BEFORE THE
PUBLIC UTILITIES COMMISSION OF
THE STATE OF CALIFORNIA




Rulemaking on the Commission's Own Motion to	)
Assess and Revise the Regulatory Structure		)	Rulemaking 98-01-011
Governing California's Natural Gas Industry.	)	




COMMENTS OF THE
ALBERTA DEPARTMENT OF ENERGY
AND THE
CANADIAN ASSOCIATION OF PETROLEUM PRODUCERS


I.	Introduction and Summary

	Pursuant to the January 21, 1998, order of Administrative Law Judge Kim Malcolm in this proceeding, and the order of assigned Commissioners Richard A. Bilas and Jessie K. Knight, Jr., of March 17, 1998, the Alberta Department of Energy ("ADOE") and the Canadian Association of Petroleum Producers ("CAPP") hereby provide their joint comments on this rulemaking to adopt further revisions to the regulatory structure governing California's natural gas industry.  

	These comments respond to questions posed in the Order inaugurating the rulemaking and to issues raised and discussed in the accompanying report of the Commission's Division of Strategic Planning, "Strategies for Natural Gas Reform: Exploring Options for Converging Energy Markets" ("Gas Strategy Report").  ADOE and CAPP do not, however, respond to all questions nor address all issues raised.  ADOE and CAPP focus on those which are judged most likely to affect the interests of outside suppliers, shippers, and sellers to the California market -- the common roles of CAPP members and those who market Canadian gas to California.  Nonetheless, ADOE and CAPP expect to pay close attention to the comments of other parties and the subsequent decisions of the Commission in pursuing its restructuring agenda, and reserve the right to participate in any later procedure ordered or to respond to any proposal offered.  

	The key issues on which ADOE and CAPP comment are the proposals to unbundle numerous gas utility services that can be offered competitively, and to move toward direct transmission rights and secondary trading of those transmission rights.  On these issues, ADOE and CAPP believe that the Strategic Planning Division's perceptions of both the problems and the remedies are constructive and progressive.  ADOE and CAPP support the proposed unbundling of services discussed by the Gas Strategy Report, but believe that the Commission should consider taking greater steps than the Report discusses toward unbundling of utility gas transmission from distribution services, which could then facilitate the separate offering of transmission rights and a secondary market for transmission rights.  

	ADOE and CAPP further note that price cap ratemaking, as suggested by the Gas Strategy Report, is one form of incentive ratemaking, which has been tried in Canada and appears to be succeeding in the respects the Gas Strategy Report suggests.  Such ratemaking may offer Californians greater rate stability at considerably less regulatory cost and effort and still achieve ratepayer savings at least equal to those which are generated by more traditional cost-of-service ratemaking.

	ADOE and CAPP support the Gas Strategy Report's primary recommendation of a clean break between the competitive commodity sales function, on one hand, and the regulated transportation and distribution functions, on the other.  While the California utilities must still retain an obligation to deliver natural gas to all customers, they no longer need retain an obligation to serve, once all customers are able to select their own suppliers.  A competitive commodity supply sector will then allow the further streamlining of regulation, because the utilities' own commodity roles, to the extent they continue, can be disciplined by the competitive market rather than by this Commission's regulatory oversight of commodity purchase practices, sources, or costs.  Customers who have competitive alternatives and knowledge of them will provide the most effective oversight of utility gas purchasing.  

	Customers should, however, be protected by a reasonable program of requiring prospective suppliers to register and demonstrate their capability and accountability for serving the customers they plan to serve.  ADOE and CAPP have no objection to supplier registration requirements as the Report suggests, because legitimate suppliers, like consumers, have a great interest in making sure the market is protected from fly-by-night suppliers who may leave consumers without promised service and tarnish the reputation of all independent suppliers.

	The "converging energy markets" reflected in the title of the report require, in ADOE's and CAPP's view, more attention to the need for convergent regulatory approaches to both gas and electricity regulation.  In particular, regulation of bulk transmission economics for the two energy forms appears at present likely to result in divergent approaches and rates, rather than the parallel and consistent approaches indicated for such converging energy industries and markets.  Such differences may over time create distortions that will be embedded in consumer decisions, investments in facilities, and siting decisions -- distortions driven by lack of regulatory and institutional parity, not by underlying energy or utility economics.  A comprehensive gas strategy should seek consistency between gas transmission and electric transmission regulation as this trend towards convergence continues.

