Document ID: FERC-2005-0538-0001
Agency: ferc
Document Type: Notice
Title: Practice and procedure: Natural gas pipelines;selective discounting policy
Posted Date: 2005-11-23T05:00Z

[Federal Register: November 23, 2005 (Volume 70, Number 225)]
[Notices]               
[Page 70802-70819]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23no05-67]                         

-----------------------------------------------------------------------

DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

[Docket No. RM05-2-001]

 
Policy for Selective Discounting by Natural Gas Pipelines; Order 
Denying Rehearing

November 17, 2005.

    Before Commissioners: Joseph T. Kelliher, Chairman; Nora Mead 
Brownell, and Suedeen G. Kelly.

    1. On May 31, 2005, the Commission issued an order (May 31 
Order)\1\ in this proceeding reaffirming the Commission's current 
policy on selective discounting. Timely requests for rehearing of that 
order were filed by the Illinois Municipal Gas Agency (IMGA) and, 
jointly by Northern Municipal Distributor Group and the Midwest Region 
Gas Agency (Northern Municipals). For the reasons discussed below, the 
requests for rehearing are denied.
---------------------------------------------------------------------------

    \1\ 111 FERC ] 61,309 (2005).
---------------------------------------------------------------------------

Background

    2. The prior orders in this proceeding set forth the background and 
development of the Commission's selective discounting policy.\2\ 
Generally, as explained in those orders, the Commission's regulations 
permit pipelines to discount their rates, on a nondiscriminatory basis, 
in order to meet competition. For example, if a fuel-switchable shipper 
were able to obtain an alternate fuel at a cost less than the cost of 
gas including the transportation rate, the Commission's regulations 
permit the pipeline to discount its rates to compete with the alternate 
fuel, and thus obtain throughput that would otherwise be lost to the 
pipeline. As the Commission has explained, these discounts benefit all 
customers, including customers that do not receive the discounts, 
because the discounts allow the pipeline to maximize throughput and 
thus spread fixed costs across more units of service. Further, as the 
Commission has explained, selective discounting protects captive 
customers from rate increases that would otherwise occur if pipelines 
lost volumes through the inability to respond to competition. The 
Commission's regulations permitting selective discounting were upheld 
by the court in Associated Gas Distributors v. FERC (AGD I).\3\
---------------------------------------------------------------------------

    \2\ 109 FERC ] 61,202 at P 2-10; 111 FERC ] 61,309 at P3-8.
    \3\ 824 F.2d 981, 1010-12 (D.C. Cir. 1987).
---------------------------------------------------------------------------

    3. The prior orders also explained the rationale behind the 
Commission's policy of allowing a discount adjustment and stated that 
the adoption of the discount adjustment resulted from the court's 
discussion in AGD I. In AGD I, the court addressed arguments raised by 
pipelines that the selective discounting regulations might lead to the 
pipelines under-recovering their costs. The court set forth a numerical 
example showing that the pipeline could under-recover its costs, if, in 
the next rate case after a pipeline obtained throughput by giving 
discounts, the Commission nevertheless designed the pipeline's rates 
based on the full amount of the discounted throughput, without any 
adjustment.\4\ However, the court found no reason to fear that the 
Commission would employ this ``dubious procedure,'' \5\ and accordingly 
rejected the pipelines'' contention.
---------------------------------------------------------------------------

    \4\ Id. at 1012.
    \5\ Id.
---------------------------------------------------------------------------

    4. In response to the court's concern, the Commission, in the 1989 
Rate Design Policy Statement,\6\ held that if a pipeline grants a 
discount in order to meet competition, the pipeline is not required in 
its next rate case to design its rates based on the assumption that the 
discounted volumes would flow at the maximum rate, but may reduce the 
discounted volumes so that the pipeline will be able to recover its 
cost of service. The Commission explained that if a pipeline must 
assume that the previously discounted service will be priced at the 
maximum rate when it files a new rate case, there may be a disincentive 
to pipelines discounting their services in the future to capture 
marginal firm and interruptible business.
---------------------------------------------------------------------------

    \6\ Interstate Natural Gas Pipeline Rate Design, 47 FERC ] 
61,295, reh'g granted, 48 FERC ] 61,122 (1989).
---------------------------------------------------------------------------

    5. Since AGD I and the Rate Design Policy Statement, the issue of 
``gas-on-gas'' competition, i.e., where the competition for the 
business is between pipelines as opposed to competition between gas and 
other fuels, has been raised in several Commission proceedings.\7\ In 
these proceedings, certain parties have questioned the Commission's 
rationale for permitting discount adjustments, i.e., that it benefits 
captive customers by allowing fixed costs to be spread over more units 
of service. These parties have contended that, while this may be true 
where a discount is given to obtain a customer who would otherwise use 
an alternative fuel and not ship gas at all, it is not true where 
discounts are given to meet competition from other gas pipelines. In 
the latter situation, these parties have argued, gas-on-gas competition 
permits a customer who must use gas, but has access to more than one 
pipeline, to obtain a discount. But, if the two pipelines were 
prohibited from giving discounts when competing with one another, the 
customer would have to pay the maximum rate to one of the pipelines in 
order to obtain the gas it needs. This would reduce any discount

[[Page 70803]]

adjustment and thus lower the rates paid by the captive customers.
---------------------------------------------------------------------------

    \7\ IMGA raised this issue in a petition for rulemaking in 
Docket No. RM97-7-000. In the NOI, the Commission stated that it 
would consider all comments on this issue in Docket No. RM05-2-000 
and terminated the proceeding in Docket No. RM97-7-000. The 
Commission explained that the issues included in Docket No. RM05-2-
000 include all the issues raised in the Docket No. RM97-7-000 
proceeding. IMGA did not seek rehearing of the Commission's decision 
to terminate Docket No. RM97-7-000 proceeding and did not in its 
comments object to the procedural forum offered to it in Docket No. 
RM05-2-000.
---------------------------------------------------------------------------

    6. On November 22, 2004, the Commission issued a Notice of Inquiry 
(NOI) seeking comments on its policy regarding selective discounting by 
natural gas pipelines.\8\ The Commission asked parties to submit 
comments and respond to specific questions regarding whether the 
Commission's practice of permitting pipelines to adjust their 
ratemaking throughput downward in rate cases to reflect discounts given 
by pipelines for competitive reasons is appropriate when the discount 
is given to meet competition from another natural gas pipeline. The 
Commission also sought comments on the impact of its policy on captive 
customers. Comments were filed by 40 parties.
---------------------------------------------------------------------------

    \8\ 109 FERC ] 61,202 (2004).
---------------------------------------------------------------------------

    7. On May 31, 2005, after reviewing the comments, the Commission 
issued an order \9\ reaffirming the Commission's current selective 
discounting policy. The Commission concluded that, in today's dynamic 
natural gas market, any effort to discourage pipelines from offering 
discounts to meet gas-on-gas competition would do more harm than good. 
Accordingly, the Commission decided not to modify its 16-year old 
policy to prohibit pipelines from seeking adjustments to their rate 
design volumes to account for discounts given to meet gas-on-gas 
competition.
---------------------------------------------------------------------------

    \9\ 111 FERC ] 61,309 (2005).
---------------------------------------------------------------------------

    8. The May 31 Order stated that interstate pipelines face three 
types of so-called gas-on-gas competition: (1) Competition from other 
interstate pipelines subject to the Commission's NGA jurisdiction, (2) 
competition from capacity releases by the pipeline's own firm 
customers, and (3) competition from intrastate pipelines not subject to 
the Commission's jurisdiction. The May 31 Order recognized that a 
significant portion of pipeline discounts are given to meet competition 
from other interstate pipelines. Some commenters contended that 
customers receiving such discounts are not fuel switchable and thus 
would take the same amount of gas even if required to pay the maximum 
rate of whichever pipeline they choose to use. The Commission rejected 
this contention, finding that discounts to non-fuel switchable 
customers can increase throughput and thus benefit captive customers. 
The Commission pointed to at least five examples of why this is so.
    9. First, the Commission stated that industrial and other business 
customers of pipelines typically face considerable competition in their 
own markets and must keep their costs down in order to prosper. Lower 
energy costs achieved through obtaining discounted pipeline capacity 
can help them do more business than they otherwise would, thereby 
increasing their demand for gas.
    10. Second, discounts may reduce the incentive for existing non-
fuel switchable customers to install the necessary equipment to become 
fuel switchable. In addition, potential new customers, such as 
companies considering the construction of gas-fired electric 
generators, may be more likely to build such generators if they obtain 
discounted capacity on the pipeline.
    11. Third, the Commission stated that an LDC's need for interstate 
pipeline capacity depends upon the demand of their customers for gas, 
and that demand is elastic, since some of their customers are fuel 
switchable. They also have non-fuel switchable industrial or business 
customers whose gas usage may vary depending upon cost.
    12. Fourth, pipeline discounts may enable natural gas producers to 
keep marginal wells in operation for a longer period and affect their 
decisions on whether to explore and drill for gas in certain areas with 
high production costs.
    13. Finally, the Commission pointed out that on many pipeline 
systems, the bulk of the pipelines' discounts are given to obtain 
interruptible shippers. All interruptible shippers may reasonably be 
considered as demand elastic, regardless of whether they are fuel 
switchable, since their choice to contract for interruptible service 
shows that they do not require guaranteed access to natural gas.
    14. The Commission thus found no basis to conclude that overall 
interstate pipeline throughput would remain at the same level, if the 
Commission discouraged interstate pipelines from giving discounts in 
competition with one another. The Commission also found that, apart 
from the issue of the extent to which such discounts increase overall 
throughput on interstate pipelines, discounts arising from competition 
between interstate pipelines provide other substantial public benefits, 
which would be lost if the Commission sought to discourage such 
discounting. The Commission pointed out that, as a result of increased 
competition in the gas commodity and transportation markets, there are 
now market prices for the gas commodity in the production area and for 
delivered gas in downstream markets. The difference between these 
prices (referred to as the ``basis differential'') shows the market 
value of transportation service between those two points.
    15. The May 31 Order found that discounting pipeline capacity to 
the market value indicated by the basis differentials provides a number 
of benefits. First, such discounting helps minimize the distorting 
effect of transportation costs on producer decisions concerning 
exploration and production. Second, if several interstate pipelines 
serve the same downstream market, discounting can help minimize short-
term price spikes in response to increases in demand by making the 
higher cost pipeline more willing to discount down to the basis 
differential in order to bring more supplies to the downstream market. 
Third, discounting enables interstate pipelines with higher cost 
structures to compete with lower cost pipelines. Fourth, discounting 
helps facilitate discretionary shipments of gas into storage during 
off-peak periods. Finally, selective discounting helps pipelines more 
accurately assess when new construction is needed.
    16. In addition, the May 31 Order found that a discount adjustment 
for discounts given in competition with capacity release promotes the 
Commission's goal of creating a robust competitive secondary market, 
and that discouraging pipelines from competing in this market would 
defeat the purpose of capacity release and eliminate the competition 
that capacity release has created. The Commission also pointed out that 
capacity release provides substantial benefits to captive customers. 
Similarly, the Commission determined in the May 31 Order that there was 
no reason to create an exemption from the selective discounting policy 
for expansion capacity. However, the Commission stated that under the 
Commission's current policy as set forth in the Certification of New 
Interstate Natural Gas Pipeline Facilities (Certificate Pricing Policy 
Statement),\10\ unless the new construction benefits current customers, 
the services must be incrementally priced and the Commission would not 
approve a discount adjustment that would shift costs to current 
customers.
---------------------------------------------------------------------------

    \10\ 88 FERC ] 61,227 (1999), order on clarification, 90 FERC ] 
61,128 (2000), order on further clarification, 92 FERC ] 61,094 
(2000).
---------------------------------------------------------------------------

    17. IMGA and Northern Municipals seek rehearing of the May 31 
Order. Generally, these parties argue that the May 31 Order is not 
based on substantial or factual evidence, that the selective discount 
policy does not benefit captive customers, that the Commission has not 
properly assigned the burden of proving that discounts were given to 
meet competition, and

[[Page 70804]]

that the Commission did not address certain arguments of the parties 
that oppose the policy. The issues raised in the requests for rehearing 
are discussed below.

Discussion

A. Procedural Matters

    18. The NOI invited interested persons to submit comments and other 
information on the matters raised by the NOI within 60 days. The NOI 
did not provide for reply comments. Forty parties submitted comments in 
response to the NOI. Only one party, IMGA, filed reply comments. In the 
May 31 Order, the Commission found that in these circumstances, it 
would not consider IMGA's reply. On rehearing, IMGA argues that it was 
error for the Commission to reject their reply comments.
    19. The Commission has broad discretion to establish the procedures 
to be used in carrying out its responsibilities.\11\ In this case, the 
Commission sought comments and responses to specific questions from 
interested parties, but did not authorize the filing of replies to the 
comments. Because reply comments were not authorized and IMGA was the 
only party to file reply comments, the Commission reasonably determined 
that it would not be appropriate or fair to the other parties in the 
proceeding to consider IMGA's reply comments. This was not error and 
was clearly within the Commission's discretion. In any event, IMGA's 
request for rehearing sets forth the arguments that IMGA made in its 
reply comments and those arguments are addressed in this order.
---------------------------------------------------------------------------

    \11\ E.g., Mobile Oil Exploration & Producing Southeast, Inc. v. 
United Distrib. Cos., 498 U.S. 211, 230 (1991); Vermont Yankee 
Nuclear Power Corp. v. Natural Resources Defense Council, Inc., 435 
U.S. 519, 524-25, 543 (1978).
---------------------------------------------------------------------------

