Future Role Up In Air
LDCs Facing Unprecedented
Challenges From Unbundling
by Jeff Share, Editor,
Pipeline & Gas Journal
The impact of unbundling on local distribution companies is unprecedented
and is pushing gas utilities across the nation to the brink as they search
for ways to survive and prosper, according to a leading regulatory expert
on energy issues.
One of the biggest issues, said Commissioner Ruth K. Kretschmer, who for
16 years has served on the Illinois Commerce Commission, is whether the
LDCs should be allowed, or even ordered, to maintain their merchant
function or merely function as a transporter. That ultimate decision
should not be affected by the Federal Energy Regulatory Commission, which
pulled the interstate pipelines out of the merchant business.
“Many gas utilities are forced to make decisions that they’ve never
had to make before, one of them is purchasing natural gas. I believe that
LDCs should be able to retain their merchant status if they choose to do
so,” Kretschmer told about 300 natural gas officials at the 11th Annual
LDC Forum sponsored in Chicago by the Interchange Energy Group in
September. “In fact,” she added, “during the transition to a fully
competitive market, it may be necessary to order an LDC to provide
merchant services. One reason is customer choice. Why shouldn’t a
customer be allowed to choose if he wishes to?”
Money is the bottom line for all customers, large and small, but it’s
questionable how much they will actually benefit, Kretschmer said.
“Everyone agrees that the incumbent LDC will continue to deliver the gas
from the city gate to the customers’ burner tip. I don’t see any
savings for customers in delivery.”
In Illinois, retail rates already include cost savings because of
competitive purchasing and transportation markets. That leads her to
question whether savings will be significant for Illinois residential
customers. Kretschmer said the best she’s heard is that there may be a
2-4% savings in billing and metering costs. It leads her to ask whether
the potential savings justify the time and money being spent on unbundling
the natural gas industry at the LDC retail level. Also, do residential
customers really want choice or do they just want lower prices?
Kretschmer pointed to a recent study on residential participation on gas
customer choice programs released by the National Regulatory Research
Institute which concluded—on its analysis of pilot programs—that small
gas customers are reluctant to relinquish bundled sales service provided
by their local gas utility even when alternate service would mean lower
bills. Some felt that it’s not worth the risk; others felt confused or
intimidated by the unbundling process while discriminatory actions by the
LDC may prevent or discourage customers from switching, that report
concluded.
Kretschmer said gas marketers responded that unbundling will provide
numerous other benefits which customers will find appealing such as new
services, increased quality of service and improving billing and metering.
“By 2003, we will have answers to these issues,” she said.
The commissioner, who has gained a national reputation for her outspoken
views, acknowledged that competition is here to stay. She urged the gas
industry to keep legislators and regulators out of the picture as much as
possible, pointing to the morass being encountered by the electric
industry which is unlikely to be unbundled in her state until 2006, at the
earliest.
“The question is not if your service territory will be open to
competition, but when it will open. When you open your service territory
to marketers, you will be able to compete successfully both through an
affiliate and as a regulated utility.”
Utilities throughout the gas industry are spending top dollars on building
brand names and logos, she noted. An unregulated affiliate’s advertising
won’t matter if the service he receives from the regulated LDC is
substandard, Kretschmer warned. “Your regulated business is a foundation
for the future growth of your unregulated business. You may spend millions
promoting brand names, advertising in every available media and promoting
good will with charitable contributions, but if the quality of service is
low and the price is high, your company will lose market share.”
She told listeners to concentrate on improved customer service in order to
earn loyalty and suggested the first way to do that is by changing their
telephone systems so that customers do not have to talk to a recording.
“As a customer, I’m constantly surprised and annoyed by the lack of
care many companies exhibit when dealing with customers. It’s quite
clear that in coming years, a dissatisfied customer will change his
supplier.”
Noting that convergence will continue to dominate strategy among electric
companies and LDCs, Kretschmer predicted by 2003, there will be few
utilities that market only one source of energy. This has led to the
“bigger is better” mentality prevalent among corporate executives, a
strategy that is easier said than done, she claimed, and one which shows
no signs of letting up, either.
“There’s no question that natural gas companies, like all companies,
are searching for opportunities to use all their assets to enhance
shareholder value. But mergers are difficult to implement because they
involve not only assets but people, management styles and operating
strategies. We’ve seen mergers that have been costly and have had an
adverse impact on earnings for several years.
“Let’s be brutally frank: if an electric utility wants to expand its
market, the fastest strategy is to buy an LDC, and many electric utilities
have the resources to do it.” Kretschmer noted a recent report by
Merrill Lynch indicating that merger and acquisition activity has picked
up speed in the past year because the electrics realize the pool of
potential natural gas targets is dwindling. “It doesn’t take a crystal
ball to predict that mergers, acquisitions and partnerships will continue.
But I have seen few mergers that produce benefits for customers.”
Kretschmer also took a moment to discuss the biggest merger war now going
on between Nisource, which is trying to take over Columbia Energy Group in
a hostile takeover. “Talk about hostile - this is a war. CEOs Gary Neal
(Nisource) and Rick Richard (Columbia) are both smart and tough, but if I
had to make a bet on this one, I’d pick Richard. That’s going to
happen in the next few months, but the longer it takes, the less likely it
is that the merger will happen.”
