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California Utility Says Prices of Gas Were Inflated by Richard A. Oppel Jr. and Lowell Bergman New York Times, May 13, 2001

One of California's struggling utility companies accused the El Paso Corporation yesterday of artificially inflating the price of natural gas in the state by $3.7 billion over the last year by using its partial control of a major pipeline to curtail the flow of gas.

In a filing with the Federal Energy Regulatory Commission, the utility, Southern California Edison, said that market manipulation by El Paso had cost Edison alone at least an extra $1 billion for electricity generated by gas-fueled power plants over the 13 months ended March 31.

The commission is reviewing a complaint by California regulators that a chief reason for the state's soaring natural gas prices during the last year was market manipulation by El Paso, which owns the largest pipeline connecting Southern California with gas-producing regions in the Southwest.

In a response, also filed yesterday, an El Paso subsidiary said that the high prices for gas in California came from "unexpected and unprecedented demand and an insufficient supply infrastructure," not from withholding of supply. California's energy problems, the company said, reflect "more than a decade's worth of bad public policy decisions that are now coming back to haunt the state."

"This was a car wreck waiting to happen," said Joseph Kalt, a Harvard economics professor working on the case for El Paso. Mr. Kalt attributed the high prices to a severe shortage of pipeline capacity and resistance over the years by California officials to build more. Southern California Edison, which is supporting the state's complaint, said its claims were based on records that it recently obtained as part of the discovery process in the federal proceeding.

The controversy stems from a deal in February 2000 in which one El Paso subsidiary, El Paso Natural Gas, sold a sister company, El Paso Merchant Energy, the right to ship 1.2 billion cubic feet of gas a day on the pipeline. That is about 30 percent of the pipeline's total capacity and about one-sixth of California's daily demand.

In March, the F.E.R.C. ruled that there was nothing improper in the deal between the two El Paso units but ordered further investigation into whether the company had manipulated the gas market in California. State regulators say that the price paid for gas at the California end of El Paso's pipeline plays a large role in setting the price for all gas sold in the state — and, consequently, is a primary component in the cost of electricity and heating.

According to sealed documents that are part of filings in the federal proceedings, El Paso Merchant executives said in internal memorandums that the unit's deal for capacity on the pipeline would give it "more control" of gas markets, including the "ability to influence the physical market" to benefit the company's financial positions. El Paso officials, citing a protective order prohibiting parties from discussing the sealed documents, have declined to comment on the documents except to say they have been taken out of context.

In Southern California Edison's filing yesterday, the Brattle Group, a consulting firm in Cambridge, Mass., hired by the utility, said that El Paso Merchant "withheld significant amounts of capacity from the market" between June and November of last year.

During that period, the consultants said, El Paso Merchant used just 53 percent of the capacity it controlled on the pipeline that goes into the delivery system operated by the Southern California Gas unit of Sempra Energy, even though it would have been profitable to use more capacity. Other shippers made "significantly greater" use of the capacity they controlled through contracts with El Paso Natural Gas, the consultants said.

In its filing yesterday, Edison also attributed some blame to Southern California Gas — a utility that provides gas service to homes and businesses across Southern California — saying it did not store enough natural gas last year in preparation for the winter heating season. In its response yesterday, El Paso Merchant stated that it had "consistently made an effort to maintain high utilization" of the pipeline capacity. However, operational, service and scheduling restrictions pose an obstacle to that, while "credit, or the risk of not getting paid for the gas, is an important consideration."

On the portions of the pipeline capacity that are not hemmed in by special restrictions, Mr. Kalt said, El Paso Merchant, since June, has consistently offered more than 95 percent of its unused capacity to other shippers on terms consistent with the rest of the industry.

He said the numbers Edison cited were extremely misleading because they did not account for the restrictions imposed on El Paso Merchant's capacity. "To put out numbers like that, and not tell people that you are comparing apples and oranges, is misleading and diverts attention away from the real problems California faces," he said.

Denise King, a spokeswoman for Southern California Gas, said that the company had met its obligation to serve its core residential and small-business customers. Some large industrial customers and power generators that hold storage capacity on the company's system did not store as much gas as they could have last year, she said, but that was their decision.

Beginning in November, prices began to soar at the California border, and by early December the difference between the price of gas in Texas and its spot price at the California border — known as the basis differential — peaked at almost $50 per million British thermal units, or more than five times what gas cost in other parts of the country. (One million B.T.U.'s roughly equals 1,000 cubic feet of gas.)

According to Edison's consultants, had El Paso Merchant fully used its capacity last year, and had Southern California Gas properly filled its core storage inventory, the gas market would have been considerably less constrained. Instead, El Paso Merchant's withholding of capacity increased the basis differential an average of $8.28 per million B.T.U.'s from December to March, according to Edison's filing.

In all, the Brattle Group concluded that El Paso Merchant overcharged customers by at least $864.3 million on sales of gas at the California border during the 13-month period, only part of the $3.7 billion in higher costs that have affected California over all, the consultants said, because of El Paso Merchant's actions and the lack of gas storage that resulted.

El Paso Merchant denies that it has reaped large profits from the pipeline capacity, saying it has entered into hedging transactions that limited its risk but also its potential profit from rising gas prices in California. Mr. Kalt, for example, said that during December — when the average basis differential was $17 per million B.T.U.'s — El Paso Merchant's average differential on natural gas it sold into California was $3.04, after offsetting hedging losses. "When the price spiked, they weren't going to capture that spike," Mr. Kalt said. "It's the most misleading part of Edison's case."

El Paso Merchant also said prices for natural gas sold into California had not come down, even though the company decided earlier this year to relinquish the controversial pipeline capacity, which, after the end of May, will mostly be controlled by other companies. Prices actually rose after this was disclosed, the company's filing stated, and "this outcome is the opposite of what would have been expected" if the market believed El Paso Merchant had been trying to manipulate prices higher in California by restricting supply.