Notice of Availability on ALJ Terkuerst PD
Attachment A - List of Appearances to ALJ Terkuerst PD
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ALJ/CFT/epg DRAFT Agenda ID # 4076

Decision PROPOSED DECISION OF ALJ TERKEURST (Mailed 11/16 /2004)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Order Instituting Investigation into the Gas Market Activities of Southern California Gas Company, San Diego Gas and Electric, Southwest Gas, Pacific Gas and Electric, and Southern California Edison and their impact on the Gas Price Spikes experienced at the California Border from March 2000 through May 2001.

Investigation 02-11-040

(Filed November 21, 2002)

(See Attachment A for List of Appearances.)

INTERIM OPINION ON PHASE 1.A ISSUES

TABLE OF CONTENTS

I. Summary .....................................................................................22

II. Procedural Background ....................................................................88

III. The 2000/2001 Natural Gas Crisis in Southern California .......................1515

IV. SoCalGas Knowledge and Expectations Regarding the
2000/2001 Gas Market ...................................................................2525

V. SoCalGas Conduct During the Subject Period ......................................4242

VI. Gas Procurement Incentive Mechanisms ............................................9696

VII. Comments on Proposed Decision ....................................................121121

VIII. Assignment of Proceeding ............................................................121121

Findings of Fact .................................................................................121121

Conclusions of Law ............................................................................132132

ORDER ...........................................................................................132132

Attachment A - List of Appearances

INTERIM OPINION ON PHASE 1.A ISSUES

I. Summary

We undertook this initial phase of Investigation (I.) 02-11-040 to examine factors that caused increased gas prices at the California border and, in particular, to assess whether the gas market activities of Southern California Gas Company (SoCalGas) and San Diego Gas & Electric Company (SDG&E) contributed to the high border prices from March 2000 through May 2001 (the subject period). During this Phase I.A, no party has alleged that any actions of SDG&E contributed to the gas price increases during the subject period. Issues regarding whether any of SoCalGas and SDG&E's affiliates or their parent company, Sempra Energy (Sempra), played a role in causing the increases in border prices and, more specifically, whether affiliates' or the parent's financial position caused SoCalGas and/or SDG&E to take actions that may have increased gas costs during the subject period will be addressed in pending Phase I.B. We will address activities of other California gas utilities during the subject period in a subsequent Phase II.

In Section III, we describe a number of factors which drove demand up and reduced the availability of gas in southern California during the subject period. We are not able to quantify the effects of each individual supply or demand factor on southern California gas prices. However, it is clear that there were times during the subject period when any increase in inelastic demand or decrease in supply (flowing from out-of-state producing basins, in-state production, or storage withdrawal) could have a disproportionate and at times exponential effect on border prices. This conclusion is critical in examining the effect of SoCalGas' actions on gas prices in the context of other, potentially larger dislocations in the market.

SoCalGas acknowledges that its low level of physical storage going into the 2000/2001 winter put upward pressure on border prices. However, it maintains that it had no reason to anticipate that outcome, because forward market prices during the summer of 2000 indicated that gas supplies during the winter would not be tight. As we describe in Section IV.B, the record demonstrates that, despite this market "backwardation,"1 SoCalGas understood clearly during the summer and fall of 2000 that actions it took that increased winter reliance on flowing gas and decreased the availability of stored gas would contribute to market constraints and put upward pressure on border prices.

The Commission has allowed SoCalGas to engage in hub activities, including hub loans, and to procure and sell gas to noncore customers, as means to improve the use of core assets and lower gas costs. SoCalGas may also use financial hedges to provide core customer protection from volatility in gas prices. We find, however, that SoCalGas misused these operational tools during a portion of the subject period, with the intent of boosting shareholder earnings under its gas cost incentive mechanism (GCIM) and, in the most benign interpretation, with apparent disregard for the effect on core customers and the broader energy markets.

In particular, beginning in June 2000, SoCalGas entered into a hub loan program with unprecedented levels of winter repayments and made after-market sales while shortchanging storage injection for core customers. Despite clear and growing indications that gas demand would reach unprecedented levels--due in part to increased demand for gas-fired electricity generation--and that pipeline operational and other constraints would limit the amount of gas that would be brought into southern California during the winter, SoCalGas entered the winter withdrawal season with only 53.1 Bcf of core gas in its four operating storage fields. This was 11.9 Bcf below the bottom of the Commission-established target range and the lowest level of gas in core storage at that time of year since the GCIM has been in effect. SoCalGas continued actions detrimental to core customers and the broader gas market throughout the remainder of the winter withdrawal season of the GCIM Year 7 cycle.

Some of SoCalGas' actions, such as purchasing and storing additional gas during the spring of 2000 and then selling excess gas in May 2000 at a profit, may be explained by an intent to use the arbitrage opportunities created by the existing GCIM structure to achieve GCIM profits. As we explain in Section V.D, SoCalGas' after-market sales through May 2000 were undertaken in a manner that benefited both shareholders and core customers. We do not find fault with SoCalGas' actions through May 2000.

