COPING WITH HIGHER GAS PRICES

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					COPING WITH HIGHER GAS
        PRICES
                   Ken Costello
            Senior Institute Economist
    The National Regulatory Research Institute

                       for

  The Tennessee Regulatory Authority Natural Gas
                  Symposium

               Nashville, Tennessee

                 August 19, 2003
     The Meaning of Protecting
           Consumers
 From the perspective of an increasing number of state
  commissions and gas utilities, “consumer protection”
  requires the combination of adequate gas supplies,
  reasonable prices, and some degree of price stability
 The big concern lies with protecting consumers from
  “high” market prices during the winter heating season
 As discussed this morning, high prices essentially caused
  by tight gas supplies relative to market demand
 Many PUCs and gas utilities have recognized that
  protecting consumers may involve shifting some of the
  risk associated with market prices away from consumers
  via hedging and other gas-utility activities
     The Meaning of Protecting
       Consumers -- continued
 From an economist’s perspective, protection connotes
  minimizing consumer economic-welfare losses from high
  or rising gas prices – for most markets, this is normally
  achieved by consumers reducing their consumption
 This is difficult to do in the case of gas consumed by
  small customers, who consider natural gas as essential
  with little opportunities for substitution in the short run
 It is because of this feature of the gas market that
  attention should be paid to protecting consumers
 As a side note, supply shortages do not pose a serious
  problem as long as prices are allowed to vary in
  response to changed supply and demand conditions –
  not like the period prior to the 1980s
    The Meaning of Protecting
      Consumers -- continued
 Recently, questions have centered around (1)
  whether consumers want price stability, (2) the
  kind and degree of price stability they want,
  (3) how much they are willing to pay for price
  stability,(4) the assurance of affordable gas to
  low-income households, and (5) demand-side
  actions that consumers can take
 Price caps at the retail level is a bad idea -
  - look at what happened in California with
  regard to electricity restructuring
 Also, bad is the notion of setting prices at the
  lower of market and contract/hedged price
Different Options for Protecting
           Consumers
   The Commission, the LDC, and consumers themselves have
    available several options to buffer the effect of higher prices on
    winter gas bills, which represents the core of the problem; they
    include:
     Energy conservation, some of which is low cost; what should
        be the role of the Commission and other governmental
        agencies, and gas utilities? For example, providing information
        to consumers on the benefits of turning the thermostat down
        to 68 degrees from 72 degrees, subsidizing conservation
        measures such as weatherization; evidence has shown that
        many consumers are not availing themselves of highly cost-
        effective, low cost conservation options
     Levelization of purchased gas cost throughout the year, which
        would shift some of winter gas costs to other seasons of the
        year (need to create a special account from which deferred
        costs can be recovered by the utility)
     Emergency assistance to low-income households
     Notification of low-income consumers of assistance programs
        funded by the federal, state, and local governments
Different Options for Protecting
     Consumers -- continued
 Available options – continued
   Weather normalization adjustments (a form of
    hedging since gas prices and consumption are
    highly correlated during the winter months –
    high gas prices usually mean a cold winter and
    high consumption)
   Fixed-price tariffs offered by the utility
   The Commission and LDCs, jointly or
    separately, issuing press releases and meeting
    with the media
   Training of commission staff in responding to
    customer questions
   Moratorium on winter disconnects
Different Options for Protecting
     Consumers -- continued
 Available options – continued
   Structuring PGAs so as to avoid rapid run-up of
    prices
   Designing rates to reallocate fixed costs away
    from volumetric billing elements
   Physical and financial hedging by the gas utility
   Customer choice programs
   Aggressive marketing of budget billing (reduces
    winter bills, but the consumer still pays for high
    market gas prices)
 A Case Study: Arkansas Natural
  Gas Procurement Plan Rules
 The LDC is expected to take all reasonable
  and prudent steps to develop a diversified
  gas supply portfolio
 The LDC has to submit its gas supply
  portfolio plan (by May 15), along with its
  contracting and/or hedging objectives, for
  Commission staff review and determination
  as to whether or not it appears to be
  consistent with policy objectives
 Hedging costs, including fee-based costs,
  can be flowed through the PGA or GSR
   Arkansas Rules --           continued

