[Federal Register: June 27, 2006 (Volume 71, Number 123)]
[Rules and Regulations]
[Page 36611-36638]
[DOCID:fr27jn06-8]

-----------------------------------------------------------------------

Part II

Department of Energy

-----------------------------------------------------------------------

Federal Energy Regulatory Commission

-----------------------------------------------------------------------

18 CFR Part 284

Rate Regulation of Certain Natural Gas Storage Facilities; Final Rule

-----------------------------------------------------------------------

DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 284

[Docket Nos. RM05-23-000, AD04-11-000; Order No. 678]

Rate Regulation of Certain Natural Gas Storage Facilities

Issued June 19, 2006.
AGENCY: Federal Energy Regulatory Commission, DOE.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Federal Energy Regulatory Commission (Commission) is
amending its regulations to establish criteria for obtaining market-
based rates for storage services offered under part 284. First, the
Commission is modifying its market-power analysis to better reflect the
competitive alternatives to storage. Second, pursuant to the Energy
Policy Act of 2005, the Commission is promulgating rules to implement
new section 4(f) of the Natural Gas Act, to permit underground natural
gas storage service providers that are unable to show that they lack
market power to negotiate market-based rates in circumstances where
market-based rates are in the public interest and necessary to
encourage the construction of the storage capacity in the area needing
storage services, and where customers are adequately protected. These
revisions are intended to facilitate the development of new natural gas
storage capacity while protecting customers.

DATES: Effective Date: The rule will become effective July 27, 2006.

FOR FURTHER INFORMATION CONTACT:
Sandra Delude, Office of the General Counsel, Federal Energy Regulatory
Commission, 888 First Street, NE., Washington, DC 20426. (202) 502-
8583.
Robert McLean, Office of General Counsel, Federal Energy Regulatory
Commission, 888 First Street, NE., Washington, DC 20426. (202) 502-
8156.
Ed Murrell, Office of Energy Markets and Reliability, Federal Energy
Regulatory Commission, 888 First Street, NE., Washington, DC 20426.
(202) 502-8703.
Berne Mosley, Office of Energy Projects, Federal Energy Regulatory
Commission, 888 First Street, NE., Washington, DC 20426. (202) 502-
8625.

SUPPLEMENTARY INFORMATION:

Before Commissioners: Joseph T. Kelliher, Chairman; Nora Mead Brownell,
and Suedeen G. Kelly

I. Introduction

    1. The Final Rule reforms the Commission's current pricing policies
to ensure access to storage services on a nondiscriminatory basis at
just and reasonable rates and to ensure that sufficient storage
capacity will be available to meet anticipated increases in market
demand. To achieve these goals, the Commission is modifying its market-
power analysis to permit the consideration of close substitutes to
storage in defining the relevant product market. This will ensure that
market-based rates are not denied because of an overly narrow
definition of the relevant market. Second, the Commission is adopting
regulations implementing section 312 of the Energy Policy Act of 2005
(EPAct 2005 or the Act),\1\ which permits the Commission, in
appropriate circumstances, to authorize storage providers to charge
market-based rates for service utilizing new capacity even when the
storage providers cannot (or do not) demonstrate that they lack market
power. The revisions adopted in the Final Rule are intended to
facilitate the development of new natural gas storage capacity while
protecting customers.
---------------------------------------------------------------------------

    \1\ Energy Policy Act of 2005, Pub. L. 109-58, 119 Stat. 594
(2005).(2005).
---------------------------------------------------------------------------

II. Background

    2. On August 8, 2005, EPAct 2005 was signed into law. Section 312
of the Act, adding a new section 4(f) to the Natural Gas Act (NGA),\2\
permits the Commission to allow a natural gas storage service provider
placing new facilities in service to negotiate market-based rates even
if it is unable to show that it lacks market power if the Commission
determines that market-based rates are in the public interest and
necessary to encourage the construction of the storage capacity in the
area needing storage services, and that customers are adequately
protected.\3\
---------------------------------------------------------------------------

    \2\ 15 U.S.C. 717, et seq. (2000).
    \3\ Energy Policy Act of 2005, Pub. L. 109-58, section 312, 119
Stat. 594, 688 (2005).
---------------------------------------------------------------------------

