September 24, 2002
Administrative Law Judge Says El Paso Withheld Capacity

Economists' conventional knee-jerk belief is that it almost never pays a company to withhold output unless it has a durable monopoly. If it withholds output it loses sales. It gets a higher price for what it does sell, true, but its competitors take its market share--and that market share will be expensive to win back.

One of the nice things about being at Berkeley is that you can run into people who tell you when you are being an idiot, and thus you learn more stuff.

In this case that person if Professor Severin Borenstein, who carefully and patiently explains to me why the energy market is different. First, what does El Paso lose by withholding pipeline capacity for natural gas deliveries? It loses the pennies that are paid from shipping natural gas from one place to another, but the natural gas itself can be and is easily stored. It's not as if they had to idle factories or destroy output in order to withhold supply from the market. So withholding output is very cheap. Because one hydrocarbon molecule is much like another, there is no difficulty in regaining market share. So there are next to no costs from withholding output.

And there are enormous benefits. Full pipelines being run by competitors means that nobody else can expand supply if, as was the case, California natural gas storage tanks are dry. Inelastic demand means a small supply restriction provokes a large price increase. El Paso got only 15-20 percent of that increase. But so what? Suddenly deciding that pipeline maintenance had to be performed meant that El Paso (and its competitors) made out like bandits.

"The crux of the matter," Severin says, "is that when supply and demand are inelastic all standard intuitions about market power--derived from industries with elastic supply and demand--are badly, badly false. An HHI of 1200 means absolutely nothing at all, for it is irrelevant to the real question: can this firm through its own uncoordinated actions alone boost its profits by withholding supply?"


WSJ.com - Major Business News: ...El Paso Corp. helped drive California natural-gas and electricity prices to record levels during that state's energy crisis by withholding sorely needed supplies of gas, the top hearing judge at the Federal Energy Regulatory Commission concluded. The ruling sent El Paso shares plummeting 36% as investors feared the Houston energy concern could be forced to pay billions of dollars in refunds to California energy consumers. Curtis Wagner, FERC's chief administrative law judge, said in a 23-page decision that El Paso's interstate gas pipeline unit withheld "extremely large amounts" of capacity that could have carried additional natural gas to its California delivery points, which substantially tightened the supply of natural gas at the California border. Under FERC procedures, the judge's findings are subject to approval of the agency's commissioners.

Mr. Wagner recommended that El Paso be forced to pay penalties for its behavior, which took place during California's 13-month energy crisis that ended in June 2001 after FERC imposed electricity-price caps throughout the West. During the crisis, California racked up electricity costs of $40 billion, more than quadruple the cost during the same period a year earlier -- dealing a blow to an economy that was central to the country's high-tech boom...

El Paso denied it manipulated market prices and said it operated its pipeline to the "extent permitted by safety and operational considerations." Peggy Heeg, El Paso's general counsel, called the judge's decision "wrong as a matter of law, as a matter of fact and as a matter of policy" and said the company was confident it will be vindicated.

Judge Says El Paso Withheld
Gas Supplies From California

By ALEXEI BARRIONUEVO and MITCHEL BENSON
Staff Reporters of THE WALL STREET JOURNAL

El Paso Corp. helped drive California natural-gas and electricity prices to record levels during that state's energy crisis by withholding sorely needed supplies of gas, the top hearing judge at the Federal Energy Regulatory Commission concluded. The ruling sent El Paso shares plummeting 36% as investors feared the Houston energy concern could be forced to pay billions of dollars in refunds to California energy consumers.

Curtis Wagner, FERC's chief administrative law judge, said in a 23-page decision that El Paso's interstate gas pipeline unit withheld "extremely large amounts" of capacity that could have carried additional natural gas to its California delivery points, which substantially tightened the supply of natural gas at the California border. Under FERC procedures, the judge's findings are subject to approval of the agency's commissioners.

Mr. Wagner recommended that El Paso be forced to pay penalties for its behavior, which took place during California's 13-month energy crisis that ended in June 2001 after FERC imposed electricity-price caps throughout the West. During the crisis, California racked up electricity costs of $40 billion, more than quadruple the cost during the same period a year earlier -- dealing a blow to an economy that was central to the country's high-tech boom.

El Paso denied it manipulated market prices and said it operated its pipeline to the "extent permitted by safety and operational considerations." Peggy Heeg, El Paso's general counsel, called the judge's decision "wrong as a matter of law, as a matter of fact and as a matter of policy" and said the company was confident it will be vindicated.

The ruling crushed the stocks not only of El Paso but also its energy-trading rivals. Shares of El Paso plunged 36%, or $4.16, to $7.51 in 4 p.m. composite trading on the New York Stock Exchange. Dynegy Inc. and Williams Cos., whose energy dealings during the California power crisis also are under scrutiny, saw their shares drop as well. Shares of Williams fell 35 cents, or 15%, to $1.99 and Dynegy slipped 20 cents, or 15%, to $1.17.

High natural-gas prices dealt a blow to California's economy because gas is used to fuel a higher proportion of its electricity-generating plants than in any other state except Texas. Record-high gas prices not only drove up home-heating costs for millions of Californians, but they also contributed to record-high electricity prices that have crippled the finances of the state and its biggest utilities.

The FERC judge's decision could have broad implications for efforts by California officials to recoup billions of dollars they claim are owed to businesses and residences for inflated gas and electricity prices. The state's claim is now pending before the commission.

Doug Porter, senior counsel for utility Southern California Edison Co., a unit of Edison International, said the company had testified to FERC that El Paso's alleged withholding of natural-gas capacity cost the state more than $3 billion in higher electricity prices in the year ended March 2001, and the California Public Utilities Commission estimated that El Paso's alleged actions cost Californians $3.2 billion in increased natural-gas costs from December 2000 to March 2001.

