8356 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

1Avoca Natural Gas Storage, 68 FERC ¶ 61.045

(1994); Koch Gateway Pipeline Co., 66 FERC

¶ 61,385 (1994); Bay Gas Storage Company, LTD. 66

FERC ¶ 61,354 (1994); Petal Gas Storage Co., 64

FERC ¶ 61,190 (1993); Transok, Inc., 64 FERC

¶ 61,095 (1993); Richfield Gas Storage System, 59

FERC ¶ 61,316 (1992).

2 66 FERC ¶ 61,202 (1994).

3 68 FERC ¶ 61,401 (1994).

4Policy Statement on Incentive Regulation, 61

FERC ¶ 61,168 (1992).

jurisdictional customers and relevant

State commissions by postage paid, U.S.

Mail.

Any person desiring to be heard or

protest said filing should file a motion

to intervene or protest with the Federal

Energy Regulatory Commission, 825

North Capitol Street NE., Washington,

DC 20426, in accordance with Rules 211

or 214 of the Commission’s Rules of

Practice and Procedure (18 CFR 385.211

or 385.214 (1994)). All such motions or

protests should be filed on or before

February 23, 1995. Protests will be

considered by the Commission in

determining the appropriate action to be

taken, but will not serve to make

protestants parties to the proceeding.

Any person wishing to become a party

must file a motion to intervene. Copies

of this filing are on file with the

Commission and are available for public

inspection in the Public Reference

Room.

Lois D. Cashell,

Secretary.

[FR Doc. 95–3573 Filed 2–13–95; 8:45 am]

BILLING CODE 6717–01–M

[Docket No. RM95–6–000]

Alternatives to Traditional Cost-ofService Ratemaking for Natural Gas

Pipelines; Request for Comments on

Alternative Pricing Methods

February 8, 1995.

The Federal Energy Regulatory

Commission (Commission) requests

comments on criteria to evaluate rates

established through methods other than

the traditional cost-of-service

ratemaking method. The Commission’s

traditional approach to rate regulation

sets an annual revenue requirement

based on operating and capital costs

occurring during a historical test period,

adjusted for known and measurable

changes expected to occur by the time

suspended rates take effect. Rates are

generally designed to recover the annual

revenue requirement based on contract

capacity entitlements and projected

annual or seasonal volumes.

Recently, the Commission has

received a number of requests from

natural gas pipeline companies to

approve rates based on various other

pricing methods, some of which are

cost-based, and some of which are not.

For example, the Commission has

approved a number of proposals for

market-based rates for storage services.1

In Stingray Pipeline Company,2 the

Commission approved a one-year

experimental interruptible

transportation rate based on costs

allocated to Stingray’s interruptible

service, subject to a price cap. In KN

Interstate Gas Transmission Company

(KN),3 the Commission addressed KN’s

proposal to offer market-based rates and

negotiated terms and conditions of

service on its Buffalo Wallow System.

Most recently, Florida Gas Transmission

Company’s section 4 filing in Docket

No. RP95–103–000 included a ‘‘Market

Matching Program,’’ under which

shippers would have the option of

negotiating rates and terms of service

different from the tariff rates and terms

of service. Florida Gas also proposed an

experimental inflation indexing

mechanism for rate changes, using costof-service rates as the starting point.

The Commission is interested in

developing a framework for analyzing

proposals involving alternative pricing

methods for natural gas pipelines. There

are a number of different ratemaking

methods that could be used instead of

the traditional individual company

embedded cost-of-service method. In

addition to market-based pricing, there

are a number of cost-based methods that

vary from the individual company costof-service method traditionally used by

the Commission. The Commission

recognizes that it may be necessary to

develop different criteria for evaluating

alternative pricing proposals, depending

upon the method proposed. To this end,

the Commission’s staff has prepared a

paper, which is attached, proposing

criteria for the evaluation of proposals

for market-based rates. The staff paper

draws from basic antitrust market power

analysis, that has been used in the past

by the Commission and in other

contexts, to develop a proposed

analytical framework to use in

evaluating gas pipeline market-based

rate proposals. The Commission is

interested in receiving comments on all

aspects of the staff paper, including the

following:

1. a. Under what circumstances are marketbased rates appropriate for natural gas

pipelines and services regulated by the

Commission?

b. Please identify and discuss any legal

issues, beyond those discussed in the staff

paper, that should be considered.

2. a. Are the Department of Justice/Federal

Trade Commission Horizontal Merger

Guidelines, from which the staff proposal is

drawn, the best framework to evaluate market

power in the interstate natural gas pipeline

context?

b. Are there other approaches to evaluating

market power that would be less

burdensome?

3. a. Are the criteria proposed in the staff

paper reasonable, too strenuous, or not

strenuous enough?

b. Should the Commission use a different

standard for different types of service, such

as mainline transmission, storage, or market

hub services?

4. a. Should the Commission consider

treating companies with a small market share

differently from larger or dominant sellers,

and if so, under what circumstances?

b. How should the Commission view cases

in which large sellers face large buyers (that

is, where a single buyer represents a large

share of a transporter’s market?

c. Can a buyer’s monopsony power

mitigate a seller’s market power, and if so,

how should the Commission analyze such

cases?

5. Do commenters agree or disagree with

staff’s analysis that capacity release does not

constitute a good alternative to firm

transportation?

6. What procedures should the

Commission employ to evaluate marketbased rate proposals; should the Commission

change its current policy of using declaratory

orders or ruling on pro forma tariff sheets?

7. Are there particular requirements the

Commission could impose that would

increase the availability of shippers’ service

alternatives and mitigate the market power of

a natural gas company that would not

otherwise qualify for market-based pricing?

8. Are there regulatory policies or

ratemaking methods that would better serve

the Commission’s regulatory goals of flexible,

efficient pricing in today’s environment? For

example, should the Commission focus on

‘‘backstop’’ proposals, where pipelines

would be free to negotiate rates and terms of

service, so long as customers could always

choose service under traditional cost-ofservice rates and terms of service?

In addition, the Commission also

invites comments on the criteria for

evaluating incentive rate proposals.

While the Commission currently has a

policy for evaluating cost-based

incentive rate proposals, to date no

natural gas company has submitted a

proposal in response to the

Commission’s invitation to submit

incentive rate proposals for an

experimental period. The Commission’s

October 30, 1992 policy statement on

incentive regulation defined the

essential elements of an incentive

ratemaking policy and set guidelines for

incentive rate proposals.4 The policy

statement adopted two general

principles: That incentive regulation

should encourage efficiency, and that

starting rates under incentive regulation

must conform to the Commission’s
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8357

1See Mobil Exploration & Producing Southeast

Inc. v. United Distribution Companies, 498 U.S. 211

(1991) (affirming the Commission’s Authority to

consolidate existing ‘‘vintage’’ price categories and

set a single ceiling price for ‘‘old’’ gas); Duquesne

Light Co. v. Barash, 488 U.S. 299, 310 (1989);

Permian Basin Area Rate Cases, 390 U.S. 508, 517

(1979); FPC v. Hope Natural Gas Co., 320 U.S. 591,

602 (1944).

2Farmers Union Central Exchange, Inc. V. FERC,

734 F.2D 1486, 1503 (D.C. Cir. 1984) (Farmers

Union II), cert. denied sub nom., Williams Pipe Line

Co. v. Farmers Union Central Exchange, Inc., 469

U.S. 1034 (1984) (citing Permian Basin Area Rate

Cases, 390 U.S. 747 (1968)).

3 Farmers Union II at 1502 (citing Mobil Oil Corp.

v. FPC, 417 U.S. 283 (1974)).

4 Id. at 1509 (citing Texaco, Inc. v. FPC, 474 F.2d

416, 422 (D.C. Cir. 1972), vacated, 417 U.S. 380

(1974) (the court of appeal’s decision was vacated

on other grounds)).

5 Id.

traditional cost-of-service ratemaking

standards. The policy statement also

established five regulatory standards for

the evaluation of specific proposals—

that incentive proposals must: (1) Be

prospective, (2) be voluntary, (3) be

understandable, (4) result in quantified

benefits to consumers, and (5)

demonstrate how they maintain or

enhance incentives to improve the

quality of service. The standard

pertaining to the quantification of

benefits requires the inclusion of an

absolute upper limit on the risk to

consumers, with the overall cap on

incentive rate increases based on

projected traditional cost-of-service

rates. In view of the lack of response to

the October 30, 1992 policy statement

and the changes in the natural gas

market that have occurred since the

issuance of the policy statement

(principally the implementation of

Order No. 636), the Commission

believes it is appropriate at this time to

revisit the issue of incentive rates for

pipeline services and requests

comments in response to the following

questions:

9. Why have there not been any incentive

proposals under the policy established in

Docket No. PL92–1–000?

10. a. Should the Commission change its

existing standards for incentive rate

proposals?

b. If so, what specific criteria should the

Commission employ when evaluating

incentive rates?

11. Are there models for incentive

regulation that the Commission should

consider, such as the California performancebased program?

12. a. What are the benefits and drawbacks

of incentive rates, and the policy objectives

the Commission should pursue with an

incentive rate method?

b. Is incentive ratemaking appropriate for

the natural gas companies regulated by the

Commission?

c. Please identify and discuss any legal

issues that the Commission has not yet

considered with this type of rate method.

There are other pricing methods

which are neither market-based nor

incentive-based, such as reference

pricing (in which the rate is determined

by reference, e.g., to the rates of another

company or the price of another

product). The Commission also requests

comments on criteria for evaluating

such proposals:

13. What other rate methods should the

Commission consider beyond the marketbased and incentive-based methods covered

above?

14. a. What would be the benefits and

drawbacks of any such methods?

b. Please identify and discuss any

particular legal or procedural issues raised by

a specific method.

15. What criteria would the Commission

use to evaluate such proposals?

The Commission is requesting written

comments on these questions and the

attached staff paper on market-based

rates. The Commission requests parties

to identify the numbered questions in

their comments to the maximum extent

possible. An original and 15 copies of

written comments should be filed with

the Secretary of the Commission within

60 days of the issuance of this notice,

and should refer to Docket No. RM95–

6–000.

By direction of the Commission.

Lois D. Cashell,

Secretary.

Table of Contents

I. The Applicable Legal Standards

II. The Commission’s Prior Experience With

Market-Based Rates

A. The Gas Inventory Charge Cases

B. The Storage Cases

C. The Oil Pipeline Cases

D. The Electric Cases

III. Proposed Criteria for Evaluating MarketBased Transportation Rate Proposals

A. General Framework and Criteria

B. An Example of the Analysis Applied to

Firm Transportation

C. Application of Criteria to Other Services

D. Review of Market Power Findings

Appendix: Analysis of Other Industries

Market-Based Rates for Natural Gas

Companies

A Staff Paper

The Commission has been requested

by various companies to approve

market-based pricing for both firm and

interruptible transportation, for capacity

released in the secondary market, for

storage and for market hub services such

as the ‘‘switching’’ and ‘‘parking’’ of

natural gas. Approval of any of these

proposals is contingent on the

Commission finding that the company

in question lacks significant market

power. The purpose of this paper is to

propose criteria that could be used to

evaluate these proposals.

In developing these criteria staff has

reviewed the Commission’s prior

experience with market-based

ratemaking for natural gas companies,

oil pipelines, and public utilities. In

those cases the Commission consistently

used the same general framework to

evaluate requests for market-based rates.

In addition, the experiences in three

other industries (railroads,

telecommunications, and airlines) also

have been reviewed to determine

whether there are lessons that can be

drawn. For illustrative purposes the

paper applies the proposed criteria to a

hypothetical case. Finally, the paper

discusses the other services that may

qualify for market-based rates as well as

factors the Commission may want to

consider in monitoring market-based

rates.

I. The Applicable Legal Standards

Operating under the ‘‘just and

reasonable’’ standard of the Natural Gas

Act (NGA), the Federal Power Act

(FPA), and the Interstate Commerce Act

(ICA), the Commission generally

authorizes rates based on the cost of

service. However, as the Supreme Court

has ruled on numerous occasions,1 the

just and reasonable standard does not

limit the Commission to any particular

ratemaking methodology; rather, the

Commission has flexibility in selecting

ratemaking methods.

Courts have held that non-cost factors

can legitimate a departure from costbased rates. Departures from cost-based

rates have been found to be justified

when: (1) The changing characteristics

of the industry make advisable or

necessary a new approach; 2 (2) the

deviations from costs are not

unreasonable or inconsistent with

statutory responsibilities; 3 and (3) the

regulatory scheme acts as a monitor to

determine whether competition will

keep prices within a zone of

reasonableness or to check rates if it

does not.4 However, in ruling that rates

need not be linked to costs in order to

be just and reasonable, the court in

Farmers Union II held that the

Commission cannot merely assume that

competition will ensure just and

reasonable prices: ‘‘[m]oving from heavy

to lighthanded regulation within the

boundaries set by an unchanged

statute,’’ can only ‘‘be justified by a

showing that under the current

circumstances the goals and purposes of

the statute will be accomplished

through substantially less regulatory

oversight.’’ 5

The Commission’s authority to

approve market-based rates under the
8358 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

6 10 F.3d 866, 870 (D.C. Cir. 1993)

(Elizabethtown).

7The court cited Mobil Oil Exploration v. U.S.,

111 S. Ct. 615, 624 (1991): ‘‘* * * the just and

reasonable standard does not compel the

Commission to use any single pricing formula

* * *.’’ 10 F.3d at 870.

8 Id. (quoting Tejas Power Corp. v. FERC, 908

F.2d 998, 1104 (D.C. Cir. 1990).

9 10 F.3d at 870–71 (quoting Transcontinental Gas

Pipe Line Corp., 55 FERC ¶ 61,446 at 62,234.

10FPC v. Texaco, Inc., 417 U.S. 380, 397 (1974).

11 417 U.S. at 387–91

12The Commission stated that the just and

reasonable standard would be applied, and

enumerated various factors, in addition to

prevailing market prices, that would be taken into

account. The Court observed that these

representations were relevant to the validity of the

order, but ruled that because they were not made

in the order itself—only on appeal—they were

unavailing. 417 U.S. at 397.

13 417 U.S. at 397.

14Elizabethtown, 10 F.3d at 870.

15 996 F.2d 401 (D.C. Cir. 1993).

16 Id. at 410. See also National Rural Telecom

Assoc. V. FCC, 988 F.2d 174 (D.C. Cir. 1993)

(approving flexible pricing for local exchange

companies, subject to a ceiling rate).

17 114 S. Ct. 2223 (1994).