    3. The enactment of EPAct 2005 added momentum to efforts already
underway at the Commission to adopt policy reforms that would encourage
the development of new natural gas storage facilities while continuing
to protect consumers from the exercise of market power. On September
30, 2004, the Commission issued a staff report that examined
underground natural gas storage.\4\ On October 21, 2004, the Commission
held a public conference with representatives of the industry to
discuss the Staff Storage Report and issues relevant to underground
storage.\5\ The Commission received oral and written comments in
connection with the Staff Storage Report and conference.
---------------------------------------------------------------------------

    \4\ Current State of and Issues Concerning Underground Natural
Gas Storage, FERC Staff Report, Docket No. AD04-11-000 (Sept. 30,
2004) (Staff Storage Report).
    \5\ State of the Natural Gas Industry Conference, Docket No.
PL04-17-000, October 21, 2004; see State of Natural Gas Industry
Conference; Staff Report on Natural Gas Storage; Notice of Public
Conference, 69 FR 59917 (Oct. 6, 2004) (summarizing the issues to be
discussed at the conference).
---------------------------------------------------------------------------

    4. On December 22, 2005, the Commission issued a notice of proposed
rulemaking (NOPR) in which it proposed a two-prong approach for
reforming its current storage pricing policy.\6\ First, the Commission
proposed modifications to its traditional market-power analysis to
permit the consideration of close substitutes to storage in defining
the relevant product market. Second, the Commission proposed
regulations to implement section 312 of EPAct 2005 that permits the
Commission, in appropriate circumstances, to authorize storage
providers to charge market-based rates for service utilizing new
capacity even when the storage providers cannot (or do not) demonstrate
that they lack market power.
---------------------------------------------------------------------------

    \6\ Rate Regulation of Certain Underground Storage Facilities,
Notice of Proposed Rulemaking, 70 FR 77079 (Dec. 22, 2005), FERC
Stats. & Regs., Regulations Preambles ] 32,595 (Dec. 29, 2005).
---------------------------------------------------------------------------

    5. The Commission received numerous comments from a variety of
entities.\7\ Based on careful consideration of the comments submitted
in response to the NOPR, the Commission adopts a Final Rule that
generally follows the approach of the NOPR with certain exceptions.
---------------------------------------------------------------------------

    \7\ A list of the commentors is included as an appendix to this
Final Rule. We have not considered the supplemental reply comments
filed by INGAA on May 31, 2006, due to the lateness of the filing.
---------------------------------------------------------------------------

    6. First, the Final Rule modifies the Commission's market-power
analysis to better reflect the competitive alternatives to storage.
Specifically, we adopt a more expansive definition of the relevant
product market for storage to explicitly include close substitutes for
gas storage services, including pipeline capacity, local production,
and liquefied natural gas (LNG) supplies. The Commission will evaluate
potential substitutes in the context of individual applications for
market-based rates. The Final Rule eliminates the NOPR's requirement
that storage providers

granted market-based rates on the basis of a market power analysis file
updated market-power analyses every five years. Instead, storage
providers with market shares of ten percent or less would generally be
exempt from such a requirement. We will consider in individual cases
whether the specific facts and circumstances presented require
additional reporting for other storage providers.
    7. Second, the Final Rule adopts regulations implementing section
312 of EPAct 2005, which permits the Commission to authorize market-
based rates even if a lack of market power has not been demonstrated,
in circumstances where market-based rates are in the public interest
and necessary to encourage the construction of storage capacity in the
area needing storage services and that customers are adequately
protected. Finding that the definition of facilities eligible for
treatment under new NGA section 4(f) is ambiguous, the Commission
defines ``facilities'' as it traditionally has for purposes of the
certification requirements of section 7(c). However, to receive market-
based rate authorization, the storage provider will still need to
satisfy the other requirements of section 4(f).

