Suit Claims Firms Limited Gas Supply to Raise Prices

In their search for the causes of skyrocketing natural gas prices, California officials are focusing on a 1996 meeting in a Phoenix hotel room where a group of high-ranking gas pipeline industry executives discussed “opportunities” arising from the Golden State’s newly deregulated electricity market.

By the time they left Room 431 of the Embassy Suites Hotel, 11 officials from El Paso Natural Gas Co., Southern California Gas and San Diego Gas & Electric had agreed to kill pipeline projects that would have brought more and cheaper gas into California, according to allegations in court documents.

One of those firms, energy giant El Paso, which owns the main pipeline transporting out-of-state gas to Southern California, is now being targeted in suits by state regulators, electricity utilities and antitrust attorneys. They say the Houston-based company used that meeting and its market power to drive up the price of natural gas for Californians.

The companies have denied any wrongdoing. They say California is the victim of its own soaring electricity demand and overreliance on fluctuating spot markets.

Natural gas is a critical part of California’s energy crisis. The state relies on the commodity to generate half its power.

It is also the most expensive component in generating electricity. And the price of electricity for peak demand hours--the most expensive period in the day--is established by plants fired by natural gas.

In the last several months, natural gas prices have tripled across the nation for a variety of reasons--including a shortage of supplies to meet this year’s voracious demands for home heating. But during the same period, California gas prices rose about twentyfold, from roughly $3 per million British thermal units to nearly $60 per million BTU.

California prices have moderated since their December peak, averaging $12.48 per million BTU in January. But experts say the price could spike again if, for example, there’s another wave of frigid weather.

Officials with Southern California Edison and the California Public Utilities Commission and antitrust attorneys lay most of the blame for the high prices on El Paso, one of the most powerful oil and gas companies in the United States.

El Paso owns and operates the pipeline system that transports gas from Southwestern fields to the California-Arizona border. From there it is piped through smaller intrastate pipelines.

Under federal regulations, El Paso is required to sell all of its pipeline space to utilities, gas marketers and other gas users.

El Paso has sold about 40% of that pipeline capacity to its trading arm, El Paso Merchant Energy. And therein lies the problem, critics say. By hoarding pipeline space during critical periods, El Paso Merchant Energy is pushing up spot prices, the PUC and others say in public documents.

“What we are seeing is high gas prices that cannot be attributed to the cost of gas but the ability of El Paso to exercise market power and manipulate prices,” Harvey Morris, a PUC attorney, said in an interview.

The impact of this alleged manipulation has been most apparent in the last two months when the “basis spread”--the difference between the price of gas at the California border and the price at Southwestern supply points--soared as high as $48.50 per million BTU. The average spread over a similar period in the previous four years was 50 cents.

For every 10-cent increase in the price of gas at the California border, electricity costs rise at least $34.2 million per year, lawyers for Southern California Edison said in filings with the Federal Energy Regulatory Commission. If the cost of gas in the last two months of 2000 continued for an entire year, the increase in electricity costs would be $3.4 billion, using Edison’s estimates.

These estimates only cover the impact on electricity prices. In addition, the higher costs incurred by industrial users of natural gas, many of whom have seen their bills spiral to astronomical levels, are forcing temporary shutdowns, layoffs and other unpleasant business decisions.

To protect themselves from fluctuations in natural gas prices, major gas customers rent space on El Paso’s pipeline under long-term contracts. Recently, many generators and other firms have had to pay a premium because--to meet unexpected rising demands--they need more gas than they had contracted for.

Gas Price Hikes Boost Power Cost

Higher gas prices mean that power generators will charge more for the electricity they sell to debt-burdened utilities. Houston-based Reliant Energy Co., one of the largest suppliers of electricity to California, said it now spends approximately $5 million to $15 million a day to fuel its four power plants. Historically, the company’s gas bill has averaged about $1 million a day.

“It’s gotten completely absurd,” said Jack Farley, head of Reliant’s Western wholesale operations.

Farley said Reliant has been told that higher gas prices were caused by a shortage of pipeline capacity to California. “We’ve scoured the market [for this capacity] and we’ve had to pay whatever they were asking,” he said.

