Please forward this to all ETS lawyers.  DF

All:  Please take a look at this article.  El Paso's inartful internal 
documents are creating the same kind of fun for them that Microsoft had 
during the recent antitrust unpleasantness.  I know that we can't control the 
way people think about issues such as market behavior, price strategy, etc.  
We can, however, remind ourselves and our clients to be very precise and 
careful in the way we talk about, and particularly, write about, such 
issues.  I'd like each of us and our clients to keep problems like El Paso's 
and Microsoft's in mind when we put pen to paper or fingers to keyboard.  
Thanks.  df       

---------------------- Forwarded by Drew Fossum/ET&S/Enron on 03/27/2001 
12:06 PM ---------------------------





Business/Financial Desk; Section A
Deal for Use of Gas Pipeline Stirs Dispute on Competition
By RICHARD A. OPPEL Jr. and LOWELL BERGMAN

03/26/2001
The New York Times
Page 1, Column 4
c. 2001 New York Times Company

Early last year, the El Paso Natural Gas Company took bids from two dozen 
companies for the right to ship enough natural gas through its pipeline from 
Texas and New Mexico to meet one-sixth of the daily demand of energy-starved 
California. 
The winner: El Paso's sister company, the El Paso Merchant Energy Company, 
which buys, sells and trades natural gas. The bidding was not close. El Paso 
Merchant offered twice as much for the capacity as the other companies bid, 
in total, for bits and pieces.
Why pay so much more? California officials, who are pressing a complaint 
against El Paso at the Federal Energy Regulatory Commission, say the answer 
is simple. The state contends that El Paso Merchant, with help from its 
sister company, saw the transaction as a way to manipulate the price of 
natural gas by using its control of pipeline capacity. 
According to sealed documents obtained by The New York Times that are part of 
filings in the federal case, executives at El Paso Merchant said internally 
that the deal would give them ''more control'' of gas markets, including the 
''ability to influence the physical market'' to benefit the company's 
financial positions. 
El Paso executives called the accusations fanciful, and in a formal response 
to California's complaint, said the state ''grossly distorted'' company 
documents by quoting words and phrases out of context. 
The dispute opens a window on an important debate about oversight of the 
natural gas industry, which fuels a growing share of the nation's electric 
power plants. 
At issue is whether current safeguards do enough to prevent anticompetitive 
abuses in the marketing and trading of natural gas, and whether federal 
regulators adequately enforce existing rules. In particular, many industry 
officials question whether regulated pipeline companies are able to favor 
unregulated sister companies that trade natural gas and are free to maximize 
profits. 
More than 200,000 miles of interstate pipelines crisscross the country, 
moving natural gas from Canada, the Southwest and other producing regions to 
fuel factories, power utilities and heat houses. 
Not long ago, many parts of the country had excess pipeline capacity. But 
experts say that several regions, including California, New York and New 
England, now face constraints as demand soars for gas to fuel power plants. 
In California, state officials and utility executives said the documents in 
the federal case, and El Paso's actions, were proof that the state's energy 
crisis stemmed not just from an ill-conceived deregulation plan but from 
price manipulation and profiteering. 
''They are the market maker with this pipeline,'' said Loretta Lynch, the 
president of the California Public Utilities Commission, which has struggled 
to cope with skyrocketing power prices and supply shortages. 
El Paso ''sets the price in California,'' Ms. Lynch said, and what it did was 
intentional. ''It has affected the price,'' she said, ''for everything 
related to heat and electrical power prices in the state.'' 
California's complaint to the federal agency contends that El Paso Merchant 
''has hoarded capacity and refused to attractively price unused capacity'' on 
the pipeline. The state also charges that El Paso Natural Gas, the pipeline's 
owner, has had no incentive to spur competition, by offering discounts to 
other users, because the two companies are corporate siblings. The state said 
that El Paso had violated federal natural gas statutes that prohibit 
anticompetitive behavior. 
The sealed filings in the El Paso case indicated that the company expected to 
make money by widening the ''basis spread'' -- the difference between what 
gas can be bought for in producing basins of Texas and New Mexico, at one end 
of the pipeline, and its price on delivery to Southern California. 
As it turned out, spreads widened enormously over the last year as the price 