	In general, ADOE and CAPP believe that the Gas Strategy Report poses most of the right issues and many of the right prescriptions to optimize the California gas utility industry and regulation.  ADOE and CAPP are pleased that the Commission is undertaking further gas regulatory reforms at this time and look forward to playing a constructive role in helping the Commission identify an industry regulatory structure that makes the most sense for the gas market, because that is the same regulatory structure that will prove to make the most sense for California customers and their gas suppliers alike.

II.	General Principles

	ADOE and CAPP congratulate the Commission on its initiative in acting to update and improve its natural gas regulatory structure.  The goal should be to maintain the appropriate protections for consumers and shippers while fostering the further pro-competitive evolution of the natural gas industry in California.  

	ADOE and CAPP also agree with all of the principles and general strategy steps for the further restructuring of the California gas market laid out in the Gas Strategy Report (at pp. 2, and generally in Chapter III).  These include: (1) distinguishing between competitive market functions and natural-monopoly market functions, unbundling and freeing the former to respond to competitive forces, and retaining regulation for the latter; (2) reforming regulation to make it more efficient and less burdensome for those functions which still require regulation; (3) maintaining consumer protections to the extent consumers cannot protect themselves through arms-length commercial arrangements; and (4) maintaining reliability of supply and services.  

	ADOE and CAPP would add to these general principles some corollaries that may be implicit in the Gas Strategy Report's articulation of them, but ought perhaps to be made explicit in any general policy pronouncement the Commission makes: 

(1) 	that there be full respect for the sanctity of the private contracts that provide the legal structure of all unregulated, competitive market functions;

(2)	that to the extent change in commercial arrangements is necessitated by changes in policy, the parties to those contracts be allowed the time and freedom to renegotiate their arrangements if and as necessary, rather than have change imposed by fiat; 

(3) 	that protecting consumers primarily means protecting competition itself from anti- competitive actions or dominance, and protecting the unregulated market from any residual tendency to tilt the competitive playing field to favor certain competitors or to capture perceived benefits; and 

(4)	that protecting consumers and competition also entails adequate consumer education and information to permit the consumer to make wise and timely market decisions.

	ADOE and CAPP believe that, in the interim years since the Commission last adopted broad policy structures and principles for California's natural gas markets on a statewide basis, a foundation has been laid for fundamental policy consensus on transition issues and regulatory structures.  In particular, ADOE and CAPP believe that the Gas Accord adopted by settlement to govern rates and terms of transportation on the Pacific Gas & Electric Company ("PG&E") system last year in D.97-08-055 showed both the market's willingness and the Commission's readiness to think outside the regulatory boxes that were drawn at the end of the initial gas restructuring effort.  The merits of doing so are already being proven, and are clearly reflected in the Gas Strategy Report's recommendations.

III.	Unbundling of additional services continues to be a good idea

	A.	The Commission should consider unbundling intrastate transmission capacity and creating a secondary market for capacity rights

	ADOE and CAPP note that the Gas Strategy Report suggests but does not advocate capturing the potential benefits of moving toward unbundled utility transmission and distribution services.  These services are seen to be less prone to competition, and more imbued with traditional natural monopoly characteristics.  The report suggests at pp. 49-52 that intrastate transportation services, among others, ought to be offered by the utilities at their own revenue risk, rather than with assured cost coverage from ratepayers.  The report indicates that the Commission might wish to "foster more market-responsive gas intrastate transportation services." But the report does not suggest unbundling of the services themselves.

	ADOE and CAPP believe that in this respect the Gas Strategy Report should go further.  The key to greater unbundling of intrastate transportation services is subdividing them into transmission and distribution services, and recognizing that there is much greater potential for competition in transmission services than distribution services.  It is on the transmission system where there are enough separate shippers moving gas and seeking capacity from the same input points to the same delivery points that there is the potential for the creation of capacity rights.  This is not the case on the distribution system.  

	The Gas Strategy Report explicitly clarifies that its consideration of revising the allocation of revenue risk for transportation services does not mean that transportation services are no longer natural monopoly services: "Transportation will continue to remain a natural monopoly, requiring the Commission's oversight in establishing recourse or default rate frameworks and in enforcing equal, non-discriminatory access to the transportation system."  But ADOE and CAPP believe that there may be alternatives, at least on the transmission part of the gas transportation systems, to make them partially competitive.