B. Substantial Evidence in Support of the Policy

    20. Throughout their requests for rehearing, both IMGA and Northern 
Municipals argue that the Commission's decision is not supported by 
substantial evidence because it is not based on facts and empirical 
data, but is based on theory and speculation. Northern Municipals 
assert that the Commission has not provided any hard data or factual 
support for its conclusion that the selective discounting policy will 
increase overall throughput and benefit captive customers. Instead, 
Northern Municipals state, the Commission posited a number of examples 
that might lead to increased throughput. However, they argue, the 
Commission failed to quantify any increase in throughput, failed to 
analyze whether the increase would be in the form of an overall 
increase to the national grid or simply an increase to one pipeline and 
a decrease to another, and failed to analyze whether the benefits of 
such an increase to captive and other customers would be outweighed by 
the costs of subsidizing the discounts. Similarly, IMGA argues that the 
May 31 Order merely adopts the comments of the supporters of the policy 
and that those comments were based on allegation and speculation, 
rather than substantial evidence.
    21. Northern Municipals assert that the Commission should engage in 
a cost/benefit analysis of the policy and should review all orders 
issued on the merits for base rate cases for a period of time to 
determine how often discount adjustments were allowed and whether 
pipelines routinely file for such adjustments. If discounts are 
routinely allowed, Northern Municipals argue, that is an indication 
that the pipeline considers the recovery of discounts an entitlement, 
and this undermines the validity of the Commission's premise that 
pipelines will always seek the highest rate for their service.
    22. While the Commission will address below Northern Municipals' 
and IMGA's arguments regarding the basis for each of the Commission's 
challenged findings, some general comments about the type of evidence 
considered in this proceeding are appropriate at the outset. Rehearing 
applicants ask the Commission to change a policy of 16 years and 
establish a blanket rule that prohibits pipelines from seeking a 
discount adjustment in a rate case for discounts given to meet gas-on-
gas competition. While the permission given by the Commission to 
pipelines to discount their rates between a minimum and maximum rate 
was promulgated in Order No. 436 and adopted as a regulation,\12\ the 
adjustment in throughput to recognize discounting is not a rule, but is 
a policy that was adopted by the Commission in the Rate Design Policy 
Statement.\13\ Therefore, in individual rate cases, the parties are 
free to develop a record based on the specific circumstances on the 
pipeline to determine whether the discounts given were beneficial to 
captive customers. The pipeline has the burden of proof under section 4 
of the NGA in a rate case to show that its proposal is just and 
reasonable. If there are circumstances on a particular pipeline that 
may warrant special considerations or disallowance of a full discount 
adjustment, those issues may be addressed in individual 
proceedings.\14\ Parties in a rate proceeding may address not only the 
issue of whether a discount was given to meet competition, but also 
issues concerning whether the discount was a result of destructive 
competition and whether something less than a full discount adjustment 
may be appropriate in the circumstances.
---------------------------------------------------------------------------

    \12\ 18 CFR 284.10 (2005).
    \13\ Interstate Natural Gas Pipeline Rate Design, 47 FERC ] 
61,295, reh'g granted, 48 FERC ] 61,122 (1989).
    \14\ See, e.g., Natural Gas Pipeline Company of America, 73 FERC 
] 61,050 at 61,128-29 (1995), and El Paso Natural Gas Co., 72 FERC ] 
61,083 at 61,441 (1995).
---------------------------------------------------------------------------

    23. The November 22 NOI gave all participants in the natural gas 
industry an opportunity to provide comments on whether gas-on-gas 
discounts help increase overall throughput on interstate pipelines and 
asked specific questions concerning whether customers receiving such 
discounts could increase their throughput. The Commission did this to 
develop a record upon which to base its decision whether to change the 
selective discounting policy. Forty parties filed comments. The 
Commission appropriately relies on the record developed and the 
comments of experienced industry participants. Because the Commission 
provided all interested parties with an opportunity to present 
evidence, it need not now undertake a separate and independent 
analysis.
    24. Further, the Commission need not undertake such an analysis for 
the purposes of determining whether, as Northern Municipals allege, the 
Commission's rationale for the policy is undermined because discount 
adjustments are ``routinely'' granted and pipelines therefore consider 
them an entitlement. The Commission does not routinely grant pipelines 
a discount adjustment, but grants such an adjustment only to the extent 
that the discount was required to meet competition. The Commission has 
denied pipelines the adjustment where the pipeline has failed to meet 
its burden of showing that the discount was required to meet 
competition. For example, in Panhandle Eastern Pipe Line Co,\15\ 
Williams Natural Gas Co,\16\ and Trunkline Gas Co.,\17\ the Commission 
held that the pipeline had not met its burden to show that its 
discounts to its affiliates were required by competition. In addition, 
in Iroquois Gas Transmission System \18\ and

[[Page 70805]]

Trunkline Gas Co.,\19\ the Commission disallowed a discount adjustment 
with respect to discounts given to non-affiliates. In both cases, the 
discounts were given to long-term, firm customers. The Commission found 
that the parties opposing the discount adjustment had raised enough 
questions about the circumstances in which those long-term discounts 
were given to shift the burden back to the pipeline to justify the 
discount. The Commission then found that, when a pipeline gives a long-
term discount, the Commission would expect that the pipeline would make 
a thorough analysis whether competition required such a long-term 
discount, and in both these cases the pipeline had failed to present 
any evidence of such an analysis. A discount adjustment is not an 
entitlement and the pipelines would be ill-advised to consider it so.
---------------------------------------------------------------------------

    \15\ 74 FERC at ] 61,109 at 61,401-02 (1996).
    \16\ 77 FERC at ] 61,277 at 62,206-07 (1996).
    \17\ 90 FERC at ] 61,017 at 61,096 (2000).
    \18\ 84 FERC at ] 61,086 at 61,476-78 (1998).
    \19\ 90 FERC at ] 61,017 at 61,092-95 (2000).
---------------------------------------------------------------------------

    25. Moreover, the Commission need not conduct such a fact-specific 
analysis in order to meet the requirement that its decision be 
supported by substantial evidence. In AGD I, the court explained that 
promulgation of generic rate criteria involves the determination of 
policy goals and the selection of the means to achieve them, and that 
courts do not insist on empirical data for every proposition on which 
the selection depends.\20\ The court cited Wisconsin Gas Co. v. 
FERC,\21\ where certain parties had objected to the Commission's 
curtailment of the minimum bill because it allegedly would result in 
shifting costs to captive customers. In response to these arguments, 
the Commission stated that the increased incentive to compete 
vigorously in the market would eventually lead to lower prices for all 
consumers. The court noted that the Wisconsin Gas court accepted this 
response without record evidence ``presumably because it viewed the 
prediction as at least likely enough to be within the Commission's 
authority.'' \22\ The court further stated ``agencies do not need to 
conduct experiments in order to rely on the prediction that an 
unsupported stone will fall; nor need they do so for predictions that 
competition will normally lead to lower prices.'' \23\
---------------------------------------------------------------------------

    \20\ 824 F.2d at 1008.
    \21\ 770 F.2d 1144 (D.C. Cir. 1985).
    \22\ 824 F.2d at 1008.
    \23\ Id. at 1008-09.
---------------------------------------------------------------------------

    26. Similarly in INGAA v. FERC,\24\ the Commission narrowed the 
right of first refusal (ROFR) to eliminate the ROFR for discounted 
contracts. In justifying this change, the Commission stated that if a 
customer is truly captive, it is likely that its contract will be at 
the maximum rate. Parties challenged this finding as not being based on 
substantial evidence, but rather on the agency's own supposition and 
presented hypothetical examples to the contrary. The court upheld the 
Commission and stated that while the Commission had cited no studies or 
data, its conclusion seemed largely true by definition and that it was 
a ``fair inference'' that customers paying less than the maximum rate 
for service had other choices in the market. The court further found 
that the hypothetical counter examples given by the petitioners failed 
to undermine the Commission's conclusion that generally, discounts are 
given in order to obtain and retain load that the pipeline could not 
transport at the maximum rate because of competition.
---------------------------------------------------------------------------

    \24\ 285 F.3d 18 at 55 (D.C. Cir. 2002).
---------------------------------------------------------------------------

    27. In AGD I, the court cited to economic treatises in reaching its 
decision,\25\ and courts rely on economic theory in their decisions. 
For example, the decisions in Williston Basin v. FERC,\26\ Iroquois Gas 
Transmission System v. FERC,\27\ and Arco Alaska, Inc. v. FERC,\28\ 
rely on economic theory in reaching their conclusions. Therefore, the 
Commission rejects the arguments of Northern Municipals and IMGA that 
the May 31 Order is not based on substantial evidence because it relies 
on economic theory rather than empirical data. To the extent that the 
Commission's orders on the selective discounting policy rely on 
economic theory, that is entirely proper, and economic theory may be 
the basis for the Commission's decision.
---------------------------------------------------------------------------

    \25\ Id. at 1010 (citing 2 A. Kahn, The Economics of Regulation: 
Principles and Institutions (1987)), 1011n.12 (citing E. Gellhorn & 
R. Pierce, Regulated Industries 185-89 (1987)), and n.13 (citing, 
inter alia, Tye & Leonard, On the Problems of Applying Ramsey 
Pricing to the Railroad Industry with Uncertain Demand Elasticities, 
17A Transportation Research 439 (1983)).
    \26\ 358 F.3d 45, 49-50 (D.C. Cir. 2004) (citing Alfred E. Kahn, 
The Economics of Regulation: Principles and Institutions 132-33 
(1988)).
    \27\ 172 F.3d 84, 89 (D.C. Cir. 1999) (``We note that classic 
analysis of non-cost-based discounting by carriers has turned on 
differences in the price elasticity of demand for the carried 
product. It pursues the goal of an optimal trade-off between the 
desirability of maximizing output and the necessity of the utility's 
recovering all its costs.'').
    \28\ 89 F.3d 878, 883 (D.C. Cir. 1996) (Explaining the now 
``inverse-elasticity rule, Ramsey Pricing allocates joint costs in 
inverse proportion to the demand elasticities of different customers 
to yield the most efficient use of a pipeline.).
---------------------------------------------------------------------------

C. Legal Basis for Upholding the Policy

    28. In the May 31 Order, the Commission discussed its 
responsibilities under the NGA and cited to Order No. 636:

    The Commission's responsibility under the NGA is to protect the 
consumers of natural gas from the exercise of monopoly power by the 
pipelines in order to ensure consumers ``access to an adequate 
supply of gas at a reasonable price.'' [Tejas Power Corp. v. FERC, 
908 F.2d 998, 1003 (D.C. Cir. 1990).] This mission must be 
undertaken by balancing the interests of the investors in the 
pipeline, to be compensated for the risks they have assumed, and the 
interests of consumers, and in light of current economic, 
regulatory, and market realities.\29\
---------------------------------------------------------------------------

    \29\ Order No. 636 at 30,392.

    The Commission then concluded that, in light of existing conditions 
in the natural gas market, its existing policies concerning selective 
discounting are more consistent with the goal of ensuring adequate 
supplies at a reasonable price, than any of the alternatives proposed 
in the comments in response to the NOI.
    29. On rehearing, IMGA argues that the Commission did not apply the 
proper legal criteria in reaching its conclusion. IMGA argues that the 
selective discount policy is unlawful unless it can be shown that it 
produces a net benefit to captive customers \30\ and that the burden of 
proof is on the supporters of the policy to produce substantial 
evidence to show that the discount adjustment benefits captive 
customers. It argues that the Commission's cite to Tejas was taken out 
of context and that it is a ``perversion of the ruling in Tejas Power 
Corp. to employ it to support a conclusion that it is okay to exploit 
captive customers where that exploitation could arguably increase gas 
supply because it produces higher prices.'' IMGA states that regardless 
of whether higher gas prices is a lawful objective, it is not lawful if 
the mechanism produces a violation of the prohibition against undue 
discrimination of sections 4 and 5 of the NGA. Further, IMGA argues, it 
is of no benefit to captive shippers that the discount adjustment 
reduces their transportation costs if it also increases their gas 
supply costs, and that in Maryland People's Counsel v. FERC, \31\ the 
court concluded that it was unlawful for the Commission to focus only 
on the benefits of lower transportation costs and ignore the potential 
offsetting impact of higher gas prices.
---------------------------------------------------------------------------

    \30\ IMGA cites the Order No. 637 NOPR, Transcontinental Gas 
Pipe Line Corp. v. FERC, 998 F.2d 1313, 1318, 1321 (D.C. Cir. 1993); 
Columbia Gas Transmission Corp. v. FERC, 848 F.2d 250, 251-254 (D.C. 
Cir. 1988); Maryland People's Counsel v. FERC, 761 F.2d 768, 770-771 
(D.C. Cir. 1985).
    \31\ IMGA cites 761 F.2d 768, 770-71 (D.C. Cir. 1988).
---------------------------------------------------------------------------

    30. The Commission has correctly stated its responsibilities under 
the

[[Page 70806]]

NGA. The citation to Order No. 636 and Tejas merely state, as do 
numerous other Commission and court decisions,\32\ that the 
Commission's responsibility under the NGA is to ensure customers access 
to natural gas at reasonable prices, and that in carrying out its 
mission, the Commission must balance a number of competing interests. 
In Order No. 636, the Commission cited to the Natural Gas Wellhead 
Decontrol Act of 1989 (Decontrol Act),\33\ enacted by Congress in order 
to create more abundant natural gas supplies at lower prices by 
creating competition among efficient producers.\34\ The House Committee 
Report urged the Commission to ``retain and improve'' the competitive 
structure in natural gas markets in order to maximize the benefits of 
wellhead price decontrol.\35\ The Decontrol Act did not, however, alter 
the Commission's consumer protection mandate.
---------------------------------------------------------------------------

    \32\ E.g., FPC v. Hope Natural Gas Co., 320 U.S. 591, 603 
(1943); Atlantic Refining Co. v. Public Service Commission of New 
York, 360 U.S. 378, 388, 389, 392 (1959) (fundamental purpose of NGA 
is to assure the public of a reliable supply of gas at reasonable 
prices).
    \33\ 103 Stat. 157 (1989).
    \34\ Order No. 636, Regulations Preambles ] 30,939 at p. 30,397 
(1992), citing H.R. Report No. 29, 101st Cong., 1st Sess., at p. 2 
(1989).
    \35\ H.R. Report No. 29, supra, at p.2.
---------------------------------------------------------------------------

