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ANSWERS OF F. JOSEPH GRAHAM ON BEHALF OF
UNION CARBIDE CORPORATION AND THE PETROCHEMICAL

ENERGY GROUP TO SENATOR J. BENNETT JOHNSTON
POST-HEARING QUESTIONS, HEARING ON TITLE X OF 8. 341

THE NATIONAL ENERGY SECURITY ACT OF 1991

I.

Answer to question propounded at the hearing of March 7,
1991.

First, please allow me to respond to the question propounded by you at the hearing which I asked leave to answer at a later date. Because of the extreme significance of the question, I wanted the opportunity to consult with the sponsors of my testimony before answering.

The question, as I recall, was: whether the concerns of the industrial users would be satisfied if the Act would mandate open access, as defined in the NES, on all interstate pipelines. I regret that the answer must be in the negative, for the following reasons:

(A) In my testimony of March 4, 1991, at page 24, I attempted to make the point that the two preconditions in the NES are critical, not only for industrial end users, but for all consumers. Those two preconditions were and are:

(1) the pipeline provides comparable service to third party shippers; and

(2)

the pipeline (or the broker) does not have

market power.

(B) The inference I drew from the question was whether the first of the above two preconditions would suffice. That is, would mandatory open access that would guarantee comparable service to third party shippers suffice to the degree that the call for an assessment of whether the pipeline also had market power could be dropped.

(C) After due consideration, I regret to say that the answer is in the negative. If one were to assume that the interstate pipelines would continue to have monopoly and monopsony power constrained by federal regulation, then the answer would be in the affirmative. However, that assumption is not a safe one in light of either s. 341 or of the National Energy Strategy Act. Some lessening, if not removal, of constraints on the exercise of monopoly and monopsony power are contemplated by the legislation. Therefore, the answer must be in the negative.

The reason can perhaps be best illustrated by reference to oil pipelines regulated by the FERC. In theory, if not in practice, these oil pipelines are supposed to be common carriers, a more extreme version of "open access" than is sought or contemplated for natural gas pipelines. If the oil pipeline is allowed to set whatever rates, terms, and conditions it wishes, the enforcement of common carriage is meaningless where the pipeline exercises market power. For example, where the oil pipeline is the only access between supply and markets, or even the dominant one, then being able to secure transportation is no solace when the pipeline can charge a monopoly rate, one so high as to preclude an economic arrangement.

This same principle holds true, even more true, with natural gas pipelines. It is even more true since the natural gas pipeline is also a merchant of gas and has every incentive to raise the rates for competitors using the pipeline for transportation so that consumers wili be forced to buy from the pipeline itself.

Therefore, we remain persuaded that both pre-conditions are required in order to constrain the exercise of monopoly and monopsony power.

II.

Questions propounded on March 11, 1991.

1.

To the extent necessary, please supplement your testimony with a more detailed analysis of title II of 8. 570, the National Energy Strategy Act. Please address both the policy implications of title II and questions raised by the individual provisions of title

II.

Answer: Union Carbide Corporation and the Petrochemical Energy Group filed supplemental testimony on the National Energy Strategy Act on March 6, 1991. Our review to date leads us to conclude that we have nothing to add at this time.

2.

In particular, please address section 201 of 8. 570,
the so-called mandatory interconnect provisions.

What are the policy issues raised in connection
with this section?

a.

b.

Does the section achieve its stated purpose of
authorizing the FERC to order upstream
interconnection but not downstream
interconnection, i.e., bypass?

C.

What are the technical questions raised by the manner in which section 201 is drafted? How would you resolve these questions? Please provide suggested substitute language if to do so would be helpful.

Answer to 2 (a): This subject was briefly covered in the testimony of March 6, 1991, at page 3 and in Appendix A to that testimony at page 1. The policy issues raised are:

(A) Does new Section 7(a) (1) include "transportation" of natural gas? According to the analysis provided by the Secretary of Energy, this provision is supposed to authorize the Commission to direct an interconnection with a jurisdictional or non-jurisdictional pipeline (limited to the new 7(k) pipelines) "to direct delivery or sale to local distribution companies", said to be similar, existing authority when applied to jurisdictional pipelines. The word "delivery" is taken to mean "transportation" gas as dist uished from "sales" gas, the latter purchased from the pipeline and the former purchased from a third party.

(1) It is not clear from the wording of new Section 7(a) (1) that "transportation" gas is included. The wording may be construed to mean sales only, purchased from the pipeline itself, because of the presence of the words "and sell gas to" in the section.