It wasn't clear what actions, if any, FERC commissioners will take in response to the judge's finding. FERC, which hasn't faced a similar case in 15 years, has no prescribed penalties that El Paso might face, agency officials said.

Analysts said that if FERC upholds the judge's decision, it could spark more lawsuits seeking to link the higher natural-gas prices to California's dozens of blackouts and billions of dollars in inflated power prices. El Paso already faces at least 11 lawsuits, filed in California state courts, that allege the company manipulated the price of natural gas sold into California.

The ruling was unexpected. Last October, Mr. Wagner ruled that El Paso had violated codes of conduct designed to keep affiliates from favoring each other. But the judge said he didn't find convincing proof that the company had used its clout in the California market to drive up natural-gas prices. The commission directed the judge in December to resume investigating, focusing on whether El Paso made all of its capacity available to California delivery points from November 2000 to March 2001.

In his latest ruling, Mr. Wagner said he found that El Paso withheld an average of 696 million cubic feet of natural gas a day out of 3,290 million cubic feet a day it was obligated to deliver to the state. Of that, 210 million cubic feet a day of capacity wasn't made available because El Paso's pipeline unit didn't operate at its maximum pressure. All told, the judge found that El Paso only delivered 79% of the gas its pipeline was capable of delivering.

The judge also found that capacity of 35 million cubic feet a day would have been available if the company hadn't performed "non-essential" maintenance at two pipeline stations during the winter heating season. Ms. Heeg, El Paso's general counsel, called it a "dangerous precedent" for a judge to be "second-guessing about pipeline-maintenance activity."

Write to Alexei Barrionuevo at alexei.barrionuevo@wsj.com5 and Mitchel Benson at mitchel.benson@wsj.com6

Posted by DeLong at September 24, 2002 10:48 AM | Trackback

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Comments

Paul Joskow, Severin Borenstein, and Frank Wolak were most important in helping us understand the nature of the California "energy crisis" - Paul Krugman

Posted by: on September 24, 2002 11:39 AM

The extent of business duplicity or corruption exposed in the last year is astonishing. Of course, all the exposed parties claim they have done nothing wrong but it is obvious there has been a strong anti-social current to business leadership that must be sharply curbed.

Posted by: on September 24, 2002 12:07 PM

The severe inelasticities apparently were peculiar to California's energy market. I think that it's right to put "energy crisis" in quotes, but wrong to imply that the government is blameless and the private sector deserves all the blame. I still think that if you turn the crisis upside-down, it says "made in Sacramento."

Posted by: Arnold Kling on September 24, 2002 02:29 PM

Note that it is El Paso the Regulated Pipeline operator found guilty by Ferc. Media accounts have been blaming El PAso Merchant(unregulated) for manipulating prices.

The pipeline operator was found to withhold capacity(21% of capacity -depends on what max capacity is)by three mechanisms-
1) The process by which pipeline capacity is allocated for transport was flawed. This is an automated process and one which should have been corrected prior to California's summer based on a prior Ferc decision against Wyoming.

2) Operating the pipeline below maximum allowable operating pressure(MAOP). i.e. The pipe is rated for 350 psi and is operated at 300 psi. The lower the pressure the less volume of gas can be transported. The judge ruled the pipeline could have operated at its MAOP. The pipeline will contest this and should. Maintenance is a serious issue.

3) The final withholding was at an interconnect to the El Paso pipe which Ferc says could have been used to increase capacity.

This ruling vindicates one of Gov Davis's contentions that Ferc failed in its oversight function of the Regulated Pipeline.

Posted by: Jon A on September 25, 2002 06:19 AM

This ruling vindicates one of Gov Davis's contentions that Ferc failed in its oversight function of the Regulated Pipeline.

Yes, but it still does not excuse Davis' bungling, incompetence, and failure to act in the crisis. Compound this with is dubious fundraising efforts and you can opportunist to that list as well.

Posted by: Steve on September 27, 2002 10:32 AM

Happily Gov Davis has done quite a fine job for California and will be re-elected.

Posted by: on September 27, 2002 10:55 AM

Happily Gov Davis has done quite a fine job for California and will be re-elected.

Let me see...

1. Huge State budget deficit, which not too long ago was billions dollars in surplus. Sure he is not alone to blame, but he was definitely a factor. Lets think about this for a minute. Krugman has ripped Bush a new one for his tax cut based on overly optimistic projections on the surplus. Davis and the pols in Sacramento did the same thing. They had this influx of revenue due to the dotcom industry and went on a spending spree as if the party'd never end. Same thing.

2. His horrendous response to the energy crisis. He failed miserably. He even went public once stating that if he wanted to raise electricity rates he could solve the problem in five minutes. While that is probably an exaggeration it would have mitigated the problem. Now rate payers are going to pay billions in higher rates due to Davis' inaction and incompetence.

3. Davis seems to have a habit of collecting money from people who benefit from State spending contracts and projects. There was also the corruption with the people he hired to work on the State's long term electricity contracts who had connections/interests in the energy industry.

For example, he has just signed the Paid Family Leave Act which could cost over a billion dollars to firms and employees.

Simon may not be a great alternative, but Davis is a rotten governor and has done alot to harm the state.

Posted by: Steve on September 27, 2002 10:51 PM

Sorry, I was wrong on the Davis statement. It actually went:

"If I wanted to raise rates, I could solve this problem in 20 minutes."
Governor Gray Davis, quoted in National Journal, the Hotline, March 8, 2001.

He is an incompetent.

Posted by: Steve on September 27, 2002 11:00 PM
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