18Nos. 93–1562, 93–1568, 93–1590, and 93–1624

(D.C. Cir. Jan. 20, 1995).

appropriate circumstances was recently

and clearly affirmed in Elizabethtown

Gas Co. v. FERC.6 There, the court

upheld the Commission’s approval of a

natural gas pipeline’s proposal, as part

of a pre-Order No. 636 restructuring

settlement entered into with its

customers, to sell gas for resale at

market-based prices. Noting that the

Supreme Court has held on numerous

occasions that the just and reasonable

standard does not dictate any single

pricing methodology,7 the court held

that where there is a competitive

market, the Commission ‘‘may rely upon

market-based prices in lieu of cost-ofservice regulation to assure a ‘just and

reasonable’ result.’’ 8 In sustaining the

Commission’s approval of market

pricing in this case, the court alluded to

the Commission’s specific finding that

the pipeline’s markets were

‘‘sufficiently competitive to preclude

[the pipeline] from exercising

significant market power in its merchant

function* * *.’’ 9 Specifically, the

Commission had determined—and no

record evidence to the contrary was

cited on appeal—that adequate

divertible supplies of gas existed to give

customers options to buy from sellers

other than the pipeline, thus assuring

that the pipeline would have to sell its

own gas at competitive prices. This

finding, the court reasoned, justified the

Commission’s conclusion that the

pipeline would be able to charge only a

price that was just and reasonable

within the meaning of section 4 of the

NGA.

In reaching this result, the court of

appeals in Elizabethtown distinguished

the Supreme Court’s decision in FPC v.

Texaco, Inc. (Texaco),10 in which the

Supreme Court had remanded an FPC

order exempting small gas producers

from direct regulation of their prices.

The Commission order under challenge

in Texaco provided that small

producers’ prices would be subject to

scrutiny only as a part of the rates of

pipelines and large producers to whom

they sold their gas, and then only

through review of the pipeline and large

producer rates. This indirect review

procedure was found by the Court to be

permissible under the NGA.11 However,

the order was remanded because the

Commission had not clearly shown

how, or even whether, the just and

reasonable standard would be applied to

the small producers’ prices in this

process.12 The Court admonished that

on remand the Commission must adhere

to the principle that ‘‘the prevailing

price in the market cannot be the final

measure of ’just and reasonable’ rates

mandated by the Act.’’ 13

The court in Elizabethtown reasoned

that the point of Texaco was only that

if Congress has subjected an industry to

regulation because of anticompetitive

conditions in the industry, the market

cannot be the ‘‘final’’ arbiter of the

reasonableness of a price.14 Further, the

court in Elizabethtown stated, in the

Texaco proceeding the Commission had

not even mentioned the ‘‘just and

reasonable’’ standard, but rather

appeared to apply only the marketplace

standard in determining the

reasonableness of small producers’

rates. In contrast, in the order

challenged in Elizabethtown, the

Commission had made it clear that it

would exercise its section 5 authority if

necessary to assure that a market rate is

just and reasonable.

A hybrid cost/market-based pricing

scheme under the FPA was approved by

the court in Environmental Action v.

FERC.15 There the Commission had

approved the application of certain

regulated and non-regulated electric

utilities to operate a power pool in

which transactions would be priced

according to the market, subject to a

uniform ceiling price based upon a

hypothetical average utility’s costs. The

court, in rejecting challenges to the

pricing mechanism, emphasized the

speed and administrative efficiency

benefits of market-based pricing. In

addition, the court also cited the

Commission’s expressed intention to

monitor transactions and invoke its

investigatory powers under section 206

(either sua sponte or upon complaint) to

redress abuses. Thus, the court

concluded that ‘‘[i]n sum, FERC sought

to preserve the Pool’s efficiencies even

as it guarded against price gouging. On

the facts in evidence, we find no basis

for concluding it acted

unreasonably.’’ 16

The court’s treatment of market-based

pricing policies implemented by other

agencies offers little guidance to the

Commission since much of the focus on

increasing competition and reducing

federal regulations has been through

statutory reform, rather than through

agency interpretation of existing

statutory authorities. The bounds of

agency authority to interpret existing

statutory procedural requirements in a

manner to facilitate a move to marketbased pricing was addressed by the

Supreme Court in MCI

Telecommunications Corporation v.

American Telephone and Telegraph

Company (MCI II),17 and by the court of

appeals in Southwestern Bell

Corporation v. FCC (Southwestern

Bell).18 However, MCI II and

Southwestern Bell do not speak to the

substantive validity of market-based

regulation under a just and reasonable

statutory standard. Judicial precedents,

as explained above, uphold the use of

market-based ratemaking, or some

variation thereon, if the agency finds

that clearly delineated non-cost factors

(including the Commission’s oversight

and remedial authorities) are sufficient

to protect the interests of consumers.

II. The Commission’s Prior Experience

With Market-Based Rates

A. The Gas Inventory Charge Cases

1. The Analysis Used

In 1988, the Commission began its

movement towards light-handed

regulation of some aspects of natural gas

markets. The light-handed regulation

first appeared with the implementation

of market-based gas inventory charges

(GIC) for pipeline sales service. In

determining whether a pipeline could

implement a GIC mechanism, the

Commission looked at three key factors:

Market definition, the availability of

divertible gas supplies and measures of

market power. Additionally, the

Commission considered whether the

transportation of alternative supplies

would be on a comparable basis to the

terms and conditions of transportation

service provided for gas purchased

under the GIC. If the supply markets

were found to be competitive and

transportation terms and conditions
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8359

19See Transwestern Pipeline Company, 43 FERC

¶ 61,240 (1988); El Paso Natural Gas Company, 49

FERC ¶ 61,262 (1989 and 54 FERC ¶ 61,316 (1991);

and Transcontinental Gas Pipe Line Corporation, 55

FERC ¶ 61,446 (1991) aff’d Elizabethtown, supra.

20An HHI is calculated by summing the squares

of each seller’s market share. For example, if there

are two sellers of a product having shares of total

sales of 75 percent and 25 percent, respectively,

then the HHI will equal

(.75) 2+(.25) 2=.5625+.0625=.625. Rounding to two

significant digits, the HHI is .63.

21An HHI of .18 is equivalent to having 5–6 equal

sized competitors in the market. In El Paso, the

Commission indicated that it would use a case-bycase approach to determine the lack of market

power. The HHI was used as an initial screening

tool only. El Paso, 49 FERC at 61,920. See also Petal

Gas Storage Co., 64 FERC ¶ 61,190 at 62,573 (1993)

(market power determined on a case-by-case basis).

22Transwestern Pipeline Co., 43 FERC ¶ 61,240

(1988).

23Foster Natural Gas Report, No. 1741, for the

week ended September 21, 1989, pp. 2–3.

24 908 F.2d 998 (D.C. Cir. 1990) (Tejas).

25FERC Regulations Preambles, ¶ 30,939 at

30,439.

26Richfield Gas Storage System, 59 FERC

¶ 61,316 (1992).

comparable, pipelines were permitted to

implement a GIC.19

In applying these standards in El

Paso, for example, the Commission

found that the relevant product market

was delivered firm gas. El Paso

maintained that the product market was

not simply natural gas, but energy

generally (i.e. fuel oil, coal, propane,

hydroelectric power, and purchased

power). However, El Paso did not

provide sufficient evidence to make

such a case. Thus, the Commission

excluded alternative fuels from the

product market.

The Commission established that

‘‘firm’’ gas was a dimension of the

product market since El Paso was

proposing to sell firm gas under its GIC.

The Commission also found that

‘‘delivered’’ gas was a second dimension

of the relevant product market because

firm gas supplies that could not be

transported to the city-gate were not

substitutes for supplies under the GIC.

In defining El Paso’s geographic

market, the Commission acknowledged

that it could consist of the entire United

States or North America. The

Commission stated, however, that the

relevant geographic market was the

geographic area containing those

suppliers that can affect any attempt by

El Paso to exercise market power. The

Commission decided to take a cautious

approach and considered three areas of

gas supplies in order of the most

narrowly defined: (1) The counties in

the three basins where El Paso

purchases gas that are already

connected to El Paso’s system, (2) all

counties in the three basins, and (3) all

counties from which El Paso purchased

gas in 1987, including counties outside

the three basins. The Commission

reasoned that if El Paso lacked market

power in the most narrowly defined

market, then it would also lack market

power in a more broadly defined

market. Alternatively, even if El Paso

could exercise market power in a

narrowly defined market, it might be

demonstrated that El Paso nonetheless

lacked market power when the

definition was expanded.

The Commission found that 1.07 Bcf/

d was the minimum measure of the

amount of divertible, or alternative, gas

supplies needed to prevent El Paso from

exercising market power. The 1.07 Bcf/

day represented the gas dedicated to El

Paso under long-term contracts, together

with its affiliates’ volumes. The

Commission determined that sufficient

divertible supplies existed in each of the

defined geographic markets, at

competitive prices, such that El Paso

would be precluded from exercising

market power. The Commission defined

divertible supplies as those that were

uncommitted, or committed under

contract to a buyer for no longer than

some short period such as one year.

The Commission then measured each

seller’s share of the market. To compute

El Paso’s market share the Commission

used its sales to each customer at the

time of peak usage. These market shares

were then used to compute the level of

concentration in the market using the

Hirschman-Herfindahl Index (HHI).20

The Commission used an initial screen

of .18 to determine if the market

concentration was low enough to

indicate that the competitors in the

market could not exercise market

power.21 The Commission found that

the market concentration was low, i.e.,

below .18.

The Commission also found that the

transportation service to be provided by

El Paso for the transportation of third

party supplies was comparable, with

certain modifications, to the

transportation provided under the GIC.

Therefore, based on this analysis, the

Commission found that El Paso lacked

market power and permitted the

implementation of a market-based GIC.

2. The Subsequent History of the GIC

Cases

On May 11, 1988, the Commission

found that Transwestern lacked market

power with respect to the gas

commodity. Southern California Gas

Company (SoCal), the only company

directly affected, had sufficient

alternative gas supply sources that

Transwestern’s prices would be

constrained. Therefore, the Commission

approved, with some modifications,

Transwestern’s proposed market-based

Gas Inventory Charge (GIC).22

When Transwestern attempted to put

its GIC charges into effect, SoCal

nominated zero volumes of

Transwestern’s gas.23 This is an extreme

example of a lack of market power; an

attempt to get a premium above the

available spot price led to virtually a

100 percent reduction in Transwestern’s

sales.

In July, 1990, in Tejas Power Corp. v.

FERC,24 the court of appeals

emphasized the importance of a market

power determination in the approval of

a GIC mechanism, even in the context

of a settlement. In Tejas, the court found

the Commission’s reliance on the

agreement of the LDCs, in approving a

GIC settlement proposed by Texas

Eastern Transmission Corp., was

misplaced because there was no finding,

supported by substantial evidence, that

the pipeline lacked significant market

power. All of the Commission’s

subsequent market-based GIC cases

examined the market power of the

pipeline applicant.

The series of pipeline-by-pipeline GIC

cases allowing market-based pricing for

the gas commodity was broadened to a

generic finding in Order No. 636. The

Commission allowed pipelines to have

market-based pricing for unbundled gas

sales upon full compliance with the

final rule.25

In conclusion, the Commission’s

experience with deregulation of the gas

commodity has shown that competition

can restrain prices. In fact, the statutory

wellhead deregulation and the

Commission’s open access policies have

led to a current price for the gas

commodity that is well below the

regulated prices that prevailed several

years ago.

B. The Storage Cases

1. The Analysis Used

Starting with the the Commission’s

order in Richfield Gas Storage System

(Richfield) 26 in June 1992, the

Commission has permitted companies

to institute market-based storage rates

subject to light-handed regulation when

the applicants have shown that they

lack significant market power. In

making these market determinations,

the Commission primarily looked at the

defined markets, the availability of good

alternatives, and measures of market

power. However, the Commission also

considered other factors, such as the fact

that the applicants were generally new

entrants, the applications were generally

unopposed, and the possibility of other
8360 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

27 Koch Gateway Pipeline Co., 66 FERC ¶ 61,385

at 62,301–302 (1994).

28Buckeye Pipe Line Company, L.P., 53 FERC

¶ 61,473 (1990). Williams Pipe Line Company, 69

FERC ¶ 61,136 (1994). Both cases were litigated and

the Commission made its findings that certain

markets were competitive based on the records

presented at the hearings.

29BEAs are geographic regions surrounding major

cities that are intended to represent areas of actual

economic activity.

new entrants. In applying these

standards in Koch, for example, the

Commission agreed with Koch’s

definition of product and geographic

markets. Koch applied a narrow and

broad definition to both markets. Koch

argued that if it did not have market

power in narrowly defined markets, it

would not have market power when the

definitions were broadened.

Koch defined the narrow product

market as natural gas storage. The

narrow geographic market was defined

to contain those storage facilities in the

states of Texas, Louisiana, and

Mississippi that are connected to Koch.

The record showed that Koch owned

only 11.9 percent of the contract storage

capacity and 6.1 percent of the contract

storage deliverability in the narrow

market. The market concentration was

computed using the HirschmanHerfindahl Index (HHI) to be .13 for

capacity and .12 for deliverability

indicating a relatively low concentration

in the narrow market.

The Commission also reviewed the

fact that five new suppliers may enter

the market by 1996 that would

potentially have direct connects to

Koch.

The broader product market was

defined to include non-storage

alternatives and storage alternatives not

connected to Koch, such as, capacity

release of storage in new or existing

storage facilities, purchase of natural gas

from producers or other marketers,

selling gas to customers that have

several suppliers, access to no-notice

storage, to name a few. The broader

geographic market was defined as

alternatives outside of Texas, Louisiana

and Mississippi.

The Commission gave much

consideration to whether or not the

alternatives identified by Koch were

‘‘good’’ alternatives. The Commission

defined a good alternative as one that is

available soon enough, has a price that

is low enough, and has a quality high

enough to permit customers to

substitute the alternative for Koch’s

service. In addition, the alternative must

be available in sufficient quantity to

make Koch’s price increase

unprofitable.

The Commission found that good

alternatives were available in sufficient

quantities and at competitive prices.

The Commission determined that

unutilized storage capacity was

available in large quantities in Texas,

Louisiana and Mississippi during peak

periods based on statistics found in

EIA’s Natural Gas Monthly. The

Commission reasoned that if this

unutilized capacity was not under

contract it was available for purchase.

Unutilized capacity that was committed

under contract, the Commission

reasoned, would be available through

capacity release. Therefore, given the

small size of Koch in relation to other

storage providers, the abundant storage

alternatives available to Koch’s

customers, and that the alternatives are

‘‘good’’ alternatives, the Commission

concluded that Koch could not exercise

market power in providing storage

service.

2. The Experience After Approving

Market-Based Rates

The market-based storage cases

approved by the Commission (Richfield,

Petal, Transok, Bay State, Avoca, and

Koch) are quite recent. The companies

in question were not subjected to any

special reporting requirements. Thus,

there is little information currently to

evaluate these decisions. In addition,

the pipelines in several of these cases

executed long term contracts at the same

time they were seeking market based

rates. The contracts set the prices for the

term of the contract. No complaints

have been filed so far regarding the

market based storage rates. However,

one would not expect to see the

complaints so early in the process.

