition. It also helped to make Florida the 5th largest gas user in the country, accounting for 4.6 percent of national consumption, behind Texas, California, Louisiana, and New York. In terms of electric generation, Florida trails only Texas in gas consumption and is ahead of such states as California and New York.

8.4 Transgulf Pipeline and Federal Rate Regulation

In January 1974, amid gas supply problems, Florida Gas Transmission filed for a certificate from the Federal Power Commission to remove from service (“abandon,” in regulatory terms) part of its natural gas mainline to be able to become a “common carrier” of gasoline, heating oil, jet fuel, and other petroleum products under the jurisdiction and regulations of the Interstate Commerce Commission (ICC). The 692 MMcf/d gas line would be reduced by 9 percent to 630 MMcf/d (Florida Gas Company, 1973 Annual Report: 2).

The proposed Transgulf Pipeline Company project between Baton Rouge and Fort Lauderdale, a distance of 890 miles, would carry 200,000 barrels a day of petroleum products, displacing a like amount of deliveries by truck, barge, and tanker to a state whose total energy requirement was 75 percent oil products.

One attraction for switching part of the line to oil carriage was higher maximum allowable profits under federal regulation. Rate ceilings for interstate oil lines were set partly on the replacement cost of the built facilities rather than, as for interstate natural gas lines, the depreciated original cost. Oil interstates thus had a higher rate base upon which to apply an allowed rate of return (Bradley: 811—16, 826—32, 886—88).

Terms of service were also different for ICC-regulated interstate oil pipelines. Such lines were common carriers. They were thus required by the ICC to offer transportation service at identical rates and terms of service to all comers up to capacity, whereupon a pro-rata allocation would apply. Interstate gas pipelines were private carriers until the mid-1980s when the FERC implemented a new regulatory regime, mandatory open access, whereby pipeline sales was replaced by transportation service of the gas bought and sold by others, and shipper priority was set on a first come-first, first-serve basis.

FPC hearings for FGT to abandon the part of its gas capacity began on April 15, 1975. Of concern to the sponsor was a dispute over the valuation of the line on an oil basis, the surplus of which over its valuation for natural gas (original depreciated cost) would accrue to natural gas ratepayers upon abandonment from gas to oil. (The valuation would then be the rate base for setting oil transportation rates.) FERC, which replaced the FPC in October 1977, finally approved the project in July 1983. Maritime interests appealed the decision, which was turned down by a federal appeals court in October 1984. The court’s decision became final later that year (FGT, 1984 Form 10-K: 3—4).

Marketing came next for the proposed common carrier line transporting a range of petroleum products from Gulf Coast refineries—diesel, fuel oil, gasoline, kerosene, and jet fuel. Long-term contracts were necessary to justify the sunk-cost investment. But with oil markets loosening and transportation costs falling, there was a lack of customer interest in executing long-term contracts to support the conversion.

The project was finally cancelled in 1986, some 12 years after it was first proposed. But there was a silver lining. The Florida market needed the gas capacity that the project would have displaced, and FGT’s new owner, Houston Natural Gas Corporation, decided to spend $28 million to expand the line 100 MMcf/d instead (“Zeroing In” 7).

8.5 Ken Lay and LNG Pricing

Commissioner Pinkney Walker and commissioner de facto Ken Lay worked to defeat a proposal by several major interstate natural gas pipelines to average down the cost of much more expensive liquefied natural gas (LNG) by pooling it with their price-controlled supply. The economists argued that LNG should be priced separately (marginally) to make sure that the supply increment was really viable.

FPC Opinion 622 (July 1972), running over one hundred pages, was followed by a second opinion several months later, where Walker/Lay, joined by Commissioner Rush Moody, reiterated their basic point that “if there is no market for this gas at its full cost, this project cannot be described as economically sound.” Some of the nation’s biggest pipelines, including Transcontinental Gas Pipe Line, ready to invest hundreds of millions of dollars in LNG facilities, were stymied.

To use an example, if a pipeline had nine units of regulated gas at $0.25/Mcf and one unit of LNG at $1/Mcf, rather than selling ten units at $0.325/Mcf, the average or “rolled in” price, the economist would want to know if the last (marginal) unit was really economic to buy and sell by itself. So the LNG would have to be priced and find a buyer at $1.00 per Mcf, leaving the rest of the market with gas priced at $0.25/Mcf. Far from hypothetical, this was a major case that Walker and Lay determined.

The rationale for not allowing rolled-in pricing was as much redistributive (and thus philosophical) as it was economics. Existing consumers, mostly small users, would pay more under rolled-in pricing than they would under so-called full-cost pricing. The winners of rolled-in pricing would be the LNG customers, particularly if they would not have purchased the gas on an incremental basis.

However, given that consumers were facing curtailments under price regulation, at least during the peak demand winter season, it is not clear that higher rolled-in pricing is inefficient. Peak cost-based pricing from an LNG roll-in would help ration demand to available supply, although the supply-side price signal would also be going to LNG suppliers, not wellhead suppliers, as in a free market situation.

Thus the Walker/Lay position, given price controls and physical shortages, is more about textbook efficiency than real-world efficiency.

Bibliography for Chapter 8 Internet Appendix

Bradley, Robert, Jr. Oil, Gas and Government: The U.S. Experience. Lanham, MD: Rowman & Littlefield, 1996.

Florida Gas Company. Annual Reports (various years).

Florida Gas Company. Form 10—K for December 31, 1984.

The Houston Corporation. Special Report, September 15, 1959.

President’s Materials Policy Commission. 5 vols. Resources for Freedom (Washington, DC: U.S. Government Printing Office, 1952). Called Paley Commission.

Stanley, Floyd. “Text of Dedication Address Commemorating the Introduction of Natural Gas Service to the Florida Market,” Jacksonville, Florida, June 1, 1959, copy in author’s files.

Tussing, Arlon, and Bob Tippee. The Natural Gas Industry: Evolution, Structure, and Economics. Tulsa, OK: PennWell Books, 1995.

“Zeroing In,” Enron People, May 1986, 5—8.

Interviews for Chapter 8 Appendix

Horton, Stan. Interview by Robert Bradley Jr., February 21, 2001.

Sullivan, Selby. Interview by Robert Bradley Jr., May 5, 2005

Leave a Reply

Your email address will not be published. Required fields are marked *