III. Need and Purpose for the Rule

    8. The underground storage of natural gas is critical in assuring
that overall demands and specific requirements of natural gas customers
are met. Currently, there are approximately 200 storage facilities
subject to the Commission's jurisdiction, with an aggregate working gas
capacity of approximately 2.5 Tcf. Estimates of total domestic working
gas capacity (both subject to and exempt from NGA jurisdiction) range
up to 4.7 Tcf.\8\ Considering future storage needs of the United States
and Canada together, the National Petroleum Council (NPC) estimates an
additional 700 Bcf will be required by 2025.\9\ Although current and
projected storage development is keeping pace with aggregate national
storage demands, underground storage development in some market areas,
such as New England \10\ and the Southwest, is not.\11\
---------------------------------------------------------------------------

    \8\ The Department of Energy's Energy Information Administration
(EIA) reports that in 2002 working gas storage capacity varied
between 4.4 and 4.7 Tcf, whereas the Department of Energy's Office
of Fossil Energy reports that in 2003 there were 415 underground
storage facilities with a working gas capacity of 3.9 Tcf. The Staff
Storage Report considered the range of estimated aggregate existing
working gas and concluded that the present working gas capacity is
3.5 Tcf, of which 2.5 Tcf is subject to NGA jurisdiction, and that
by improving existing storage reservoirs (i.e., by reengineering
existing facilities to enhance efficiency, rather than by expanding
cavern capacity), there is the potential to obtain another 200 to
500 Bcf. See Staff Storage Report at 7-10.
    \9\ Balancing Natural Gas Policy--Fueling the Demands of a
Growing Economy, NPC, Volume II at 261 (2003).
    \10\ New England appears to have little geologic potential for
the development of underground storage facilities.
    \11\ See, e.g., Southwestern Gas Storage Technical Conference,
Docket No. AD03-11-000, Transcript at 23, lines 10-14 (Aug. 26,
2003).
---------------------------------------------------------------------------

    9. Over the last several years, there has been a marked increase in
the cost of natural gas and sharp swings in gas prices. Storage can
have a moderating influence on gas prices. As a physical hedge,
customers can build up underground inventories during times of lower
demand, and then rely on these supply stores to avoid paying high spot
market gas prices. Among the key findings highlighted by the Staff
Storage Report is that the ``continued commodity price volatility
indicates that more storage may be appropriate'' and that storage ``may
be the best way of managing gas commodity price, so the long-term
adequacy of storage investment depends on how much price volatility
customers consider `acceptable.' '' \12\
---------------------------------------------------------------------------

    \12\ Staff Storage Report, at 1 (Sept. 30, 2004).
---------------------------------------------------------------------------

    10. In consideration of these factors, the Commission is amending
its regulatory policies in the Final Rule in order to facilitate the
development of new natural gas storage capacity to ensure that adequate
storage capacity will be available to meet anticipated market demand
and to mitigate natural gas price volatility, while continuing to
protect consumers from the exercise of market power.

IV. Discussion

A. Market-Power Test

    11. The Commission evaluates requests to charge market-based rates
for storage services under the analytical framework of its 1996 Policy
Statement on Alternatives to Traditional Cost-of-Service Ratemaking for
Natural Gas Pipelines and Regulation of Negotiated Transportation
Services of Natural Gas Pipelines (Policy Statement).\13\ In the NOPR,
the Commission observed that in applying its market-concentration and
market-share screens in these cases to date, the Commission has looked
only to the availability of other storage alternatives (in the relevant
geographic market), in assessing whether a storage provider can
exercise significant market power. Noting that its current approach to
analyzing market power may be too limiting in some circumstances in
today's natural gas markets, the Commission proposed to reform its
market-power test for natural gas storage operators to more accurately
reflect the competitive conditions in the market for gas storage
services. The Commission proposed to adopt a more expansive definition
of the relevant product market for storage to explicitly include close
substitutes for gas storage service, such as appropriate combinations
of available pipeline capacity, and local gas production or LNG
terminals, on a case-by-case basis in the context of individual
applications for market-based rates. We posited that consideration of
these alternative products will ensure that the Commission's market-
power analysis accurately reflects whether a storage applicant is able
to exercise significant market power.
---------------------------------------------------------------------------

    \13\ Alternatives to Traditional Cost-of-Service Ratemaking for
Natural Gas Pipelines and Regulation of Negotiated Transportation
Services of Natural Gas Pipelines, 74 FERC ] 61,076 (1996), reh'g
and clarification denied, 75 FERC ] 61,024 (1996), petitions denied
and dismissed, Burlington Resources Oil & Gas Co. v. FERC, 172 F.3d
918 (D.C. Cir. 1998).
---------------------------------------------------------------------------