of gas soared in California, adding to costs for wholesale electricity that 
pushed the biggest utilities near bankruptcy. California utilities paid $6.2 
billion above competitive prices for wholesale electricity over the last 10 
months, state officials estimated. The utilities are not allowed to recoup 
the costs from customers. While the cost of 1,000 cubic feet of gas typically 
is less than $1 higher at the California end of the pipeline, spot prices in 
the state rose to almost $50 more than the Texas-New Mexico price in 
December. 
To executives of the parent company, the El Paso Corporation, the accusations 
of market manipulation are ludicrous. 
High gas prices in California, El Paso executives said in interviews, are 
easily explained by soaring demand, the poor credit standing of the state's 
utilities and the failure of the utilities to retain pipeline capacity or 
store enough gas for winter. 
''The idea that anybody is holding back on California is really ridiculous,'' 
said Clark C. Smith, president of El Paso Merchant's operations in North 
America. 
Some El Paso customers, though, agreed with California officials. The Pacific 
Gas & Electric Company, the San Francisco-based utility, condemned El Paso in 
a filing with the federal agency after its lawyers reviewed the sealed 
company documents. 
''It is now very clear from the business records of El Paso Energy 
Corporation,'' the utility said in the filing, ''that the business strategy 
El Paso Merchant was authorized at the highest corporate levels to pursue 
involved manipulation of price spreads.'' 
The agency has not ruled on California's complaint, which asks that the deal 
between El Paso Natural Gas and El Paso Merchant be invalidated. Based on the 
agency's history of policing energy providers lightly, many industry 
observers predicted that the complaint would be dismissed, perhaps as soon as 
the agency's public meeting on Wednesday. 
Nonetheless, El Paso Merchant is feeling some pressure. The subsidiary said 
recently that it planned to relinquish control of all but about 22 percent of 
the capacity on the pipeline to California, rather than exercise an option 
that would have allowed it to retain the entire capacity of 1.2 billion cubic 
feet of gas a day. 
Critics said they believed El Paso made the move in hopes of lessening the 
chance of government action. El Paso executives deny that but do say that 
their decision was influenced by the backlash over the arrangement. 
Surrendering the pipeline capacity made for a ''gut-wrenching'' decision, Mr. 
Smith said, but was ''a first-class gesture'' to California. El Paso Merchant 
paid $38.5 million to control the pipeline capacity from March 1, 2000, until 
May 31, 2001. While Mr. Clark said he did not know the return on that 
investment, he acknowledged that it was lucrative. 
''No doubt about it,'' Mr. Clark said, ''we made good money.'' 
The question of whether El Paso's conduct has driven gas prices higher is 
expected to be scrutinized by legislators in Sacramento this week. The 
company also faces several lawsuits, including one by the city of Los 
Angeles, that accuse it of conspiring with other companies to prevent 
pipeline projects that could have eased California's energy crisis. El Paso 
denied the accusation. 
With pipeline capacity and gas supplies tighter, concerns about 
anticompetitive behavior have increased as price volatility has created 
soaring profits for energy marketers and traders. 
Dynegy Inc., a Houston-based energy trader, was once the target of complaints 
to federal regulators that it had artificially raised prices by abusing 
capacity that it controlled on El Paso's pipeline to California. 
In a filing with regulators in January, Dynegy contended that pipeline 
companies routinely favored affiliates. ''Abuses abound because of financial 
windfalls, difficulty of detection, lengthy investigations and increased 
complexity of the market,'' the company said. 
''There are some red flags right now,'' said William L. Massey, a member of 
the Federal Energy Regulatory Commission since 1993. Mr. Massey said he was 
troubled by the potential for abuses when pipeline companies own gas and 
power marketing subsidiaries as well as electric plants fueled by natural 
gas. El Paso is in all those businesses. 
''What the commission ought to be serious about is: What are the forces at 
work? Is it simply robust markets responding to true supply-and-demand 
signals, or is it a market defined by market power and some measure of 
affiliate abuse?'' he said. 
Many in the industry do not believe changes are needed. 
''There are rules in place today that protect against affiliate abuse,'' said 
Stanley Horton, chief executive for gas pipeline operations at the Enron 
Corporation and chairman of the Interstate Natural Gas Association of 
America, the industry's trade group, referring to the rules under which 