    31. Thus, the Commission must, in all of its decisions, balance a 
number of interests, and that is what it has done here. The Commission 
recognizes its obligation to protect captive customers and it has met 
that obligation here. However, the Commission also has broad 
responsibilities to develop policies of general applicability. The 
Commission has analyzed the concerns of IMGA and Northern Municipals in 
the context of the overall benefits to the national pipeline system 
provided by the selective discount policy. The Commission has concluded 
that the selective discount policy, including allowing a discount 
adjustment for gas-on-gas competition, generally benefits all customers 
including customers who do not receive the discount.
    32. We find IMGA's view of the Commission's responsibilities too 
narrow. Under IMGA's view, if there could be circumstances where a 
discount does not benefit captive customers then the policy must be 
abandoned. While the Commission has concluded that the selective 
discounting policy generally benefits all customers, it has also 
recognized that there may be circumstances on some pipelines where 
captive customers may require additional protections. It is not 
necessary, however, for the Commission to eliminate entirely the 
discount adjustment for gas-on-gas competition in order to address 
those limited situations. The cases cited by IMGA are not to the 
contrary.
    33. As the Commission explained in the May 31 Order, it is possible 
to adopt measures to protect small publicly owned municipal gas 
companies in circumstances where the policy works an undue hardship on 
them and at the same time retain the competitive benefits of the policy 
for the majority of shippers. This is the proper balancing of interests 
in this proceeding and the Commission applied the appropriate legal 
standards in balancing these interests. The Commission's decision here 
meets both goals of promoting a competitive natural gas market and 
protecting captive customers. This is the type of balancing decision 
that the courts have recognized is within the Commission's discretion 
in developing its policies in a competitive marketplace.\36\
---------------------------------------------------------------------------

    \36\ See, e.g., Midcoast Interstate Transmission, Inc. v. FERC, 
198 F.3d 960, 970 (D.C. Cir. 2000).
---------------------------------------------------------------------------

    34. IMGA's characterization of the Commission's decision as 
concluding that it is ``okay'' to exploit captive customers where that 
exploitation could increase gas supply by producing higher prices is 
not an accurate characterization of the Commission's decision. As 
stated above, it is the Commission's responsibility to ensure that 
consumers have access to natural gas at reasonable prices, not to 
promote policies that increase prices, and there is no basis for 
concluding that the discount policy increases the delivered price of 
natural gas to consumers. Further, it is clearly established that 
selective discounting based on different demand elasticities does not 
constitute undue discrimination under the NGA.\37\
---------------------------------------------------------------------------

    \37\ E.g., AGD I at 1011; United Distribution Companies v. FERC, 
88 F.3d 1105, 1142 (D.C. Cir. 1996).
---------------------------------------------------------------------------

D. There Is Substantial Evidence To Support the Commission's Conclusion 
That Discouraging Discounts Would Do More Harm Than Good

    35. IMGA and Northern Municipals argue that the Commission's 
decision that discouraging gas-on-gas discounting by disallowing any 
adjustment to rate design volumes to account for such discounts would 
do more harm than good is not based on substantial evidence. They raise 
a number of issues which, they allege, the Commission either failed to 
address or did not adequately address in the May 31 Order. As the May 
31 Order stated, there are three different categories of gas-on-gas 
competition. One category is competition from other interstate 
pipelines subject to the Commission's jurisdiction. The second category 
is competition from capacity releases by the pipeline's own firm 
customers. The third category is competition from interstate pipelines 
that are not subject to the Commission's jurisdiction. The May 31 Order 
gave different reasons for allowing discount adjustments for each of 
these categories of gas-on-gas discounts. Accordingly, in addressing 
the rehearing requests, we will continue to discuss these categories of 
gas-on-gas competition separately.
1. Competition From Other Interstate Pipelines
    36. IMGA and Northern Municipals contend that the Commission erred 
in not adopting their proposals to adopt a rule prohibiting adjustments 
to rate design volumes for discounts a pipeline gives in competition 
with another interstate pipeline. They attack both of the primary bases 
of the Commission's decision: (1) that gas-on-gas discounts do play a 
role in increasing throughput on interstate pipelines and (2) such 
discounts provide substantial other public benefits which would be lost 
if the Commission sought to discourage such discounting.
    37. Before addressing the specific arguments of the two rehearing 
applicants in support of their position, several general comments are 
in order. First, the Commission has never codified its policy 
concerning discount adjustments in any definitive rule or regulation. 
Rather, the Commission has developed its discount adjustment policy 
first through the 1989 Rate Design Policy Statement and subsequently in 
individual rate cases. Under that policy, the pipeline may propose as 
part of a section 4 rate filing to adjust its rate design volumes to 
account for any discounts it gave during the test period, including 
discounts given in competition with other pipelines. By proceeding on 
this basis, the Commission must find, based on the record developed in 
each rate case, that the pipeline has met its section 4 burden to show 
that any approved discount adjustment to rate design volumes is just 
and reasonable.\38\ In addition, as the Commission stated in the May 31 
Order \39\ and discusses further below, the Commission will consider 
the impact of any discount adjustment on captive customers in specific 
proceedings. The Commission's termination of the instant rulemaking

[[Page 70807]]

proceeding is a decision to continue to address the discount adjustment 
issue in the same case-by-case manner. Thus, the May 31 Order should 
not be interpreted as establishing any definitive rule that pipelines 
will in all instances be permitted a full discount adjustment for 
discounts given in competition with another pipeline. Rather, the 
Commission simply determined in the May 31 Order to reject the 
rehearing applicants' proposal to establish a definitive rule 
prohibiting pipelines from proposing in section 4 rate cases discount 
adjustments with respect to discounts given in competition with other 
pipelines.
---------------------------------------------------------------------------

    \38\ Pacific Gas & Electric Co. v. FPC, 506 F.2d 33, 48 (D.C. 
Cir. 1974).
    \39\ 111 FERC ] 61,309 at P 57.
---------------------------------------------------------------------------

    38. Second, the Commission's approach to this issue appropriately 
balances several factors. Given the increasingly competitive nature of 
both the gas commodity and pipeline capacity markets, the Commission 
believes there are undeniable public benefits to giving pipelines 
flexibility to discount their rates consistent with the market value of 
their capacity, including in the context of competition with other 
interstate pipelines. At the same time, the Commission must take into 
account the effect of such discounting on truly captive customers. 
While the Commission believes that in most instances such discounts 
either help keep the rates of the captive customers lower than they 
otherwise would be or are at least neutral in effect, the Commission 
recognizes that there may be some situations where gas-on-gas 
discounting could shift costs to the captive customers. However, the 
Commission believes that such situations are sufficiently isolated that 
they are best dealt with on a case-by-case basis, rather than by 
establishing a generic rule discouraging interstate pipelines from 
giving discounts in competition with one another.
    39. The Commission now turns to a discussion of the public benefits 
of competition between interstate pipelines. The May 31 Order found 
that pipeline discounts in competition with one another leads to more 
efficient use of the interstate pipeline grid by enabling pipelines to 
adjust the price of their capacity to match its market value, and that 
discouraging such discounting would lead to harmful distortions in both 
the commodity and capacity markets. On rehearing, IMGA and Northern 
Municipals argue that there is no substantial evidence in the record to 
support this conclusion. The Commission disagrees.
    40. As the Commission found in both Order No. 637 and the May 31 
Order, and as many of the comments in this proceeding reiterate,\40\ 
the deregulation of wellhead natural gas prices, together with the 
requirement that interstate pipelines offer unbundled open access 
transportation service, has increased competition and efficiency in 
both the gas commodity market and the transportation market. Market 
centers have developed both upstream in the production area and 
downstream in the market area. Such market centers enhance competition 
by giving buyers and sellers a greater number of alternative pipelines 
from which to choose in order to obtain and deliver gas supplies. As a 
result, buyers can reach supplies in a number of different producing 
regions and sellers can reach a number of different downstream markets.
---------------------------------------------------------------------------

    \40\ Id. at P 31.
---------------------------------------------------------------------------

    41. The development of spot markets in downstream areas means there 
is now a market price for delivered gas in those markets. That price 
reflects not only the cost of the gas commodity but also the value of 
transportation service from the production area to the downstream 
market. The difference between the downstream delivered gas price and 
the market price at upstream market centers in the production area 
(referred to as the ``basis differential'') shows the market value of 
transportation service between those two points. As a result, ``gas 
commodity markets now determine the economic value of pipeline 
transportation services in many parts of the country. Thus, even as 
FERC has sought to isolate pipeline services from commodity sales, it 
is within the commodity markets that one can see revealed the true 
price for gas transportation.'' \41\ These basis differentials vary on 
a daily and seasonal basis as market conditions change and are largely 
determined by the gas-on-gas competition that occurs at the market 
centers.\42\
---------------------------------------------------------------------------

    \41\ Order No. 637 at 31,274 (quoting M. Barcella, How Commodity 
Markets Drive Gas Pipeline Values, Public Utilities Fortnightly, 
February 1, 1998 at 24-25).
    \42\ Gulf South comments at 17.
---------------------------------------------------------------------------

    42. Under the Commission's original cost method of determining just 
and reasonable rates, the maximum just and reasonable rate in a 
pipeline's tariff reflects embedded costs and depreciation. As a 
result, the pipeline's maximum tariff rate need not reflect the market 
value of its capacity on any given day or season of the year. Moreover, 
the maximum rates of competing pipelines may substantially differ from 
one another. Allowing each pipeline to discount its capacity to the 
market value indicated by the basis differentials taking into account 
the time period over which the discount will be in effect provides 
greater efficiency in the production and distribution of gas across the 
pipeline grid, promoting optimal decisions concerning exploration for 
and production of the gas commodity and transportation of gas supplies 
to locations where it is needed the most and during the time periods 
when it is needed.
    43. The May 31 Order gave a number of examples of the public 
benefits provided by enabling pipelines to discount their rates to the 
market value. First, such discounting helps minimize the distorting 
effect of transportation costs on producer decisions concerning 
exploration and production. Second, discounting enables interstate 
pipelines with higher cost structures to compete with lower cost 
pipelines. Third, if several interstate pipelines serve the same 
downstream market, discounting can help minimize short-term price 
spikes in response to increases in demand by making the higher cost 
pipeline more willing to discount down to the basis differential in 
order to bring more supplies to the downstream market. Fourth, 
discounting helps facilitate discretionary shipments of gas into 
storage during off-peak periods. Finally, selective discounting helps 
pipelines more accurately assess when new construction is needed.
    44. IMGA and Northern Municipals contest each of the public 
benefits found by the Commission. However, a large majority of the 
commenters in this proceeding affirmed that discounts given by 
competing pipelines based on the market value of their capacity do 
produce significant public benefits. IMGA and Northern Municipals do 
not seriously contest the finding that basis differentials between two 
points show the current market value of the transportation capacity 
between those two points. Rather, they suggest, in essence, that by 
discouraging pipelines from discounting maximum rates that exceed the 
basis differentials, the Commission could force whatever reductions in 
the delivered price of gas the market requires to be made with respect 
to the commodity component, rather than the transportation component of 
the delivered price. For example, IMGA states that, without discounts, 
wellhead prices may fall somewhat. However, the Commission believes 
that any effort to insulate one component of a price from market forces 
would cause harmful distortions and ultimately fail.
    45. IMGA and Northern Municipals contend that, in today's market, 
with its higher natural gas commodity prices,

[[Page 70808]]

there is no need to be concerned that unavailability of discounts to 
the basis differentials could lower producer net backs. They argue 
that, if no discount is granted, the producer will either adjust its 
price to clear this market, or will choose to flow its gas to some 
other market where a consumer is willing to pay more, a correct result 
in a competitive market. Also, Northern Municipals suggest that, given 
the deregulation of wellhead prices, the Commission should no longer be 
concerned with the effect of interstate transportation rates on 
producers.
    46. However, as already discussed, when Congress deregulated 
wellhead prices in 1989, it directed that the Commission exercise its 
remaining NGA jurisdiction over transportation in manner that would 
improve the competitive structure of the natural gas market. In 
response to that directive, the Commission has consistently taken into 
account the effect of its rate policies on natural gas production, most 
significantly when it adopted the straight fixed variable (SFV) rate 
design for firm transportation rates in Order No. 636. The purpose of 
that policy was to minimize the distorting effect of transportation 
costs on producer decisions concerning exploration and production. As 
the Commission stated in the May 31 Order, the various interstate 
pipelines competing in the same downstream markets generally bring gas 
from different supply basins. For example, different interstate 
pipelines serving California are attached to supply basins in the 
Texas, Oklahoma, Gulf Coast area; the Rocky Mountain area, and Canada. 
Given the differences between pipeline maximum rates based on their 
differing historical costs and given the fact that market value of 
transportation between two points is at times less than the pipeline 
maximum rates, any effort by the Commission to insulate pipelines from 
market forces would be inconsistent with the Congress's directive that 
the Commission seek to improve the competitive structure of the natural 
gas market. Without discounts by the higher cost pipelines, producers 
in supply basins served by higher cost pipelines would generally face 
the burden of any price reductions necessary to meet the market price 
for delivered gas in the downstream areas.\43\ As a result, gas 
reserves from supply areas served by lower cost pipelines would have a 
built-in cost advantage over gas reserves served by higher cost 
pipelines.
---------------------------------------------------------------------------

    \43\ Reliant Energy at 11; Gulf South at 30.
---------------------------------------------------------------------------

    47. IMGA and Northern Municipals also contend that the Commission's 
statement that discounts help interstate pipelines with higher cost 
structures to compete with lower cost pipelines, enabling the capacity 
for both pipelines to be utilized in the most efficient manner 
possible, provides no support for the selective discounting policy. 
However, it is clear that in such a situation the pipeline with the 
higher maximum rate may need to discount to compete with the pipeline 
with the lower maximum rate to the extent the pipeline with the lower 
maximum rate has available capacity. Discouraging the pipeline with the 
higher maximum rate from discounting in that situation would only harm 
that pipeline's captive customers, since it would lose throughput over 
which it could otherwise spread its fixed costs. IMGA and Northern 
Municipals suggest that such discounts would provide no overall public 
benefit, since they would not increase overall throughput on both 
interstate pipelines. Rather such discounts would only serve to switch 
throughput from one pipeline to the other. However, the Commission 
finds there is a clear public benefit to maximizing the ability of 
higher cost pipelines to compete with lower cost pipelines. Otherwise, 
the higher cost pipeline will tend always to lose throughput over which 
to spread its fixed costs, thus exacerbating the difference in rates 
between the two pipelines making it more and more difficult for the 
higher cost pipeline to compete and leading the captive customers of 
the higher cost pipeline to bearing an inequitably high transportation 
cost vis-[aacute]-vis the captive customers of the lower cost 
pipeline.\44\
---------------------------------------------------------------------------

    \44\ See Michigan Consolidated Gas Co. comments at 4-5, 
describing the adverse effect on TransCanada Pipeline and its 
customers due to its inability to discount in competition with the 
United States pipelines; Transco comments at 9-10.
---------------------------------------------------------------------------