    12. We explained that, as a general matter, competition to a
storage provider can come from entities that have the ability to
deliver gas in the same market as the storage facility. In producing
areas, storage may compete with production or LNG supply, in addition
to other storage facilities. In market areas, there may also be local
production or LNG available. In addition, available pipeline capacity
can function as a close substitute by delivering gas at peak times to
compete with storage. For these reasons, we suggested it would be
appropriate to permit applicants to present evidence that both
available pipeline capacity and local production/LNG supply in the
geographic market area can reasonably be considered as alternative
products to storage services.
    13. In addition, we suggested that firm capacity available through
capacity release can be a good alternative in appropriate
circumstances. Under the Commission's capacity release regulations,
holders of firm capacity are free to release the capacity to other
shippers, as well as to make bundled sales at alternate delivery
points. Because of this flexibility, some portion of firm, contracted-
for capacity may have a sufficiently elastic demand (a willingness to
re-sell firm capacity when price rises) to serve as a good alternative
to an applicant's storage service. While pipeline capacity held by a
local distribution company (LDC) that is needed to meet state-mandated
service obligations for captive retail customers may not be considered
a good alternative during peak periods, LDCs

and marketers also serve industrial and other customers under
interruptible contracts. That portion of the LDC's capacity might
constitute a reasonable alternative.
    14. Moreover, we stated that, in some circumstances, an applicant
may be able to show that even when firm capacity on a pipeline is
reserved for captive customers, e.g., residential and small commercial
customers, potential product or service substitution in downstream
markets might result in capacity becoming available in upstream markets
to compete with storage while captive customers continued to be served.
Under the Commission's open-access program, competition in a downstream
market may create competition in upstream markets, particularly due to
Order No. 636's requirement that pipelines provide flexible receipt and
delivery points and segmentation including backhaul. Thus, an LDC's
ability to buy capacity from another pipeline or storage facility or to
purchase gas in the downstream market may free it to release upstream
capacity to compete with storage in the upstream market. This ability
to buy capacity from another pipeline or storage facility or to buy gas
in the market area is present in the large downstream markets in the
United States including California, Chicago and the Northeast.
    15. The Commission requested comments on these alternatives, as
well as suggestions regarding other approaches for quantifying the
amount of pipeline capacity that might be available to compete with an
applicant's storage services.
1. Expansion of the Product Market Definition
Comments
    16. A number of commentors generally support the Commission's
proposal to liberalize the Commission's market-power test for market-
based rate authorization by expanding the kinds of storage alternatives
that it will consider in analyzing an applicant's market power with
certain proposed changes discussed below.\14\ They agree with the
Commission that available pipeline capacity, capacity release, local
gas production and LNG terminals all may serve as adequate substitutes
for gas storage in appropriate circumstances. These commentors also
state that they believe that the Commission's proposal should provide
further incentives for the development of new natural gas storage
capacity that will improve gas service reliability and promote price
stability in the future. The NYPSC agrees with the Commission that
local gas production, pipeline capacity and LNG potentially can be
offered as alternatives to storage service but requests the Commission
to adhere to the case-by-case approach and to allow for consideration
of whether there are realistic alternatives available on a firm and
long-term basis.
---------------------------------------------------------------------------

    \14\ Comments of INGAA, Northern Natural, Duke, Williston Basin,
the NiSource Pipelines, Dominion, Sempra, DTE, NYPSC, Falcon,
EnCana, Bridgeline, Unocal, Enstor and Jefferson Storage. The full
names of commentors and the abbreviations used in this document are
shown in the appendix.
---------------------------------------------------------------------------