	One option is obviously the creation of additional but independent transmission capacity.  At a time when capacity is adequate, however, this threatens to create additional costs for ratepayers to the extent they are required to continue bearing the costs of existing capacity, and has become known to this Commission as "uneconomic bypass."  If transmission were unbundled from distribution, however, existing utilities could be held responsible to offer general transmission rates sufficiently low to meet such competition   and not merely selected discounts to certain customers   or else be responsible themselves for any stranded capacity costs when a competing pipeline was nonetheless constructed.

	Other options are available, however, which do not require the construction of additional capacity when there is already adequate capacity.  These options involve the creation of and assignment of fixed capacity rights on a given pipeline, together with creation of a secondary market in those rights.  Such rights can be permanent as well as temporary.  For example, the Commission has approved the sale of an interest in place in its Lines 401 and 300 by PG&E to SMUD.  Such partial capacity sales could create the conditions for competitive transportation rates and services to be offered, even within the same pipe.

	But separate rights can be sold under long-term service agreements to shippers who would then have the right to use them, or to reassign them to others.  The Gas Strategy Report talks encouragingly (at pp. 53-54) about the creation of a secondary market for transportation rights in California, in order to achieve the benefits of valuing capacity and maximizing its efficient use that are being achieved through secondary capacity markets elsewhere.  The Gas Accord has provided northern California a head start in this direction.  

	ADOE and CAPP believe that such a secondary market can only be created if there is assignment of capacity rights within California as there is on interstate pipelines.  Only where one has separable rights to transportation capacity can one create a secondary market in which those rights can be bought and sold.  Since it is not practicable for such rights to be created on the distribution system, the creation of such a secondary market mandates the unbundling of the transmission system from the distribution system.

	A key issue in any such secondary market for capacity rights has been whether shippers will have the ability to obtain rates for released capacity in excess of the regulated rates they themselves pay to the pipeline or utility for the capacity.  ADOE and CAPP believe that there is no basis for a cap on rates paid in the secondary market to the "as-billed" level, as FERC currently requires.  First, such limitations are inherently unenforceable, because there are no end of manners in which additional consideration can be offered to a capacity holder over and above the regulated rate.  Second, only by having the ability to collect more than regulated rates when there is demand for capacity can a shipper justify committing to pay fully allocated rates when there is surplus capacity and a market value below the regulated rate levels.  Allowing uncapped rates will make the capacity much more marketable and help assure that the utility's own costs for it are recovered.  

	Canada's system of secondary capacity marketing is not subject to "as-billed" rate caps, and there have not been significant problems from the perspective of shippers or pipelines.  In northern California, again the Gas Accord has led the way by adopting this concept.   Of course, the primary rates must continue to be regulated, because the utility does continue to have a natural monopoly, but information from the secondary market can readily be utilized under an incentive or rate-cap regulatory approach in helping to determine where the rate cap should be set.

	Unbundling the transmission and distribution systems of the utilities may require some additional metering investment to allow certainty of whose gas from the transmission system was delivered into which distribution branches.  But ADOE and CAPP believe that these costs would be relatively low.

	For these reasons, ADOE and CAPP urge the Commission to consider moving beyond the relatively limited consideration the Gas Strategy Report gives to the concepts of increasing competitive intrastate transmission services through unbundling of transmission from distribution and creating a vibrant secondary capacity market.

	B.	Unbundling interstate demand charges

	ADOE and CAPP recognize that utility turn-back of interstate pipeline capacity is gradually and effectively accomplishing the unbundling of interstate pipeline demand charges as it is, although it is doing so at different rates for different utilities.  This is therefore a transition-cost issue that should be handled on a utility-by-utility basis.  For PG&E's service area, the Gas Accord has dealt with any residual issues remaining after PG&E's contractual obligations to upstream interstate pipelines were terminated.  In SoCalGas' service area, ADOE and CAPP recognize that a proceeding is currently under way in which this is an issue, A. 97-12-048.  This proceeding should move to completion quickly for the sake of rate stability, certainty, and encouragement of customers.  Once made, these decisions allocating transition costs should not be reopened in the context of this rulemaking.

	C.	Unbundling public purpose programs

	ADOE and CAPP understand the perceived desirability of some of the public purpose programs which have heretofore been financed with surcharges on utility bills that all customers paid.  ADOE and CAPP also understand that moving toward competitive services and competitive supplies means that the utilities cannot remain obligated to collect the entire cost of programs believed to benefit the entire market, including those parts the utilities no longer serve.  These programs ought to be "unbundled" in the sense that their costs should be equitably shared by gas consumers.