Complaints would be more likely to

occur when the parties seek to negotiate

new pricing provisions at the end of the

contract term, if new capacity becomes

available, or if the circumstances which

served as the basis of the Commission’s

decision changed.

Earlier, however, the Commission

approved an experiment wherein Koch

storage was allowed to charge any price

it could negotiate up to a cap which

exceeded the cost-based rate. The

Commission did not make a finding that

Koch lacked significant market power.

The results of the ‘‘Market Responsive

Storage and Delivery Service’’ (MRSDS)

experiment suggest that competition

constrained Koch to prices actually

below the cost-based rates. All marketbased MRSDS rates charged by Koch

were below the cap. During the two full

heating seasons of the experiment,

customers fully subscribed all the

capacity allocated to MRSDS.27

C. The Oil Pipeline Cases

In the oil pipeline area, two

companies have the authority to charge

market-based rates—Buckeye Pipe Line

Company, L.P. (Buckeye) and Williams

Pipe Line Company (Williams). In both

cases the Commission determined that

the pipeline lacked market power in

markets for which each was allowed to

charge market-based rates.28

1. The Analysis Used

In conducting its analysis of whether

the applicant had market power, the

Commission first defined the product

and geographic markets. It then

evaluated whether the applicant had

significant market power in those

markets by first doing an initial screen

for market concentration in each market

(using the Herfindahl-Hirschman Index)

and then considering, weighing and

balancing a number of other factors,

such as, the potential entry of

competitors into the market, available

transportation alternatives, market

share, availability of excess capacity,

and the presence of large buyers able to

exert downward monopsonistic

pressure on transportation rates.

In Buckeye, for example, the relevant

product market was defined as the

transportation of refined petroleum

products. The Commission agreed with

the ALJ and rejected the position

advanced by ATA that the product

market should be markets in which

Buckeye transports only jet fuel. The

Commission concluded that the ease of

product substitution among pipelines is

an important reason why the relevant

product market should be the

transportation of refined petroleum

products rather than the transportation

of a specific petroleum product, such as

gasoline, fuel oil or jet fuel.

The relevant geographic markets were

defined as the areas that include all

supplies of transportation from all

origins to United States Department of

Commerce, Bureau of Economic

Analysis Economic Areas (BEAs).29 The

Commission concluded that the

evidence of record supported the

findings of the ALJ that BEAs are shown

to be appropriate geographic markets

since they are convenient, easily

identified and have been used in past

studies of the oil pipeline industry.

The Commission also concluded that

an analysis of market concentration

using HHIs should be the first step in

evaluating the likelihood of market

power being exercised in a given

market. Knowing the degree of

concentration in a market provides

useful information about where on the

competitive spectrum that market lies
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8361

30The Commission used an HHI of .18 as an

initial screen in Transcontinental Gas Pipe Line

Corp. (Transco), 55 FERC ¶ 61,446 at 62,393 (1991).

31 53 FERC 61,473 and 54 FERC 61,117.

32On March 24, 1994, the Commission accepted

a tariff that extended this experiment for an

indefinite period (66 FERC ¶ 61,348). However, the

Order stated that Buckeye was subject to the

requirements of Order No. 561, the simplified and

generally applicable ratemaking methodology for oil

pipelines, when they take effect on January 1, 1995.

On December 6, 1994, the Commission permitted

Buckeye to continue its experimental program as an

exception to the Commission’s oil pricing policies,

subject to future reevaluation. Buckeye Pipe Line

Co., L.P., 69 FERC ¶ 61,302 (1994).

33 66 FERC 61,348.

34October 26, 1994 Buckeye Pipeline filing in

Docket No. OR94–6–000, et al.

35While there was concern that Buckeye might be

able top ‘‘manipulate’’ the program by raising prices

in the competitive markets solely to raise prices in

the non-competitive markets, the Commission

found this to be a very unlikely event under the

approved program. It nevertheless committed to

monitoring for this occurrence during the

experiment (53 FERC 61,473). Since the growth rate

of revenues was higher in the competitive markets

than in the non-competitive markets (constant

annual growth rates of 6.54% versus 2.78% (66

FERC 61,348)), this demonstrates that this potential

problem did not occur during the experiment.

36February 22, 1994 ‘‘Statement of James A.

Spicer on behalf of Buckeye Pipe Line Company,

L.P.’’

In contrast to oil pipelines, natural gas pipelines

are permitted to selectively discount. Thus, gas

pipelines would be able to structure such a deal

under the Commission’s traditional cost-based rate

regulation.

and what other factors will have to be

weighed to enable a finding as to the

existence or absence of significant

market power. For measuring market

concentration, the Commission

concluded that a proper screening

device is an HHI.30 The Commission

also concluded that the use of delivery

data, e.g., deliveries into each BEA, is

the best method for calculating HHIs in

Buckeye.

In Buckeye (Opinion No. 380), market

power was defined as the ability to

profitably raise the price above the

competitive level for a significant time

period. Significant market power was

defined as the ability to control market

price by sustaining at least a 15% real

price increase, without losing sales, for

a period of two years. The Commission

further concluded that the relevant price

for the purposes of making a

determination of whether Buckeye can

profitably increase its transportation

prices above the competitive level is the

delivered product price. Because

shippers or customers in the destination

market often have the option of

switching away from purchasing

transportation into the market, and,

instead, purchasing the delivered

product itself, suppliers of

transportation must compete with

suppliers of the delivered product.

There were 22 markets examined in

Opinion No. 380. The Commission

found that in 15 Buckeye lacked

significant market power; in two

Buckeye had no tariffs on file thus no

finding was warranted; in one the

record was insufficient and so

continued regulation was necessary;

and, in four, Buckeye was found to have

market power.

2. The Buckeye Experiment

In Opinions No. 380 and 380–A, the

Commission also authorized a three year

experimental program proposed by

Buckeye.31 During this experiment,

rates in each competitive market were

subject to two limitations: (1) Individual

rate increases could not exceed a ‘‘cap’’

of 15% real increase over any two-year

period, and (2) individual rate increases

would be allowed to become effective

without suspension or investigation

only if they did not exceed a ‘‘trigger’’

of the change in the Gross Domestic

Product (GDP) deflator plus 2%. Rate

decreases were presumably valid but

could not result in rates below marginal

costs.

In the markets the Commission did

not find to be competitive, no rate could

be increased by more than the volumeweighted average rate increase in the

competitive markets. Conversely, every

rate in the ‘‘non-competitive markets’’

had to reflect the volume-weighted

average of rate decreases in the

competitive markets.32

No protests of rate changes or

complaints against existing rates were

filed during the three year experiment.

In addition, no protests were filed in

opposition to Buckeye’s filing to extend

the experiment indefinitely.33 Buckeye

noted that this lack of opposition to its

market-based program was ‘‘in sharp

contrast to the years of complex and

expensive rate litigation that preceded

adoption of * * *’’ this program.34

No rates were changed by more than

the GDP+2% trigger during the three

year period. In the competitive markets,

rate increases were generally well below

the trigger, and in the non-competitive

markets, rate increases were below the

allowed volume-weighted average

increase in the competitive markets. The

allowable and average actual rate

changes are shown in the table below.

BUCKEYE RATE CHANGES

Year (April 1 to March

31) Cap (GDP+15%) (percent) Trigger (GDP+2%) (percent)

Competitive markets average rate change (percent)Non-competitive markets

average rate change

(percent)

90–91 19.16 6.16 3.86 3.58

91–92 22.32 5.16 3.14 2.74

92–93 20.69 4.53 1.45 0.97

Since all changes in rates are based on

an index not reflecting the pipeline’s

costs, there is no danger of the raising

of rates in non-competitive markets

through shifting costs attributable to

competitive markets.35 This attribute is

not exclusive to the Buckeye program;

approaches which base rate changes on

something other than the pipeline’s

costs would eliminate this concern

about cost shifting.

Finally, under the market-based

program Buckeye was able to engage in

some successful marketing in very

competitive situations. For example, in

Indianapolis, where Buckeye held less

than three percent of the market in

1990, Buckeye raised its share to 17

percent in 1993. ‘‘These increased

volumes resulted from Buckeye’s deep

price discounts (as deep as 40%) in

1991 and later a volume incentive tariff

to attract new refinery business from a

recently restarted independent refinery

* * *’’ 36 As a result of Buckeye’s

actions, the total size of the Indianapolis

market increased and its concentration

decreased.

D. The Electric Cases

Since 1986, the Commission has

approved many applications from

public utilities to sell electricity in

wholesale transactions at negotiated

market-based rates. In a recent order

addressing a request for market-based

rates from an electricity marketer

affiliated with a traditional public
8362 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

37Heartland Energy Services, 69 FERC ¶ 61,223

(1994).

38See, e.g., Kansas City Power & Light, 67 FERC

¶ 61,183 (1994).

39 In PSI, 51 FERC ¶61,367 (1990), order on reh’g

52 FERC ¶61,963 (1990), the Commission

determined that a seller with a market share of less

than 20 percent did not dominate the market.

40 52 FERC ¶ 61,193 at 61,708–61,709 (1990).

41See, e.g., Hartwell, 60 FERC ¶ 61,143 (1992).

42 67 FERC ¶ 61,183 (1994).

43See Enron Power Marketing, 65 FERC ¶ 61,305

(1993), order on reh’g, 66 FERC ¶ 61,244.

44The current policy was announced in

Hermiston Generating, 69 FERC ¶ 61,035 (1994). 45E.g., Transco, 55 FERC at 62,393.

utility, the Commission summarized its

position. The Commission:

* * * allows market-based rates if the

seller (and each of its affiliates) does not

have, or has adequately mitigated, market

power in generation and transmission and

cannot erect barriers to entry. In addition, the

Commission considers whether there is

evidence of affiliate abuse or reciprocal

dealing.37

Applicants for whom the Commission

approved market-based rates are

required to file periodic reports or

studies to demonstrate their continuing

lack of market power and the absence of

abusive affiliate practices.

The first step in evaluating market

power in generation is to identify the

relevant product and geographic

markets.38 In those markets, suppliers’

market shares are calculated. Low

market shares demonstrate that the

seller is unlikely to be able to assert

market power in that market.39 An

applicant with a high market share

would be subject to further scrutiny.

For example, in Enron Power

Enterprises Corporation,40 the

Commission looked at the market for

generating services bid to New England

Power Company (NEPCO). In that

market, Enron’s market share was 4

percent. Furthermore, there were 18

projects out of 22 finalists that were not

selected. Thus, NEPCO had numerous

additional alternatives to choose from

other than Enron. In addition, NEPCO

negotiated several favorable provisions

in its agreement with Enron suggesting

that Enron was not a dominant supplier

at the time of the solicitation.

There have been two additional

factors of concern to the Commission in

electricity cases: Affiliate abuse and the

ability to erect barriers to entry. With

respect to affiliate abuse, in recent cases,

the Commission has required the

affiliated parties to file separately for

any sales or purchases of electric power

between the marketer and its affiliated

utility. In addition, the Commission

requires the affiliated marketer to

purchase any transmission services it

may receive from its affiliated utility

under a generally applicable, openaccess, comparable tariff.

With respect to an applicant’s ability

to erect barriers to entry, only a few

electric cases have raised this issue.

Some affiliates of natural gas pipelines

have sought market rate approval for

sales of electricity.41 However, the

Commission has looked to Order No.

636 procedures mandating open access

transportation on jurisdictional

pipelines to preclude pipelines from

erecting barriers to entry.

As a result of Enron and other cases,

the Commission has developed

considerable experience in analyzing

generation markets. Recently, in Kansas

City Power and Light,42 the Commission

concluded that new generating facilities

were being built by many different

parties and that there was no evidence

that any party could assert market

power in markets being served by new

facilities. Consequently, as did the

Commission in its series of GIC

decisions, market power analysis is no

longer required when the applicant is

proposing sales from new facilities.

The Commission’s treatment of

transmission market power does not

parallel its treatment of market power in

generation. The Commission has

basically equated applicant ownership

or control of transmission facilities with

the applicant having market power in

transmission in that region.43 The

Commission therefore requires

transmission owners to file generally

applicable open-access, comparable

transmission tariffs before the

Commission will permit them to charge

market rates.44

III. Proposed Criteria for Evaluating

Market-Based Transportation Rate

Proposals

A. General Framework and Criteria

To date, in all cases where the

Commission has considered marketbased rates, the applicant has been

required to show that it lacks significant

market power in the relevant markets.

Market power is defined as the ability

of a pipeline to profitably maintain

prices above competitive levels for a

significant period of time.

While the Commission has not

adopted a mechanistic approach to

assessing market power, it has

consistently used the same general

framework to evaluate requests for

market-based rates.

Using this general framework,

Commission staff proposes criteria to

evaluate the competitiveness of

transportation services. To show a lack

of market power over firm

transportation, for example, staff

anticipates that a pipeline would need,

initially, to show that its customers have

four to five good alternatives to the

applicant’s firm transportation service.

This is the equivalent of an HHI of .18,

which the Commission has used as an

initial screen in previous cases.45 Staff

suggests that only capacity that the

applicant shows will be available on

other pipelines when the applicant

institutes market-based rates could be

considered as an alternative.

One necessary element of showing

that customers have alternatives would

be the pipeline’s agreement to give

existing firm transportation customers

the right to renominate their contract

demand levels if a pipeline is allowed

to charge market-based rates under

existing contracts. Otherwise, the

applicant clearly has market power over

its customers if existing contracts

prevent its customers from freely

choosing alternative service or

renegotiating their contracts at the time

market forces are permitted to control

the rates for services. This situation did

not exist in the storage cases where the

Commission permitted market-based

pricing. In those cases, the applicants

were either new entrants or existing

entities offering new services. There

were no existing contracts in effect that

the Commission needed to address. This

condition is consistent with the

Commission’s practice in the GIC

proceedings where it allowed customers

to renominate their sales contract

demand levels if a pipeline instituted a

GIC.

The framework proposed would be

the same for all types of services. It

consists of three major steps:

1. Define Relevant Markets

a. Product market: identify good

alternatives to the applicant’s product;

and

b. Geographic market: identify sellers of

good alternatives.

2. Measure Firm Size and Market

Concentration

a. Measure the size of the market, calculate

each seller’s market share, and evaluate

applicant’s market share;

b. Estimate market concentration using the

Herfindahl-Hirschman Index (HHI); and

c. Evaluate market concentration by using

an initial HHI screen of 0.18; a finding

in that range is equivalent to finding that

customers have at least four or five

equal-sized alternatives to the

applicant’s service.

3. Evaluate Other Factors

a. If the applicant’s market share is large

or the market concentration is high (i.e.,

HHI exceeds 0.18), examine other factors

that might prevent or limit the exercise

of market power;
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8363

46This paper does not attempt to analyze the

capacity release market or IT service in any detail

but the same general framework would apply to

these.