    17. On the other hand, several commentors oppose changes to the
current market-power standards on grounds that liberalizing these
standards is unnecessary and potentially harmful to customers. AGA,
APGA, NGSA, SGR and UET all question whether the proposed changes would
actually encourage meaningful development of new storage facilities.
APGA questions the NOPR's assumption that a storage capacity shortage
exists. APGA states that while the NOPR discusses the upcoming need for
an additional 700 Bcf of storage capacity by 2025, the NOPR does not
suggest, much less demonstrate, that the need will not be fulfilled.
NGSA submits that there is little evidence to suggest that the
Commission's current pricing policies have had a major influence on
developers' decisions to move forward with potential storage projects.
Rather, NGSA contends that there are multitudes of technical and
commercial factors that influence a potential storage developer's
decision to build storage that are equal or paramount to the
Commission's regulatory pricing policies including geological
limitations, environmental requirements and NIMBY issues.
    18. AGA and SGR assert that the proposed changes would simply
provide existing storage providers the opportunity to charge higher
prices for services already available to the market and create
opportunities for cross-subsidies between storage and transportation
services. AGA also fears that liberalizing the market-power standards
would vastly increase the scope and complexity of the market-power
determination, while APGA submits that the NOPR's proposal to expand
the definition of the relevant product market for storage would
diminish substantially the showing required to obtain market-based
rates.
    19. APGA also argues that the proposal is inconsistent with the
Policy Statement that defines a ``good alternative'' as one that must
have the same qualities of timeliness, price and quality of the storage
service it would replace. Specifically, APGA submits that pipeline
capacity (and local production/LNG and released capacity) are not good
alternatives, much less ``close substitutes'' in terms of quality of
service to the high deliverability storage service that the NOPR seeks
to promote. Similarly, APGA argues that in terms of price, pipeline
capacity is not a good alternative or close substitute to storage
service, because pipeline capacity is more expensive than storage
capacity.
    20. NGSA submits that the expansion of the relevant product market
will not provide customers with the equivalent services uniquely
offered by new storage facilities and examining market elasticity to
determine whether product substitution can occur in downstream markets,
as suggested in the NOPR, is simply not realistic. NGSA and PGC stress
that the criteria and framework that the Commission utilizes to review
market-based rate applications have proven to be effective and
flexible, resulting in the approval of market-based rates for the
majority of applicants. Moreover, NGSA points out there are flexible
cost-based rates available to promote new storage capacity without
making wholesale changes to the Commission's exiting market-power
analysis. NGSA urges the Commission to consider whether it would be
more appropriate instead to adopt changes that will rectify the unique
problems identified in specific regions by undertaking a generic
proceeding to: (1) Identify where new storage capacity is needed; (2)
document known proposals in these regions; (3) determine what specific
obstacles may exist; and (4) establish regulatory policies to encourage
additional storage construction in those areas.
    21. IPAA expresses concern with the Commission's proposal to adopt
a more expansive definition of the relevant product market for storage
to explicitly include close substitutes for gas storage services. IPAA
urges the Commission to carefully consider the potential impact of this
expanded definition of relevant product market for storage on other
cost-based services regulated by the Commission. (e.g., the regulation
of interstate pipeline transportation rates). For example, IPAA states
that if pipeline capacity and released capacity can serve as possible
substitutes for competing storage, then the potential exists for
storage to serve as a substitute for the availability of competing
pipeline capacity in evaluating applications for market-based
transportation rates. IPAA states it most likely would have concern
with efforts to expand the acceptance of market-