(2) One policy question is whether an interconnection for the purpose of receiving transported gas should be specifically included. However, once the facility is constructed, it seems almost a given that the facility could be used for transportation as well as, or in lieu of, a sale under open access conditions. Not only would the delivery point be available for open access transportation, but the LDC would likely have conversion rights, with or without a Gas Inventory Charge.

(3) In any event, the basic question remains as to whether any interconnection should be reserved only for sales service by the interstate pipeline and not made available for third party competitors of the pipeline.

(B) Does new Section 7(a) (2) adequately provide for "transportation" of natural gas? According to the analysis provided by the Secretary of Energy, this provision would authorize the FERC to order an interconnection "in order to receive gas from the other facilities for transportation in the pipeline." The following policy questions are raised.

(1) with the use of the words "any person", it appears that mandatory interconnections can be ordered on behalf of a number of classes, including but not limited to: industrial end users; local distribution companies; producers; marketers; gatherers; other interstate pipelines; and intrastate pipelines.

(2) Anticipating the answer to Senator Johnston's Question 2(b), there is no limitation on the interconnection being "upstream" but not "downstream." Leaving aside for the moment the issue of "bypass" by an end user of a local distribution company, it seems clear that the interconnection can be ordered anywhere on the affected pipeline system. This could be in the market area, in the production area, or anywhere in between. For example, a pipeline seeking to increase sales or service related to imports of Canadian gas could seek an interconnection in the market area or near the market area of another pipeline.

(3) Squarely facing the "bypass" issue, it seems clear that an industrial end user could invoke the Commission's jurisdiction to compel an interconnection with an affected pipeline, one that would "bypass" the facilities of a local distribution company.

(4) The limitation in the statutory language "in order to receive natural gas from the petitioner's facilities" carries with it the same implication discussed under (2).with respect to the new 7(a) (1). Here it is clear that transportation gas is included, but for purposes of securing the interconnection the gas supply would move to, not from, the pipeline. Once built, however, given the open access conditions, the interconnection should be available for transportation in, as well as out of, the facility. It may well be better policy to remove the limitation from the statute, so that there will be a clear two way street. For example, if one pipeline is allowed to tap into another pipeline, it is not good policy to make the facility available only for one pipeline's use.

(5) Having responded to the request to indicate the policy issues raised, we respectfully suggest that the proposed section be adopted, with the removal of the initial limitation as discussed in (4). Section 7(a) (3) provides adequate protection for existing customers' service. The only real reason why a mandatory interconnection should av to be sought is because one type of monopoly or another refuses to deal with a customer seeking access to the interstate pipeline system and a gas supply secured from third parties.

Answer to 2 (b): The section does not achieve its "stated purpose" of authorizing the FERC to order upstream interconnection but not downstream interconnection, i.e., bypass. First, on its face it includes local distribution companies who

will predominantly be "downstream." Further, as set forth above, there is no limitation on the geographical limits of the interconnection authority. It could be anywhere on an affected pipeline.

Answer to 2 (c): In the above discussion "technical" questions have already been discussed, and suggestions made. However, in view of Senator Johnston's comments with respect to this section at the hearing of March 7, 1991, we wish to suggest possible substitute language that would achieve his stated goal, even though we do not advocate consideration only of the problems related to the producing areas.

We begin with a background summary.

As a general proposition, lines that originate at the wellheads in the producing areas are classified as "gathering" and therefore are exempt from Section 1(b) of the Natural Gas Act. Passing over a more detailed legal analysis, unless requested, the following situation has evolved:

(1) If the "gathering" lines are owned by an interstate pipeline, then the rates and charges are regulated for the purpose of inclusion in the rates and charges for sales for resale customers, as decided by the Supreme Court in the 1940s. The Commission has held that this principle applies for the purposes of open access transportation, and this holding is under review by the u.s. Court of Appeals for the Eighth circuit.

(2) If the "gathering" lines have been certificated by the FERC (or the FPC, its predecessor), then the lines can be regulated by the FERC unless and until an abandonment is obtained.

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(3) If neither of the above two conditions are met that is, if the gathering lines are in the hands of producers or independent gatherers and there is no certificate covering the facilities, then there is no FERC jurisdiction, subject to the outcome of the case in the Eighth Circuit, referred to in (1).

(4). However, whether a particular line is a "gathering" line or is "transmission", with the latter being fully regulated by the FERC, if it otherwise has jurisdiction, is an uncertainty that plagues business planning. This problem is probably more acute in the OCS than onshore, but it is a problem nonetheless. The FERC has jurisdiction to classify the facilities, subject to judicial review.

The problem comes in several subsets, not the least of which involves access to and from "gas processing facilities", where valuable natural gas liquids are extracted from the gas stream, as detailed in the testimony of March 4, 1991, at page 4.

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