	D.	Revenue cycle services

	ADOE and CAPP support unbundling of revenue cycle services, since this can provide additional efficiencies and savings.  In Ontario, unbundling of revenue cycle services has helped to facilitate a competitive commodity market in the wake of unbundling commodity and transportation services.  This is also under consideration in other Canadian provinces.

IV.	The Commission should allow price-cap or incentive regulation where consumers and utilities agree on its structure.

	ADOE and CAPP support the Gas Strategy Report's call for adopting a price-cap model or incentive model for future utility rates, but only in circumstances where the utility and its shippers and customers can agree among themselves on the level of the rate cap, if applicable, or on how the up-side benefits and down-side risks should be divided.   The regulatory effort and costs involved in cost-of-service reviews, combined with the inherently backward-looking nature of cost-of-service regulation, makes the old regulatory model less appropriate for a progressive new age of the gas industry.  But where utilities and their customers cannot themselves agree on the risk/reward balance they should each undertake in an alternative arrangement, an alternative of that sort should not be imposed by regulators.

	With more vibrant markets for unbundled services and natural gas as a commodity, there will be fewer costs subject to regulatory allocation and less of a risk that a price-cap or incentive approach to regulation would fundamentally undercompensate or overcompensate the utility.  To the extent the utilities are expected to take more utilization risk for their facilities, it is appropriate that they have better assurance that they can benefit from their own improved efficiencies and productivity in using those facilities.

	Again it appears that real experience in California has preceded the general policy prescription in the Gas Strategy Report, with an effective capped rate program in effect under the Gas Accord in northern California, incentive rates in effect for SDG&E and under consideration for SoCalGas, and the Global Settlement of SoCalGas expressing an agreed division of risks and rewards for a significant period.  

	Experience in Canada with incentive/price-cap model regulation also suggests that it can be promising, although one should not judge the long-term resiliency and fairness of such a fundamental change in economic regulation based merely on short-term experience.  Incentive regulation (including some structures with price caps) is currently in place for natural gas transportation on the systems of, among others, TransCanada Pipelines Ltd.,  Nova Gas Transmission Ltd., Westcoast Energy, Trans-Quebec & Maritime, and Northwestern Utilities, Ltd. (of Alberta), as well as on the Interprovincial Pipe Line oil system.

V.	The core market is ready for competitive supply opportunities

	ADOE and CAPP believe that core supply services should be unbundled from transportation and distribution services and offered on an unbundled basis to all customers.  ADOE and CAPP do not believe, however, that the unbundling process must necessarily indeed be carried to the logical extreme proposed in Option 3 of the Market Structure Options analyzed in the Gas Strategy Report (at pp. 78 - 85) -- the elimination of the utility role in gas commodity procurement for any customer.  The utilities are practiced and often well-trusted aggregators for core customers.  There may be a negative customer reaction against the industry as a whole if all customers are forced to the point of identifying and contracting with an alternate supplier even if they are perfectly happy with their current service.

	Instead, the key policies should be that the utilities' commodity procurement services be fully open to competition from alternate suppliers seeking to serve those customers, that all customers be made aware that they have a choice to exercise if they seek to do so, and that information be presented to customers allowing them to make the best choice without bias toward the incumbent utility.  Customers should clearly understand that the reliability of continued utility delivery service for gas will remain unaffected, but that they may, if they choose, seek a more economical gas supplier.  They should be informed that most large noncore customers have now procured their own gas for years from non-utility independent suppliers, and have achieved cost savings as a result.  But they should have the option to remain with their utilities as gas suppliers if they choose to do so.  

	Clearly core market loads must be effectively aggregated for core customers to achieve and exercise the gas-purchase clout that noncore customers have effectively utilized.  Independent core aggregation efforts to date have been less than fully successful.  However, unbundled intrastate transmission and revenue cycle services may go far toward putting independent core aggregators into a posture to compete successfully for customers currently served by the utilities on a bundled basis.  Independent suppliers should be offered this opportunity on a level competitive playing field, but the utilities should not be driven from that playing field.

	Allowing the utilities to remain active as commodity suppliers in a competitive supply market does not mean that the current regulation of utilities for their commodity procurement services cannot be streamlined and updated.  ADOE and CAPP believe that a small effort by the Commission to assure that competitors have full and fair access to core customers will allow competitive market forces to substitute for the major effort the Commission has frequently expended in reviewing and judging the reasonableness of the utilities' procurement efforts.  There will be no need for the Commission to supervise or retroactively review the sources, prices, and contracts entered into by the utilities for their gas supply, because the market itself will quickly penalize a utility whose supply costs are out of line as long as the utility customers are free to switch to another supplier.