For its part, El Paso has denied manipulating the market. “The primary cause of the volatility in the California natural gas market is demand for electric power that has outstripped supply,” the company said in December in its response to the lawsuits.

California customers, who could have secured cheaper gas supplies though long-term contracts, now “find themselves subject to the vagaries of the spot market,” El Paso said.

As the state’s energy crisis has deepened, El Paso’s revenues have soared. Last week, the company announced that El Paso Merchant Energy saw revenues more than quadruple in the fourth quarter, to $211 million from $45 million, thanks in large part to gas sales to California. The Merchant Energy operation helped El Paso’s overall profits climb to $176 million from $112 million.

“Two years ago, they didn’t even have that business,” said Mark Easterbrook, an energy analyst at the Dallas office of Dain Rauscher Wessels. “And that’s also the reason you’ve seen the healthy uptick in the growth.”

Court documents paint a more sinister portrait of the company’s success.

In a motion urging the FERC to invalidate the contract between El Paso and its affiliate, PUC attorneys, citing e-mails from top El Paso executives, allege that those executives withheld key information from competitors so that El Paso Merchant Energy would win the auction for capacity on El Paso’s pipeline. The FERC commissioners have yet to rule on the matter.

Of even greater concern to El Paso, observers say, is a class-action lawsuit filed by a phalanx of top antitrust attorneys who accuse the firm of plotting with Southern California Gas Co. and San Diego Gas & Electric--two firms that later merged to form Sempra Energy--to eliminate competition in California’s energy market. The suit seeks billions in damages.

Plaintiffs’ attorneys plan to use the agenda and notes of the 1996 meeting in Phoenix as a road map showing how these firms planned to limit natural gas deliveries to Southern California.

The meeting took place Sept. 26 in an executive suite in an Embassy Suites Hotel near Phoenix’s Sky Harbor Airport. The agenda included discussion about projects the companies were competing for--such as gas distribution service to the Samalayuca power plant in Chihuahua, Mexico.

Around the time the meeting was held, Southern California Gas’ near-monopoly as a local distribution firm was being threatened by two pipeline projects that El Paso controlled through its acquisition of Tenneco Energy four months earlier.

Tenneco’s Altamont pipeline would have delivered cheaper and abundant Canadian gas directly to customers in Southern California and Baja California, bypassing pipelines operated by Southern California Gas and SDG&E.;

About the same time, El Paso’s plan to build a pipeline from Texas to Samalayuca was being challenged by Southern California Gas, which was also bidding on the project and could have completed it for a lot less money, according to the suit.

At the Phoenix meeting, Southern California Gas and El Paso decided to get out of each other’s way: They agreed that Southern California Gas would withdraw from competing for the Samalayuca pipeline and El Paso would effectively kill the Altamont pipeline, the suit alleges.

Three weeks after the Phoenix meeting, Southern California Gas announced that it was withdrawing from the Samalayuca project. Ten days later, El Paso refunded money it had collected from companies that had bought capacity on the Altamont pipeline.

The meeting between executives of El Paso, Southern California Gas and SDG&E; would not have come to light but for an antitrust suit filed in Texas federal court by Intratec, a Colorado firm that owned capacity on the Altamont pipeline.

That suit was dismissed in January 2000 on a technicality when the presiding judge found that Intratec was not a proper party to bring an antitrust suit. Intratec is appealing that ruling.

But documents turned over by El Paso during discovery in that case have become a treasure trove for attorneys pursuing the class-action suit.

Notes Cited as Evidence of Collusion

Foremost among them are some handwritten notes taken at the Phoenix meeting by Al Clark, El Paso’s vice president of marketing and operations. On an 8- by 11-inch sheet of paper, participants carved California into two zones, according to Clark’s notes.

Under the heading “Team 1,” Clark listed Southwest gas producers, El Paso Natural Gas, Southern California Gas and Southern California electricity generators. Canadian gas producers and Northern California electricity generators were designated “Team 2” along with Pacific Gas & Electric and Pacific Gas Transmission, a pipeline linking Alberta to Northern California.

Plaintiffs’ attorneys in the anti-trust suit say Clark’s notes provide ample evidence that El Paso and Southern California Gas agreed to exclude new and cheaper Canadian gas from the Southern California marketplace.