    48. Indeed, discounting has become an integral part of today's 
dynamic natural gas market.\45\ The U.S. natural gas pipeline grid has 
become increasingly interconnected since the transition to unbundled, 
open access transportation service pursuant to Order Nos. 436, 636, and 
637, with pipeline companies making substantial investments in 
constructing new pipeline facilities. In response to a 2005 INGAA 
survey, 36 pipelines reported that they had spent $19.6 billion for 
interstate pipeline infrastructure between 1993 and 2004, and during 
the 1990s interregional natural gas pipeline capacity grew by 27 
percent.\46\ As a result, most major markets are now served by multiple 
interstate pipelines. For example, customers in the Chicago 
metropolitan area are served by eleven interstate pipelines, giving 
them access to natural gas supplies in Western Canada, the Rocky 
Mountains, New Mexico, Oklahoma, Michigan, Louisiana, the Gulf coast, 
and Texas.\47\ In this environment, gas-on-gas competition and 
alternate fuel competition are interchangeable. Discounts given by 
competing pipelines also serve to increase the market share of natural 
gas versus alternate fuels.\48\
---------------------------------------------------------------------------

    \45\ INGAA comments at 7-10; Duke comments at 18-22; Transco 
comments at 5-8, 27-28; Process Gas comments at 3-4; Gulf South 
comments at 10, 11, 17-19; Dominion Resources comments at 3-5; NGSA 
comments at 8-10.
    \46\ INGAA comments at 9.
    \47\ Kinder Morgan comments at 10.
    \48\ Kinder Morgan comments at 7, 18.
---------------------------------------------------------------------------

    49. In their rehearing requests, IMGA and Northern Municipals 
contend that, whatever public benefits may arise from discounts given 
by one interstate pipeline to meet competition from another interstate 
pipeline, captive customers should not have to bear the cost of those 
discounts through a discount adjustment to rate design volumes. They 
contend that the Commission erred when it found that such discounts 
benefit captive customers, since the customers receiving such discounts 
are demand elastic and therefore those discounts help increase overall 
throughput on interstate pipelines.
    50. In their rehearing requests, IMGA and Northern Municipals do 
not seriously contest the Commission's finding that such discounts will 
increase the demand of the customers receiving them in at least some of 
the ways found by the Commission. For example, the Commission stated 
that industrial and other business customers of pipelines typically 
face considerable competition in their own markets and must keep their 
costs down in order to prosper. Lower energy costs achieved through 
obtaining discounted pipeline capacity can help industrial and other 
business customers of pipelines, who typically face considerable 
competition in their own markets, do more business than they otherwise 
would, thereby increasing their demand for gas. Also, such discounts 
may reduce the incentive for existing non-fuel switchable customers to 
install the necessary equipment to become fuel switchable. In addition, 
potential new customers, such as companies considering the construction 
of gas-fired electric generators, may be more likely to build such 
generators if they obtain discounted capacity on the pipeline.
    51. However, the thrust of IMGA and Northern Municipals' argument 
is that

[[Page 70809]]

the Commission has not shown that such increased demand will translate 
into increased overall throughput or revenues on interstate pipelines. 
IMGA contends that a study presented by INGAA in its comments shows 
that the demand elasticity in the natural gas transportation market is 
very limited, with the result that, for every 10 percent decrease in 
the price of transportation, demand for transportation increases by 
only about 1.2 percent.\49\ IMGA contends that, as a result, any 
additional revenues generated by a pipeline decreasing its rates 
through discounts in competition with another pipeline will not offset 
the effects of the rate decreases.\50\ IMGA also argues that even if a 
discounted rate given to customers with access to more than one 
pipeline would cause them to increase their consumption of natural gas, 
the increased price that the discount adjustment would charge to 
captive shippers would cause them to decrease their consumption by a 
similar amount. IMGA states that this is because the difference between 
captive customers and discounted shippers is not the elasticity of 
their demand, but whether there are alternative pipelines from which 
they can purchase.
---------------------------------------------------------------------------

    \49\ IMGA cites pages 14-15 of an affidavit by Bruce B. Henning 
attached to INGAA's comments.
    \50\ IMGA illustrates its contention with the following example: 
It assumes a pipeline with revenues of $250.00 based on charging 
$.50 per Mcf for throughput of 500 Mcf. If the pipeline reduced its 
rate by 10 percent to $.45 per Mcf in order to increase its 
throughput by 1.2 percent to 506 Mcf, it would then generate 
revenues of $227.70, about 9 percent less than its revenues without 
the rate reduction.
---------------------------------------------------------------------------

    52. Similarly, Northern Municipals state that the Commission makes 
conclusory statements that overall throughput on the national grid will 
increase as a result of discounting, but provides no studies or 
evidence to back this up. Similarly, Northern Municipals argue that 
unless the reduction in fixed costs to captive and other customers is 
greater than the discounts they are forced to absorb, the increase in 
throughput does nothing to protect the interests of captive customers 
and, they allege, there is no solid evidence to support the conclusion 
that any increase in throughput will result in a net decrease in rates 
to consumers. Northern Municipals states that the May 31 Order provides 
no support for the presumption that increased throughput results in 
more spreading of fixed costs, thus benefiting consumers that are not 
entitled to discounts by providing them with lower overall rates. They 
state that the only thing the order proves is that if a rate is 
discounted heavily enough, it may attract some additional volumes. But, 
they argue, if the discount the ratepayers must absorb is greater than 
the offsetting reduction in the portion of the fixed costs that those 
ratepayers must bear, there is no justification for the discount.
    53. The Commission recognizes that the discounts a pipeline gives 
in competition with another interstate pipeline may or may not increase 
the overall revenue collected by interstate pipelines. As discussed 
below, the revenue effects of particular gas-on-gas discounts given by 
a pipeline depend on the circumstances in which the pipeline gave the 
discount. However, the Commission's experience has been that such 
discounts generally do not cause significant cost shifts to captive 
customers. Therefore, the Commission reaffirms its conclusion that 
discounts given by competing pipelines provide sufficient public 
benefits that we will not modify our policy to adopt a blanket 
prohibition on adjustments to rate design volumes to reflect such 
discounts. As we stated in the May 31 Order, if there are circumstances 
on a particular pipeline that warrant additional protections for 
captive customers, including a limitation on the discount adjustment to 
rate design volumes, those issues can be considered in individual rate 
cases.
    54. IMGA and Northern Municipals assume that, where two pipelines 
compete with one another they will engage in a destructive bidding war, 
with the result that all customers with access to the two pipelines 
will receive heavily discounted rates for all their service without 
regard to their elasticity of demand. However, this assumes that in 
such a situation the customers with access to the two pipelines will 
have all the bargaining power, and the two pipelines will have none. 
This is unlikely to be the case. If the total capacity of the two 
pipelines is not greatly in excess of the demand for transportation 
service in the markets served by the two pipelines, competition between 
the customers for the pipelines' capacity should give the pipelines 
some ability to minimize any discounts and target the discounts they do 
give to the customers whose demand will increase with a lower rate so 
as to fill the pipeline.
    55. Moreover, pipelines have an incentive not to discount too 
deeply, because they recognize that, to the extent they do file a rate 
case to attempt to raise rates to their remaining customers, the demand 
of those customers could go down. Also, those customers would then have 
more of an incentive to seek alternatives of their own, for example 
through participating in the expansion of another pipeline. The 
affidavit of Bruce Henning, submitted by INGAA and relied on by IMGA, 
pointed out that long-run elasticities of demand are always higher than 
short-term demand elasticities, usually two to three times.\51\ That is 
because in the long-run consumers can make capital investments to 
increase price responsiveness, including investments to increase their 
efficiency, and their alternative fuel capacity. In addition, the 
pipelines should recognize that the Commission has stated that it may 
not permit a full discount adjustment in situations where that would 
lead to an inequitable result.\52\
---------------------------------------------------------------------------

    \51\ Henning Affidavit at 15.
    \52\ See Natural Gas Pipeline Company of America, 73 FERC ] 
61,050 at 61,128-29 (1995), and El Paso Natural Gas Co., 72 FERC ] 
61,083 at 61,441 (1995).
---------------------------------------------------------------------------

    56. There is nothing in the record developed in response to the NOI 
to suggest that the Commission's general policy of permitting pipelines 
to propose discount adjustments for gas-on-gas competition has led to a 
widespread cost shift to captive customers. The NOI asked the 
commenters for specific examples of rate cases where the discount 
adjustment has impacted captive customers. No party was able to point 
to any rate case where discounts due to gas-on-gas competition actually 
caused a substantial cost shift to captive customers. In response, IMGA 
referred to discounts in Docket No. RP95-326, Natural Gas Pipeline Co. 
of America, where, IMGA asserts, discounts produced adjustments in 
throughput that resulted in rates so high that Natural chose not to 
increase their tariff rates as much as could have been justified. IMGA 
also referred to Southern Natural Gas Co.,\53\ where it had submitted 
testimony concerning discounts given by Southern during the period May 
1992 through April 1993. Northern Municipals referred to the discount 
given to CenterPoint on Northern.
---------------------------------------------------------------------------

    \53\ 65 FERC ] 61,348 (1993).
---------------------------------------------------------------------------

    57. These specific Commission proceedings cited by the parties 
seeking rehearing do not support a finding that gas-on gas discount 
adjustments have caused a significant cost shift to captive customers, 
requiring a drastic policy change seeking to discourage such discounts. 
Instead, they support the conclusion that individual rate cases provide 
the appropriate forum for determining the extent to which a discount 
adjustment for this type of discount is just and reasonable in the 
circumstances of the particular case. As IMGA points out, in the 
Natural

[[Page 70810]]

decision, the circumstances resulted in the pipeline not implementing 
the full discount adjustment. Indeed, in its rehearing request,\54\ 
IMGA recognizes that Natural, and a second pipeline which faces 
substantial gas-on-gas competition, Gulf South Pipeline Company, have 
been able to engage in effective and efficient competition. As a 
result, they have not had to shift large amounts of costs to captive 
customers through discount adjustments. IMGA also recognizes that one 
factor in the ability of these pipelines to successfully compete has 
been the Commission's 1996 policy of permitting pipelines to negotiate 
rates using a different rate design from their recourse rates.\55\
---------------------------------------------------------------------------

    \54\ IMGA rehearing at 20.
    \55\ Alternatives to Traditional Cost-of-Service Ratemaking, 74 
FERC ] 61,076 (1996).
---------------------------------------------------------------------------

    58. In the Southern decision cited by IMGA, the parties reached a 
settlement. Moreover, in the May 31 Order the Commission found that the 
testimony presented in that case concerning discounting practices of 
one interstate pipeline over ten years ago are not probative of the 
prevalence of gas-on-gas discounting by all interstate pipelines 
today,\56\ and IMGA does not contest that finding in its rehearing 
request. As discussed more fully below, the issue of whether Northern 
should receive a full discount adjustment in connection with the 
CenterPoint discount has not been decided and parties will have an 
opportunity to address all the relevant facts concerning this discount 
in Northern's next rate case.
---------------------------------------------------------------------------

    \56\ 111 FERC ] 61,309 at P 20.
---------------------------------------------------------------------------

    59. Thus, appropriate actions have been taken in individual rate 
cases to resolve this issue. In the individual rate cases, parties can 
investigate the specific facts surrounding the discount to determine 
whether a full discount adjustment is warranted and whether any special 
circumstances require additional protections for captive customers. 
This approach retains the competitive benefits of discounting and at 
the same time allows the Commission to take action to mitigate the 
impact of a discount adjustment if the circumstances require.
    60. Thus, the Commission finds that the responses to the NOI 
produced no evidence to support IMGA's allegation in its brief to the 
D.C. Circuit on the appeal of Order No. 637 that the discount 
adjustment for gas-on-gas competition has burdened captive customers by 
a cost ``tilt of billions of dollars of costs.'' \57\ As a result, the 
Commission concludes that a continuation of its current general policy 
permitting pipelines to seek discount adjustments for gas-on-gas 
discounts in individual section 4 rate cases, with the ability to 
consider limits on a case-by-case basis, strikes the best balance 
between enabling the industry to obtain the benefits of such 
discounting discussed above, while minimizing the potential ill 
effects. Thus, the Commission rejects the request of IMGA and Northern 
Municipals that it establish a blanket rule prohibiting pipelines from 
proposing such a discount adjustment in a section 4 rate case.
---------------------------------------------------------------------------

    \57\ INGAA v. FERC, 285 F.3d 18, 58 (D.C. Cir. 2002).
---------------------------------------------------------------------------

    61. In its rehearing request, Northern Municipals contends that, 
even if the Commission does not prohibit discount adjustments for 
discounts given in competition with another pipeline, the Commission 
should require pipelines to demonstrate in their initial rate filing 
that such discounts actually increased throughput sufficiently that the 
proposed rates are lower than they would have been had no discount been 
granted. Under current Commission policy, the Commission gives shippers 
a full opportunity to litigate all issues concerning the justness and 
reasonableness of any proposed discount adjustment. While the 
Commission does not require pipelines in their initial rate filing to 
include evidence justifying why competition required each and every 
test period discount underlying the pipeline's proposed discount 
adjustment, the customers have the ability through discovery in the 
rate case to inquire into why the pipeline provided each such discount. 
In their rehearing requests, IMGA and the Northern Municipals seek to 
portray the Commission's presumption that discounts given to non-
affiliates were required by competition as an insuperable obstacle to 
contesting the need for any such discounts. However, as the Commission 
clarifies elsewhere in this order that is not a correct interpretation 
of our policy. To the extent a pipeline is unable during the discovery 
process to explain what competitive alternatives the recipient of any 
particular discount had or otherwise give a satisfactory explanation of 
why the discount was required, that fact by itself would be sufficient 
to rebut the presumption that competition required the discount.
    62. Moreover, as indicated by the Commission's orders in Natural 
\58\ and El Paso,\59\ even where a pipeline is able to show that 
particular discounts were required to meet competition from another 
pipeline, parties may argue that the competition between the two 
pipelines led to such deep discounts that a full discount adjustment 
would lead to an inequitable cost shift to the captive customers. As 
the Commission stated in the May 31 Order, the Commission continues to 
be mindful of its obligations to captive customers and will consider 
the impact of any discount adjustment on those customers in specific 
proceedings. In this regard, the Commission notes that Northern 
Municipals in its rehearing request has contended that certain 
discounts Northern has recently provided to two large LDCs will lead to 
an improper cost shift in Northern's next rate case. However, as the 
Commission has stated in its orders concerning those discounted rate 
transactions, if Northern proposes in its next rate case a discount 
adjustment based on those discounted rate transactions, the parties may 
litigate all issues concerning the justness and reasonableness of any 
such discount adjustment.
---------------------------------------------------------------------------