Another speaker, Tim Collins, managing director of marketing for El Paso
Energy, also spoke on the trend toward mergers. El Paso in recent years
has been among the most active merger candidates, having acquired Tenneco
Energy in 1996, is acquiring Sonat, and has itself been eyed by Southern
Company. By the end of 1997, M&A activity in the gas industry were up
four-fold since 1992; last year, 90 energy companies said they were
involved in some form of strategic M&A activity, and by early this
summer, more than 30 mergers were still on the plate, he said.
Federal and state deregulation continues to be the basis for many utility
mergers. Deregulation, however, also has unleashed pent-up value in
regulated companies, even if it also led to the dumping of some of those
assets, Collins said.
“I believe what is driving mergers in the industry as a whole, now and
in the future, shows much more responsiveness to raw economic and market
forces.”
Companies like to package economies of scale with the ability to deploy
the same system over a broad base of operations, he said. El Paso’s
takeover of Tenneco, and soon with Sonat, enables it to leapfrog the
industry to create the largest pipeline operation in the nation.
“There is an ‘if you can’t beat ‘em, buy ‘em rationale, that
says mergers are expedient ways to acquire new markets that otherwise
might be too difficult or expensive to reach on your own. Given the
meteoric pace of our industry, you simply don’t have time to develop new
skills or need the resources internally, so you merge with someone who has
what you don’t have.
“The final instinct of eat or be eaten drives many companies to join up
with their former competitors to force new critical mass of assets and
resources. There’s also the idea that mergers allow you to buy your way
into growth. This has long-term implications, but I wonder if it’s safe
to conclude that outcomes will be as predictable or as traditional.”
In the keynote address, Cuba Wadlington Jr., now chief operating officer
of Williams who will become president and CEO on Jan. 1, told the forum
that a significant opportunity in the gas markets exists which must be
exploited promptly.
“If we don’t take advantage of that opportunity, frankly, it is going
to disappear,” he warned. Between 1997 and the 2005, the market in the
eastern part of the U.S. will grow on an annual basis from 5.3 to 6.5 Tcf,
equivalent to 3.3 Bcf/d, he estimated.
“We need to move it to the East Coast because that’s where the gas is
going to be needed in the future. If we can get the types of efforts from
regulators, that gas will be allowed to move to the eastern markets, we
will reach the 30 Tcf market,” he said. Wadlington, who until recently
ran Williams’ Transco pipeline in Houston, said the gas market’s
growth primarily will come from power generation. “We don’t think
power generation has any other options between now and the year 2005 but
to use natural gas. That will be the fuel of choice,” he said, adding
that the most important issue for every industry executive is to make sure
that the gas is available and gets to the markets in the cheapest manner
possible.
As a result, the industry needs additional supply, Wadlington said.
“It’s extremely critical because power generators most likely will
build facilities dependent on gas, and we need certainty of supply in
order for them to be able to count on the gas being there when they turn
their plants on. Those supplies need to be economically accessed in order
for it to flow; then we need economical transportation from supply to
market.”
For that to happen, Wadlington urged that regulations be enacted that
allow the industry to build pipelines in a very rapid, responsive manner,
because the market that they are trying to bring onstream—power
generation—is one that determines exactly when they need their plants to
be sited.
“We need to have pipeline facility construction in place in order to be
there on the day when the plant opens. To do that, we have to have
construction and certification rules and regulations that allow us to do
what’s necessary in order to get permitted and have regulating agencies
respond so facilities can be built on time and be in place when the power
generators need them.”
Wadlington said the industry has to change the pricing of transportation
facilities. “We need to go to a pricing mechanism that reflects the
market. We need to move off the current pricing approaches that we use,
such as straight fixed variable rate design and instead use pricing
methodologies that allow power generators to pay when they are dispatching
power, so they really shouldn’t have to pay if they’re not dispatching
power.
“We need flexibility to set terms and conditions in contracts that we
enter into with power generators in order to provide them with the gas
when they need it during the hours that they need it, then we have the
ability to price it in a manner that is above the cost of providing that
service. In essence, we need to be able to work with power generators so
that pipelines providing these services can accept downside risk as well
as upside opportunities. If we can do those things, we will be able to
capture the 30 Tcf market. If we cannot do those things, it’s going to
be very difficult for the industry as it is structured today to meet the
needs of power generating orders.”
Gas supply to serve these markets will come from western Canada, the Rocky
Mountain region, the Gulf Coast and Sable Island. Much of the gas already
is headed to Chicago and more will be coming when the huge Alliance
Pipeline goes into service late next year. Between Alliance and the
recently expanded Northern Borders Pipeline, an additional 2 Bcf/d of
throughput will be headed into the Chicago hub, far more than that
metropolis requires. Chicago now receives in excess of 1 Bcf/d, when in
fact it needs less than that amount, Wadlington said.
In addition to being a partner in both Alliance and Northern Borders,
Williams is involved in several projects to move that gas out of Chicago,
including the proposed Independence Pipeline project with ANR and
MarketLink, a project that is facing some intense opposition by New Jersey
residents following the disastrous Texas Eastern explosion several years
ago. P&GJ
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