	ADOE and CAPP further believe that the establishment of a competitive unbundled supply function for the core market will finally and happily disengage the regulatory considerations of pipeline and distribution rate-setting from the market considerations of gas supply options.  The regulated rates and conditions for access to and use of pipeline and distribution capacity should be driven by the costs and capacities of the pipes, not the ups and downs of the gas commodity market.  Yet efforts to steer cheaper gas to certain consumers through use of monopoly powers over pipeline and distribution system rates have in the past distorted both the competitive commodity market and the cost-of-service analysis which was used to set transmission and distribution rates.

	B.	Assuring reliability of supply is critical, but can be managed

	ADOE and CAPP agree with the Gas Strategy Report that preserving the reliability of the system is critical and will require special conditions such as registration and accountability of suppliers and the development of the role of a default gas supplier.  The Commission's experience with electric marketers should make clear that a serious program to require the registration and accountability of those who market gas to consumers needs to be developed.  As major companies experienced in the business of marketing natural gas and dedicated to the healthy advancement of a competitive and minimally regulated natural gas supply industry, CAPP members recognize the importance of assuring consumers that they will only be served by reputable and reliable suppliers.  The gas market should not have to experience any "Boston- Finney"-type issues.

	In the supply of natural gas, a key component of an open, competitive market is the assurance of direct accountability for supply reliability.  Suppliers and customers need to be accountable to each other for their actions and decisions.  Without such accountability, there exists the opportunity to free-ride, or benefit at the expense of someone else or the system as a whole.  This accountability is expressed in contracts and their enforcement.  

	Given the essential nature of gas service to core customers, however, and the non- interruptibility of their usage, mechanisms need to be created that provide assured back-stop supply under all circumstances.   In a functional competitive gas market, there will at all times be gas available to anyone willing to pay the going price of available gas.  That price can be high under extreme climate conditions.  The key is, therefore, to assure that the consumers are served gas, and that the responsibility for paying a short-term high market price to replace failed supplies lands where it ought to land, as a function of the contract between the consumer and his contracted supplier.

VI.	Converging energy markets require convergent or at least parallel regulation

	ADOE and CAPP believe that the Commission is correct in understanding that the natural gas and electricity utility industries are converging, and are doing so in ways that warrant consideration of a similar convergence in the manner in which they are regulated.  While the Gas Strategy Report pays significant attention to the problems of preventing market power in one energy form from influencing markets for the other, the report deals only briefly (at pp. 58-59) with the need to address the competitive effects of divergent rate regulation on the critical bulk energy transportation services in these converging energy markets.  

	In particular, the Commission must be alert to distortions that may be caused in fuel choices, facility siting, and capacity utilization if the regulated rates and conditions for natural gas transmission service into California vary significantly from the rates and conditions which apply to electricity transmission.  At present it appears that natural gas transmission rates carry a significantly greater portion of the fixed costs of the system than the electric transmission rates charged by the Independent System Operator.  Consumers cover the electric transmission system revenue requirement in their bundled charges for electricity service.  

	As a result, a power generator in California using gas will pay approximately the same electricity transmission rate as a power generator outside California, but will also pay a significant gas transmission rate the outside generator avoids entirely.  This puts in-state gas-fired generation, and those who supply gas to that generation, at a competitive disadvantage.  There is also residual bias in any end-use competition between gas and electric power that may take place, because any consumer with electric service is already paying the fixed costs of the power transmission grid in his electric bill, and would not perceive those costs as variable, but would see the gas transmission costs as variable in the costs of the gas.

	ADOE and CAPP believe that the Commission should move toward better unbundling of transmission and distribution services on the electric side as well as the gas side, and should then work to assign the fixed costs of the electric transmission grid to the transmission tariff paid by bulk power transporters.  This would all better parallel regulatory structures, as well as promoting meaningful assignment of transmission capacity rights and secondary markets in those rights for both energy commodities.

	Unless these different approaches are addressed generically over the near term, the converging energy markets will develop with a fundamental distortion driven by regulatory and institutional factors, not economic factors.  The Commission should focus attention on these issues earlier rather than later, after major investment and contractual decisions are premised on such non-economic distinctions.

	
						Respectfully submitted,



						John W. Jimison, Esq.
						Brady & Berliner, P.C.
						1225 19th Street, N.W., Suite 800
						Washington, D.C. 20036

						Attorney for
						Alberta Department of Energy
						   and
						Canadian Association of Petroleum Producers


March 23, 1998