    \58\ 73 FERC ] 61,050 (1995).
    \59\ 72 FERC ] 61,083 (1995).
---------------------------------------------------------------------------

    63. Finally, Northern Municipals refer to an example provided in 
the initial comments of the Commission's Office of Administrative 
Litigation (OAL) and assert that the Commission did not adequately 
refute the conclusion drawn from this example that overall throughput 
is not increased when a selective discount is given to meet gas-on-gas 
competition. We will restate that example here:

    Assume that an LDC is attached to three pipelines, Pipelines A, 
B, and C, each with their own contracts to transport 20,000 MMbtu/
day. If the LDC's contract with Pipeline A is set to expire at the 
end of Year 1, the LDC will negotiate with all three pipelines to 
obtain the best price for the desired capacity. If Pipeline B offers 
the best discounted price, Pipeline A will have lost the contract. 
If the loss of volumes is sufficient Pipeline A will file a rate 
case, and receive an increase in rates, based on the reduced 
throughput of the lost LDC contract. All captive customers of 
Pipeline A will pay higher maximum rates.
    Meanwhile, Pipeline B will have increased its throughput by 
20,000 MMbtu/day. All other things being equal, since Pipeline B's 
volumes now exceed those upon which its rates were designed by 
20,000 MMbtu/day, the additional volumes will simply increase 
Pipeline B's earned rate of return until such time as the pipeline 
files a rate case.
    If, during of Year 2, the LDC's original contract with Pipeline 
B (a maximum rate contract for a different 20,000 MMbtu/day) 
expires, the pipelines again can bid for the capacity and offer 
discounts. If Pipeline C wins the contract, Pipeline B's overall 
throughput will decrease back down to the level it was at before it 
acquired the volumes from Pipeline A. Now, however, Pipeline B may 
have to file for a rate increase because, even though it is selling 
the same volumes

[[Page 70811]]

upon which its rates were designed, 20,000 MMbtu/day of those 
volumes (i.e., the volumes it took from Pipeline A which it still 
has) now move at a discounted rate. As a result, Pipeline B will 
show a revenue shortfall, and it will be given a discount adjustment 
for the discounted rate it is receiving from the LDC for the 
capacity it acquired that originally was under contract with 
Pipeline A.
    If, during Year 3, Pipeline C's original contract with the LDC 
expires, the pipelines again can bid for the capacity and offer 
discounts. If Pipeline C wins the contract again, but at a steep 
discount, it may have to file for a rate increase as its revenues 
may be short of its costs even though it has increased its 
throughput volumes.

    64. Northern Municipals state that three conclusions can be drawn 
from this hypothetical: First, the LDC did not change the total amount 
of gas it transported and consumed. Second, two of the three pipelines 
were able to increase their earned rates of return for a period of time 
due to the excess volumes captured from the pipeline holding the 
original contract. Third, maximum rates to captive customers left on 
the LDC's original pipeline experienced an increase in rates due to the 
LDC's defection, and eventually, captive customers on the other 
pipelines also experienced an increase. Northern Municipals state that 
all this occurred with no increase in net throughput. Thus, they 
conclude, the final result is that the LDC and its customers enjoy 
lower rates, but the captive maximum rate and other customers pay 
higher rates with no corresponding benefits and, thus, subsidize the 
discount to the LDC.
    65. There are several problems with this overly simple example, 
which was clearly developed to prove the result that it assumes. In the 
first place, the example assumes that both Pipeline B and Pipeline C 
have 20,000 MMBtu/day of unsubscribed capacity that is available for 
sale to the LDC. The example does not, however, explain how those units 
of unsubscribed capacity were accounted for in Pipeline B and C revenue 
requirement or the cost impact of the unsubscribed capacity on the 
current customers. If those costs are not being collected by Pipeline B 
and C, its customers will be better off if the pipeline sells its 
unsubscribed capacity at a discount, rather than if it files a rate 
case to recover the costs of the unsubscribed capacity from its current 
customers. The discounts will protect the captive customers from 
absorbing the full costs of the unsubscribed capacity. The example also 
assumes that if Pipeline A loses 20,000 MMBtu/d, it will file a rate 
case and the Commission will allow it to shift all the costs of its 
unsubscribed capacity to its captive shippers. Neither of these of 
scenarios may occur. Pipeline A would likely try to resell this 
capacity and, if Pipeline A did file a rate case, the Commission might 
not allow the recovery of all of the costs of the unsubscribed capacity 
from the captive customers. In any event, Northern Municipals does not 
cite any case or real-life example where anything like this occurred.
    66. As discussed above, the Commission understands that there may 
be circumstances where gas-on-gas competition could result in discounts 
and no increase in throughput. However, this example cited by Northern 
Municipals provides no basis for making any changes in the Commission's 
current policy.
2. Competition From Capacity Release
    67. In the May 31 Order, the Commission found that there was no 
basis for creating an exemption from the selective discounting policy 
for discounts that result from competition from capacity release. The 
Commission explained that its goal in creating the capacity release 
market in Order No. 636 was to create a robust competitive secondary 
market for capacity, and stated that the capacity release program, 
together with the Commission's policies on segmentation and flexible 
point rights has been successful in achieving this goal. The Commission 
stated that to prevent pipelines from competing effectively in this 
market would defeat the purpose of capacity release and eliminate the 
competition that capacity release has created. The Commission also 
explained that capacity release benefits captive customers by allowing 
them to compete with pipelines for their unused capacity, and this 
provides them with an opportunity to offset a portion of their 
transportation costs. The Commission stated that it is not unreasonable 
to require shippers to compete with the pipeline for the sale of 
released capacity. In addition, the Commission stated that releasing 
customers have some competitive advantages over the pipelines in the 
capacity release market. Thus, the Commission explained that flexible 
point rights and the ability to segment capacity enhance their ability 
to compete in the secondary market, and that shippers have an 
additional advantage in the secondary market because the capacity that 
is being released by the shippers is firm capacity, while the pipeline 
may be limited to selling service on an interruptible basis because it 
has already sold the capacity to the releasing shipper on a firm basis. 
Northern Municipals and IMGA seek rehearing of the Commission's ruling 
on this issue.
    68. Northern Municipals state that capacity release is based on a 
fundamentally different concept than the selective discounting policy. 
They assert that the capacity release program is intended to enable 
firm customers of pipelines to sell any excess firm capacity and 
thereby recoup some of the costs associated with holding that firm 
entitlement. Order No. 637 was also intended to benefit captive 
customers, Northern Municipals argue, by reducing their revenue 
responsibility through a combination of increased capacity release 
revenues, revenue credits, reduced discount adjustments, and lower 
long-term rates on pipelines instituting peak/off peak or term 
differentiated rates. On the other hand, Northern Municipals state, the 
selective discount policy is premised on the belief that discounting 
increases throughput on the overall national grid to the benefit of 
captive customers. Northern Municipals argue that allowing pipelines to 
use selective discounting to compete with their own firm capacity 
holders is at odds with the general goals of the capacity release 
program, as well as the goals of Order No. 637.
    69. Northern Municipals are correct that the selective discount 
policy and the capacity release programs are based on fundamentally 
different concepts. The Commission discussed the differences in the 
development of these policies in the NOI in this proceeding \60\ as 
well as in its order in Williston Basin Interstate Pipeline Co.\61\ As 
the Commission explained, the selective discount policy was adopted as 
part of Order No. 436 and is based on a monopolistic model, while the 
capacity release program was adopted in Order No. 636, where the 
Commission began to move away from the monopolistic selective discount 
model to a more competitive model, especially for the secondary market. 
In Order No. 636, the Commission adopted significant changes to the 
structure of the services provided by natural gas pipelines in order to 
foster greater competition in the natural gas markets.
---------------------------------------------------------------------------

    \60\ See NOI at P 2-6.
    \61\ 107 FERC ] 61,229 at P 3-9 (2004).
---------------------------------------------------------------------------

    70. One of these changes was the adoption of the capacity release 
program. As Northern Municipals state, one of the purposes of the 
capacity release program was to enable customers to sell their unused 
capacity in the secondary market and thus mitigate the shift to the SFV 
rate design.

[[Page 70812]]

However, this was not the only or the primary purpose of the capacity 
release program. As the Commission explained in Order No. 636-A, the 
capacity release mechanism is intended to create a robust secondary 
market where the pipeline's direct sale of its capacity must compete 
with its firm shippers' offers to release their capacity. The 
Commission stated that this competition would help ensure that 
customers pay only the competitive price for the available 
capacity.\62\ In upholding the capacity release program in UDC v. 
FERC,\63\ the court recognized that capacity release is intended to 
develop an active secondary market with holders of unutilized firm 
capacity rights reselling those rights in competition with capacity 
offered directly by the pipeline.
---------------------------------------------------------------------------

    \62\ See Order No. 636-A, FERC Stats. & Regs. at 30,553 and 
30,556.
    \63\ 88 F.3d 1105, 1149 (D. C. Cir. 1996).
---------------------------------------------------------------------------

    71. The issue therefore is how best to accommodate the policies 
behind selective discounting and capacity release. The Commission 
believes that the May 31 Order strikes the appropriate balance. 
Northern Municipals and IMGA would have the Commission focus only on 
the goal of allowing captive customers to recoup some of their 
transportation costs. But, the capacity release program, as upheld by 
the court in UDC v. FERC, was also intended to create a robust 
competitive secondary market. It was not the intent of the Commission 
to allow customers to release capacity without competition between the 
customers and the pipelines, and it was entirely reasonable for the 
Commission to require customers to compete with the pipelines in these 
circumstances. The Commission always intended that customers would be 
required to compete with pipelines for the sale of this capacity and to 
protect customers from this competition would negate an equally 
important part of the capacity release policy.
    72. The Commission must adopt policies of general application that 
promote the Commission's goals in the national gas market. Competition 
in the secondary market benefits all users of the system. Reduction of 
incentives for pipelines to offer discounts would reduce competition. 
The public interest is best served when the Commission's policies 
promote competition and market efficiency to the maximum practical 
extent. The Commission's policies on capacity release and pipeline 
discount adjustments act together to maximize competition and economic 
efficiency, resulting in lower delivered energy prices for consumers in 
aggregate. Denying pipelines a discount adjustment for capacity sold 
below the maximum rate in competition its customers would inhibit the 
competitive market that capacity release has created.
    73. Further, Northern Municipals argue that the Commission has not 
demonstrated how the goal of increasing throughput on the national grid 
and, thus, spreading fixed costs over more units of service, is 
furthered by allowing discount adjustments for capacity sold by an 
interstate pipeline in competition with released capacity. In these 
circumstances, Northern Municipals argue, the pipeline is merely 
competing to resell the same capacity that has already been sold to the 
releasing shipper as firm capacity. Northern Municipals state that the 
fixed costs associated with this capacity have already been paid, and, 
therefore the charge paid for this capacity will not add to the 
recovery of fixed costs. Further, Northern Municipals argue, the impact 
on throughput will be the same whether the pipeline sells this capacity 
or the releasing shipper sells this capacity.
    74. Northern Municipals' argument misunderstands how increased 
throughput on the pipeline impacts the reservation charges of firm 
customers. Increased capacity sold by the pipeline, in competition with 
capacity release or otherwise, will not impact the current reservation 
charges paid by firm customers, but will reduce those charges in the 
next rate case. In a rate case, rates are determined by dividing the 
revenue requirement by the units of throughput. The higher the 
throughput, the lower the rates and, thus, if the pipeline's throughput 
during the rate case test period is increased due to discounting the 
reservation charges in the next rate case will be lower than they would 
have been without the increased throughput. If firm shippers release 
capacity in competition with the pipeline and a replacement shipper 
buys the capacity from the shipper instead of the pipeline, then there 
will be no increase in the pipeline's throughput from that transaction 
to reduce rates in the next proceeding. But, the releasing shipper has 
instead received an immediate and direct benefit by making the sale of 
capacity and thereby recovered some of its reservation charges. When 
the Commission implemented Order No. 636, it recognized that 
competition from capacity release would reduce the amount of 
interruptible transportation service the pipelines would be able to 
sell. Therefore, in the Order No. 636 restructuring proceedings of 
individual pipelines, the Commission permitted the pipelines to reduce 
their allocation of costs to interruptible service. However, the 
Commission determined then, and reaffirms now, that enabling firm 
shippers to release their capacity when they are not using it and 
immediately recover some of their reservation charges provides a 
greater benefit that more than offsets the cost of any reduced 
allocation of fixed costs to interruptible service.
    75. In addition, Northern Municipals dispute the Commission's 
conclusion that the releasing shipper has a competitive advantage over 
the pipeline and states that circumstances on Northern give it some 
advantages over the releasing shipper. First, Northern Municipals 
state, Northern offers a daily firm service which may be more 
attractive to shippers than released capacity. Further, Northern 
Municipals assert, Northern has a competitive advantage over releasing 
shippers in terms of price because during the summer months there is 
excess capacity on Northern and the price for this capacity is very 
low. In addition, Northern Municipals assert, Northern may enter into 
contracts that exempt shippers from surcharges, giving Northern a price 
advantage over a releasing firm shipper that is subject to these 
charges. Northern Municipals state that Northern can undercut the 
releasing shipper by this amount without absorbing any costs, and then 
turn around and propose a selective discount adjustment that raises the 
rates of the shipper against whom Northern was competing to sell the 
capacity. Northern Municipals state that these advantages are not the 
result of a competitive market, but are instead the result of 
Northern's ability to use its monopoly power to manipulate rates in a 
manner that maximizes its revenues, contrary to the fundamental notion 
that interstate pipelines should not be permitted to use their market 
power to the detriment of their customers.\64\
---------------------------------------------------------------------------

    \64\ Northern Municipals cites UMDG v. FERC, 88 F.3d 1105, 1127 
(D.C.Cir. 1996).
---------------------------------------------------------------------------