47See ‘‘Importance of Market Centers,’’ Office of

Economic Policy, FERC (Washington, D.C.), August

21, 1992. Some pipelines have defined market hubs

differently.

48Koch Gateway, 66 FERC at 62,299.

49 During the winter peak period we would expect

that excess capacity would be at a minimum and

that customers’ alternatives would be fewer than in

off-peak periods.

50 In Buckeye Pipe Line Company, L.P., Opinion

No. 360, the Commission held that a 15 percent

increase was an appropriate level to measure

market power. 53 FERC 61,473 at 62,681 (1990),

order on reh’g, Opinion No. 360–A, 55 FERC

¶ 61,084 (1991). However, in Williams Pipe Line

Co., Opinion No. 391, the Commission declined to

adopt a specific rate increase as a litmus test for

market power. 68 FERC ¶ 61,136 at 61,657. In Koch

Gateway Pipeline Company, the Commission

suggested that potential alternatives would include

services that though presently not used, would be

economic if prevailing prices were to rise by a

modest amount, e.g., five to 15 percent. 66 FERC

¶ 61,385.

b. These other factors might include ease

of entry, excess capacity held by

competing sellers, and buyer power.

Each of these steps is discussed

further below. In section B of this part

is an example showing the application

of this analysis to a hypothetical

interstate pipeline in a market supplied

by a number of pipelines.

There are some services that are more

likely to pass these criteria than others.

These are discussed more fully in

section IV.C. below.46 For example, IT

and hub services have different

characteristics than firm transportation

and might more easily satisfy these

criteria. If the capacity release program

is functioning well, IT service may

compete with capacity release offered

by all of the pipeline’s customers in the

relevant zones. Capacity release may be

a good alternative for IT service. There

are, by definition, several pipelines at

each market hub.47 Each of the pipelines

at the hub may be able to offer the same

hub services as good alternatives to each

other.

As a practical matter, it may well be

difficult for long-term firm

transportation to qualify under this

framework. The nature of the

transportation grid ensures that

pipelines typically face few direct

competitors in delivering gas from one

point to another. In addition, given the

long-term contracting for firm

transportation service that exists, staff

believes it may be difficult for pipelines

to show that customers have the ability

to freely move to alternative long-term

transportation. For example, if a

pipeline that proposes market-based

rates for firm transportation has existing

long-term contracts for that service, the

pipeline would need to allow its

customers to terminate their contracts to

freely move to alternative services.

1. Market Definition

Market definition identifies the

specific products or services and the

suppliers of those products or services

that provide good alternatives to the

applicant’s product or service. In this

market staff would test the applicant’s

ability to exercise market power.

Naturally, the more narrowly the market

is defined, the harder it is to show a lack

of market power.

The Commission’s order approving

market-based storage rates for Koch

Gateway, defined good alternatives as

follows:

A good alternative is an alternative that is

available soon enough, has a price that is low

enough, and has a quality high enough to

permit customers to substitute the alternative

for Koch Gateway’s service.48

a. The Product Market

The applicant’s service together with

other services that are good alternatives

constitute the relevant product market.

The applicant must fully, and

specifically, define the product market.

For example, the applicant must be

specific in defining whether the product

market consists of firm transportation

only, or if the product market consists

of off-peak interruptible transportation

service only, etc. The applicant must

also be responsible for developing and

justifying any substitutes for the

relevant product that can be considered

competitive alternatives, e.g., storage

delivery services, gathering services, etc.

For example, pipelines might suggest

numerous alternatives to FT in their

applications: IT, storage services,

residual fuel oil, etc.

It is likely that applicants will argue

that the market should be defined

broadly. Given the natural monopoly

features of many transportation services,

staff suggests that the Commission take

a more conservative approach and

define the product market narrowly as

only firm transportation. For purposes

of defining relevant gas transportation

markets, staff focuses here on the

pipeline customers’ peak.49

i. Timeliness

Generally, antitrust authorities have

used one year as the time period in

which to test whether a product can

become a substitute. This is probably

not appropriate for long-term firm

transportation because capacity on

competitors would typically need to be

available simultaneously to offer a

viable alternative to customers. If the

pipeline applicant relies on the

existence of capacity that will not be

available immediately, it would also

need to show that its customers would

not be committed to long term contracts

on its system under the operation of the

right of first refusal rules, so that the

alternative would not be available.

ii. Price

Along with showing that alternative

capacity will be available in a

reasonable time frame, the applicant

must demonstrate that the price for the

available capacity is low enough to

effectively restrain the applicant from

increasing prices. In prior cases, the

Commission has defined such a

threshold price level as being at or

below the applicant’s approved

maximum cost-based rate plus 15%.50

The regulated price has been used as

the prevailing price—a proxy for the

competitive price. This is necessary

because almost all prices for

transportation are regulated and a

competitive price level would be at best

a guess. However, the use of prevailing

prices presents analytic problems. For

example, three pipelines that follow

parallel courses may have radically

different rates because of different

historical costs, despite the fact that in

a competitive market they would offer

almost identical services at almost

identical prices. Which of the

alternative pipelines’ prices should be

used as the ‘‘prevailing’’ price? This

question would have to be addressed in

deciding whether the prices of

alternatives are appropriate references.

iii. Quality

A good alternative must provide

service in which the quality is at least

as high as that of the service provided

by the applicant. In order to make this

showing the applicant must first be

required to describe its own services.

Then, the applicant must demonstrate

that any available third party capacity

must be comparable in service to the

transportation service provided by the

applicant.

Staff believes that with Order Nos.

436 and 636, all interstate pipelines

currently provide operationally

comparable firm transportation (FT)

service.

However, even if a customer can find

available capacity on an alternative

pipeline, the overall package of services

available may not be comparable to that

it currently receives from the applicant.

For instance, no-notice service may not

be available from other pipelines

(though a similar service might be

available from third parties). Under

Order No. 636 interstate pipelines
8364 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

51Alternatively, the applicant could include a

seller in the market if the seller can connect to the

customer sufficiently cheaply that the customer

receives a netback as least as large as it would

receive if it used the applicant’s transportation

service.

52The netback is the delivered price of gas less

the transportation costs paid by the producer. That

is, the netback is the net price received by the

producer.

53The geographic market is a region in which a

hypothetical monopolist that is the only present or

future provider of the relevant product at locations

in that region would profitably impose at least a

‘‘small but significant and nontransitory’’ increase

in price. In the case of an origin market, the

hypothetical monopsonist will impose a small but

significant and nontransitory decrease in netbacks.

Thus, a service is a good alternative if the netback

using the alternative is at least as big as the netback

using the applicant’s facilities after the netback

decrease.

which offered no-notice sales service

prior to restructuring were required to

offer no-notice transportation service to

their existing sales customers at the time

of unbundling. Pipelines had the option

of making no-notice service available to

non-sales customers. Thus, while many

interstate pipelines currently provide

no-notice transportation service, they do

not and are not required to offer such

service to new customers. Thus,

comparable no-notice service probably

is not available on other pipelines.

Also, applicants may wish to

demonstrate that intrastate pipelines

offer comparable firm transportation

service. Transportation services offered

by intrastate pipelines under section

311 of the NGPA are also subject to the

same open-access and nondiscriminatory access standards as

interstate pipelines are under Order No.

436. Therefore, to the extent that

intrastate pipelines offer firm

transportation service, Staff believes

that such service would be offered

under terms and conditions that are

substantially comparable to the firm

transportation services offered by openaccess interstate pipelines. However,

intrastate pipelines are not required to

offer firm transportation services and

currently only a few intrastate pipelines

offer firm transportation. Thus, firm

transportation services may not be

available on intrastate pipelines.

Applicants wishing to make a

showing that interruptible

transportation services make good

alternatives to the applicant’s firm

services would have to demonstrate that

an adequate amount of capacity is

unsubscribed during peak periods so

that the quality of the IT service would

be comparable to that of the applicant’s

FT service.

b. The Geographic Market

In addition, in defining the market,

one must identify all the sellers of the

product or service. The collection of

alternative sellers and the applicant

constitutes the relevant geographic

market. Specifying the relevant product

and geographic market tells us what

alternatives the customer has if it

attempts to avoid a price increase

imposed by a seller.

Geographic market definition is

particularly important in transportation

markets. Gas pipelines can transport gas

out of a producing or origin region.

They also deliver gas into a consuming

or destination region.

The applicant must specify both the

origin and destination markets for its FT

service. Only in that way can the

applicant identify good alternatives to

the pipeline’s service.

Staff proposes a two-step process of

defining the geographic market. First,

the applicant would identify those

alternative sellers who offer service

between the same origin and destination

markets. Second, the applicant would

identify those competitors that provide

service either out of the origin market or

into the destination market. This twostep process generally follows the

analytic approach developed in the

Report of Commissioner Branko Terzic

on Competition in Natural Gas

Transportation (May 24, 1993).

i. Transportation Between Markets

The first stage of the analysis

identifies sellers offering transportation

service over the same route. Examining

different sellers serving the same

transportation link simplifies the

analysis. For instance, there is no need

to consider whether different producing

areas offer ‘‘good’’ alternatives to each

other.

To show that another pipeline

provides a good direct alternative, the

applicant must show that customers

could purchase the relevant service

from the alternative supplier. Such a

demonstration will probably include

showing that capacity would be

available on the alternative, that the

customer can obtain any services

needed to use the competitor’s facilities

in both origin and destination markets

over the term of the service receiving

market-based rates.

If a customer has a continuing

obligation to take gas at a particular

receipt point, or to deliver gas to a

specific delivery point, beyond the term

of its FT contract, competition from

parallel pipelines is particularly

important in evaluating market power

on a pipeline seeking market-based FT

rates. Then the applicant may have

market power over the shipper even if

both the origin and destination markets

are otherwise competitive. While the

shipper will have good alternatives to

the applicant for getting gas to the citygate, it may not have good alternatives

for getting gas from that particular point

to its city-gate. It could, of course, sell

its contract gas from that particular

point on the spot market in the

production area and buy an equal

amount of spot gas in an area where it

had good transportation alternatives.

But the spot price at which it sells might

be lower than the spot at which it buys,

causing extra expense and providing

some opportunity for the applicant

pipeline to raise its price. Additionally,

the shipper may value the reliability of

the contract gas and be concerned that

it might not be able to buy spot gas

when it needs it.

In practice, parallel route competition

is most likely to occur in two situations.

One is the secondary market (including

pipeline IT) where parties offer service

on the same facility. The other is for

transportation between well-functioning

market centers, as illustrated in the

example in part B.

ii. Transportation at Origin and

Destination Markets

Parallel route competition is not the

only source of market discipline on gas

transporters. A shipper in the

production area will typically have

alternative destination markets to which

it could send gas. Similarly, a

downstream shipper will typically have

a choice of several producing areas from

which to buy gas. Pipelines that provide

such alternative service may offer an

additional check on the market power of

a shipper.

Natural gas transportation typically

originates in the production area. In the

production area (or the mainline receipt

point), the applicant must identify the

transportation alternatives available to

customers. Customers could include

producers with gas supplies attached at

a receipt point, LDCs, and endusers

with firm long-term supply contracts.

To define a particular region as an

origin market, the pipeline must

identify all pipelines which compete

with it to move gas out of that area. To

demonstrate that these other pipelines

are good alternatives (that is, are in the

market), the applicant must show that

its producer/shippers are physically

connected to these other pipeline

transportation alternatives.51 The

applicant must also show that these

transportation alternatives provide a

netback 52 to producer/shippers roughly

the same as they would receive if they

used the applicant’s transportation.53

An alternative is not a good alternative

to a producer seeking to move gas out

of the origin market if the alternative is
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8365

54The applicant could include a seller in the

destination market if the seller can connect to the

customer sufficiently cheaply that the customer

pays a delivered gas price no higher than that paid

when using the applicant’s FT service.

55The geographic market is a region in which a

hypothetical monopolist that is the only present or

future provider of the relevant product at locations

in that region would profitably impose a least a

‘‘small but significant and nontransitory’’ increase

in price. In the case of an destination market, a

service is a good alternative if the delivered gas

price using the alternative is less than or equal to

the delivered gas price using the applicant’s

facilities after the price increase.

56 Given the nature of the interstate pipeline

industry, ease of entry would be difficult to show

except in cases involving minor facilities. For major

facilities, the cost of construction and the time

needed for environmental analysis would suggest

that entry may not be easy.

57The capacity on pipeline systems owned or

controlled by the applicant’s affiliates should not be

considered among the customer’s alternatives.

Rather, the capacity of its affiliates offering the

same product should be included in the market

share calculated for the applicant. Similarly,

alternative pipelines must be aggregated with their

respective affiliates in order to identify meaningful

alternatives to customers. It is not reasonable to

expect a profit-maximizing firm to allow its

affiliates to compete with one another.

58El Paso Natural Gas Company, 49 FERC

¶ 61,262 (1989). See also Buckeye, 53 FERC at

62,667.

59See Williams Pipe Line Co., Opinion No. 391,

68 FERC ¶ 61,136 (1994).

60FPC v. Hope Natural Gas Co., 320 U.S. 591, 610

(1944). See also Elizabethtown, supra n. 6

(sustaining the Commission’s approval of market

pricing based on the Commission’s conclusion that

the pipeline’s markets were sufficiently competitive

to preclude it from exercising significant market

power); Farmers Union II, supra n.2 (holding that

the Commission cannot merely assume that

competition will ensure just and reasonable prices).

associated with a much higher cost than

the applicant’s cost-based rates, i.e., it

must give roughly the same netback.

In contrast, the ultimate destination

market for gas is typically a city-gate.

There, the applicant must identify the

transportation alternatives available to

endusers and LDCs who want to receive

gas in this area. To define a destination

market, the applicant must demonstrate

that its customers are physically

connected to alternative gas

transportation facilities that move gas

into the area.54 The applicant must also

demonstrate that those alternatives will

deliver gas at a price no higher than

would be paid with the use of the

applicant’s transportation service to

deliver gas into the area.55

Applicants for market-based rates

might allege that LPG and LNG can be

good alternatives to the use of

applicant’s transportation service. If so,

the applicant must show that there are

sufficient quantities of these available,

and the transport of LPG and LNG into

the destination market (e.g., by truck)

provides gas at an overall delivered

price no higher than the overall

delivered price from pipeline transport

with a fifteen percent transportation rate

increase on the pipeline’s transportation

rate.

c. Summary and Conclusion

Thus, in order to specify a gas

transportation market, the applicant

must first identify all products and

services available as good alternatives to

the applicant’s customers. Next, the

applicant must identify the origin and

destination of that transportation. The

relevant geographic market will be

defined in two steps: First, those

alternative sellers that offer service

between the same origin and destination

markets and second, all economically

substitutable transportation sold by

pipelines (or other good alternative

products and services) serving either the

origin market or the destination market.

