NATURAL GAS SUPPLY ASSOCIATION

805 15th Street N.W., Suite 510
Washington, D.C. 20005

POSITION PAPER:
CONTINGENCY PLANNING

Executive Summary
The Natural Gas Supply Association (NGSA) is a trade association of gas producers who believe that natural gas can achieve its optimal role in the economy only if the gas industry effectively and reliably meets high priority needs during unexpected disruptions to gas supply or interruptions of transportation capacity.

Gas plays a critical role in meeting the energy needs of consumers across the country. Experience has shown that the allocation of this resource to those who need and value it the most can best be accomplished through the unfettered operation of competitive market forces, as reflected in freely negotiated contracts tailored to meet customer needs. The interstate gas shortages of the 1970s proved the fallacy of relying on government-mandated allocation plans to meet emergency needs. Government mandates for gas diversion discouraged investment in production, rewarded poor planning, and created a less reliable domestic natural gas system.

Well-executed contingency planning, together with reliable supply and transportation contracts, including appropriate mutual assistance agreements, should prevent the need for government-mandated diversions of gas. The process of contingency contracting will stimulate the growth of a reliable infrastructure.

In today's Order 636 environment, capacity interruptions should be dealt with by a pro rata allocation of available space. Supply disruptions should be resolved by private contracts.

State public utility commissions (PUCs) should encourage contingency planning by providing guidelines to local distribution companies (LDCs) that encourage private contracts, including mutual assistance agreements with other LDCs and/or end users. PUCs can ensure that plans are in place prior to an emergency, and that these plans rely on contractual agreements.

Background: Capacity Interruption and Supply Disruption
Contingency planning is designed to address the occurrence of unanticipated shortfalls in gas deliveries. These shortfalls must be viewed in two separate contexts: "capacity interruptions" and "supply disruptions". In the former, there is no shortage of gas supplies, but rather the shortfall is due to an outage of pipeline facilities such that all firm transporters can not use 100 percent of their contracted capacity for some period of time. Capacity interruptions typically occur as a result of any number of unplanned operational events on the pipeline. In contrast, a supply disruption occurs when some customers are unable to secure their contracted gas supplies due to an event temporarily restricting gas supplies at or near the points of production, such as a hurricane or severe freeze.

Background: Federal Curtailment Regulation
Historically, interstate pipelines have been the predominant suppliers of natural gas in the marketplace. Pipelines acted as gas merchants, buying gas from producers at or near the wellhead and reselling it to LDCs or end-users. The term "curtailment" in the gas industry implied the allocation of pipeline merchant gas ("system supply") by federal mandate in circumstances where that supply was insufficient to meet the demands of the pipeline's resale customers. Because of the supply/demand distortions caused by federal wellhead price controls, shortages of gas in the interstate market in the 1970s became almost systemic, and curtailment became a long-standing federal regulatory issue.

Prior to the Natural Gas Policy Act (NGPA), the Federal Power Commission adopted an "end-use" curtailment policy which categorized the "use" of the gas and assigned curtailment priorities for each gas consumption category. In the hierarchy of end-use curtailment, "essential human needs", primarily hospitals and residential users, were assigned top priority. With the passage of the NGPA in 1978, Congress established a mandated end-use curtailment priority for pipeline system supply generally consistent with prior regulatory policy.

In the years that followed passage of the NGPA, the wellhead price incentives contained in the NGPA worked to eliminate gas shortages in the interstate market. Concurrently, producers, marketers, and customers began to market or purchase their gas directly. As a result, pipelines began to lose their dominant role as merchants of gas and increasingly became transporters. As system supply decreased as a percentage of the total gas in the system, the amount of gas subject to curtailment mandates declined, making the application of the end-use priorities contained in the NGPA largely irrelevant.

While the Federal Energy Regulatory Commission (FERC) has the authority to mandate the allocation of pipeline capacity in the event of capacity interruptions, it does not have the authority to mandate allocation of transportation gas during a supply disruption. As a result of the implementation of Order 636 and the total deregulation of natural gas at the wellhead, the supply and demand for gas are now driven by market forces. In this environment, market-driven commercial arrangements, including mutual assistance agreements, are best able to deal with the allocation of gas during supply disruptions to provide for human needs. Even though pipelines may have some flexibility to use storage and "line pack" gas to meet emergency needs on a short-term basis, deliveries of transportation gas must ultimately balance receipts into the pipeline system. In such circumstances, market mechanisms have proven themselves superior to regulatory fiat in the allocation of scarce resources.

