TransCanada Decision Will Have Major Impact on Eastern Gas Commodity Market

June 2013

• The NEB’s decision to allow TransCanada discretion in the pricing of Interruptible Transportation and Short Term Firm Transportation will affect not only the eastern Canadian transportation market but also the gas commodity market by making it harder and less profitable for gas marketers to get gas to key trading points.
• The result will be a more significant difference in pricing from one supplier to the next.
• In this new reality, it will be essential for gas buyers to have a portfolio of suppliers to reduce risk and achieve cost savings.

The National Energy Board recently released its decision on the mainline tolls and services for TransCanada PipeLines. This was a significant decision, for the issues it addressed and for the measures the Board adopted in its decision.  We have discussed elsewhere the expected impact of the decision on how shippers will contract for capacity, and the impact on their cost of transportation services. However, we expect the decision will also have a significant impact on the commodity market for natural gas in eastern Canada, with buying gas at some points becoming harder and more expensive.  As a result, gas users will have to rethink long-held practices and having a portfolio of suppliers will become essential.

It is fair to say that some of the ripple effects of the NEB’s decision have only started to become clearer in the weeks since the decision, as TransCanada has taken steps to adapt to its new reality and as shippers have reacted to those moves by TransCanada. We think there are other consequences that will become apparent only after the new regime goes into effect.

In a recent filing with the National Energy Board, TransCanada notes that the Board’s decision in the mainline tolls and services case seems to imply a fundamental shift in the Board’s thinking about how the pipeline, and especially spare capacity on the pipeline, is to be used. In its May 22 reply to comments on its Compliance Filing, TransCanada expresses the view that the decision shifted “from a regime in which the value was captured largely by certain market participants with the ability and inclination to trade in that capacity, to a regime in which all shippers have an opportunity to capture a large part of this value if TransCanada can take advantage of the pricing discretion granted in the Board’s Decision” (emphasis in the original).

This view held by TransCanada is reflected in their recent proposals to ensure that they can control the use of spare capacity as much as possible, so as to increase their ability to maximize revenues from the sale of this spare capacity through Interruptible Transportation (IT) and Short Term Firm Transportation (STFT). One example is the proposal to limit the rights of Firm Transportation (FT) shippers to divert gas to other points to make use of otherwise spare capacity.

TransCanada has filed an application with the NEB for review and variance of the mainline tolls decision. However, in the request for review, TransCanada has not challenged the fundamental shift in the NEB’s underlying philosophy, so we can likely expect the changes resulting from the decision to be implemented, sooner or later.

The focus of industry discussion since the NEB decision has been on tolls, the cost of transportation, and the contractual rights shippers will have under various types of service. What has not been discussed widely is the significant impact this new paradigm will have on the commodity market itself.

Gas users in eastern Canada are accustomed to buying their gas at several different points on the pipeline network: points like Dawn, Parkway, Enbridge CDA, Union EDA, and so on. Some of these points are much more active and liquid trading points than others, but generally buyers have been able to source gas at all of these points from a number of different suppliers, at generally comparable prices. These characteristics are indicative of a competitive market.

Gas marketers are dependent on transportation resources to get gas from points of supply to points of demand. Flexibility in their transportation arrangements is important for them to be able to respond to changing market conditions, to get gas where it is most needed (as indicated by a higher price). While some gas marketers will hold Firm Transportation contracts from point A to point B, others have relied on the “secondary market” for capacity. This is really a market where excess firm capacity is used to capture a market opportunity. Spare capacity is traded from those with it to those who need it. Shippers with unused FT are happy to recover part of their sunk costs by reselling it (through diversion or assignment, or in the past, through use of TransCanada’s now defunct Risk Alleviation Mechanism or RAM credit). This is called the secondary market because it is not TransCanada selling the capacity, but the shipper reselling the capacity. The capacity has been sold at a market price, in a commercial, unregulated transaction. To the extent possible, TransCanada has competed in this market with flexibly priced IT and STFT, subject to their toll floors.

TransCanada’s recent statement as quoted earlier signals its belief that this way of operating is to be replaced with a paradigm where most of the spare capacity is sold in the primary market. Either shippers contract for more FT (as we think the decision is meant to encourage them to do), or they contract with TransCanada for IT or STFT when extra capacity is needed. The market for assignments and diversions will not disappear, but it will be much less widespread.

The Risk Alleviation Mechanism was eliminated in the NEB decision, as anticipated. This mechanism significantly contributed to the active secondary market by turning unused contracted firm capacity into monetary credits that could be used to offset the cost of interruptible transportation on any path.

Contracting firm capacity is an unreasonable risk for a marketer without a firm market, as it represents a significant fixed cost obligation. Limited diversion rights will mean they will have little chance to make flexible use of this capacity.

In any market that goes from many buyers and sellers to only a few (and particularly when there becomes one dominant seller), competition suffers, liquidity decreases, and pricing becomes less efficient. To the degree this happens in the eastern Canadian transportation market as a result of the NEB decision, it will cause the same thing to happen in the eastern Canadian gas commodity market. Gas marketers who relied on the secondary market for capacity to get gas to key gas trading points will find it harder and less profitable to get gas to those same points in future, and are therefore less likely to do so, or will do so less frequently. The result will be that buying gas at some points will become harder and more expensive. The difference in pricing from one supplier to the next will be more significant.

We have already seen this occur, with some major gas suppliers recently unwilling to quote one year terms to supply gas in the Union EDA, and with the spreads increasing between those suppliers who were willing to quote.

What to do about it?

Aegent has always strongly recommended that gas buyers should have a portfolio of suppliers, and the coming changes in the gas market reinforce the importance of this approach. The changes in the transportation market will affect different marketers differently, depending on what transportation assets they hold. We will see times when some suppliers do not have gas to sell at certain points, even though they may have been active sellers at that point in the past. We will see wider price spreads in the asking price from various sellers at the same trading point. It is essential for risk reduction and cost savings to have a portfolio of suppliers to increase the chance of getting the gas you need at the lowest possible price.

Gas users will also have to rethink their transportation portfolio with a view to securing access to liquid trading points. Buying gas downstream has had few risks in the past, but holding some pipeline capacity in order to ensure access to a competitive gas market may be a reasonable trade-off in the future.

The NEB decision on TransCanada’s tolls and services really does shift the basis of operation of the eastern Canadian gas market. End users need to do a fundamental review of their long held practices to ensure they are ready for these new realities.

NEB’s TransCanada Decision Will Have Broad Impacts for End Users  Read more »