2. Firm Size and Market Concentration

Pipelines might be able to exercise

market power if customers have few

good alternatives to the pipeline’s

service either, in the first instance, over

a given route or, in a second analysis,

separately in origin and destination

markets. The applicant might have

market power in the origin market if

producer/shippers have few good

alternatives to transport their product

out of the origin area. In the destination

market, pipelines might be able to

exercise market power if downstream

customers have few good transportation

alternatives that reach their city-gates. If

customers have long term supply

contracts, it will be particularly

important for the pipeline to

demonstrate that it has no market power

over customers on a given route.

There are two ways in which a seller

can exercise market power. It can

attempt to raise its price acting alone or

it can attempt to raise its price by acting

together with other sellers.

i. Acting Alone

One of the indicators which has been

examined to determine whether a seller

could exercise market power acting

alone is the seller’s market share. A

large market share is generally a

necessary condition for the exercise of

market power. If the seller has a small

market share it is unlikely that it can

exercise market power. But, a company

with a large market share may not be

able to exert market power if entry into

the market is easy 56 or there are other

competitive forces at work.

The applicant must submit

calculations (and supporting data) of its

market share in all relevant origin and

destination areas.

ii. Acting Together with Other Sellers

A second way in which a seller can

exercise market power is to act together

with other sellers to raise prices. To

evaluate whether a seller can act

together with others to exercise market

power, the Commission has typically

examined the market’s concentration.

To measure market concentration, one

generally considers the summary

measure of market concentration known

as the Herfindahl-Hirschman Index

(HHI). If the HHI is small, less than .18,

then one can generally conclude that

sellers cannot exercise market power in

this market. A small HHI indicates that

customers have sufficiently diverse

sources of supply in this market that no

one firm or group of firms acting

together could profitably raise market

price. If the HHI is greater than .18 then

additional analysis is needed to

determine if the seller can exercise

market power.

The applicant should be required to

submit calculations of the HHI for the

relevant markets. The HHI must be

computed for each origin market as well

as each destination market. The

Commission should require applicants

to submit information for each mainline

receipt point (origin market) and each

delivery point (destination market). If

the applicant wishes to argue for a

broader market definition it should also

include calculations for its market

definitions. Only sales or capacity

figures associated with good alternatives

should be used in calculating the HHI.

In calculating the HHIs, the applicant

should be required to aggregate the

capacity of affiliated companies into one

estimate for those affiliates as a single

seller.57

In the GIC cases, the Commission

established a threshold level for the HHI

at .18.58 In an oil pipeline case, the

Commission used .25 as an initial

screen.59 The Commission may wish to

establish a standard under which it will

presume no potential for the exercise of

joint market power exists. Since the

Commission has a positive obligation

under the Natural Gas Act to ‘‘protect

consumers against exploitation at the

hands of natural gas companies,’’ 60 staff

believes it would be appropriate to use

the relatively strict initial screen of .18.

This would indicate that there are four

to five good alternatives to the

applicant’s service in each market.

3. Entry and Other Competitive Factors

Even if the applicant’s market share

were large in a concentrated (and

properly identified) market, one might

not conclude that the applicant would

be able to exercise market power. For
8366 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

61As stated before, entry would probably only be

relevant for gas pipelines in the case of minor

facilities such as facilities that could be constructed

under a blanket certificate.

example, if the applicant were to

increase its price, entry into the market

might be so easy that sellers attracted by

the profit opportunity created by the

higher price would quickly take

customers away from the applicant by

offering a lower price. This would make

the applicant’s price increase

unprofitable. Thus, the applicant would

not be able to exercise market power,

despite its large market share and

despite the high market concentration.61

Ease of entry is one of several

competitive factors that might lead to

the conclusion that an applicant lacks

market power. It is most likely to apply

to circumstances that do not require the

large sunk costs of major construction—

for instance, perhaps in offering shorthaul market center services. Another

competitive factor that might be alleged

by an applicant would be the presence

of buyer power. An applicant might

argue that if a single buyer is a large

customer of the pipeline, is

knowledgeable and sophisticated in its

buying, and has been in business for a

lengthy period of time, the buyer may

have the knowledge and large-scale

purchasing power to negotiate

reasonable rates even in a concentrated

market. However, just because buyers

develop sophisticated purchasing

systems and market knowledge as the

result of dealing with various suppliers

in numerous markets, there still is

reason to have some skepticism that a

buyer in a single destination area served

by one or a few pipelines will have such

capabilities.

The applicant must demonstrate that

sufficient quantities of good alternatives

are available to its customers to make a

price increase unprofitable. In other

words, the applicant must show that

customers would replace a significant

proportion of its throughput with other

transportation alternatives if the

applicant raised its price.

B. An Example of the Analysis Applied

to Firm Transportation

1. Introduction

To illustrate the application of the

market power analysis discussed above

to a request for market-based

transportation rates, staff shows an

analysis of a hypothetical filing by an

interstate pipeline. In that hypothetical

filing, the ABC Pipeline Company seeks

Commission approval to offer firm

transportation (FT) at market-based

rates. ABC’s primary proposal is for

market-based FT rates for its entire

system (see map). As an alternative,

ABC requests market-based rates for

firm transportation between two market

centers, the Free Parking Hub, located in

the production area, and the Just

Visiting Hub, located in its market area.

In its alternative proposal ABC Pipeline

offers cost-based rates for service

upstream of the Free Parking Hub and

downstream of the Just Visiting Hub.

Finally, as part of its alternate proposal

ABC Pipeline is proposing to add

facilities so that it will interconnect

with all the pipelines at the Free

Parking Hub. The interconnections will

allow ABC to provide switching service

at the hub. ABC proposes market-based

rates for the switching service.

BILLING CODE 6717–01–P
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8367

BILLING CODE 6717–01–C
8368 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

62Of course, the pipeline would need to provide

the same information for all other origin and

destination markets.

The facts in this hypothetical are

patterned after the facts of a large

pipeline company and one of its major

customers. Facts have been added or

changed to better illustrate points in the

analysis.

In order to analyze ABC’s proposal,

staff identifies the relevant product and

geographic markets, measures the size of

the market, and calculates market shares

and the market’s concentration using

the Herfindahl-Hirschman Index (HHI).

Where market shares and the HHI are

high, staff examines other competitive

factors that might constrain the exercise

of market power.

A two step analysis is used to

examine both of ABC’s proposals. First,

one examines whether there is sufficient

competition along parallel routes for the

proposed market-based services.

Second, if there is not, one examines if

there is sufficient competition in the

origin and destination markets to

constrain the exercise of market power.

The Commission would deny ABC

Pipeline’s request if it finds that ABC

has market power over customers on the

relevant routes and in either origin areas

or destination areas of the geographic

market. To identify relevant geographic

markets, one first identifies pairs of

origin and destination markets. The

pipeline might identify one such pair as

the hypothetical Baltic field and City

Distribution Company (City).62

2. The Applicant’s Primary Proposal

a. The Relevant Facts

City Distribution is a large natural gas

public utility that serves millions of

customers. Its service area covers a large

metropolitan area. City’s service area is

located 100 miles downstream of the

Just Visiting Hub.

City has its own storage facilities with

a maximum daily storage withdrawal

capability of 1.0 Bcf/day and a total

working gas capacity of approximately

30 Bcf. Its peak day system demand is

approximately 3.0 Bcf/day. Thus, at full

utilization of its storage, City needs at

least 2.0 Bcf/day (3.0 Bcf/day—1.0 Bcf/

day) of transportation capacity on its

peak day to meet customer demand.

City has over 30 interconnections

with five interstate pipelines: ABC

Pipeline Company, the Short Line

Pipeline Company, the Boardwalk

Pipeline Company, the Ventnor Pipeline

Company, and the Pennsylvania

Pipeline Company. Table 1 shows City’s

contract rights to, and use of,

transportation capacity on all pipeline

connections to its city gate for 1994.

Table 1 shows the total capacity of the

pipelines in City’s metropolitan area.

The totals include capacity used to

serve another LDC within that

metropolitan area.

TABLE 1

Pipeline

MDQ

Rights

(Bcf)

USE

(Bcf)

Capacity

(Bcf)

ABC Pipeline (FT) . 1.3 1.5 1.5

The Short Line

Pipeline .............. 0.3 0.2 0.3

Boardwalk Pipeline

(FT) .................... 0.2 0.2 0.7

All Sources of IT .... ........... 0.3 ...........

The Ventnor Pipeline ..................... 0.2 0.2 0.7

The Pennsylvania

Pipeline .............. 0.1 0.1 0.1

Total ................... 2.1 2.5 3.3

City currently purchases a portion of

its peak day from gas produced in the

Baltic field. ABC Pipeline is currently

the only pipeline that connects to the

gathering system in the Baltic field.

Table 2 displays the nearest pipelines

and the estimated cost to connect these

pipelines to the Baltic field gathering

system :

TABLE 2

Pipeline* Connection

costs

The Atlantic Pipeline ................. $1,000,000

The Ventnor Pipeline ................ 2,400,000

The Boardwalk Pipeline ............ 17,000,000

The St. James Pipeline ............ 15,000,000

The Park Place Pipeline ........... 12,000,000

*The Atlantic and Ventnor Pipelines are affiliated, as are the Boardwalk and Park Place

Pipelines.

b. Product Market

In its filing to the Commission, ABC

might allege that there are numerous

good alternatives to its FT service for

City. It might start by alleging that two

other pipelines directly connect areas

that are very close to the Baltic field and

City’s city gate, and offer good

alternatives to customers on both ends

of the pipeline. It might further argue

that customers on each end can use FT

and interruptible transportation (IT)

service on other pipelines leading to

different market areas (in the case of

Baltic field shippers) or other supply

areas (in City’s case).

FT on other pipelines may be a good

alternative to ABC Pipeline’s FT.

However, ABC must demonstrate that

its customers can actually get firm

capacity on these other pipelines and

that the quality of such FT is

comparable to its own. Also, ABC must

demonstrate that other pipelines can

provide FT that is price competitive

with ABC’s.

IT service on other pipelines might be

a good alternative for FT. Indeed, Table

1 shows that City used 0.3 Bcf of IT to

meet its transportation needs on its 1994

peak day. ABC might argue that similar

levels of IT have been available at peak

for many years and can be expected to

be available in the future. If so, this

suggests that, at a minimum, IT was of

a sufficiently high quality (i.e., had a

sufficiently low probability of

interruption) that it could substitute for

FT in the past and could probably do so

in the future. However, ABC Pipeline

would need to present evidence that IT

was provided at a price that rendered

the price of delivered gas using IT at or

below the price of delivered gas using

FT. That might not be the case if City’s

receipt of IT required payment of IT

rates on several upstream pipelines,

thereby making IT not price

competitive. City might have been

forced to purchase IT even if its price

were much higher than that of FT. Also,

the IT shown in Table 1 was received

by City over several pipelines, including

ABC Pipeline. Thus, because ABC

would be able to affect the delivered

price of gas using IT service, it cannot

be counted as a good product alternative

to ABC Pipeline’s own FT.

Therefore, for both the primary and

alternate proposals, staff is defining the

product market to include ABC

Pipeline’s FT and FT on other pipelines.

However, interruptible transportation is

included in the product market for

switching service at the Free Parking

Hub.

c. Geographic Market: Parallel Route

In its application, ABC might argue

that three pipelines provide service

from the same production area as the

Baltic field to the same metropolitan

area as City and thus are parallel routes:

ABC Pipeline (with 1.5 Bcf of capacity),

the Boardwalk Pipeline (with .7 Bcf of

capacity) and the Ventnor Pipeline

(with .7 Bcf of capacity). ABC computes

an HHI of .39 for these three routes—

equivalent to about three equally large

firms. ABC might argue that this

provides some degree of competition,

which combined with other factors,

would justify a market-based rate. One

of the factors ABC mentions is that City

has buyer power because of its size.

However, ABC Pipeline does not

provide sufficient factual basis to

evaluate the level of City’s buyer power,

so staff is unable to consider this factor.

A closer examination of the example

would show that there are no parallel

route pipelines. Neither of the other
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8369

63See U.S. v. Aluminum Co. of America, 148 F.2d

416, 424 (2d Cir. 1945). The main issue in this case

was whether secondary scrap aluminum was in the

same market as primary aluminum. Judge Learned

Hand held that since Alcoa had produced the metal

reappearing as reprocessed scrap, it would have

taken into account in its output decisions the effect

of scrap reclamation on future prices, and therefore

secondary scrap should not be in the same market

as primary aluminum.

pipelines directly connect with the

producers in the Baltic field. Each

would need to build significant facilities

to reach the same origin market. Finally,

the applicant has not shown that

capacity would be available on either of

the two other pipelines in the same time

frame for which it seeks market-based

pricing.

d. Geographic Market: Destination Area

The relevant geographic destination

market includes all alternative sellers

that can provide FT to City’s city-gate

priced at or below transportation

services over ABC’s system, assuming a

15 percent FT price increase by ABC. If

ABC Pipeline wished to include all the

pipelines listed in Table 1, it would

have to demonstrate that their

transportation services met this criteria.

It would also have to demonstrate that

the transportation services over those

pipelines at least matched the quality of

transportation service over ABC

Pipeline.

Consider a simple measure of market

size and concentration first. Table 3

displays market shares and market

concentration for the FT suppliers to

City in 1994. Market shares are

calculated based on capacity at City’s

city-gate. There is additional pipeline

capacity within the metropolitan area.

ABC Pipeline, however, has not

provided evidence to show that the

capacity could be easily connected to

City’s city-gate. Absent such a showing

staff has used the lower capacity rights

figures in our calculations.

TABLE 3

Seller

MDQ

rights

(Bcf)

Market

share

Contribution

to HHI

ABC Pipeline

(FT) ............ 1.3 .62 .38

Short Line

Pipeline ...... 0.3 .14 .02

Boardwalk

Pipeline ...... 0.2 .10 .01

Ventnor Pipeline ............. 0.2 .10 .01

Pennsylvania

Pipeline ...... 0.1 .05 —

Total ........... 2.1 1.01 .42

In this instance, ABC has a very large

market share, 62 percent. Also, the HHI

is quite high (.42) indicating that the

market is concentrated. The market’s

HHI is well above the threshold levels

of .18–.25 commonly used by antitrust

authorities to identify competitive

markets. Were ABC to seek Commission

approval for market-based

transportation rates, it would have to

document that there are other factors,

such as ease of entry, excess capacity,

etc., that would eliminate the ability to

exercise market power that is not ruled

out by these high market shares and

high HHI.

ABC Pipeline might also allege that

released capacity on its own system and

on other pipelines would provide good

alternatives for City. However, in one

very important respect released

capacity, especially on ABC Pipeline

itself, will have little, if any, impact on

the assessment of ABC Pipeline’s

underlying market power in the primary

long-run FT market. An analogy might

help. Suppose there were only one

manufacturer of automobiles, but robust

used-car and leasing markets. Would the

manufacturer have monopoly power?