based transportation rates. Thus, IPAA strongly encourages the
Commission to consider the effect the expanded definition of relevant
product market could have on all services under the Commission's
jurisdiction, not just within the confines of an individual application
by a storage operator. NGSA requests that the Commission clarify that
these changes will not be used for the future evaluation of market
power for interstate transportation services but only for new storage
facilities as it has proposed for the EPAct 2005 provisions.
    22. UET asserts that the Commission has not demonstrated that the
proposed change in the market-power analysis is needed to reduce
natural gas price volatility because price volatility is mitigated on a
national, as opposed to a regional basis, and storage development is
keeping pace with national demands. UET also argues the proposed change
is not necessary to solve regional storage capacity shortages in
underserved markets such as New England and the Southwest, because
proposals for new storage in these areas have failed for reasons other
than rate treatment. Finally, UET asserts that the proposed rule is not
necessary to cater to power generation load because the Commission is
able to meet the needs of power generation customers by developing rate
designs that would permit storage operators to earn higher revenues
from short-term services during peak periods.
    23. UET also maintains that changing the market-power analysis as
proposed could discourage rather than encourage expansion of existing
storage facilities. It asserts that cost-based rates treat the storage
company fairly and also enable storage customers to participate
sufficiently in the natural gas value chain that runs from the wellhead
to the burner tip. UET alleges that market-based rates may disrupt the
value chain to such an extent that potential storage customers,
particularly marketers, will simply choose to exit the market rather
than serve as the vehicle for funneling market-based rate revenues to
storage providers. Thus, UET maintains that storage projects, for which
there is a demand at cost-based rates, may not be built because the
demand is not there for a project that would qualify for market-based
rates under the relaxed proposed standards. In addition, noting that
price volatility has increased as the number of major marketers has
decreased, UET urges the Commission to exercise care in embracing
market-based rates to encourage new storage in the name of price
volatility mitigation when those rates may actually increase price
volatility by further decreasing the number of marketers.
    24. Finally, AGA, NGSA and Process Consumers argue that the NOPR is
unnecessary given the alternative of section 4(f) of the NGA. For
example, AGA asserts that the proposed regulations pursuant to new NGA
section 4(f) fully address the need to provide incentives for new
storage services and there is no need to provide more latitude for
qualifying for market-based rates for existing storage facilities. At
most, AGA asserts the Commission should considering broadening the
market-power test only after it has had an opportunity to assess the
impact and outcome of the new rules under section 4(f), a minimum of
two years after implementing regulations under section 4(f). Similarly,
NGSA while supporting the Commission's goal of maximizing storage
believes that liberalizing the traditional market-power test is
unsupported and unnecessary. Given that Congress enacted EPAct 2005 as
the primary vehicle to encourage the development of new storage
facilities, NGSA urges the Commission to focus its attention in this
proceeding on properly implementing EPAct 2005, and not engaging in an
unnecessary effort to provide incentives for new storage by revising
the existing market-power test. At a minimum, NGSA urges the Commission
to take an incremental approach and maintain the existing market-power
procedures, at least until it can assess whether its implementation of
the EPAct 2005 provisions can provide a sufficient and workable program
that provides a valid incentive to potential new storage developers.
Commission Determination
    25. The Commission finds it is appropriate to adopt a more
expansive definition of the relevant product market for storage to
explicitly include close substitutes for gas storage services,
including pipeline capacity and local production/LNG supplies. As
explained below, this modification to our market-power analysis better
reflects the competitive alternatives to storage and is supported by
changes in the natural gas markets that have occurred since the mid
1990s. In today's markets, these non-storage products may well serve as
adequate substitutes for gas storage in appropriate circumstances.
    26. As we explained in Order No. 637, the deregulation of wellhead
natural gas prices, the advent of open-access transportation and the
requirement that interstate pipelines offer unbundled open-access
transportation service, has increased competition and efficiency in
both the gas commodity and transportation market.\15\ Market centers
have developed both upstream in the production area and downstream in
the market area, providing shippers with greater gas and capacity
choices. The wholesale market has grown with new participants that have
the ability to deliver gas into many markets. The expansion of the
product market definition to include close substitutes simply
recognizes that buyers and sellers have a greater number of
alternatives from which to choose in order to obtain and deliver gas
supplies. From an end-use customer's perspective, gas is fungible,
whether it comes from storage, local production or more distant
supplies transported by pipelines. Competition with storage can come
from any of these sources that can deliver gas in the same market as
the storage facility. For these reasons, we will permit a storage
applicant to include non-storage products and services, including
pipeline capacity and local production/LNG supply in the calculation of
its market concentration and market share.
---------------------------------------------------------------------------

    \15\ Regulation of Short-Term Natural Gas Transportation
Services and Regulation of Interstate Natural Gas Transportation
Services, Order No. 637, FERC Stats. & Regs., Regulations Preambles
(July 1996-December 2000) ] 31,091 at 31,249-63 (Feb. 9, 2000).
---------------------------------------------------------------------------