However, SoCalGas' hub loan program commenced in June 2000 and its after-market sales undertaken when it should have been building its storage inventory for winter use raise serious concerns. These actions deferred the acquisition of gas needed for core customers' winter use, thus requiring more expensive replacement purchases later in the yearly cycle, an outcome detrimental to core customers but with no shareholder consequences under the current GCIM structure.

These actions also acted to constrain market supplies during the 2000/2001 winter and increased winter gas prices at the California border. As an example, in December 2000, net hub loan repayments and SoCalGas' own border purchases constituted 30% of core burn and over 11% of total SoCalGas send out that month. With the tight supply/demand conditions in the winter of 2000/2001, these volumes were sufficient, as SoCalGas acknowledges, to affect border prices, with the higher prices borne by all border purchasers. These price effects occurred even though, as SoCalGas points out, the volumes of winter hub loan repayments were small relative to other supply and demand that occurred during the subject period.

It is not clear whether SoCalGas undertook these actions solely to profit from the GCIM arbitrage opportunities--with SoCalGas viewing the prospect that its actions would increase prices as an acceptable consequence--or whether SoCalGas had an express intent to constrain the winter gas market in order to increase border prices and further enhance its arbitrage profits. Lacking convincing evidence of intent, we stop short of drawing the latter inference. Phase I.B may shed additional light regarding SoCalGas' intent in this regard.

By scheduling significant volumes of winter hub loan repayments, which caused increased reliance on flowing gas supplies during peak winter periods; by failing to fill core storage adequately during the injection season; and by choosing not to withdraw the core's working gas in the Montebello storage field even during extremely tight system conditions, SoCalGas knowingly contributed to supply constraints and effectively withheld gas supply during peak winter months. These actions increased gas prices and volatility at the California border. By selling gas during the resulting price spikes, SoCalGas profited from the price increases caused by its actions. As a result, we conclude that SoCalGas' actions went beyond GCIM-incented profiteering into the realm of market manipulation and an exercise of market power.

Because SoCalGas' GCIM profits between June 2000 and March 2001 were the result of market manipulation and an exercise of market power at the expense of core customers, we find that shareholder receipt of those profits was not reasonable. We require that SoCalGas refund all profits that shareholders received due to operation of the GCIM mechanism during those months. The refund will total approximately $28.8 million, plus interest.

The record does not contain a full analysis of market conditions and SoCalGas' actions during April and May 2001, the first two months of the GCIM Year 8 cycle. As a result, we do not have sufficient information to assess whether SoCalGas' actions during those months raise concerns comparable to those we have found for GCIM Year 7 with commencement of the hub loan program starting in June 2000.

Many of SoCalGas' financial transactions appear to have been undertaken in a reasonable manner to hedge against the risk that gas prices would increase for needed purchases. However, there is evidence that some of SoCalGas' financial positions were taken for speculative purposes. In addition, some border hedges indicate an intent to profit from the tight winter conditions occurring, in part, due to SoCalGas' own hub loan and storage activities. The fact that SoCalGas undertook such border hedges buttresses our finding that SoCalGas knowingly manipulated the gas market and exerted market power through its hub loan program and other activities during the subject period.

In order to better align GCIM incentives with customer interests, we take steps today to modify GCIM in certain respects. First, we direct SoCalGas to eliminate hub services and sales of gas to core customers from its Gas Acquisition group's activities effective April 1, 2005, which marks the beginning of the next GCIM year. We also adopt the goal to replace the GCIM's benchmark based on its actual gas sales with a more exogenous benchmark. We will evaluate in a subsequent phase of this proceeding specific proposals for mechanisms that achieve this result and that also provide the flexibility to accommodate the diverse portfolio and procurement pre-approval process we authorized in Decision (D.) 04-09-022. In that phase, we will also evaluate risk management activities and related tools that may be appropriate, whether within SoCalGas' GCIM or undertaken as a complement to the low-cost procurement incentive mechanism.

We note that several changes in California's natural gas market since 2000 have reduced the differences between the SoCalGas and the Pacific Gas and Electric Company (PG&E) systems that originally may have necessitated differences between their respective procurement incentive mechanisms. These changes include the requirement that the El Paso pipeline provide path-specific rights to firm capacity holders and other improvements to El Paso's system, and a requirement that SoCalGas file in December 2004 a proposal to implement firm access rights.

The refund of GCIM profits will return SoCalGas' ill-gotten GCIM gains to core customers. In imposing this requirement, we do not address potential culpability for harm to market participants other than core gas customers. As a result, and in light of our findings that SoCalGas exercised market power and manipulated the gas market during the subject period, we refer our Phase I.A findings to the Attorney General of the State of California, who is currently investigating the activities of Sempra and its subsidiaries, including SoCalGas, during the energy crisis, or to other appropriate law enforcement agencies.

1 In a "backwardated" market, current prices exceed forward prices. In a "carry" market, forward prices exceed current prices.

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