    76. Nothing in Northern Municipals' argument negates the fact that 
Order No. 637's policies on segmentation and flexible point rights 
enhance a shipper's ability to compete in the secondary market. 
Moreover, since the shippers have contracted for guaranteed firm 
service for the entire term of their contracts, they can release 
guaranteed firm service for whatever term they do not require the 
service themselves. This does give them the ability to sell a high 
quality service in the secondary market, rather than the short-term 
daily firm service described by Northern

[[Page 70813]]

Municipals. It may be that Northern has some advantages as well, but 
this has not hampered competition in the secondary market. The 
Commission's policies have led to an active and competitive secondary 
market for the sale of capacity.
    77. Northern Municipals and IMGA argue that a discount adjustment 
for discounts given in competition with capacity release amounts to a 
subsidy and that therefore captive and other firm shippers are required 
to subsidize the very discounts that kept them from selling their 
excess capacity. IMGA argues that the Commission's citation to AGD I 
\65\ as justification for the discount adjustment is inapposite because 
the Commission's current discount policy with the discount adjustment 
was not before the court and thus any statement regarding the discount 
adjustment was dicta.\66\ Moreover, IMGA asserts, AGD I also made clear 
that the ``opportunity to recover costs does not guarantee that those 
costs are recoverable in the face of competition.'' \67\ Thus, IMGA 
states, if captive customers' rates are increased to offset the loss 
the pipeline would otherwise incur in discounting in competition with 
capacity release, those discounts are subsidized, and, unless there is 
evidence that captive customers benefit from the subsidy, it is 
unlawful.
---------------------------------------------------------------------------

    \65\ A GD I at 1012.
    \66\ IMGA states that the D.C. Circuit made this clear in 
Mississippi Valley Gas Co. v. FERC, 68 F.3d 503, 506-07 (D.C. Cir. 
1995); Transcontinental Gas Pipe Line Corp. v. FERC, 998 F.2d 1313, 
1318, 1321 (D.C. Cir. 1993); Columbia Gas Transmission Corp. v. 
FERC, 848 F2d 250, 251-254 (D.C. Cir. 1988).
    \67\ IMGA cites AGD I at 1001.
---------------------------------------------------------------------------

    78. Contrary to the suggestion of IMGA and Northern Municipals the 
discount adjustment is not a subsidy. Pipelines are not, as IMGA and 
Northern Municipals suggest, reimbursed for the discount by the captive 
customers through the discount adjustment and the discount adjustment 
should not raise the rates of captive shippers. As explained above, in 
a rate case, the rates going forward are determined by dividing the 
pipeline's projected costs by its projected future throughput on the 
volumes transported during the rate case test period. If some of the 
test period volumes were transported at a discount, the discount 
adjustment recognizes that these volumes were transported at less than 
the maximum rate. Therefore the units of throughput for ratemaking 
purposes are reduced to reflect the discounting.
    79. To the extent that a discount adjustment for discounts given to 
interruptible customers in competition with firm customer capacity 
release results in a higher allocation of costs to firm services, as 
opposed to interruptible services, that allocation appropriately 
recognizes that firm service with the right to release capacity in 
competition with the pipeline and the right to segment and use flexible 
point rights is a higher quality service with substantial rights.
    80. Further, while it is true that the discount adjustment was not 
before the court in AGD I, the court clearly indicated its concern that 
the absence of a discount adjustment would be a ``dubious'' practice 
that could result in denying the pipelines and opportunity to recover 
their costs. It was not error for the Commission to respond to the 
court's concern in further developing its discount policy.
    81. Of course, if there were no discount adjustment and all of the 
discounted volumes were included in the test period throughput as 
though they had been transported at the maximum rate, the rate derived 
using those volumes would be lower than the rates that would be derived 
using the discount adjustment. But, if the Commission required 
pipelines to include the full amount of all volumes transported at a 
discount, then, as the court pointed out in AGD I, the pipeline would 
be in jeopardy of not having an opportunity to recover its cost of 
service. This would discourage discounting. In these circumstances, it 
is likely that the pipeline would not have transported the volumes at 
the discounted rate and the throughput in the next rate case would be 
lower than if the volumes had been transported at a discount.
    82. Further, IMGA argues that discounting in competition with 
capacity release does not benefit captive customers and therefore the 
policy cannot be continued. First, IMGA states, small captive customers 
on one-part rate schedules are not permitted to release capacity and, 
second, even if a captive customer benefits from capacity release, that 
does not mean that it benefits from discounting in competition with 
capacity release.
    83. Again, IMGA's focus is too narrow. The Commission recognizes 
its obligation to protect captive customers from the monopoly power of 
the pipelines, but the Commission has other obligations as well and 
must balance a number of interests in developing its policies. Captive 
customers might be better off if they were able to sell their capacity 
in the capacity release market without competition from the pipelines, 
but this would defeat the Commission's purpose in adopting the capacity 
release program to develop a robust competitive secondary market for 
capacity. It is not unreasonable for the Commission to require firm 
shippers to compete with pipelines for the sale of capacity in the 
secondary market.
    84. As the Commission explained in Order No. 636-B,\68\ because 
customers paying a one-part \69\ rate do not pay a reservation charge 
to reserve capacity, they cannot release that capacity. However, the 
Commission also stated that the pipeline should develop procedures that 
would enable customers served under one-part rate schedule to convert 
to a two-part rate schedule if they choose to convert in order to 
release capacity. Presumably, IMGA's one-part rate shippers could 
convert to a two-part rate schedule if they choose to take advantage of 
the benefits of capacity release. The one-part volumetric rate with an 
imputed load factor paid by small customers is a subsidized rate that 
provides them with a lower rate than they would pay if they paid the 
rate applicable to larger shippers. The choice is for the small shipper 
to decide if it prefers the benefits of its lower one-part rate to the 
benefits of capacity release.
---------------------------------------------------------------------------

    \68\ Order No. 636-B, 61 FERC ] 61,272 at 61,998 (1992).
    \69\ As the Commission explained in the May 31 Order, small 
captive customers pay one-part volumetric rates on many pipelines. 
Small shippers paying these one-part rates do not pay a reservation 
charge to reserve capacity and their rates are often developed using 
an imputed load factor that is higher than the customer's actual use 
of the system.
---------------------------------------------------------------------------

3. Competition From Intrastate Pipelines
    85. In the May 31 Order, the Commission stated that competition 
from intrastate pipelines is not subject to the Commission's 
jurisdiction and the Commission therefore has no ability to discourage 
intrastate pipelines from offering discounts in competition with 
interstate pipelines. Therefore, the Commission stated that interstate 
pipeline discounts to avoid loss of throughput to non-jurisdictional 
intrastate pipelines do benefit captive customers of the interstate 
pipelines. The Commission stated that the commenters opposing the 
discount adjustment seemed to recognize this and therefore focused 
their comments on competition from interstate pipelines and capacity 
release.
    86. On rehearing, Northern Municipals argue that the Commission has 
provided no support for its statement that customers benefit from 
discounts given to avoid loss of throughput to intrastate pipelines. 
Northern Municipals assert that the analysis of whether a discount 
given to meet competition from an intrastate pipeline is no different 
from the

[[Page 70814]]

analysis that should apply to a discount given to meet competition from 
an interstate pipeline, i.e., does the discount that shippers are being 
asked to bear outweigh any benefits from retaining the load in 
question. Northern Municipals assert that competition from an 
intrastate pipeline will almost always involve competition from another 
interstate pipeline and that they believe that the majority of 
intrastate pipelines are not built to allow a shipper to directly 
access a production area, but instead are built to provide access to 
another interstate pipeline. Thus, they argue, the analysis is not 
different than if a shipper went directly to the competing interstate 
pipeline.
    87. Northern Municipals give as an example the discount given by 
Northern to CenterPoint. Northern Municipals state that the discount 
granted to CenterPoint was for capacity that CenterPoint already had 
under contract and therefore no increase in throughput would result 
from the CenterPoint deal either on Northern or on the interstate grid. 
Northern Municipals state that the competition in this case was from an 
intrastate pipeline and that CenterPoint's competitive alternative was 
to build or have built an intrastate pipeline to access another 
interstate pipeline, not to access directly the production area. 
Northern Municipals further state that while the Commission has assured 
Northern Municipals that it can attack this discount in a future rate 
case, the Commission's statement that discounts given to meet 
competition from intrastate pipelines do benefit captive customers of 
the interstate pipeline prejudges that issue.
    88. Parties did not generally argue in their initial comments that 
discounts to meet competition from intrastate pipelines would not 
increase throughput on the national transportation grid, as they did 
with regard to discounts given to meet competition from other 
interstate pipelines. Therefore, the May 31 Order did not focus on this 
issue. The Commission lacks jurisdiction over intrastate pipelines and 
thus cannot discourage them from discounting through its ratemaking 
policies. Therefore, interstate pipelines must be allowed to compete 
with intrastate pipelines or throughput will be lost to the intrastate 
pipelines to the detriment of the interstate customers.
    89. If an interstate pipeline gives a shipper a discount in order 
to keep that shipper on the system, the discount benefits the captive 
customers of the pipeline by retaining that throughput. If instead the 
volumes left the system to be transported on an intrastate pipeline, 
the overall volume on the interstate system would be lower as a result. 
If the volumes were retained on the interstate pipeline rather than 
moving via an intrastate pipeline to another interstate pipeline, the 
issues would be similar to those discussed above with regard to 
competition between interstate pipelines. As the Commission has 
concluded above, competition between interstate pipelines can increase 
throughput on the interstate grid and can produce additional benefits 
to users of the system. Thus, the Commission has concluded that in 
either case a discount to gain or retain throughput may be appropriate 
if the pipeline is able to show that the discount was necessary to meet 
competition.
    90. In any event, the issue of whether the discount given to 
CenterPoint should receive a discount adjustment under the Commission's 
policy can be addressed in the rate case where Northern seeks a 
discount adjustment. Northern Municipals raised issues concerning the 
CenterPoint discount when Northern filed its service agreement with 
CenterPoint for the Commission to approve various material deviations 
in the service agreement. As the Commission's March 23, 2005 \70\ and 
June 8, 2005 \71\ Orders in that proceeding made clear, the Commission 
has made no determination as to whether Northern will be able to obtain 
a discount adjustment in its next rate case for the discount given to 
CenterPoint, and neither does anything in this order prejudge that 
issue. Similarly, as the Commission explained in the November 1, 2005 
Order in Northern Natural Gas Co.,\72\ the issue of whether Northern 
will be permitted to adjust its rate design volumes in its next rate 
case to reflect discounts given to another Northern customer 
(Metropolitan Utilities District) will be decided in that next rate 
case. The issue of whether any other equitable relief would be 
appropriate in the circumstances of these discounts can also be 
addressed in the next rate case.
---------------------------------------------------------------------------

    \70\ Northern Natural Gas Co., 110 FERC ] 61,321 at P 32 (2005).
    \71\ Northern Natural Gas Co., 111 FERC ] 61,379 at P 8 (2005).
    \72\ 113 FERC ] 61,119 (2005).
---------------------------------------------------------------------------

    91. Thus, as a general rule, a discount granted by an interstate 
pipeline to meet competition from an intrastate pipeline will result in 
greater throughput on the interstate system than without such a 
discount to the benefit of all customers. If there are special 
circumstances that the Commission should consider, it can do so in an 
individual rate case.

E. The Discount Adjustment for Discounts Given on Expansion Capacity

    92. In the May 31 Order, the Commission found there was no reason 
to create an exemption from the selective discounting policy for 
expansion projects. The Commission explained that new construction is 
no longer undertaken solely for the purpose of serving new markets, but 
also to provide natural gas customers with competitive alternatives to 
existing service. The Commission stated that, as a result of recent 
expansions, there are fewer captive customers,\73\ and policies that 
encourage these expansions will provide more options to customers that 
are currently captive and thus enable them to benefit from the 
competitive markets. However, the Commission also clarified that in 
receiving approval for the expansion project, the pipeline must meet 
the criteria set forth in the Certificate Pricing Policy Statement,\74\ 
and if the expansion does not benefit current customers, the services 
must be incrementally priced. The Commission would not approve a 
discount adjustment in circumstances that would shift the costs of an 
expansion to existing customers that did not benefit from the expansion 
because this would be contrary to the Commission's policy. IMGA and 
Northern Municipals seek rehearing of this ruling.
---------------------------------------------------------------------------

    \73\ INGAA states that since the implementation of the Order No. 
636, substantial new capacity has been built, leading to more gas-
on-gas competition and thus fewer captive customers. INGAA states 
that the 36 pipeline companies that responded to a 2005 INGAA survey 
reported that they spent $19.6 billion for interstate pipeline 
infrastructure between 1993 and 2004.
    \74\ 88 FERC ] 61,277 (1999), order on clarification, 90 FERC ] 
61,128 (2000), order on further clarification, 92 FERC ] 61,094 
(2000).
---------------------------------------------------------------------------

    93. On rehearing Northern Municipals argue that the Commission 
failed to address the issue of how new construction can be a true 
competitive alternative if, in the absence of discounting, it is a 
higher priced alternative. Northern Municipals state that in a 
competitive market, the correct result is that the construction will 
not be undertaken because there is lower-priced capacity already 
available. Northern Municipals state that a competitive market is not 
one in which one alternative is artificially priced lower than its cost 
by forcing other shippers, not interested in the construction, to 
subsidize that construction so that it can compete with other, lower-
priced service.
    94. Northern Municipals state that there is no evidentiary support 
for the Commission's statement that as a result of expansions, there 
are fewer captive