Yes. Even with a perfectly competitive

secondary market for automobiles, the

manufacturer could ‘‘contrive’’ a

scarcity by making fewer new

automobiles and charging a higher price

than necessary to cover costs.63

Similarly, if a pipeline has market

power, it would exploit it by

‘‘contriving a scarcity.’’ Although a

pipeline with a well-functioning

capacity release program might not

withhold existing capacity, it could

choose not to expand. Customers can

only release capacity they don’t need;

they can’t build. As demand grows, a

pipeline with market power could

simply enjoy higher prices and refuse to

build even if its customers were willing

to pay the incremental cost of

expansion. It would build only when

the market clearing price for FT went

above the monopoly price.

Thus, this analysis suggests that the

secondary market on ABC Pipeline may

discipline market power the pipeline

may have in selling IT and unsubscribed

or ‘‘short-term’’ FT, but not in new

primary FT. Released capacity on other

pipelines might discipline any market

power ABC Pipeline may have in the

long-term FT market, but the secondary

market on ABC Pipeline can do little to

discipline its market power in

supplying primary FT.

e. Other Competitive Factors

ABC Pipeline might argue that entry

is sufficiently easy that ABC would be

constrained from exercising market

power by new firms quickly entering the

market at relatively low cost. It seems

unlikely that building major new

transportation facilities to serve City

would be inexpensive or timely. Rather,

in a densely-populated urban area,

building a new pipeline would likely be

a contentious political and

environmental issue. ABC Pipeline

might, however, argue that the

Boardwalk Pipeline or other pipelines

could expand their existing

interconnections with City. To support

this argument it would need to show

that the connections could be made

without great expense or delay.

It may be that the four other pipelines

have significant amounts of excess

capacity at or close to City’s city-gate. In

the event that ABC Pipeline were to

attempt to exercise market power,

arguably such excess capacity could be

used by City to defeat such an attempt.

However, evidence currently at hand

suggests that only the Short Line

Pipeline has excess capacity.

Finally, staff did not address ABC

Pipeline’s argument regarding buyer

power since the destination market was

so highly concentrated and the analysis

was not fully developed.

f. The Destination Area: Caveats and

Conclusion

The market share and HHI

calculations in this example are based

on simplifying assumptions which

minimize market shares and market

concentration. First, by assuming that

any of City’s customers could be

supplied by any of the five pipelines

connecting to City, staff has

intentionally expanded the market and

thereby lowered market shares and HHI.

Second, staff did not include nonotice service. For this higher quality

service City may have very few

alternatives indeed, since no-notice

service would only be available to prerestructuring customers on the

alternative pipelines.

Rather than ABC Pipeline, the

Ventnor Pipeline or the Short Line

Pipeline might file for market-based

transportation rates to serve City on the

basis that the market shares shown in

Table 1 document their lack of market

power, despite the destination market’s

high HHI. If, however, City fully utilized

all of its FT at peak, then the Ventnor

Pipeline or the Short Line Pipeline

would be able to exercise market power

despite their small shares of the market.

Therefore, the Ventnor Pipeline or the

Short Line Pipeline would have to

demonstrate that City had alternatives at

peak, as well as demonstrating that they

lacked market power in the origin

markets.
8370 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

g. Geographic Market: The Origin Area

ABC’s pipeline is connected with the

gathering system in the Baltic field in

Louisiana. ABC Pipeline is the only

inter or intrastate pipeline that is

connected to this gathering system.

As for good alternative suppliers in

the origin area, ABC Pipeline would

have to demonstrate that the quality of

FT on other pipelines is comparable to

its own. Also, ABC would have to

demonstrate that other pipelines can

provide FT that is priced competitively

with ABC’s.

To show that other pipelines could

become good FT alternatives, ABC

Pipeline would have to show that other

pipelines could easily connect with the

gathering system in the Baltic field. Or,

ABC Pipeline might argue that the

producers could build gathering lines to

connect to these other pipelines at a

nominal cost. In either case, ABC would

have to show that building these

facilities would not reduce the netback

to these producers.

In this example, all of the pipelines

would have significant connection

costs. At most, it appears that only on

Atlantic would the cost of connecting

the Baltic field result in a price increase

of less than 15%. Thus, in the Baltic

origin area, producers seem to have at

most one good pipeline alternative to

ABC Pipeline. The conclusion,

therefore, is that staff cannot rule out

the possibility, indeed likelihood, that

ABC Pipeline has market power over

shippers transporting gas out of the

Baltic field origin area.

h. Primary Proposal: Conclusion

Our conclusion from analysis of this

hypothetical is simple and

straightforward. It is conceptually

possible to demonstrate that pipelines

lack significant market power over

shippers buying transportation from

supply fields to their city-gate

customers. However, the City example

suggests that such a showing would be

difficult.

3. The Applicant’s Alternate Proposal

a. The Relevant Facts

ABC Pipeline has also included a

more limited market based proposal in

its filing. ABC argues, at a minimum, it

should be able to charge market-based

rates for service between two market

centers on its system, the Free Parking

Hub and the Just Visiting Hub, and for

its proposed new switching service at

the Free Parking Hub. Table 5 shows the

six pipelines at the Free Parking Hub

and their capacity:

TABLE 5

MDQ

rights

(Bcf)

Market

share HHI

ABC Pipeline ..... 2.0 .21 .04

Oriental .............. *1.8 .29 .08

Vermont ............. *1.0 ........... ...........

Reading ............. 2.3 .24 .06

Pacific ................ .8 .08 .01

Mediterranean ... 1.7 .18 .03

Total ............... 9.6 1.00 .22

*Since Vermont and Oriental are affiliated

their capacity has been combined in computing market shares and HHIs.

Table 6 shows the five pipelines at the

Just Visiting Hub:

TABLE 6

MDQ

rights

(Bcf)

Market

share HHI

ABC Pipeline ..... 2.0 .20 .04

Short Line Pipeline ................. .5 .05 ...........

The Pennsylvania .................. *2.7 .54 .29

Reading ............. *2.5 ........... ...........

Oriental .............. 2.1 .21 .04

Total ............... 9.8 1.00 .37

*Since the Pennsylvania and Reading are

affiliated their capacity has been combined in

computing market shares and HHIs.

Three pipelines provide firm

transportation service between the two

hubs. Their capacity on the route is

shown in Table 7. In computing market

shares and HHIs staff has used the lower

of the pipeline’s capacity at the Just

Visiting and Free Parking Hubs as our

estimate of the maximum amount of

capacity that shippers can reserve

between the two hubs.

TABLE 7

MDQ

rights

(Bcf)

Market

share HHI

ABC Pipeline ..... 2.0 .33 .11

Reading ............. 2.3 .38 .14

Oriental .............. 1.8 .30 .09

Total ............... 6.1 *1.01 .34

*Total does not equal 1 due to rounding.

ABC Pipeline generally defines the

product market as firm transportation.

However, ABC argues that interruptible

switching service at the Just Visiting

Hub and the Free Parking Hub is the

functional equivalent of firm service.

b. Geographic Market: Parallel Route

In the example, three pipelines

provide firm transportation service

between the Free Parking Hub (origin

market) and the Just Visiting Hub

(destination market): ABC Pipeline

(with a .33 market share), Reading

Pipeline (with a .38 market share), and

Oriental (with a .30 market share). This

results in an HHI of .34 for this route—

equivalent to three equal sized firms.

ABC Pipeline might argue that the three

parallel route pipelines provide some

degree of competition. ABC might argue

that when this is combined with

additional competition at the origin and

destination markets there is sufficient

competition to justify market-based

rates.

In its alternate proposal ABC has not

proposed market-based rates for

transportation upstream of the Free

Parking Hub or downstream of the Just

Visiting Hub. Instead, it proposes a

regulated rate for such services that

would recover only the (relatively

small) costs of the facilities between the

Baltic field and the Free Parking Hub or

between the Just Visiting Hub and City’s

city-gate. This would ensure ABC could

not use market-based rates to exercise

market power over shippers at the

extremities of its system. However, such

a proposal would raise serious cost

allocation issues between ABC’s marketbased and cost-based services.

In the alternate proposal there is the

possibility of parallel route competition

because there are three pipelines that

serve both the origin and destination

markets. However, this is only the

beginning of the analysis. ABC Pipeline

must also show that: its customers can

switch gas between ABC and the

alternative pipelines at a low cost; its

customers can actually get firm capacity

on the Reading and the Oriental

Pipelines; and the quality and price of

firm service on these alternative

pipelines is comparable to that provided

on ABC Pipeline.

ABC argues that the Free Parking Hub

is a header that offers firm switching

service at minimal cost and that the Just

Visiting Hub offers interruptible

switching service among all the

pipelines. The first may offer the

customers good alternatives. The second

probably does not. Potential market

power problems here might be mitigated

if firm switching service was offered at

the Just Visiting Hub.

ABC argues that capacity release

programs can make capacity available

on the alternative pipelines. However, it

has not shown that customers can

obtain the same long-term FT service

through the release program. Potential

market power problems might be

mitigated if ABC could show that its

customers could buy the same long-term

service through the release market

(perhaps if the customers had many
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8371

64This example demonstrates the effect that

pipeline affiliation can have on market

concentration. If Reading and Pennsylvania were

not affiliated, the HHI for the Just Visiting Hub

would be .22, significantly lower than the .37 HHI

calculated with affiliate market share combined. An

HHI of .22 is much closer to a level which might

be deemed indicative of an unconcentrated market.

65For example, it would be necessary to identify

the cost of the facilities used for the market-based

services as well as any related operation and

maintenance costs. Also, there would need to be an

allocation of common and joint costs, such as

administrative costs, between the cost and marketbased services.

years remaining on their contracts) or at

some future time when the capacity on

all the pipelines would be available

simultaneously. It would also need to

show that such alternatives would be

competitively priced. It could do this

either by analyzing regulated prices or

by showing that all other pipelines

would be able to match any likely

market-based price on ABC. This would

be a difficult showing for any pipeline

if it was the only pipeline in the market

seeking market-based rates.

In the alternate proposal there is

possible parallel route competition

between the origin and destination

markets. However, even if all additional

market power problems were mitigated,

the HHI of the route is still well above

the .18 screen staff is using. So, staff

moves to the second step in the analysis

to examine the origin and destination

markets separately.

c. Geographic Markets: Destination

Markets

ABC Pipeline might argue four other

pipelines serve the Just Visiting Hub

and each of these pipelines would serve

as a good alternative to its service. ABC

might also argue two other pipelines,

the Ventnor and the Boardwalk have

facilities near the Just Visiting Hub.As

with the parallel route analysis, these

pipelines cannot be considered good

alternatives unless ABC Pipeline can

demonstrate its customers can get firm

transportation capacity at a price and

quality comparable to its own service.

The data indicate that the Just Visiting

Hub is highly concentrated. In

computing the HHI for the destination

market the two affiliates, the Reading

and the Pennsylvania, are treated as one

firm. Because these two pipelines

control half the capacity at the hub, the

HHI of .37 is actually higher than that

for the parallel route.64

If ABC Pipeline could show that the

Ventnor and the Boardwalk Pipelines

could easily connect to the Just Visiting

Hub this would significantly reduce the

HHI and make it easier to support

market-based rates for ABC Pipeline.

Alternatively, ABC Pipeline might argue

that market power at the Just Visiting

Hub is minimal if it could show that

there are other market centers close to

the Just Visiting Hub that could be

accessed by pipelines serving the Free

Parking Hub. If ABC Pipeline could not

show additional competitive factors that

reduce market power, the data would

not support market-based rates.

d. Hub Services

To justify market-based rates for

service between two markets, ABC must

show that both the origin and

destination markets are competitive.

ABC has not shown that the destination

market, the Just Visiting Hub, is

competitive. Therefore, it has not

supported its proposal for market-based

rates between the two hubs. However,

ABC has also requested market-based

rates for hub services at the Free Parking

Hub.

To support its proposal for marketbased rates for hub services, ABC

Pipeline might argue that currently the

Mediterranean Pipeline interconnects

with the five other pipelines at the Free

Parking Hub. When ABC builds its

additional interconnections there will

be two pipelines that connect with all

the pipelines at the Free Parking Hub.

In addition, these pipelines have several

other alternative points of

interconnection within a 100 mile

radius of the hub and within the same

rate zone. ABC argues that its customers

can get the equivalent of ABC’s

switching service at these points of

interconnection. ABC has provided a

chart which shows that in addition to its

proposed new facilities a shipper on any

one of the five other pipelines has at

least three alternative interconnections

for each pipeline within the same rate

zone. Some of these are direct

interconnections and some require

switching service at other nearby

production area hubs. Further,

interruptible capacity is consistently

available within the production area

and is of a very high quality, i.e.,

curtailments are rare. Thus, each

shipper has at least three good

alternatives to ABC’s proposed

switching service at the Free Parking

Hub. This means that the highest HHI

for ABC’s switching service with any

pipeline is .25.

The HHI of .25 for switching service

is above staff’s initial screen. However,

there are other competitive factors that

would reduce ABC’s ability to exercise

market power. One of these factors is

the open access requirement that all

open access pipelines must receive or

deliver gas to other pipelines if capacity

is available. By scheduling receipts and

deliveries at the alternative points of

interconnection a shipper can get the

equivalent of switching service. And,

when this is part of the basic point-topoint transportation service, there is no

additional charge. Another competitive

factor is ease of entry. In this area some

of the pipelines could build additional

interconnections at minimal cost. It

would be economic to build these

interconnections if ABC attempted to

exercise market power by charging

excessive rates.

ABC has shown that its customers

would have good alternatives to its

switching service. Therefore, marketbased rates are appropriate for its

switching service at the Free Parking

Hub.

e. Conclusion

Given the high level of concentration

in the route and in the destination

market, it is unlikely that ABC Pipeline

could justify market-based rates for

service between the two hubs. However,

using the same criteria, market-based

rates can be supported for hub services

at the Free Parking Hub.

In the example, staff has assumed that

a pipeline might have both cost and

market-based FT rates on its system.

Any such proposal would require a

method for allocating costs between

cost-based and market-based services.65

4. Results of Analysis of Hypothetical

Staff must conclude that ABC would

find it difficult to justify market-based

rates for point-to-point FT on its system.

Based on current data ABC may be able

to justify market-based rates for some

hub services. In the future, ABC may be

able justify market-based rates for more

services. As the transportation market

evolves, pipelines may find it economic

to build connections to more hubs. This

will increase the number of alternatives

at each hub and thus will make it easier

to satisfy the criteria for market-based

rates for hub services or for

transportation between hubs.

C. Application of Criteria to Other

Services

Under the standards proposed above,

as the example involving ABC Pipeline

shows, it is unlikely that FT rates for

any city-gate customer would be marketbased. The same is true for any rates

paid by producers directly attached at

the other end of the pipe. What role,

then, beyond the gas commodity and

storage services, would market-based

prices play?