    27. The Commission recognizes, however, that local production, LNG
and pipeline capacity may not be good alternatives to an applicant's
storage services in all circumstances. For a non-storage product to be
a good alternative it must be available soon enough, have a price low
enough and have a quality high enough to permit customers to substitute
the alternative for the applicant's services. For this reason, we will
evaluate potential substitutes in the context of individual
applications for market-based rates. In those proceedings, the
applicant will have the burden to demonstrate that the non-storage
products and services, as well as the other storage services, used in
its calculation of market concentration and market share are good
substitutes. Any party to the proceeding can challenge the inclusion of
a particular product on the grounds that it does not meet the
qualifications for a good alternative. Based on the record in the
proceeding, the Commission will determine if the proposed product is in
fact a good alternative that will limit the exercise of significant
market power by the applicant.
    28. In the NOPR, we noted that although current and projected
storage development is keeping pace with aggregate demands, underground
storage development in some market

areas, such as New England and the Southwest, is not.\16\ We also
acknowledged that our rate policies will not guarantee the
proliferation of new storage projects because storage projects fail to
for reasons other than rate treatment.\17\ A few commentors claim that
the proposed expansion of the product market is not supported because
we have not shown that a storage capacity shortage exists or that
market-based rates will ensure that storage gets built. We disagree
that such findings are necessary to support the proposed change to our
market-power analysis. The courts have permitted the Commission to
institute flexible pricing to improve market efficiency so long as the
overall regulatory scheme protects against the exercise of market power
and protects and results in just and reasonable rates.\18\ Where the
Commission determines that an applicant lacks market power, the
Commission may depart from a strictly cost-based determination of
rates, and approve rates reached as the result of competition. The
Commission's authority to approve market-based rates has been approved
by the courts when the Commission has found sufficient protection
against the exercise of market power.\19\
---------------------------------------------------------------------------

    \16\ NOPR at P 8.
    \17\ Id. at P 14.
    \18\ Environmental Action v. FERC, 996 F.2d 401, 410 (D.C. Cir.
1993).
    \19\ Elizabethtown Gas Co. v. FERC, 10 F.3d 866, 870-71 (D.C.
1993) (Elizabethtown); Louisiana Energy and Power Authority v. FERC,
141 F.3d 364, 369-370 (D.C. Cir. 1998); Interstate Natural Gas
Association of America v. FERC, 285 F.3d 18, 31-34 ((D.C. Cir.)
2002); California ex rel. Lockyer v. FERC, 383 F.3d 1006, 1013-1014
(9th Cir. 2004).
---------------------------------------------------------------------------

    29. The Commission finds that its proposed regulatory change will
protect against the exercise of market power. In analyzing market-based
rate storage proposals, the Commission will continue to addresses
whether the applicant has market power; that is, can the applicant: (1)
Withhold or restrict services to increase price a significant amount
for a significant period of time, or (2) discriminate unduly in terms
of price or conditions. Before the Commission can conclude that a
seller cannot exercise market power it must either: (1) Find that there
is a lack of market power because customers have sufficient ``good
alternatives,'' or (2) mitigate the market power (i.e. permit market-
based pricing only if specified conditions are met that prevent the
exercise of market power). The only change the Commission is adopting
in this Final Rule is to recognize that in today's market, a storage
applicant's ability to exercise market power can be constrained not
only by other storage services but also by some combination of pipeline
and other gas supply alternatives.
    30. Similarly, we do not share commentors' views that we should not
adopt the proposed revisions to the product market definition because
it may result in more complex proceedings or that there are flexible
cost-based rates available to storage providers. The Commission's
proposal is justified because it better reflects the competitive
alternatives to storage.
    31. We also find that commentors' assertion that our action here
will inappropriately raise rates ignores the connection recognized by
the courts between competition and just and reasonable rates. In
Elizabethtown, the court concluded that because of the competition in
the pipeline's sales market it appeared that the pipeline would not be
able to raise its price above the competitive level without losing
substantial business to other sellers. ``Such market discipline
provides strong reason to believe that Transco will be able to charge
only a price that is `just and reasonable' within the meaning of
section 4 of the NGA.'' \20\ Granting market-based rates in situations
where there are sufficient alternatives prevents the exercise of
significant market power. A new entrant found to lack market power
offers another choice to existing customers, and in the Commission's
experience, more choice frequently leads to lower, not higher, rates.
---------------------------------------------------------------------------

    \20\ 10 F.3d 866, at 871 (D.C. Cir. 1993).
---------------------------------------------------------------------------

