On November 15, 2007, the Federal Energy Regulatory Commission ("FERC") issued a Notice of Proposed Rulemaking ("NOPR") in which it recognized the changing characteristics of the natural gas capacity release market and prevalent role of asset managers by proposing two significant amendments to its capacity release program in an effort to improve the efficiency of the capacity release market. The proposed amendments originated from two proceedings — Pacific Gas and Electric Company (Docket No. RM06-21), in which gas pipelines asked FERC to lift the rate cap on short-term capacity release transactions, and Coral Energy Resources (Docket No. RM07-4), in which natural gas marketers asked FERC to clarify how the capacity release rules operate in relation to asset management arrangements (e.g, where a capacity holder releases a portion of its capacity to an asset manager who agrees to supply the gas needs of the releasing shipper).

Currently, pipeline companies may enter into transportation agreements with negotiated rates based on "basis differentials," which represent the basis spread between two natural gas trading points. These rates are not capped by the pipeline's maximum tariff rate. However, firm shippers that engage in capacity release transactions are subject to an as-billed maximum tariff rate cap. In the NOPR, FERC proposes to lift the maximum rate ceiling on secondary capacity release transactions of one year or less, which in turn, would maximize use of available capacity and provide more options for shippers to acquire natural gas supplies. The rate cap removal would not apply to long-term capacity releases of more than one year or to primary sales of capacity by interstate pipelines.

The proposed changes in the capacity release rules involve short-term capacity releases and not long-term releases or primary pipeline capacity sales for two reasons. First, price volatility occurs more in the short-term market. Second, FERC was concerned that removing the rate cap from primary capacity sales may incentivize pipeline companies to delay development of new infrastructure projects or take advantage of high prices when capacity is scarce.

The NOPR also proposes to exempt certain asset management arrangements from certain capacity release restrictions and requirements. FERC's current capacity release regulations require that all shipper capacity release offers be posted on the pipeline’s internet web site and that contracting be done directly with the pipeline. In addition, capacity offered for release at less than the maximum rate must be posted for bidding and the pipeline must allocate the capacity "to the person offering the highest rate (not over the maximum rate)." The current rules exempt capacity holders from these bidding requirements for releases of 31 days or less and all releases at the maximum rate and require that the release of capacity may not be tied to any extraneous conditions, such as the release of capacity on other pipelines, taking assignment of gas purchase obligations or paying other compensation to the releasing shipper.

Marketers in the Coral Energy Resources proceeding sought to clarify that certain marketing activities conducted pursuant to asset management arrangements do not violate these rules. They argued that packaging gas supply and pipeline capacity, or segments of capacity, does not violate the tying prohibition and that paying fees (such as a lump sum payment, a share of the marketer's net proceeds, etc.) to the local distribution company or releasing shipper does not violate the bidding requirements. In response to these requests, the proposed rule would exempt capacity releases made as part of an asset management arrangement from the tying prohibition and from the bidding requirements.

The NOPR defines capacity releases made as part of an asset management arrangement as "any prearranged release that contains a condition that the releasing shipper may, on any day, call upon the replacement shipper to deliver to the releasing shipper a volume of gas equal to the daily contract demand of the released transportation capacity." Asset managers would remain subject to the current notice, posting and reporting requirements.

These proposed rules are important to energy marketers, gas-fired electric generation companies and local distribution companies. We recommend that companies with interests in these areas closely scrutinize the proposed regulations. Comments in this proceeding (Docket No. RM08-1-000) are due within 45 days after publication in the Federal Register.

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