 The LDC has to maintain records for its
  hedging program
 The LDC has to educate consumers on gas
  prices for the upcoming winter heating
  season and on available options to respond
  to those prices
 The LDC has to offer small consumers a
  levelized billing plan
 LDCs are encouraged to explore and, if
  appropriate, offer fixed-commodity gas
  supply options to consumers
Comments on the Arkansas Rules
   Applicable to Tennessee
 Both an incentive and information
  problem in achieving the “optimal”
  balance of gas-procurement objectives;
  don’t know or difficult to know
   How much hedging core consumers
    want the utility to do
   The least-cost strategy for hedging
   The incentive of hedging versus not
    hedging from the utility’s perspective
   Comments on the Arkansas
       Rules -- continued
 Conflicting objectives in that hedging would
  generally be expected to drive up the average
  cost of purchased gas over time
 Rules are premised on the belief that
  consumers value hedging by the gas utility –
  what evidence is there to show this?
 The rules require the LDC to submit to the
  Commission its gas-supply portfolio plan, which
  includes its proposed hedging strategy, in
  advance for review and evaluation (eliminates
  some uncertainty to the utility and
  opportunism by the Commission)
    Comments on the Arkansas
        Rules -- continued
 This advance signal from the Commission should
  reduce the scope and complexities of a prudence
  review, which would otherwise be difficult for a utility
  if it has the burden of demonstrating prudence or for
  other parties imprudence
 The rules exclude pre-approval of all the costs; pre-
  approval of costs which could give a utility bad
  incentives (“moral hazard” problem) for executing a
  hedging or gas procurement strategy – the
  Commission and others should have the opportunity
  to question whether the utility actions complied with
  the strategy or plan considered reasonable
  beforehand by the Commission
    Comments on the Arkansas
        Rules -- continued
 The wording of the Policy Principles relating to Staff
  review and determination “as to whether or not it [the
  proposed plan] appears to be consistent with…policy
  objectives.” Is the intent outright pre-approval of the
  plan, or something less committal? To what extent
  can the Commission and other parties go back and
  question the plan after the fact? What are the parties’
  interpretations of the word “appears?”
 Under the Rules, the utility has the responsibility to
  provide substantial information in advance for
  Commission review, which is a sort of quid pro quo for
  some degree of upfront Commission commitment;
  this seems to be a reasonable trade-off
     Comments on the Arkansas
         Rules -- continued
   The Rules also rightly defines prudence, and the scope of a
    prudence review, in the traditional legal sense rather than
    in accordance with the recent practice by some
    commissions of second-guessing or 20/20 hindsight (this is
    both in reference to the plan itself and the activities
    associated with carrying out the plan)
   Requiring utility recordkeeping for its hedging plan is also a
    good idea
   Consumer education regarding what to expect in terms of
    future natural gas prices is rather obvious and fundamental
    – I would guess most consumers do not closely follow
    natural gas prices, like they do for gasoline prices, which
    are so visible and transparent; if consumers are informed
    beforehand of future prices, they might be more likely to
    take pre-empted actions such as investing in energy
    conservation or other actions that would mitigate the
    impact of higher prices
  What Other States Are Doing

 (Alabama) The Public Service
  Commission has not officially acted in
  response to the gas-supply situation,
  but something may be planned later.
  The state’s largest regulated natural
  gas utility, Alagasco, has issued a
  news release that warns the public of
  the likelihood of high gas prices for
  next winter.
   What States Are Doing --
                continued
 (Arizona) In 1998 the ACC adopted a 12-
  month rolling average PGA mechanism by
  setting the monthly PGA rate based on the
  average gas cost for the previous 12
  months. In that same year the ACC
  recognized price stability as one of the
  goals of the gas-procurement process and
  directed the LDCs to procure a portion of
  their gas supplies through longer-term
  fixed price supply options.
    What States Are Doing --
                      continued
 (Indiana) Indiana held a gas forum on July 10 to
  discuss utility supply plans for the upcoming winter.
 (Iowa) The Iowa Board issued a white paper in early
  summer and it is available on the Board’s website at
  www.state.ia.us/iub. The Board wants gas utilities to
  take the lead in communicating the current gas
  situation to their customers. The Board also wants to
  raise public-officials awareness to what could happen
  if all the pieces fall into the wrong places (The Perfect
  Storm).
    What States Are Doing --
                     continued
 (Kentucky) The Kentucky PSC is undertaking a
  major public education effort to inform consumers of
  the prospect of high heating costs this winter and of
  the steps they can take to deal with them -- budget
  billing, weatherization, assistance programs, and so
  forth. The education effort is being undertaken in
  cooperation with other state agencies and the major
  LDCs in the state. Key elements of the effort include:
   Press releases
   Media events with the LDCs and local officials to
       highlight
   Weatherization programs
   Background briefings for news media
   Speaking appearances
   Radio public-service announcements
   What States Are Doing --
                 continued
 (Michigan) The Michigan PSC has started
  a proceeding on the current gas-supply
  situation. Information on the proceeding
  can be found on the Commission’s website
  at www.michigan.gov/mp.
 (Mississippi) The Mississippi Commission
  plans to hold a technical conference in late
  August to review and discuss the current
  gas-supply situation.
     What States Are Doing --
                              continued
   (Missouri) The Missouri PSC has issued several press releases alerting
    consumers of the possibility of high natural gas prices. The Public
    Information and Education Department has also issued several fact sheets.
    For examples, see the Commission’s website at www.psc.mo.gov.

    The Commission has also taken other actions. First, it initiated a Generic
    Docket (GO-2002-452) to implement a number of recommendations of the
    Natural Gas Commodity Price Task Force regarding the timing of, and
    consistency of, PGA filings. Second, the Commission has an ongoing
    Rulemaking (GX-2002-478) that is focusing on tools to consider in
    developing a gas purchasing portfolio to mitigate upward price volatility.
    Third, the Commission is conducting ongoing Rulemaking regarding cold-
    weather rule reporting. Fourth, Commissioners are being updated on the
    status of the natural gas market and storage. The Commission has issued
    Inquiry letters and is tracking LDCs’ storage, fixed price contracts, hedging
    efforts, undercollection levels and the number of disconnected customers.
    Finally, the Commission is considering whether to hold a number of local
    public meetings in August to alert consumers to the potential of higher
    natural gas prices this winter.
   What States Are Doing --
                 continued
 (Virginia) Each October the Virginia SCC
  issues an advisory regarding the potential
  for high gas costs during the winter heating
  season. The Commission also developed an
  explanation for rising gas costs. The
  Commission strongly encourages gas
  utilities to advise customers through bill
  inserts and web site information. The
  Commission believe that the gas utilities,
  following the price shocks during the winter
  of 2000-2001, have done a good job of
  keeping state lawmakers advised of the
  gas-supply situation.
  What States Are Doing --
              continued
 (Washington) Presentations by the
  state's four natural gas companies
  were made before the Commission on
  June 27. The Commission has posted
  on its website a media advisory and a
  summary of what the panelists had to
  say.