Another reason for the Phoenix meeting was to discuss “Opportunities Resulting from [California] Electricity Industry Restructuring.”

Clark’s notes indicate that the energy executives talked about plans to “link up supply, transportation, generation and sale of electricity” and to “think/plan position now to be ready when the opportunity comes.”

Since 1996, El Paso has been on a shopping spree, leaping from a $2-billion pipeline company to a $50-billion diversified international conglomerate today. It owns stakes in key sectors across the energy spectrum--collecting, transporting, marketing and generating--and has access to virtually every market in the nation with the exception of the Pacific Northwest.

Today, El Paso is one of the largest independent oil and gas companies in the United States, owning more than 55,000 miles of pipelines in North America and boasting that it moves a quarter of this country’s natural gas to 70% of the U.S. population.

Of great concern to California regulators is the fact that El Paso Merchant Energy has accumulated ownership interests in about 25 alternative energy plants, which sell power to the utilities. Lawyers for Edison have told the federal energy commission that El Paso has additional incentives to manipulate California border prices because payments to alternative energy plants are based on the price of gas at the state border.

“Therefore, if El Paso Merchant can increase the price of gas at the border through the exercise of market power in pipeline transportation, it will also increase the amounts that Edison must pay to” El Paso’s generating plants, according to Edison’s protest before the FERC.

William E. Kovacic, who teaches antitrust law at George Washington University Law School, said the antitrust suit’s most serious allegation is that the competitors agreed not to expand transportation capacity that would have brought more gas to the region and increased competition.

“If they’ve done this, they may be exposed to hundreds of millions of dollars of damage claims. Maybe billions,” he said. “In other words, how much cheaper would gas have been if the increased capacity was built?”

Kovacic and other antitrust scholars say they found it unsettling that these competitors would meet without their attorneys.

“Most large corporations want lawyers to be clearly present at meetings that might be construed as having touched upon the topic of pricing,” said John C. Coffee Jr., a law professor at Columbia University.

Both El Paso and Sempra have denied violating any laws. “Neither El Paso Energy Corp. nor any of its affiliates have been or are now engaged in any illegal activities, alone or in combination with any other parties, to increase energy prices or create energy shortages in California,” spokeswoman Norma Dunn said after the class-action suit was filed.

In a separate letter to the FERC commissioners, El Paso Chairman William A. Wise said El Paso had limited its ability to benefit from higher gas prices in California because it had hedged most of its pipeline capacity in futures markets long before the price upswings.

Sempra also issued a denial, stating that “any allegations that Sempra Energy or its subsidiaries violated antitrust or other laws are completely false.”

Officials from both companies declined repeated requests by The Times for interviews with those present at the meeting.

In deposition testimony in the Texas antitrust case, Clark, the El Paso vice president, said Southern California Gas initiated the meeting. Clark said he received a call from Latimer Lorenz, the firm’s director of planning, who “wanted to see if there was some common activity that we could undertake in regard to Samalayuca.

“He told me that they had some kind of arrangement with [SDG&E;] that neither one of them would do anything in Mexico without the other one knowing about it, and he wanted to know if it was OK with me if he brought [SDG&E;]. And I said yes.”

Quizzed about his notes, Clark said he had no recollection about “Team 1” and “Team 2” or about plans involving “linkup, supply, transportation, generation [and] sale of electricity.”

Carole Handler, a Los Angeles antitrust attorney pursuing the class-action suit, said she and her colleagues plan to use El Paso’s own words against it.

Testifying in the case that was dismissed, Wise acknowledged that to meet its gas needs, California had nowhere to turn but El Paso. “The other pipelines are essentially full,” he said. “And therefore if you have a new need for gas [in California], you’ve got to go to the capacity that’s not full and that’s been the El Paso system.”

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Getting Natural Gas to California

These are the four pipeline systems that bring natural gas to the state. Most of Southern California’s gas comes from the Permian and San Juan basins via pipelines controlled by El Paso Energy.

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California Connection

While natural gas prices at production points remained relatively stable at the end of last year, prices at California border entry points spiraled out of control. Critics say El Paso Merchant Energy, which owns 40% of the carrying capacity of the main pipeline to Southern California, has been manipulating prices--a charge the company denies.

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Source: Gas Daily