The Regulatory Environment Introduction to the Natural Gas Industry

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The Regulatory EnvironmentIntroduction to the
Natural Gas Industry

• An AGA Workshop
• H. Edwin OvercastDirector

October 10, 2007
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Purpose

• Discuss the role of federal and state regulation
• Identify the fundamental principles of regulation
• Review the economic and financial concepts of
  regulation
• Outline the major regulatory issues facing
  regulated gas companies

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Purpose

• Discuss the role of federal and state regulation
• Identify the fundamental principles of regulation
• Review the economic and financial concepts of
  regulation
• Outline the major regulatory issues facing
  regulated gas companies

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(No Transcript)
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LDC Distribution System
From Interstate or Intrastate Transmission
Companies
City Gate (Regulators/Meters)
Distribution Service
LDC ownership begins here
X
Isolation Valves
District regulating station
X
Large Volume Customers
Meter
X
Regulator/Meter
X
Residential Customers
X
Utility owned LNG or Propane/Air Plant
Distribution Service Lines
Distribution Mains
Commercial Customers
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
District regulating station
Source AGA and Black Veatch
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Regulatory Boundaries

• Federal Regulation - Interstate transportation
  and storage rates, facilities expansion for
  pipelines
• State or Local Regulation - delivery of gas to
  end- use customers, sales of gas commodity
  (unless market is open to competition), rates,
  financing, CPCN, etc.

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Purpose

• Discuss the role of federal and state regulation
• Identify the fundamental principles of regulation
• Review the economic and financial concepts of
  regulation
• Outline the major regulatory issues facing
  regulated gas companies

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Regulation Creates Obligations and Rights
LDCs subject to state or local regulation of
rates, safety, service quality.
Obligations
Rights

• Obligation to serve
• Defined by statutory scheme, tariff or franchise
• Obligation not unlimited - line extension
  policies
• Right to reasonable return on the prudently
  incurred cost of used and useful assets
• Safe and reliable service
• Non-discriminatory rates
• Just and reasonable rates

• Right to reasonable return
• Service subject to reasonable rates, rules and
  regulations
• Protection from competition
• Eminent domain

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Purpose

• Discuss the role of federal and state regulation
• Identify the fundamental principles of regulation
• Review the economic and financial concepts of
  regulation
• Outline the major regulatory issues facing
  regulated gas companies

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Gas Ratemaking 101

• Rates based on approved costs and throughput for
  test year (Historic, Normalized and Annualized,
  Pro forma, Forecast).
• Rate determination
• Revenue requirement OMDT(GP-AD)R
• where O is operating expense, M is maintenance
  expense, D is depreciation expense, T is taxes
  and (GP-AD)R is return on rate base
• Rates Revenue Requirement / Test year
  throughput (net of losses)

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Gas Ratemaking 101 continued

• Total revenue requirement divided among classes
  of service to develop rates
• Costs and throughput re-set during general rate
  cases.
• Rates designed to provide reasonable opportunity
  to earn allowed return
• Opportunity to exceed allowed return if costs can
  be reduced below level assumed in revenue
  requirement, and/or throughput is higher than
  assumed without cost of additional throughput
  exceeding historic revenue requirement.

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Gas Ratemaking 101 continued

• Regulatory risks impact opportunity to earn
  allowed return
• Earned return is critical to financial capability

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Distribution Rates

• Rates regulated by state commissions
• Sometimes set initially by local authorities
• Distribution costs spread over fixed and
  commodity charges (some jurisdictions moving to
  pure fixed/variable rates)
• Purchased gas adjustment mechanisms to recover
  changes in supply costs
• Non-commodity rate schedules based on maximum
  demands
• Firm
• Interruptible/special contracts
• Transportation

• Non-regulatory factors affecting earned returns
• Weather
• Competition
• New construction/ marketing
• Conservation

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Purpose

• Discuss the role of federal and state regulation
• Identify the fundamental principles of regulation
• Review the economic and financial concepts of
  regulation
• Outline the major regulatory issues facing
  regulated gas companies

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Key Issues Facing LDCs

• Continued high gas commodity costs
• Declining use per customer
• Impact of system growth on rates
• Gas purchasing practices
• Infrastructure replacement cast iron, bare
  steel, failing plastic
• Manufactured gas site remediation
• Capital budgeting/capital attraction earnings
  growth story

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High Gas Commodity Costs

• Price elasticity response
• Higher uncollectible accounts expense
• Fuel switching in some markets

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Declining Use Per Customer

• Failure to recover fixed costs and lower earnings
• Volumetric delivery rates do not provide a
  reasonable opportunity to earn allowed return
• LDCs seeking new solutions - decoupling, fixed
  variable rate designs

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Impact of Growth

• New customer investment exceeds average
  investment in rates lowers return
• Drives frequent rate cases

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Gas Purchasing Practices

• Risk of adverse decision on prudence
• Small disallowances of gas cost have big impact
  on earnings
• Example of asymmetric risk

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Infrastructure Replacement

• Large capital expenditures with no new revenues
• Critical to safe and reliable service

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Manufactured Gas Site Remediation

• Uncertain costs
• Regulatory mechanisms for cost recovery

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Capital Issues

• Funding growth
• Funding infrastructure replacement
• Funding peaking supply sources
• Impact on capital structure
• Rate case driver

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Questions