[[Page 70815]]

customers. But, they argue, even if this were true, there is still no 
justification for asking existing customers of a pipeline to subsidize 
a discount adjustment for a construction project for capacity that is 
not competitively priced.
    95. Northern Municipals and IMGA argue that discount adjustments 
are contrary to the Commission's policy on expansion capacity because 
they distort accurate price signals. They quote the Certificate Pricing 
Policy Statement that rolled in pricing sends the wrong price signals 
by masking the costs of the expansion, and asserts that discounting has 
the same effect. Northern Municipals acknowledge the Commission's 
statement in the May 31 Order that it would not approve a discount 
adjustment in circumstances that would shift costs to customers that 
did not benefit from the expansion, but argues that the Commission then 
contradicts itself by stating that allowing an adjustment for discounts 
in a rate case does not amount to rolled-in pricing. Northern 
Municipals argue that if the rates are required to be incrementally 
priced under the Commission's existing policy, then an adjustment in a 
base rate case for discounts does constitute recovery of costs from 
existing shippers that do not benefit from the expansion.
    96. In addressing the issue of the application of the selective 
discounting policy to new pipelines, there is a distinction between an 
entirely new pipeline and an expansion of an existing pipeline. An 
entirely new pipeline should have the same policies applied to it with 
regard to discounting as an existing pipeline. Discount adjustments 
only affect the allocation of the costs of the pipeline that gave the 
discount among its own customers. Thus, the ability of a new pipeline 
to seek a discount adjustment in designing its own rates will not 
adversely affect customers of other pipelines. Shippers who are 
original customers on the new pipeline can negotiate risk-sharing 
arrangements with that pipeline before deciding to participate in the 
project. These original shippers are not captive customers in the same 
sense as captive customers on existing pipelines and, since they are 
not currently receiving service under the new pipeline, they clearly 
have other options. A newly constructed pipeline could be fully booked 
with firm transportation, but could obtain additional throughput 
through the sale of interruptible service at a discounted rate. In 
those circumstances, the pipeline should receive a discount adjustment, 
and there is no reason to create an exemption from the Commission's 
selective discounting policy for newly constructed pipelines.
    97. The expansion of existing pipeline capacity is, however, a 
different situation. In the Certificate Pricing Policy Statement,\75\ 
the Commission stated that in evaluating proposals for certificating 
new construction, the threshold question applicable to existing 
pipelines is whether the project can proceed without subsidies from 
their existing customers. This policy statement changed the 
Commission's previous policy of giving a presumption for rolled-in 
treatment for pipeline expansions. The Commission found that rolled-in 
treatment sends the wrong price signals by masking the true cost of 
capacity expansions to the shippers seeking the additional capacity. 
The Commission stated that the requirement that pipeline expansions 
should not be subsidized by existing customers is necessary for a 
finding of market need for the project. This generally means that 
expansions will be priced incrementally so that expansion shippers will 
have to pay the full cost of the project without subsidy from the 
existing customer through rolled-in pricing.
---------------------------------------------------------------------------

    \75\ 88 FERC ] 61,277 (1999), order on clarification, 90 FERC ] 
61,128 (2000), order on further clarification, 92 FERC ] 61,094 
(2000).
---------------------------------------------------------------------------

    98. Thus, in most cases, expansion capacity is incrementally 
priced. The Commission clarifies that in these circumstances, there 
will be no discount adjustment for service on the expansion that 
affects the rates of the current shippers, since rates for that service 
will be designed incrementally.
    99. However, the pricing policy did not eliminate the possibility 
that some or all of a project's costs could be included in determining 
existing shipper's rates. The Commission stated that rolled-in 
treatment would be appropriate when rolled-in rates lead to a rate 
decrease for the pre-expansion customers, for example because initial 
costly expansion results in cheap expansibility. In addition, rolled-in 
rates might be appropriate if the new facilities are necessary to 
improve service for existing customers. In circumstances where the 
rates for expansion capacity are rolled-in, a discount adjustment can 
be appropriate.

F. Burden of Proof

    100. In the May 31 Order, the Commission explained that under its 
current policy, in order to obtain a discount adjustment in a rate 
case, the pipeline has the ultimate burden of showing that its 
discounts were required to meet competition. The Commission further 
explained that it has distinguished between the burden of proof the 
pipeline must meet, depending upon whether a discount was given to a 
non-affiliate or an affiliate. In the case of discounts to non-
affiliated shippers, the Commission stated, it is a reasonable 
presumption that a pipeline will always seek the highest possible rate 
from such shippers, since it is in the pipeline's own economic interest 
to do so. Therefore, the Commission stated, once the pipeline has 
explained generally that it gives discounts to non-affiliates to meet 
competition, parties opposing the discount adjustment have the burden 
to raise a reasonable question concerning whether competition required 
the discounts given in particular non-affiliate transactions. Once the 
party opposing the discount adjustment raises a reasonable question 
about the circumstances of the discount, then the burden shifts back to 
the pipeline to show that the questioned discounts were in fact 
required by competition.
    101. The May 31 Order found that this allocation of the burden of 
proof is based on accurate assumptions and produces a just and 
reasonable result. The Commission stated that in view of the 
reasonableness and accuracy of the presumption that pipelines will seek 
the highest rate from non-affiliated shippers, requiring the pipeline 
to substantiate the necessity for all unaffiliated discounts would be 
unduly burdensome and would discourage a pipeline from discounting. 
IMGA and Northern Municipals seek rehearing of this ruling.
    102. Northern Municipals assert that the burden of proof is heavily 
tilted in favor of the pipeline because the burden is on the opposing 
party, who was not privy to the original negotiations, to discover all 
of the details relevant to the discounts at issue, while the pipeline, 
who knows the most about the transaction, need do nothing at the outset 
to prove that the discount was necessary. Further, Northern Municipals 
assert, the rate case in which the discount adjustment is at issue 
often occurs well after the discount is made and thus, the opposing 
party's attempts to prove that the discounts were not necessary are 
invariably met with charges that they are using `twenty-twenty' 
hindsight to challenge the discounts. Northern Municipals state that an 
additional problem with the burden of proof is that in rate cases, 
pipelines argue that they have the right to file the last round of 
testimony, giving the pipeline the final opportunity to present its 
real justification for the

[[Page 70816]]

discount, and there will be no opportunity for the shippers to rebut 
this testimony.
    103. Northern Municipals argue that pipelines should be required to 
demonstrate, through the filing of substantial evidence in their 
initial cases, that the benefits to captive customers that they and the 
Commission assume exist, actually do exist. Thus, Northern Municipals 
state, pipelines would have to compare the base rates that would have 
existed had the discounts not been granted to the base rates that would 
have existed if the discounts had been granted and a discount 
adjustment included in the computation of base rates. They argue that 
this proposal would not discourage discounts, as the Commission has 
suggested, if the discount met the test of providing some quantifiable 
benefit to captive and other customers, but would only discourage 
discounts that do not comport with the Commission's stated rationale 
for its selective discount policy.
    104. Northern Municipals overstate the burden placed upon parties 
challenging a discount adjustment. Contrary to the assertions of 
Northern Municipals, the burden placed upon the opponents of the 
discount adjustment is not an unduly heavy burden. All the challenger 
of a discount adjustment must do, after the pipeline has explained 
generally the basis for its discounts, is produce some evidence that 
raises a reasonable question concerning whether the discount was 
required to meet competition.\76\ Thus, Northern Municipals' concern 
that, in a rate case, ``the opposing party's attempts to prove that the 
discounts were not necessary are invariably met with charges that they 
are using `twenty-twenty' hindsight to challenge the discounts'' is 
unfounded. Contrary to Northern Municipals assertion, the opponent of 
the discount is not required to prove that the discount was not given 
to meet competition, but merely has to raise a reasonable question as 
to the validity of the discount and the pipeline is required to show 
that it was made to meet competition. Further, the relevant inquiry is 
whether at the time the discount was given it was necessary to meet 
competition and this inquiry would not be dismissed as hindsight.
---------------------------------------------------------------------------

    \76\ See, e.g., Northern Natural Gas Co., 111 FERC ] 61,379 at P 
18 (2005).
---------------------------------------------------------------------------

    105. It is not an undue burden to ask the parties opposing the 
discount adjustment to introduce some evidence that raises a question 
about the need for the discount. In a rate case where the discount 
adjustment is challenged, all parties have an opportunity to seek 
discovery of all the facts surrounding each discount. Thus, discovery 
will provide the parties with the information necessary to determine 
whether a challenge to a discount adjustment is appropriate and the 
ultimate burden of proof on the issue will be on the pipeline. In this 
regard, if a pipeline is unable in response to a discovery request to 
explain why competition required a particular discount, the Commission 
would regard that fact alone to raise a sufficient question concerning 
whether the discount was required to meet competition to shift the 
burden to the pipeline to justify the discount. Thus, pipelines must 
keep information relevant to each discount because if they are unable 
to explain and justify each discount, they will not be able to meet 
their burden of proof. Parties may also challenge in the rate case the 
level of discounts given and the pipeline must be able to substantiate 
that the discount was not lower than what was necessary to meet 
competition and obtain the additional throughput. Further, Northern 
Municipals' concern that shippers could be denied an opportunity at a 
hearing to rebut the pipelines case is unfounded and Northern 
Municipals cite no case where this has occurred. The pipeline must 
present evidence showing that the discount was required by competition 
and the opponents of the discount have an opportunity to challenge that 
evidence.
    106. Finally, Northern Municipals argue that the Commission should 
review its records and information submitted by the pipelines to 
determine whether pipelines are successful in recovering discounts from 
their remaining customers all or a majority of the time. If so, 
Northern Municipals argue, then the basis of the policy, i.e., that 
pipelines will always seek the highest rate because it is in its own 
economic interests to do so, must be reexamined. Northern Municipals 
argue that if pipelines are routinely permitted to recover these 
discounts through rates, then they do not need to seek the highest 
possible rate and can agree to virtually any discount from maximum 
rates because their economic interests are fully protected through 
their ability to have their other customers subsidize their discounts. 
Similarly, IMGA states that the discount adjustment does not motivate 
the pipeline to obtain the highest rate possible for the service, but 
instead motivates the pipeline to grant the discount without knowing 
whether it is necessary to meet competition because the throughput 
adjustment insulates it from the risk of its own imprudence.
    107. The Commission does not require the pipeline to initially 
present detailed evidence to substantiate that each discount was 
granted to meet competition because it assumes that, in the case of a 
discount to a non-affiliate, the pipeline will always seek the highest 
rate for its services because it is in its own best economic interests 
to do so. The Commission can make assumptions about rational business 
behavior and a pipeline, like any other business, can be presumed to 
act in its own economic best interests. Contrary to the parties' 
assertions here, the discount adjustment does not negate that 
assumption. There is no rational reason for a pipeline company to sell 
capacity at less that the highest rate it can charge. It would not be a 
good business practice for a pipeline to turn down the opportunity to 
put money in its pocket today through a higher rate in order to take a 
chance that the Commission will allow a discount adjustment in a future 
rate case.\77\ There is no guarantee that the Commission will approve a 
discount adjustment and the Commission has denied pipelines this rate 
treatment when it has not been shown that the discounts were required 
by competition.\78\
---------------------------------------------------------------------------

    \77\ See, e.g., Columbia Gas Transmission Corp., 848 F.2d 250, 
251-54 (1985) (pipeline will seek the highest possible rate).
    \78\ See, e.g., Iroquois Gas Transmission System, 84 FERC ] 
61,086 at 61,476-78 (1998), reh'g denied, 86 FERC ] 61,261 (1999); 
Trunkline Gas Co., 90 FERC ] 61,017 at 61,092-95 (2000).
---------------------------------------------------------------------------

    108. Moreover, the discount adjustment simply allows pipelines to 
project future throughput based on the volumes transported during the 
test period for the rate case and recognizes that some of these volumes 
may have been transported at a discount in order to meet competition. 
If the projection of future volumes based on the test period discounts 
is accurate, the pipeline will recover its cost of service. However, if 
competitive circumstances change, and in the future the pipeline is 
required to discount below the level of the discounts during the test 
period, the pipeline is at risk of undercollecting its cost of service 
until its next rate case. On the other hand, if the pipeline can 
transport volumes at a rate higher than the discounted rate during the 
test period, it will retain that money until the next rate case. Thus, 
the pipeline always has an incentive to collect the highest possible 
rate for its service and it makes no business sense for a pipeline to 
discount unnecessarily. It is therefore reasonable for the Commission 
to make this assumption in allocating

[[Page 70817]]

the burden of proof on this issue. As explained above, parties opposing 
the discount may address at the hearing, not only the issue of whether 
a discount was given to meet competition, but also of whether something 
less than the full discount is appropriate in the circumstances. The 
requests for rehearing are denied.

G. Protections for Captive Customers

    109. In the May 31 Order, the Commission stated that opposition to 
the discount policy comes from a group of publicly-owned municipal gas 
companies that represent a small percentage of throughput on the 
national system, and that it is possible to adopt measures to protect 
these customers in individual cases where the Commission's policy works 
an undue hardship on them and at the same time retain the benefits of 
the policy for the majority of shippers. Northern Municipals and IMGA 
seek rehearing of this ruling.
    110. These parties assert that the discount policy is opposed not 
only by publicly-owned municipal gas companies, but also that it is 
opposed at least in part by OAL, Arizona Electric Power Cooperative, 
Inc., the Missouri Public Service Commission, Calpine Corp., 
CenterPoint Energy Resources, the Northwest Industrial Gas Users, and 
seven members of Northern Municipals that are small-investor-owned 
LDCs.\79\ Moreover, Northern Municipals argue, the issues raised here 
do not turn on whether those commenting represent a large or a small 
percentage of throughput. Instead, Northern Municipals assert, the 
relevant inquiry is whether the goals of the selective discounting 
policy are adequately supported by the facts and the law. Northern 
Municipals argue, while it may be true that the Commission can take 
case-specific actions to protect captive customers, this is not 
responsive to the issue of whether the goals of the selective 
discounting policy have been adequately supported by the facts and the 
law. Further, Northern Municipals take issue with the Commission's 
statement that there are already measures in place on pipelines that 
give captive customers special rates that provide them with protection. 
Northern Municipals state that a selective discounting policy that is 
premised on the conclusion that it will lead to increased throughput on 
the national grid, and benefit captive customers and others by 
spreading fixed costs cannot be justified by simply stating that some 
of the smallest customers on a pipeline receive volumetric rates, 
particularly where those rates are the result of settlements.\80\
---------------------------------------------------------------------------

    \79\ Community Utility Company, Great Plains Natural Gas 
Company, Northwest Natural Gas Co., Sheehan's Gas Company, Inc., 
Midwest Natural Gas, Inc., Superior Water Light & Power, and St. 
Croix Valley Natural Gas, Wisconsin.
    \80\ Moreover, Northern Municipals assert, while 45 of its 
members are eligible for volumetric rates, all its members purchase 
service under Northern's two-part rate schedule, and therefore pay 
reservation charges that are impacted by discount adjustments.
---------------------------------------------------------------------------

