No smoking gun in natural-gas cost probe
By Jim Sanders
Bee Capitol Bureau
(Published April 23, 2001) 
It strikes at the heart of an energy crisis that has caused 
multibillion-dollar losses and could plunge California's economy into a 
tailspin: Did private companies manipulate markets to get rich off consumers' 
pain? 
An Assembly oversight committee spent hours last week grilling officials of 
El Paso Natural Gas Co. and an affiliate, El Paso Merchant Energy, companies 
that were accused by state regulators of anti-competitive practices that 
helped send gas prices soaring. 
Committee Chairman Darrell Steinberg, D-Sacramento, said the hearing 
convinced him that El Paso exercised "market power" -- undue influence over 
supply, demand and prices -- even though no smoking gun surfaced in the 
testimony. 
"You have to look at this from a common-sense perspective -- the price spikes 
were astronomical," Steinberg said. "Could they have occurred in such an 
extraordinary fashion absent market manipulation? The answer, to me, clearly 
is no." 
No wrongdoing has yet been proved, however, and El Paso officials contend 
they have acted legally and ethically. 
State regulators have complained to the Federal Energy Regulatory Commission 
that El Paso and its affiliates made it difficult for others to use pipeline 
capacity into California so that El Paso could constrain natural gas supply, 
increase demand and enrich itself in domino-like fashion. 
Attorney Harvey Morris of the state Public Utilities Commission told 
legislators that El Paso improperly sold 40 percent of its California 
pipeline capacity to an affiliate, which set unrealistically high shipping 
prices to discourage use by others and drive up the market. 
"To us, it was pretty obvious what was going on," Morris testified. 
The Federal Energy Regulatory Commission, which oversees interstate 
pipelines, has dismissed a PUC allegation that El Paso illegally gave 
preference to an affiliated company. But the federal agency has scheduled its 
own hearing into complaints of anti-competitive practices. FERC officials 
declined to testify at the Assembly hearing. 
El Paso executives say gas prices have been affected by weather, storage 
levels and other factors beyond their control, primarily extraordinary demand 
for natural gas needed by power plants to generate electricity. 
"We're not withholding capacity -- no one is," Ralph Eads, president of El 
Paso Merchant Energy, told the oversight panel Thursday. "With these prices, 
you want to sell every molecule." 
The controversy is fueled by records showing that natural gas prices at the 
Southern California border skyrocketed -- far exceeding national averages -- 
soon after El Paso Merchant assumed control of 1.2 billion cubic feet of 
daily pipeline capacity from its corporate parent. 
The El Paso pipeline, one of two key arteries to the state line in Southern 
California, stretches from Texas through New Mexico to the border town of 
Topock in Arizona. 
Prices more than quadrupled at Topock during the one-year period ending in 
March of this year, records show. Much of that rise stemmed from 
transportation rather than production costs. 
By February, prices at Topock had jumped from about $2.59 per million British 
thermal units to $12.69 per million Btu. Nationally, prices had risen from 
about $2.61 per million Btu to just $6 per million Btu in that same period, 
records show. 
But Assemblyman John Campbell, R-Irvine, a member of the oversight committee, 
warned against using such statistics to conclude that El Paso violated any 
federal pipeline laws or regulations. 
Making money off a crisis is not necessarily illegal, he said. Market 
conditions can place private companies in the catbird's seat, allowing them 
to reap big bucks. Are they obligated -- legally, not morally -- to restrict 
their profits? 
"To make the jump from profiting from a shortage to market manipulation is 
not something that should be done cavalierly," he said. 
The El Paso case is being watched closely by legislators and consumers. 
The PUC says that El Paso's market manipulation will cost California gas and 
electricity customers more than $100 million annually. 
The Brattle Group consulting firm has placed the figure much higher, 
estimating that cost increases for electricity customers of Southern 
California Edison Co. alone totaled about $750 million during the past year. 
El Paso and its affiliates are involved in selling pipeline space to other 
natural gas companies, selling gas themselves at the California border and 
generating alternative sources of electricity whose price is tied to natural 
gas costs. 
Shareholders stood to gain handsomely as gas prices shot upward, according to 
the PUC. 
El Paso Merchant's earnings before interest and taxes rose from $3 million in 
1999 to $563 million in 2000, according to documents filed with the 
Securities and Exchange Commission. 
The report gave no breakdown, however, of profits tied specifically to 
California. 
A research firm hired by El Paso, the Lukens Consulting Group, concluded that 
a complex chain reaction of factors -- not manipulation -- has rocked the 
state's natural gas industry and affected market dynamics and economics. 
"Higher electricity prices have caused an increase in demand for gas, which 
has led to higher prices of gas, which increased demand for pipeline 
capacity, which caused an increase in the price of pipeline capacity," the 
group said in a report distributed to legislators. 
But electricity generators, themselves under investigation in the Legislature 
for their pricing practices, make the reverse argument: Higher natural gas 
prices contributed to a rise in their costs for producing electricity. 
To support claims that El Paso acted unethically, the PUC says the company 
gave its affiliate an unfair competitive advantage in bidding for pipeline 
capacity to Southern California by: 
Structuring the auction to favor awarding the entire bloc to a single bidder. 
Twenty-four companies submitted bids for portions of the pipe. Only El Paso 
Merchant sought all of the capacity, offering $38.5 million for a 15-month 
contract. 
Failing to disclose to other bidders -- except El Paso Merchant -- that 
another affiliated company would soon offer discounted rates for use of an 
interconnection line extending from Topock into Southern California. 
Testifying before the Assembly committee, El Paso officials scoffed at the 
suggestion that their auction for pipeline capacity was rigged. 
The minimum price set for the pipeline space -- $37.5 million -- was a fair 
one. Auction terms stipulated the capacity would be parceled out if the total 
of all small bids exceeded the highest "total package" bid, the officials 
noted. 
There was nothing unusual about the El Paso affiliate, Mojave, offering a 
discount to its interconnection line. The line wasn't crucial to bidders. And 
all companies had the same opportunity to inquire about discount 
possibilities prior to submitting bids, the officials said. 
Attorney Peggy Heeg, an El Paso corporate vice president, said FERC strictly 
regulates relationships among affiliates. But it doesn't ban the types of 
rate discussions that an unrelated company might have with the corporation, 
she said. 
El Paso firms would and could not collude with each other to discourage 
competition, Heeg said. 
"(Affiliates) have to operate completely independently -- even if they have 
the same shareholders," she said.