Background: State Curtailment Regulation
While federal regulation now concerns itself primarily with the allocation of transportation capacity on jurisdictional pipelines, state regulation deals with allocations of gas by public utilities. Even under the curtailment provisions of the NGPA, state regulators are responsible for the allocation of gas delivered by a public utility. Historically, state curtailment policy generally paralleled that which was in place at the federal level.

Today, state PUCs recognize that the gas market has been transformed from one in which the pipelines dominated as merchants to one where pipelines are transporters. And instead of the one pipeline merchant of gas there are now many competing suppliers. As a result of these developments in gas markets, state regulators will have to adjust their policies to correspond to the changes brought about by the restructuring in the industry.

Despite the evolution of the gas market from one determined by regulations to one driven by market forces, the industry is not beyond the influence of short-term events that might disturb the supply/demand balance in a way that would affect human-needs customers. It is in this context that the question of "curtailment" has again arisen. How should the restructured gas industry respond during times of emergency, particularly with regard to human needs?

NGSA Position: Capacity Interruptions
In cases of capacity interruptions of firm transportation service, pipelines should implement pro rata allocation.

After discontinuation of interruptible transportation services, pipeline tariffs generally call for a reduction in deliveries to firm shippers served by the pipeline facility subject to an outage. The reduction for each firm shipper is proportional, that is "pro rata", to its "contract demand" or other measure of pipeline capacity reserved. In this paper, this method of allocating pipeline capacity is referred to as "pro rata allocation".

Pro rata allocation enhances the reliability of gas service.

Each customer now has the right and opportunity to contract for firm service with transporting pipelines. This is a key component of reliability in the Order 636 era. Before choosing the amount of capacity to reserve or to acquire through capacity release or other means, an LDC will need to evaluate its "essential human needs" and other "core" requirements in light of its own customer base and alternative gas delivery systems that can be utilized during peak periods. Large industrial firms and electric generators will also need to make a similar study of their essential requirements during peak periods and the appropriate transportation options that are available to satisfy those requirements.

In Order 636, the FERC correctly perceived that firm transportation service derives its value primarily from the assurance of pipeline capacity during periods when capacity is scarce. Indeed, reserved pipeline capacity is a critical element in building a portfolio of services reflective of desired reliability. However, the durability of that element depends on pipeline capacity being reserved by contract for the use of the firm shipper under all operating conditions, including situations when capacity is temporarily reduced due to an outage. Under pro rata allocation, a shipper's contractual reservation is honored to the maximum extent possible -- that is, regardless of the cause of the interruption, the shipper may use its portion of reserved capacity then available on the affected pipeline segment.

In contrast to pro rata allocation, end-use allocation attempts to identify, track and police the ultimate end-use of the gas flowing through the affected facility and to allocate deliveries among firm shippers based on a ranking of end uses. However, this method does not promote reliability and opens the door to undue discrimination among customers.

End-use allocation requires a consideration of factors extraneous to each customer's firm transportation contract. It also necessarily requires a valuation -- outside of the market -- of end uses. What each firm shipper may properly regard in the contracting process as a valued essential human needs or other core requirement is recognized only to the extent it falls within the FERC-approved definition of a high priority end use.

The capacity reserved by contract is largely irrelevant to this process, except to the extent that each shipper's contract demand may serve as a cap on its delivery entitlement. At precisely the time the economic value of reserved capacity is likely to be highest, those who have been paying for that capacity are denied its use. Instead, access to capacity is made a function of extraneous factors beyond the shipper's control and responsibility, including the changing customer base and portfolio composition of other shippers, and the approved hierarchy of end uses.

End-use allocation ultimately undermines delivery system reliability. It undermines individual responsibility for procuring storage, pipeline capacity, and contingency supplies by creating entitlements to gas deliveries even when insufficient service has been contracted. It also blocks market-based price signals on the value of reliability. This in return undervalues pipeline capacity, alternative fuel capability, and storage, resulting in diminished construction of infrastructure and less reliability of the entire delivery system.

Finally, regulators should recognize that end-use allocation creates strong incentives for shippers to engage in unduly discriminatory behavior. These acts could include the submission of inflated or unverifiable claims of end-use. Policing such behavior would be difficult and represents an inefficient use of regulatory resources.

Pro rata allocation can be administered cost effectively by the pipeline under emergency conditions.

Generally, capacity interruptions are short in duration. Long-term interruptions are infrequent because pipelines are generally diligent in their maintenance and repair operations. A loss of capacity can only be remedied by physical action to repair the affected facility. During such emergency periods, the pipeline's focus should be on repairing the damage and restoring service at the earliest feasible time. Pro rata allocation generates a delivery schedule for affected customers that the pipeline can implement under emergency conditions without undue cost or diversion of its resources away from these critical activities.