The answer is that market prices may

play an important role in capacityrelease, IT, and market-center services.

As illustrated in the ABC Pipeline

example, the many new sources of FT
8372 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

66For example, Transwestern was required to file

monthly reports of market based sales under Rate

Schedule ISS. 43 FERC ¶ 61,240 (1988). Buckeye

was required to file annual reports showing rates,

volumes, and revenues for each destination market.

See 66 FERC ¶61,348, for a review of these reports.

For electric utilities, the Commission has required

power marketers selling at market based rates to file

quarterly reports showing prices and quantities for

individual transactions [e.g., Heartland, 68 FERC

¶ 61,223 (1994)]. Among other things, the reports

are intended ‘‘to provide for ongoing monitoring of

the marketer’s ability to exercise market power.’’

67For example, assume in the original market

power analysis the Commission found there were

four good alternatives in an origin market. A

subsequent corporate merger of two of the pipelines

and the abandonment of facilities by another would

reduce the number of good alternatives to two.

There have been no new entrants into the origin

market. These changes probably would significantly

affect the continuing validity of the original market

power finding.

1 Judge (now Justice) Stephen Breyer gives an

example of how a merger ‘‘pessimist’’ might assess

a proposed airline merger quite differently from a

merger ‘‘optimist,’’ though both use the same

antitrust framework and agree on all the facts. See

discussion of the interplay between antitrust and

deregulation of the airline and telephone industries

in his contribution to the ‘‘Symposium: Anticpating

Antitrust’s Centennial: Antitrust, Deregulation and

the Newly Liberated Market Place,’’ 75 California

Law Review 1005–1047 (May 1987).

potentially available through the

capacity release market will have little

or no effect on a pipeline’s long-run

market power. They may, however, have

a strong effect on either the primary

capacity holder’s (i.e. LDC’s) or the

pipeline’s ability to exercise market

power in the capacity release market,

the short-term firm market, or the IT

market. For these services, there are

very few existing long term contracts.

Moreover, a major interstate pipeline

may have 10 to 20 different holders of

FT capacity within a zone. Flexible

(secondary) firm receipt and delivery

point rights, in concept, give any of

these primary holders or their

replacements the ability to move gas to

any upstream city-gate on the system.

Thus, the secondary market in FT may

well be unconcentrated. If released FT

can be shown to be a good substitute for

IT or short-term FT from the pipeline,

then the released FT, IT and short-term

FT market will be unconcentrated.

Any such arguments would depend

on the effectiveness of the capacity

release program in making released

capacity at least the equal of IT. While

it is doubtful that any such showing

could be made now, with further

improvements in the capacity release

program this could occur.

In addition, part of the showing must

contain evidence that LDCs could not

frustrate ‘‘secondary firm’’ firm

deliveries made at their city-gates by

controlling the flows behind their own

city-gate delivery points. Flexible

receipt and delivery points are the key

to a competitive finding; if an LDC is,

aside from the pipeline, the only source

of FT to its city-gate then it has market

power. If secondary firm is an effective

alternative, however, then there is a

good likelihood that these markets

would pass the stringent tests laid out

above.

Some market-center services, such as

short-term switching and parking, may

also pass the test. Market-centers, by

their nature, are where many pipelines

intersect and, often, where there are

multiple suppliers of storage service. In

such cases, it is likely that the providers

could show that customers will have

many good alternatives at the marketcenter itself or in nearby market-centers.

In conclusion, application of the

standards laid out in part IV.A is likely

to mean continued cost-based regulation

of primary FT, but may permit market

pricing for released FT, IT and shortterm FT and for market-center services

such as switching and parking.

All-in-all, the potential for further

reliance on market pricing is rather

modest. On the other hand, market

pricing in the capacity release and

market-center services markets could be

a key to their success. Hubs could play

an important role in further perfecting

the spot market for gas, but to do so is

likely to require creative approaches to

new services and new ways of adding

value to the gas commodity. Creative,

economical, new services are far more

likely to develop under market pricing

than under a cost-of-service approach.

D. Review of Market Power Findings

As discussed in part I, an important

factor to the court of appeals in

Elizabethtown, in which the

Commission permitted gas sales at

market prices, was the Commission’s

assurance that it would exercise its

section 5 authority if necessary to assure

that the market price was just and

reasonable. This means that the

Commission must consider how it will

monitor market-based rates so that it can

exercise its oversight responsibilities.

In past cases the Commission

established, on a case-by-case basis

some reporting requirements for

companies authorized to charge market

based rates.66 The Commission may

want to consider developing standard

periodic reporting requirements on

prices and quantities in market-based

transactions. Periodic reports would

make it possible for the Commission to

monitor market-based rates to ensure

that the rates are within a zone of

reasonableness. The Commission may

also want to establish a more formal

procedure for reporting changes in

circumstances that could affect the

market power finding, i.e.,

circumstances that reduce the number

of good alternatives in a market.67 If

circumstances change the Commission

could either reconsider its prior market

power findings or wait until a complaint

is filed to take action.

Appendix: Analysis of Other Industries

As discussed in the paper, the FERC has

consistently used the same general

framework to evaluate when the market,

rather than cost-of-service rate regulation,

could be relied upon to produce just and

reasonable rates. This framework has been

evolving for over one hundred years in

antitrust litigation and analysis and has now

been codified in the DOJ/FTC merger

guidelines. FERC is neither the first agency

to choose light-handed regulation where a

lack of significant market power can be

shown, nor the only one to use antitrust

standards as a framework for the showing.

The general framework, however, is far from

a set of mechanical rules; the application of

the framework to a particular industry calls

for many specific decisions and to an

individual case requires many judgement

calls.1

The Interstate Commerce Commission

(ICC), the first national regulatory agency and

pioneer in cost-of-service ratemaking, was

also among the first to move toward

deregulation or light-handed regulation for

railroads and trucks. About twenty years ago

the ICC began to lessen or eliminate

regulation of railroads and trucks, the FCC

allowed new entrants to compete for long

distance telephone service and the CAB

relaxed its price and entry controls over the

airlines. The experience of these three

agencies may provide some useful guidance

for the Commission in deciding whether

certain natural gas pipeline transportation

services should be permitted market-based

pricing and, if so, how those services should

be identified.

Railroads, airlines, long distance

telephones and natural gas pipelines all have

much in common besides being regulated.

They are all transportation/transmission

networks characterized by a high ratio of

fixed to variable costs, making ‘‘load factor’’

the key to unit operating costs, and, with the

possible exception of airlines, all have

significant economies of scale (an element of

‘‘natural monopoly’’). However, there are also

significant differences among all of these

industries so analogies and policy

conclusions based on their similar

characteristics should be made cautiously.

A. Interstate Commerce Commission

Regulation of Railroads

Railroads and natural gas pipelines have

some important characteristics in common.

Both transport using assets that are immobile

once they are constructed, though railroads

invest in ‘‘rolling stock’’ as well track and

roadbed. Further, both exhibit the same

‘‘natural monopoly characteristic’’ that the

construction costs necessary for one

company to transport a given amount

between two points are usually significantly
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8373

2The information provided here on the Interstate

Commerce Commission is drawn from the Interstate

Commerce Commission Decision, ‘‘Product and

Geographic Competition’’ Ex Parte No. 320 (Sub-No.

3), October 24, 1985.

3Former Section 1(5) of the Interstate Commerce

Act.

4Pub. L. No. 94–210, 90 Stat 31, February 5, 1976.

5Market dominance was defined in the statues as

‘‘an absence of effective competition from other

carriers or modes of transportation for the traffic or

movement to which a rate applies.’’

6Pub. L. No. 96–448, 94 Stat. 1895 (1980). One

part of the Act directed the ICC to make a finding

of no dominance if the carrier shows that a

challenged rate would yield a revenue-to-variable

cost percentage less than a given percentage. More

generally, the Act made it federal policy to rely on

competition, rather than regulation, to establish

reasonable rail rates. Additionally the Act allowed

railroads to enter into confidential agreements with

shippers, cancel existing joint rates with other

railroads that were not sufficiently profitable, and

set time limits on the abandonment process.

7 ‘‘Product and Geographic Competition,’’ supra.

The adopted guidelines were listed in Appendix C.

8 It is interesting to also note, that while

developing these guidelines, the ICC refused to

adopt specific HHI levels for reasons that are

similar to those stated by FERC when refusing to

adopt specific HHI levels in Gas Inventory Charge

and Oil Pipeline cases.

9 General Accounting Office, ‘‘Railroad

Regulation: Economic and Financial Impacts of the

Staggers Rail Act of 1980,’’ May 1990.

10 Id. at p. 5.

11Wesley W. Wilson, ‘‘Market-Specific Effects of

Rail Deregulation,’’ Journal of Industrial Economics,

62 (March, 1994), pp. 1–22. See this article’s

‘‘References’’ for other articles evaluating the effect

of deregulation on prices.

lower than the construction costs necessary

for two companies to jointly transport the

same amount between those points. Finally,

both industries make extensive use of

eminent domain granted from Federal and

state governments to acquire land to build

networks.

One significant difference between the two,

however, is that pipelines carry a fungible

product while railroads generally do not.

That is, a pipeline customer who tenders gas

in Louisiana and withdraws gas in Chicago,

does not care if the gas withdrawn came from

Appalachia while the tendered Louisiana gas

went somewhere else. In contrast, a railroad

customer in Chicago expecting a shipment of

Louisiana shrimp will be very unhappy if

Appalachian coal is delivered instead.

Another important difference is that railroads

face major intermodal transportation

competition (air competition and trucks

everywhere and barges in some areas), while

there is no viable intermodal competition to

pipelines in transporting natural gas.

Important characteristics are similar

enough between railroads and pipelines that

the Interstate Commerce Commission’s

(ICC’s) handling of market-based pricing may

inform FERC’s handling of the issue. Of

particular note are: (1) The ICC’s initial

rejection followed by the acceptance of the

traditional economic paradigm used to

evaluate competitiveness, (2) the guidelines

now used by the ICC in evaluating

competitiveness, and (3) evaluations of the

effects of increased reliance on market forces.

1. Recent Changes in Railroad Regulation 2

Before 1976, all rail rates were subject to

regulation by the Interstate Commerce

Commission (ICC) under the statutory ‘‘just

and reasonable’’ standard.3 The Railroad

Revitalization and Regulatory Reform Act of

1976 was enacted to restore financial stability

to the industry.4 This restoration was to be

accomplished partially through reducing

regulatory restraints on railroad pricing

decisions by limiting ICC jurisdiction over

maximum rates to situations where railroads

have ‘‘market dominance.’’ 5

Market dominance determinations thus

became of the utmost importance when rates

were challenged. The ICC initially adopted

three ‘‘presumptions’’ of market dominance:

the railroad handled 70% of traffic (the

‘‘market share’’ presumption), revenues

exceeded 160% of the variable costs (the

‘‘cost’’ presumption), and the shipper had a

substantial investment in rail-related plant or

equipment (the ‘‘rail investment’’

presumption). Any one of these

presumptions being established and

unrebutted would establish market

dominance and ICC jurisdiction.

The ICC determined that the relevant

market in the ‘‘market share’’ presumption

would be confined to direct carrier

competition for the specific product

movement. The ICC explicitly rejected the

traditional antitrust framework used to

evaluate competition; the ICC determined

that product competition (competition by

other products), or geographic competition

(availability of the same product from

alternative sources or destinations) was not

relevant.

Several years of experience combined with

the need to implement the Staggers Rail Act

of 1980,6 caused the ICC to abandon the

initial presumptions and adopt new

guidelines which incorporate the traditional

economic paradigm for evaluating

competition. The ICC ‘‘. . . concluded that

the presumptions did not necessarily reflect

the degree of railroad market power, and

therefore, yielded inaccurate market

dominance determinations.* * * The

quantitative measures (i.e., the market share,

cost, and rail investment presumptions) were

found to be poor indicators of market

dominance in the widely varying fact

situations to which they were designed to

apply.’’ 7

2. Current ICC Guidelines for Evaluating

Market Dominance

Some of the ICC market dominance

guidelines have no apparent relevance to

FERC because they deal with intermodal

transportation competition. However, other

aspects of the ICC guidelines deal with issues

nearly identical to those important to FERC

in analyzing competition. These potentially

informative portions of the guidelines are

briefly summarized here.8

The ICC ‘‘market dominance’’ guidelines

lay out what type of evidence is considered

important.

Regarding competition from other

railroads, the number of alternatives and the

feasibility of alternatives are important.

Feasibility is evidenced by (1) the physical

characteristics of the alternative, (2) the

direct access of both the shipper and

receiver, (3) the cost of using the alternative,

and (4) the evidence of relevant investment

or long-term contracts.

Regarding geographic competition,

considered important are: (1) The number of

alternative destinations for shippers or

alternative sources for receivers, (2) the

number of alternative destinations or sources

served by alternative carriers, (3) the

suitability of the product available at each

relevant source or required at each relevant

destination, (4) the operational and economic

feasibility of transportation from alternative

sources or to alternative destinations, (5) the

accessibility of alternative transportation, (6)

the capacity of alternative sources to supply

the product or alternative destinations to

absorb the product, and (7) the evidence of

relevant investment or long-term contracts.

Regarding product competition, considered

important are: (1) the substitutability and

availability of the substitute products, and (2)

all costs of using the substitute product

relative to using the product in question.

3. The Effect of Reducing Railroad Regulation

The 1976 Railroad Revitalization and

Regulatory Reform Act and the 1980 Staggers

Act were intended to improve the financial

health of the railroad industry. By most

measures, the railroads’ financial condition

has improved since 1980. Return on

investment averaged about 4.9% from 1980

to 1988; this is up from the 2.5% average in

the 1970s. Debt has declined from about 36%

of total capital in 1980 to about 24% in

1988.9

While the regulatory reforms were

successful in improving the financial

condition of railroads, these reforms have not

achieved total financial health for the

industry. ‘‘[T]he railroad industry as a whole

has not achieved revenue adequacy—that is,

its return on investment has not equaled or

exceeded the current cost of capital.’’ 10

Regarding the effects on rates rather than

on the railroad’s financial condition, a recent

journal article concludes ‘‘* * * the effect of

deregulation on prices has generally been to

lower them. With price decreases and cost

savings from deregulation, welfare gains from

deregulation are likely to be positive.’’ 11

B. Market-Based Rates in Long Distance

Telecommunications

To the extent there are similarities between

long distance telecommunications and

natural gas pipeline services, lessons can be

learned from the FCC’s experience with

market based pricing. The FCC used a market

power framework in its Competitive Carrier

Proceedings, when determining the

appropriate regulation for long distance

service.