California has brought its complaint about El Paso. 
To its critics, El Paso epitomizes the competitive concerns. It operates the 
nation's largest network of interstate pipelines and owns one of the largest 
reserves of natural gas. With its recent acquisition of the Coastal 
Corporation, another large pipeline operator, El Paso has a market 
capitalization of $32 billion. 
At a conference at El Paso headquarters in Houston in February, analysts 
heard executives predict net profits of $1.7 billion this year. El Paso's 
much better known rival, Enron, with its headquarters a few blocks away, is 
expected to earn about $1.4 billion. 
El Paso Merchant provides the strongest growth. Two years ago, the unit's 
profits, before interest payments and taxes, were $99 million; this year, it 
is expected to have $700 million in North America alone. In its latest 
quarterly report, El Paso attributed those profits, in part, to ''commodity 
market and trading margins'' that were enhanced by ''power price volatility, 
particularly in the Western United States.'' 
Critics contend that El Paso set out to exploit those conditions. According 
to the sealed filings, on Feb. 14, 2000, the day before El Paso Merchant was 
awarded the pipeline capacity, executives made a presentation to William A. 
Wise, chief executive of the parent company, laying out the rationale for the 
bid. 
The presentation outlined what it termed ''strategic advantages,'' including 
''more control of total physical markets'' and the ''ability to influence the 
physical market to the benefit of any financial/hedge position,'' according 
to the sealed filings. The passages suggested that El Paso expected the deal 
to give it sway over the market for trading actual volumes of gas and to 
support financial transactions it had entered into with other parties to 
limit its risk. 
For every one-cent increase in the spread on gas prices, the presentation 
said, El Paso Merchant stood to make an additional $2.4 million. 
Under the heading ''Challenges,'' according to the sealed filings, the 
presentation stated that storage was needed ''to help manipulate physical 
spreads, adding to the overall transport/storage cost.'' 
On April 14, according to the sealed filings, El Paso Merchant's president at 
the time, Greg G. Jenkins, wrote a memorandum to Mr. Wise involving an update 
for directors meeting later that month. The memorandum stated: ''We will make 
money two ways: 1) increase the load factor, 2) widen the basis spread.'' 
The language appears to suggest that El Paso Merchant would profit by 
increasing the gas flow in the pipeline -- the load factor -- while 
increasing the difference between what gas could be bought for at one end and 
what it could be sold for at the other end -- the basis spread. 
In an interview, Mr. Smith, the El Paso Merchant executive, said that the 
unit's prices, and profits, on bulk gas sales in California were locked in 
months in advance, so that the company could not benefit from rising prices 
in the spot market. 
Otherwise, Mr. Smith declined to provide any details about money made on the 
pipeline deal or about financial terms of the transactions that locked in 
prices ahead of time. In addition, Mr. Smith said that nearly all of El Paso 
Merchant's pipeline capacity was used every day when prices spiked late last 
year, with no capacity withheld to increase prices. 
The company did not respond last week to a request to discuss information in 
the sealed documents. But El Paso Merchant, in a filing with federal 
regulators, said California's complaint had ''misconstrued and incorrectly 
interpreted'' what it termed ''snippets of data.'' 
About This Report 
This article and others on California's energy problems are part of a joint 
effort with the PBS series ''Frontline'' that will result in a documentary 
later this year.


Photo: The El Paso Natural Gas pipeline passes near Topock, Ariz. A dispute 
over bidding for its use has spurred a debate about oversight of the 
industry. (John Gurzinski for The New York Times)(pg. A17) Chart: ''Boom 
Times'' Operating revenue and net income soared last year at the El Paso 
Corpor 2/3ation, which sells, transports and trades natural gas. Graphs of 
the operating revenue and the net income for the El Paso Corporation. 
(Source: Company reports)(pg. A17) Chart: ''A Spike in Prices'' The spot 
price for natural gas produced in the Permian Basin of West Texas doubled 
last year. But the price that power generators paid when the gas was 
delivered to Southern California rose almost 10-fold. State regulators say 
the gap is evidence of market manipulation. Graph showing the spot price of 
gas delivered to Southern California and the spot price of gas bought in the 
Permian Basin, from September to March. (Source: Gas Daily)(pg. A17) 


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