A database adequate to perform an end-use allocation in light of the changes that have occurred in the restructured gas industry does not currently exist. Due to the proliferation and dynamic nature of individual end users, types of use, alternative fuel capability, and multiple pipeline connections that has occurred, this database would be complex and extremely difficult to develop and administer. Moreover, capacity release compounds this complexity due to shipper identity changes. The benefits, if any, would not justify this costly and burdensome exercise.

NGSA Position: Supply Disruptions
All gas users should consider entering into reliable supply contracts and arrangements for alternative sources of supply to be delivered during emergency situations.

In contrast to capacity interruptions, supply disruptions may not result from outages of pipeline facilities. A customer's delivery shortfall may be caused by physical factors such as hurricanes or freezes affecting gas production and capacity-related interruptions on gathering or other upstream facilities. Alternatively, the shortfall can reflect non-physical causes, such as insolvency or contractual default by an individual supplier. In all these cases, supply disruptions are not amenable to interim resolution by the pipeline (through the use of system supply) due to the decline of the pipeline merchant function.

The complete deregulation of gas supplies and Order 636's unbundling of transportation gives customers the opportunity and responsibility to prudently manage these supply risks through contracts. For example, supply source diversification in a customer's portfolio will reduce the risk of interruption due to physical outages, and careful screening of suppliers will minimize interruptions due to non-physical factors.

A supply portfolio should be tailored to fit each customer's essential requirements during emergency situations. This mix of supply contracts will vary depending on the characteristics of the individual customer, but should certainly include, but not be confined to, a consideration of the availability and price of the following portfolio elements:
Both federal and state regulators should resist calls for mandated supply diversions. While the details differ, all depend on the confiscation of one customer's gas for the satisfaction of another customer's delivery shortfall. Moreover, diversion schemes actually discourage prudent contingency planning by customers. For the same reasons discussed above with respect to end-use allocation, mandatory diversion schemes will impair the reliability infrastructure of the industry. Further, since at least one party will likely be deprived of the benefit of its bargain when gas is diverted, parties are actively and perversely discouraged from responsible contracting. Regulatory or legislative emergency schemes that seize and redirect gas supplies owned by contracting parties discourage tailored supply portfolios that mitigate risk and address contingency planning.

Proponents of diversion schemes defend them on the grounds that such intrusive regulation is necessary to protect essential human-needs consumers from potential losses of supply. While these consumers should be fully protected, this objective can be accomplished under a market-driven (i.e. contract-driven) approach. Such an approach will encourage proper contingency planning by customers while also respecting the ownership rights to gas conferred by contracts.

NGSA Position: Mutual Assistance Agreements
All gas users should consider mutual assistance agreements covering supply and capacity among gas owners within a state or within a geographic region to voluntarily redirect gas to high priority users during emergencies.

A gas delivery system should have a means for prioritizing and meeting high priority customer needs in emergency situations. Historically, the pipeline acted as a high-level allocator in which it would direct its system supply gas to high priority users based on surveys previously filed by customers (generally, LDCs). With the pipeline no longer owning substantial amounts of gas, this allocator role now falls upon the current owners of gas and capacity within the market area. Mutual assistance agreements can allow the industry to do an even better job of meeting the needs of high priority users than was possible in the past. Mutual assistance agreements are voluntary contracts between market participants (usually geographically contiguous parties) involving the transfer of gas and/or capacity to alleviate delivery shortfalls. The success of mutual assistance agreements is predicated on the parties anticipating problems and devising solutions well in advance of actual emergencies.

A model mutual assistance agreement is not being proposed; the circumstances are too diverse, and the range of good approaches too great, to suggest a "best way". However, several topics that should be addressed in the process include:
The Appendix presents additional details on the above list of topics.

In addition to the factors discussed above, which relate directly to the mutual assistance agreements themselves, other related issues may need to be addressed. For example, pipeline and LDC tariffs may need to be re-examined to ensure compatibility with emergency arrangements. Particularly important is the flexibility to make quick adjustments in emergency situations, such as intraday nomination changes, utilization of "new" delivery points, and de facto "instantaneous" capacity release. In some localities it may be appropriate to seek adjustments in laws and/or regulations to facilitate emergency assistance for high priority users. For example, an "environmental waiver" may be required to allow fuel switchers to burn "environmentally restricted" fuels for short periods without penalty.

All parties should be alert to the fact that agreements of the type discussed here can, if improperly formulated, stray into areas that might raise antitrust questions. Contingency plans can be implemented consistent with antitrust laws. Consequently, antitrust counsel should be involved in all phases of the process.

NGSA Position: Role of the State Public Utility Commissions
Public Utility Commissions should promulgate procedures that encourage and facilitate gas customer contingency planning.