1. Comparison of the Industries

The long distance telecommunications

market has some similarities to the natural

gas pipeline market. First, with the original

copper and, most recently, fiber optic cable

methods of providing service, it has natural

monopoly characteristics. Second, it has long

been considered a public utility and until

recently, was subject to standard cost-ofservice regulation. Third, it provides long-
8374 Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices

12Huber, Peter W., The Geodesic Network II: 1993

Report on Competition in the Telephone Industry,

p. 3.4.

13Wall Street Journal, July 22, 1994, p. A2.

14Meanwhile, technology has begun to remove

the local natural monopoly for telephone service.

There are a large number of potential and credible

providers of local service including cable television

providers and radio-based and cellular carriers.

15First Report and Order, 85 F.C.C. 2d 5 (1980).

16Notice of Inquiry and Proposed Rulemaking, 77

F.C.C. 2d at 350 (1979); and First Report and Order,

at p. 21.

17First Report and Order at p. 21.

18Further Notice of Proposed Rulemaking, 84

F.C.C. 2d at 499–500 (1981); and Second Report and

Order. 91 F.C.C. 2d (1982).

19Notice of Inquiry and Proposed Rulemaking, 77

F.C.C. 2d at 352–353; and First Report and Order,

supra.

20Streamlining also gave (1) blanket approval for

expansions, (2) reeduced the filing period

(substantially) to 14 days, and (3) required no

financial information.

21Bailey et al., provide some of the evidence

indicating that economies of scale are modest at pp.

50–54. Fred Kahn, however, suggests that, from

hindsight, economies of scale were underestimated.

The ‘‘thoroughgoing’’ movement to a hub and spoke

system was not foreseen. See ‘‘Surprises of Airline

Deregulation,’’ American Economic Review, May,

1985, 316–322.

22See Stephen Breyer, Regulation and Its Reform,

Harvard, 1982, 197–221; and Elizabeth Bailey,

David Graham and Daniel Kaplan, Deregulating the

Airlines, MIT, 1985, 11–26.

23Senate Comm. on the Judiciary, Subcomm. on

Admin. Practice and Procedure, 94th Cong., 1st

Sess., Civil Aeronautics Board Practices and

Procedures. (1975).

24Breyer was the Committee’s chief investigator.

line service, and (since divestiture in 1984)

inter-connects with independent local

networks to deliver the service.

There are several differences as well. First,

there is no production area nor market area

for calls, although call concentration is

higher in metropolitan areas. Second, the

customer cannot determine the route that his

calls take on a carrier, and may not switch

carriers within the path. Third, calls are not

fungible or interchangeable, as are gas

molecules. For example, a customer wants to

talk to his or her family, friends, or business

associates, not someone else’s.

2. History of Long Distance Service

The history of telecommunications

regulation has been one of playing catch-up

to technological change. Local and longdistance services were assumed to be natural

monopolies, to be provided by AT&T. The

fixed plant was expensive, and subject to a

declining average cost of service, and all

customers needed to be interconnected.

The natural monopoly disappeared with

microwave technology because after a critical

mass, more traffic requires a roughly

proportionate increase in towers and more

transmitters.12 In 1977, the FCC allowed MCI

into the market. It also allowed general OCC

(Other Common Carrier) entry in 1977. In

1979, the FCC began the Competitive Carrier

proceedings which ultimately effectively

allowed market-based pricing for carriers

other than AT&T. The two largest OCCs, MCI

and Sprint, currently control 25% of the

long-distance market.13 Local services

remained a natural monopoly.14

3. Light-Handed Regulation of Non-Dominant

Firms

In the Competitive Carrier proceedings,15

the FCC minimized the regulation of OCCs.

It based its actions on two principles: First,

in order to retain business with prices above

total costs a firm must possess market power

and some firms did not. Second, regulation

imposes costs. There are the administrative

costs of compiling, maintaining, and

distributing information necessary to comply

with reporting and licensing requirements.

More significant costs on society come from

the loss of dynamism which can result. The

FCC cited to the Averch-Johnson effect in

which rate of return regulation can distort the

input choices of a regulated firm away from

production at minimum cost. It also

discussed effective competition being limited

by firms being required to give advance

notice of innovative marketing plans and

having those initiatives subject to public

comment and review. The FCC said that the

posting of prices and legal obligation to

refrain from ‘‘unjust and unreasonable

discrimination’’ may well result in artificially

stabilizing prices to the consumer’s eventual

disadvantage.

Competitive Carrier characterized carriers

as dominant (eventually only AT&T) or nondominant. Initially, it defined dominant

firms as firms with market power.16 The FCC

said that it focused on certain market features

to determine if a firm can exercise market

power: The number and size distribution of

competing carriers, the nature of barriers to

entry and the availability of reasonably

substitutable services.17

As the FCC refined its determination of

which carriers could be subject to lighterhanded regulation, it concluded that once a

determination of market power was made, it

would look at the degree of power before

determining whether regulations conferred

greater benefits on customers than costs.18

The agency reasoned that non-dominant

carriers lacked (substantial) market power,

and that the costs outweighed the benefits of

regulating such firms. It held that nondominant firms:

• Can’t charge excessive rates;

• Can’t discriminate without losing their

customers; and

• Can’t pass on the costs of inefficient

investments to customers.

Applying its definitions, the FCC

determined that AT&T was a dominant

carrier because of its historical market power,

immense financial and technological base,

control over monopoly interconnection

facilities, and substantial cross-subsidization

potential. In addition, it is an effective price

leader.19 Over time, the FCC found that all

other carriers were non-dominant.

The FCC decreased the regulations for nondominant carriers in two phases:

streamlining and forbearance. Under both,

non-dominant carriers were required to

charge just and reasonable and nondiscriminatory rates. With streamlining, the

FCC presumed that tariff filings were legal,

and required no cost justification of the

tariffs.20 Forbearance went further than

streamlining, by not requiring tariff filings

from non-dominant firms. The Supreme

Court later overruled this, as discussed in

part I above.

C. The Cab and Airlines

Airline transportation and its regulation

has many similarities to gas pipeline

transportation. On any given trip, the

variable cost of flying the aircraft is

essentially the cost of the fuel used, just as

the variable cost of transporting gas is the

fuel used by the compressors. Unit costs,

therefore, are highly sensitive to utilization

or load factors. Economies of scale attainable

through the use of larger airplanes, however,

have been thought to be less important than

for gas pipelines.21 Airline companies, like

pipeline companies, needed a public

convenience & necessity certificate to serve

or abandon any interstate route; rates and

terms and conditions were strictly regulated.

Discounts were allowed, if at all, after a

hearing at which competitors could either

challenge the proposed rates or match them.

Differences were and are important.

Airlines generally have little substantial

investment in immobile assets like roadbed,

track or in laying pipe. Airports, landing slots

and air-traffic control are generally

government supplied. Economies of aircraft

scale, while present, are less pronounced

than for pipelines. Air traffic, in contrast to

natural gas, is not fungible. When you go to

pick up your grandparents at the airport, you

expect unique rather than generic

grandparents to deplane. Regulation was

thought necessary, not because airlines were

a natural monopoly, but because they were

thought to be subject to ‘‘excessive

competition.’’ Under this theory, regulation

was necessary to prevent airlines from

bankrupting each other through overbuilding

and excessive price competition.22 Another

purpose was to provide direct subsidies to

encourage the growth of general aviation. The

history of airline deregulation also differs

greatly from that for natural gas pipelines.

While the CAB itself, under Alfred Kahn,

initiated some important changes in 1977

under the Civil Aviation Act (1938), Congress

decided, in 1978, to phase out all CAB

regulation and the agency itself by 1985. The

change from a highly regulated environment

designed to minimize competition to a free

entry environment emphasizing price

competition occurred in a remarkably short

time.

1. Problems That Led to Deregulation

The Senate held hearings on airline

regulation in February 1975. The study

released later that year was highly critical of

the CAB.23 Stephen Breyer,24 summarized

the study as revealing several ‘‘serious

defects’’ relating to rates, routes, efficiency

and agency procedures, two of which were:

Rates. Regulation led to high prices and

overcapacity. Because the airline industry

was highly competitive and because the CAB

prevented price competition, the airlines

channeled their competitive energies into

providing more and costlier service—more

flights, more planes, more frills * * * Yet the

planes themselves flew more than half

empty. (Breyer, 1982, 200)
Federal Register / Vol. 60, No. 30 / Tuesday, February 14, 1995 / Notices 8375

25The analog for pipeline transportation would

be ‘‘origin-destination’’ pairs, but both the

Commission and DOJ have generally analyzed

pipeline origin and destination markets separately.

Why the difference? Oil and gas are fungible, airline

passengers and freight are not.

26Elizabeth Bailey, David Graham, and Daniel

Kaplan, Deregulating the Airlnes (MIT, 1985), and

Steven Morrison and Clifford Winston, The

Economic Effects of Airline Deregulation

(Brookings, 1986).

27Alfred Kahn, ‘‘Supreses of Airline

Deregulation,’’ American Economic Review (May,

1988).

Routes. Regulation effectively closed the

industry to newcomers and guaranteed

relatively stable market shares to firms

already in the industry. (Id., 205)

The Airline Deregulation Act was signed

into law in 1978. The Act phased out the

CAB’s authority and the Board itself ceased

operations entirely by 1985.

2. The Role of Market Power Analysis in

Airline Deregulation and Merger Policy

Market power analysis was an important

factor in the rapid deregulation of airlines

and an even more important factor in the

merger policy that controlled consolidation

within and exit from the industry. An

important element of the case against

regulation was that but for regulation, the

industry would be much less concentrated at

the national level than it was under CAB

regulation. The relevant market for the

traveler was usually defined to be the ‘‘citypair,’’ the two cities between which the

traveler wishes to fly.25 Advocates of

deregulation did not argue that each airline

would find itself battling hosts of actual

competitors. They claimed only that the

threat of entry into a particular market by

airlines not currently serving that market

would hold prices down. An airline that

serves city A and city B, but does not fly

between them, can enter the A–B market at

very low cost, and there are several such

airlines serving most major routes.

The Board based its assessment of the

likely effects of a merger on two related

findings: that concentration measures based

on city-pair markets alone are not an accurate

gauge of competitive performance and that

potential entry would have an important

disciplining effect on performance. (Bailey et

al, 1985, 173–202). Market definitions were

often contested. The DOJ in the Northwest/

Republic merger, for example, argued that the

relevant product market was ‘‘non-stop’’

flights between city- pairs. In other cases

witnesses have argued over whether the

appropriate definition should be airport

pairs, city pairs, or the complex of services

representative of a hub and spoke network.

But in all cases the same general relevant

market definition framework has been used.

Breyer (1987) suggested that antitrust rules

designed to deal with industry in general

may not properly reflect the unique features

of the airline industry. For example, he

cautioned against applying the ‘‘optimistic’’

merger view that is more lenient on higher

concentration thresholds and places great

store on ‘‘potential competitors,’’ fearing that

such an antitrust view would not be stringent

enough. On the other hand, he would be

more lenient than the merger guidelines with

respect to the ‘‘failing company’’ or efficiency

defenses for merger, to reflect that fact that

the airline industry is emerging from forty

years of regulation.

3.The Effects of Airline Deregulation

Virtually all observers agree that airline

fares have been much lower and traffic

immensely larger than they would have been

absent deregulation.26 However, as Alfred

Kahn put it, there were some ‘‘unpleasant

surprises’’ as well.27 Although in the early

years there was much new entry, most failed

and national concentration in the industry

failed to decline as most proponents of

deregulation had predicted. Quality of

service declined. Another unpleasant

surprise to Kahn was ‘‘the persistenceindeed, intensification-of price

discrimination * * *’’ despite which the

airline industry has experienced severe

losses and only a few carriers have been

profitable.

[FR Doc. 95–3631 Filed 02–13–95; 8:45 am]

BILLING CODE 6717–01–P

Issuance of Decisions and Orders for

the Week of December 5 Through

December 9, 1994

During the week of December 5

through December 9, 1994 the decisions

and orders summarized below were

issued with respect to appeals and for

other relief filed with the Office of

Hearings and Appeals of the Department

of Energy. The following summary also

contains a list of submissions that were

dismissed by the Office of Hearings and

Appeals.

Appeal

Eric Engberg, 12/5/94, VFA–0010

CBS News Correspondent Eric

Engberg (Engberg) filed an Appeal from

a determination issued by the

Albuquerque Operations Office

(Albuquerque). The determination

denied, in part, a Request for

Information which Engberg submitted

under the Freedom of Information Act

(FOIA). Engberg requested various travel

documents submitted by security

personnel, known as couriers, who had

travelled with Secretary of Energy Hazel

R. O’Leary. Albuquerque released

responsive documents, from which

names, home addresses, Social Security

numbers, home telephone numbers,

credit card numbers, and expiration

dates had been redacted pursuant to

FOIA Exemption 6. Engberg appealed

only the deletion of the names. In

considering the Appeal, the DOE found

that Albuquerque had failed to

adequately justify the withholding of

the couriers’ names under Exemption 6.

In the course of the Appeal,

Albuquerque requested an opportunity

to re-evaluate the applicability of

Exemption 6 and other FOIA

exemptions to the withheld names.

Consequently, the DOE granted in part

the Appeal and remanded the matter to

Albuquerque for a new determination.

Refund Applications

The Office of Hearings and Appeals

issued the following Decisions and

Orders concerning refund applications,

which are not summarized. Copies of

the full texts of the Decisions and

Orders are available in the Public

Reference Room of the Office of

Hearings and Appeals.

Atlantic Richfield Company/Costain Coal, Inc ............................................................................................................ RF304–15459 12/06/94

Empire Coal Company ............................................................................................................................................... RF304–15460 ...................

Atlantic Richfield Company/Vaccaro & Son Arco et al .............................................................................................. RF304–14638 12/06/94

Crystal Water Co. et al ............................................................................................................................................... RF272–85480 12/06/94

Cubby Oil Co., Inc ...................................................................................................................................................... RF272–97229 12/06/94

Dalton Asphalt Corp et al ........................................................................................................................................... RF272–94139 12/06/94

Dart Container Corporation ........................................................................................................................................ RF272–66874 12/05/94

Dart Container Corporation ........................................................................................................................................ RD272–66874 ...................

E & B Paving, Inc ....................................................................................................................................................... RF272–67026 12/07/94

E & B Paving, Inc ....................................................................................................................................................... RD272–67026 ...................

Epes Transport System, Inc ....................................................................................................................................... RF272–93329 12/08/94

Farmers Cooperative Elevator et al ........................................................................................................................... RF272–94704 12/06/94

Good Hope Refineries/Howard Oil Company ............................................................................................................ RF339–17 12/08/94

Gulf Oil Corporation/City of Rocky River et al ........................................................................................................... RF300–21325 12/07/94

Gulf Oil Corporation/Fallwood Service Center ........................................................................................................... RF300–18460 12/06/94

Gulf Oil Corporation/Kirk Brown’s Gulf Service et al ................................................................................................. RF300–18153 12/08/94