    111. There are only two parties that continue to oppose the 
discount policy, IMGA and Northern Municipals. The other parties 
mentioned by IMGA and Northern Municipals have not sought rehearing of 
the May 31 Order. In any event, the Commission's statement that only a 
small group of customers oppose the policy was not intended to suggest 
that an otherwise unsupportable policy would be appropriate because 
only a few shippers object to it. Instead, the statement was directed 
to a balancing of competing interests in this case. Because the 
discount policy is a significant and necessary part of the Commission's 
pro-competitive policies and because it provides benefits to many 
shippers, it is appropriate for the Commission to consider whether any 
negative impacts of the policy can be mitigated. If any negative 
impacts of the selective discounting policy are relatively few and 
isolated and can be corrected, then abandoning the overall benefits of 
the policy would not be warranted.
    112. IMGA objects to the statement in the May 31 Order that one-
part rates protect small customers and are subsidized by the larger 
customers. IMGA asserts that there is no evidence that all one-part 
rates are subsidized. IMGA argues that the one-part rate does not 
protect captive customers from unlawful discrimination caused by 
raising their rates to subsidize discounted rates.
    113. One-part rates are offered by pipelines to small shippers to 
benefit those shippers by charging them lower rates than they otherwise 
would pay. Generally, one-part volumetric rates are based on an imputed 
load factor that does not reflect the actual projected volumes, but 
instead reflects a level designed to allocate some of the costs to 
larger customer services. For example, Natural Gas Pipeline Co. of 
America (Natural) explains that on its system the group of small 
municipal customers that do not have access to competitive alternatives 
from other pipelines or capacity release are served under Rate Schedule 
FTS-G (G Customers).\81\ Natural states that these customers account 
for 1 percent of the total contract requirements on its system. Natural 
explains that these small customers have firm service, but pay only 
volumetric rates. Therefore, they have firm capacity reserved for them, 
but pay for service only when they actually use that capacity. Further, 
Natural explains, the G rate is derived from the corresponding large 
customer rate at an assumed 50 percent load factor, while the actual 
load factor of G Customers is approximately 10 percent. Natural states 
that under this rate structure, the G Customers pay only about 20 
percent of what they would pay for the corresponding level of firm 
service under Rate Schedule FTS. In these circumstances, the one-part 
rates are subsidized because they do not recover all of the costs of 
the service. In any event, the Commission's reference to one-part rates 
was merely intended to show an example of a way that protections for 
small customers can be considered in individual cases.
---------------------------------------------------------------------------

    \81\ See Comments of Natural Gas Pipeline Company of America at 
14-15.
---------------------------------------------------------------------------

    114. Northern Municipals state that there is no evidence to support 
the Commission's statement that to the extent the discount policy 
furthers competition, it ``should'' encourage other pipelines to 
compete for the business of captive customers. Northern Municipals 
state that pipelines generally compete for the largest loads. Further, 
Northern Municipals argue that this portion of the order conflicts with 
the Commission's conclusion that interstate pipelines should be able to 
discount to compete with intrastate pipelines. Northern Municipals 
state that with regard to the CenterPoint discount discussed above, the 
competition that Northern was attempting to meet was from a new 
intrastate pipeline to be built. Northern Municipals state that if the 
pipeline had been built, it would have freed-up capacity in Northern's 
capacity constrained market area perhaps provided access to new or 
additional supply sources and increased competitive alternatives.
    115. In the May 31 Order the Commission stated that as the national 
transportation grid becomes more competitive, there will be fewer 
captive customers. The Commission believes that its policies promoting 
competition do encourage pipelines to compete for business, including 
the business of captive customers, and since Order No. 636, substantial 
new capacity has been built.\82\ In any event, as we have

[[Page 70818]]

explained above, issues concerning Northern's discount to CenterPoint 
can be considered in Northern's next rate case.
---------------------------------------------------------------------------

    \82\ As stated above, in response to a 2005 INGAA survey, 36 
pipelines reported that they had spent $19.6 billion for interstate 
pipeline infrastructure between 1993 and 2004, and during the 1990s 
interregional natural gas pipeline capacity grew by 27 percent.
---------------------------------------------------------------------------

    116. IMGA further states that while the Commission stated that it 
would consider the impact of discount adjustments in specific 
proceedings, IMGA and other captive customers have been paying higher 
rates than necessary and lawful because of the Commission's discount 
policy for the past 16 years and absent Commission action now, will 
continue to pay those unlawful rates. Contrary to this assertion, the 
current rates being paid by IMGA are lawful rates that have been found 
just and reasonable under section 4 of the NGA.

H. Periodic Rate Cases

    117. The May 31 Order found that selective discounting does not 
provide a basis for requiring pipelines to file periodic rate cases. 
The Commission explained that, unlike the circumstances under the 
Commission's Purchased Gas Adjustment (PGA) clause regulations there is 
no adjustment mechanism that permits a pipeline to change its rates and 
pass additional costs through to customers between rate cases. The 
Commission found that in these circumstances, the procedures under 
sections 4 and 5 of the NGA provide sufficient protections to the 
pipeline's customers.
    118. On rehearing, Northern Municipals argue that if a pipeline 
increases throughput through discounting, any resulting benefits will 
not accrue to captive customers until the throughput on which rates are 
based is adjusted in a rate case to reflect the increase. Further, 
Northern Municipals state that without a requirement for periodic 
section 4 rate filings, pipelines have the ability to manipulate the 
timing of their filings to maximize revenue. Northern Municipals also 
assert that current system rates most likely already include discount 
adjustments and that, to the extent that those adjustments were based 
on discounts that no longer accurately reflect the current level of 
discounting, they may or may not achieve the purposes of the selective 
discounting policy.
    119. Further, Northern Municipals state complaint proceedings are 
not a solution because they are time consuming and expensive, the party 
filing the complaint will not have access to the information needed to 
file the complaint in the first place, and relief is prospective only. 
Northern Municipals state that in their initial comments, they asked 
the Commission to ask Congress to amend section 5 of the NGA to provide 
for refunds. Northern Municipals state that the May 31 Order does not 
address these shortcomings of section 5 and argues that the Commission 
must fully address these issues before concluding that section 5 
provides sufficient protection to consumers.
    120. Under section 4 of the NGA, the Commission is required to 
ensure that rate changes proposed by the pipeline are just and 
reasonable, and under section 5, if the Commission finds that the 
existing rate is unjust or unreasonable, it must establish the just and 
reasonable rate for the future. This is the statutory scheme under the 
NGA and it gives the Commission sufficient authority to ensure that 
pipeline rates are just and reasonable. A requirement that pipelines 
file periodic rate cases is not part of the statutory scheme, and the 
Commission's authority to require such filings is limited.\83\ As the 
Commission stated in the May 31 Order, under this statutory scheme, the 
decision to file a rate case is always that of the pipeline and it may 
choose to file a rate at a time that it is advantageous for it to do 
so. The ``shortcomings'' Northern Municipals perceives in section 5 as 
a remedy are part of the statutory scheme. The fact that under section 
5 the burden of proof is on the complainant and that relief is 
prospective only does not give the Commission authority to order 
periodic rate filings under section 4.
---------------------------------------------------------------------------

    \83\ New York State Public Service Commission v. FERC, 866 F.2d 
487 (D.C. Cir.1989) (requiring periodic filings under NGA section 4 
beyond the Commission's statutory authority).
---------------------------------------------------------------------------

    121. Northern Municipals argue that periodic rate filings should be 
required because there are similarities between the discount policy and 
the PGA. Northern Municipals state that the fundamental premise behind 
the periodic rate filing required under the PGA regulations was that, 
in exchange for the ability to change only one cost element, pipelines 
agreed to a re-examination of all their costs and rates at three-year 
intervals to assure that the gas cost increases were not offset by 
decreases in other costs. Northern Municipals state that, similarly, 
the premise of selective discounting is that captive customers will 
benefit from subsidizing discounts because there will be an increase in 
fixed costs spreading. But, they argue, if the discounts are not 
reviewed periodically, any alleged benefits may not be realized. 
Northern Municipals assert that this is no different in principle from 
saying that the pipeline under a PGA clause must examine all costs at 
regular intervals to assure that the gas cost increases were not offset 
by decreases in other costs.
    122. The Commission affirms its conclusion that similarities 
between the PGA mechanism and the discount adjustment mechanism do not 
justify a periodic rate filing requirement. Under the PGA mechanism, 
pipelines were able to pass projected changes in their gas costs 
through to customers between rate cases. Thus, the rates adjudicated 
just and reasonable in a section 4 rate case would change prior to the 
next rate case to reflect increased gas costs. In exchange for this 
ability to increase their rates between rate cases, the pipelines 
agreed to a reexamination of all of their rates at three-year 
intervals. This is not analogous to the discount adjustment permitted 
in the pipeline's next rate case to reflect that not all test-period 
throughput volumes were transported at the maximum rate. There is no 
mechanism under the selective discount policy that permits shippers' 
rates to change between rate cases. The rates of other shippers on the 
system remain at the level determined to be just and reasonable in the 
pipeline's last section 4 rate case and are not affected until the next 
rate case is filed. In these circumstances a requirement that pipelines 
file periodic rate cases is not justified.

I. Informational Posting Requirements

    123. In the May 31 Order, the Commission concluded that its current 
informational posting requirements provide shippers with the price 
transparency needed to make informed decisions and to monitor 
transactions for undue discrimination and preference.\84\ Therefore, 
the Commission stated that it would not change its informational 
posting requirements at this time. The Commission further stated that 
it will refer allegations of non-compliance with the Commission's 
posting and reporting requirements to the Office of Market Oversight 
and Investigation for a potential audit and that, as part of the 
Commission's ongoing market

[[Page 70819]]

monitoring program, the Commission will continue to conduct audits on 
its own.
---------------------------------------------------------------------------

    \84\ Under section 284.13(b), pipelines are required to post on 
their Web site information concerning any discounted transactions, 
including the name of the shipper, the maximum rate, the rate 
actually charged, the volumes, receipt and delivery points, the 
duration of the contract, and information on any affiliation between 
the shipper and the pipeline. Further, section 358.5(d) of the 
regulations requires pipelines to post on their Web site any offer 
of a discount at the conclusion of negotiations contemporaneous with 
the time the offer is contractually binding.
---------------------------------------------------------------------------

    124. Northern Municipals argue that the Commission erred in 
refusing to amend its regulations to require pipelines to post the 
reasons for each selective discount granted and the benefits of the 
discount to captive customers. They state that if customers want to 
oppose a discount, they must know the reason for it. Northern 
Municipals state that attempting to analyze a pipeline's reasons for 
granting the discount in a later-filed rate case raises additional 
issues, including whether after-the-fact justification should be 
permitted and whether it is more difficult for the captive customers to 
eliminate discount adjustments for discounts that have already been 
provided to favored customers.
    125. As explained in the May 31 Order, under section 284.13(b) of 
the Commission's regulations, pipelines are required to post on their 
Web site information concerning any discounted transactions, including 
the name of the shipper, the maximum rate, the rate actually charged, 
the volumes, receipt and delivery points, the duration of the contract, 
and information on any affiliation between the shipper and the 
pipeline. Further, section 358.5(d) of the regulations requires 
pipelines to post on their Web site any offer of a discount at the 
conclusion of negotiations contemporaneous with the time the offer is 
contractually binding. This information provides shippers and the 
Commission with the price transparency needed to make informed 
decisions and to monitor transactions for undue discrimination and 
preference. As the court stated in AGD I,\85\ ``the reporting system 
will enable the Commission to monitor behavior and to act promptly when 
it or another party detects behavior arguably falling under the bans of 
sections 4 and 5.''
---------------------------------------------------------------------------

    \85\ 824 F.2d at 1009.
---------------------------------------------------------------------------

    126. In determining whether a discount adjustment is appropriate in 
a rate case, the Commission determines whether the discount was 
required by competition at the time it was given. Thus, the competitive 
circumstances at the time of the discount are relevant and an ``after-
the-fact'' justification that does not meet that standard would not 
support a discount adjustment. Nor would it be more difficult under 
this standard to ``eliminate discount adjustments for discounts that 
have already been provided to favored customers.'' Therefore, the 
request for rehearing is denied. The Commission will not change its 
informational posting requirements at this time.

J. Proceeding To Investigate New Cost Allocation Methodologies

    127. Northern Municipals state that in the NOI the Commission 
requested comments on what alternative changes in the Commission's 
policy could be considered to minimize any adverse effects on captive 
customers. Northern Municipals state that in response, it requested 
that the Commission institute proceedings to investigate a new cost 
allocation methodology that would more fairly allocate the costs of the 
pipeline system in proportion to the benefits a shipper derives from 
the system. Northern Municipals state that the Commission erred in not 
addressing this issue and asks the Commission address its alternative 
proposal on rehearing.
    128. Northern Municipals ask the Commission to consider and 
investigate a new approach to pipeline regulation that would mandate 
structural separation of the pipeline networks from their parent 
corporations and affiliates. Under Northern Municipals' proposal, the 
pipeline network would be independently financed, would have its own 
board of directors, and would have common carrier status. Further, 
Northern Municipals state that the Commission should utilize a cost 
allocation methodology that assigns the costs of the interstate 
pipeline network to customers in direct proportion to the benefits that 
they derive from the use of the network. Northern Municipals also ask 
the Commission to consider implementing an independent system operator 
(ISO) similar to that in the electric industry.
    129. In the NOI, the Commission sought comments on what alternative 
changes in the Commission's discount adjustment policy could be 
considered to minimize any adverse effect on captive customers. The 
issues raised by Northern Municipals are beyond the scope of this 
proceeding \86\ and the Commission will not address them here.
---------------------------------------------------------------------------

    \86\ Some of the proposals also appear to be beyond the scope of 
the Commission's authority to implement.
---------------------------------------------------------------------------

    The Commission orders: The requests for rehearing are denied.

    By the Commission. Commissioner Kelly dissenting in part with a 
separate statement attached.
Magalie R. Salas,
Secretary.
Kelly, Commissioner, dissenting in part:

    As I stated in the underlying order in this proceeding,\1\ I 
would have supported a requirement for pipelines to post on their 
Web sites the reasons for providing a selective discount to a 
particular shipper. Therefore, I respectfully dissent in part on 
this order.

    \1\ Policy for Selective Discounting By Natural Gas Pipelines, 
111 FERCSec.  61,309 (2005).
---------------------------------------------------------------------------

     Suedeen G. Kelly
[FR Doc. 05-23140 Filed 11-22-05; 8:45 am]

BILLING CODE 6717-01-P