State public utility commissions are key players in the development and implementation of advance planning as the proper response to emergency shortfalls in the delivery of contracted gas to the city-gate. State regulatory action should facilitate the development of contingency planning by encouraging LDCs and high priority end users to pre-plan for emergencies by negotiating mutual assistance agreements, and by developing a portfolio of supply and capacity contracts.

The successful transition from an environment where emergencies are responded to by government mandates to one which employs contract portfolios and mutual assistance agreements will require active support by PUCs. The topics to be addressed in mutual assistance agreements outlined in the preceding section require regulatory guidance. Guidance will be needed with respect to overlapping state jurisdictions, the definition of an emergency, appropriate parties to be involved in agreements, and compensation to assisting parties. These PUC guidelines should provide latitude for LDCs to develop the details of their contingency plans which respond to the unique needs of their systems.

Uncertainty created by the specter of post facto discussions of prudence, eligibility, and recovery of costs with respect to emergency pre-planning will inhibit the process. Contingency guidelines must send clear signals as to the standards and expectations for contingency planning against which LDCs will be judged. PUCs may wish to initiate a review process to monitor the adequacy of emergency plans and to address disallowance concerns of LDCs.

Contingency planning yields a prudent result and enhances the value of service to all LDC customers. If contingency planning is not adopted, the likely result will be a failure to meet core needs and/or the unwarranted diversion of gas. PUCs should therefore recognize and reward those utilities that have acted in advance to meet the gas supply needs of customers during an emergency.

NGSA Position: Information Flow
Modern electronic measurement and communication systems should be implemented in order to gather and transmit gas flow information to customers on a timely basis.

Historically, the industry measured gas volumes with mechanical chart recorders. The time lag between recording gas volumes and when those volumes were reported ranged from a few days to as many as 45 days. Access to gas flow information on a real time basis is a key necessity in the restructured gas industry and requirements pursuant to Order 636 have been driving pipelines to substitute electronic measurement for mechanical measurement.

The Natural Gas Council's booklet, Natural Gas Reliability, recognizes that the availability of accurate and timely information is essential in the new natural gas market. The NGC publication commented that "electronic market information systems enable buyers to locate and purchase gas, plan and order transportation services or storage, track volumes and confirm deliveries. These systems also enable industry to respond more quickly to equipment malfunctions, maintenance procedures and other temporary supply disruptions by rerouting gas."

Similarly, the National Petroleum Council's (NPC's) two year study, The Potential for Natural Gas in the United States, found that "today's operational environment reflects the need for a more global approach to automation emphasizing real-time pipeline monitoring, control, and communications to optimize pipeline operations and make it responsible to customer needs." The NPC study further found that the ultimate result of such action is to provide a system where "...a customer can obtain consistent information about transportation options...."

Such broad industry support and Order 636's equal access requirements, should accelerate pipelines' implementation of real time electronic measurement devices. Real time data will provide information necessary to manage ordinary transportation arrangements and contracted alternative supply arrangements, including mutual assistance agreements. However, this information is of value to customers (i.e. shippers, gas suppliers, transportation and storage customers - and their agents, marketers, and end users) only when pipelines transfer it to such customers through electronic bulletin boards and through standardized Electronic Data Interchange. Further, LDCs should also share appropriate real time volume flow information with their customers. This movement to real time information will greatly assist in making industry participants better able to cope with short-term emergencies, and thereby materially improve the reliability of natural gas deliveries.

Topics to Be Addressed in Mutual Assistance Agreements
  1. What conditions will constitute an "emergency" and invoke the agreement?
      I. Supply shortfall?
      II. Capacity shortfall?
      III. Distribution system pressure?
      IV. Temperature below a certain point?
  2. Who are appropriate parties to the agreements?
      I. LDC to LDC?
      II. LDC to on-system industrial?
  3. If multiple agreements are entered into, which one is triggered first? second?
  4. How will the "assisting party" be compensated for:
      I. Capacity "used"?
      II. Commodity "used"?
        a. Purchase cost
        b. Market value
        c. Alternative fuel value
      III. Storage related charges?
      IV. Administrative burden?
  5. What is the appropriate geographic scope?
      I. Within state?
      II. Multi-state?


For a detailed analysis of reliability in the Order 636 era, the NGSA recommends "Natural Gas Reliability", a 1993 publication of the Natural Gas Reliability Task Force of the Natural Gas Council.

INDEX CONTACTS PRESS STUDIES MAIL
DEMAND TRANSMISSION SUPPLY DISTRIBUTION RENEWABLES

This page was originally placed October 10, 1996; last updated August 31, 1997