    32. We also reject commentors' claim that Congress' enactment of
section 312 of EPAct 2005 bars the Commission from expanding the
product market definition for storage applicants seeking a finding that
the applicant does not possess market power. These commentors fail to
cite to any provision in section 312 of the Act that suggests Congress
intended to limit in any way the Commission's ability to revise or
modify its traditional market-power analysis. Rather in section 312,
Congress established an alternative procedure to permit storage service
providers that are unable to show that they lack market power to
negotiate market-based rates if the Commission determines that market-
based rates are in the public interest, are necessary to encourage
needed storage infrastructure and that customers are adequately
protected. The Commission finds it is reasonable to proceed under both
prongs.
    33. As to IPAA's and NGSA's concern that our actions here not
prejudge the issue of whether storage can serve as a substitute for the
availability of competing pipeline capacity in evaluating applications
for market-based transportation rates, we clarify that it is not our
intent. Our actions here only address what non-storage products may be
considered a good alternative to storage services, and should not be
construed to address what products may be considered a good alternative
to transportation services.
    34. Finally, we do not share UET's views that our action here will
negatively impact the number of marketers. Marketers, too, will have
choices in contracting for service from a newly authorized storage
service provider authorized to charge market-based rates and, as
discussed above, the price will remain just and reasonable within the
meaning of section 4 of the NGA due to the absence of significant
market power.
2. Scope of Applicability of Expanded Product Market Definition
Comments
    35. Bay Gas requests that the Commission revise proposed Sec.
284.501, Applicability, to clarify that the newly proposed subpart M
requirements do not apply automatically to previously-ordered market-
based rate authorizations. Specifically, Bay Gas requests that the
Commission add the following language to the end of that section:
``provided, if such pipeline or storage service provider was authorized
to charge market-based rates before subpart M effective date, it need
not conform under that authorization to subpart M.''
    36. Should the Commission decide to adopt its proposal to expand
the product market, AGA and NGSA urge the Commission to expressly limit
the application of any revised market-power regulations to new storage
capacity rather than to existing storage capacity that is currently
subject to cost-based rates.
    37. NiSource Pipelines request that the Commission clarify whether
existing storage providers are permitted to seek market-based rate
authority using the proposed modified market-power analysis.
Commission Determination
    38. As requested by Bay Gas, we clarify that applicants previously
granted market-based rates need not resubmit an application under the
broader definition of product market we are adopting in the Final Rule.
If an applicant has demonstrated a lack of market power under the
traditional definition of product market, it follows

that the applicant would qualify for market-based rates using an
expanded definition of product market that includes additional
substitutes. However, we do not agree that a revision to the regulatory
text is necessary.
    39. We find that NGSA and AGA have provided no support for their
request to limit the applicability of the expanded product market
definition to only new storage capacity. Pursuant to the Policy
Statement, an entity can file an application for market-based rates for
storage services if it can demonstrate that it does not have
significant market power or has sufficiently mitigated that market
power. Where a company can show a lack of market power, then
competition in the market will ensure that the company's rates will be
just and reasonable and the purpose of the NGA is met. Accordingly,
existing storage providers are permitted to seek market-based rate
authority using the proposed modified market-power analysis. However,
the Commission will consider in the case of existing storage all
relevant facts of the applicant's potential to exercise market power,
including for example, impacts on existing customers and the
applicant's relationship with transmission service providers in the
relevant market.
3. Determination and Quantification of a Good Alternative
    40. In order to show that a non-storage product or service such as
transportation is a good alternative, the Commission stated that the
storage applicant would need to meet the criteria set forth in the
Commission's Policy Statement. A good alternative is one that is
available soon enough, has a price that is low enough, and has a
quality high enough to permit customers to substitute the alternative
for the applicant's services.
Comments
    41. SCE stresses that the Commission needs to adopt an analysis
that is as robust as its analysis of the electric markets and takes
into consideration the interdependence of gas and electric markets'
competitiveness. SCE urges the Commission to seriously examine the
limits on ``substitutability'' among the various products in each
market, noting the complex dynamic relationships involved in
determining this. SCE states that storage serves three basic functions:
price arbitrage, balancing and peak reliability, and customers consider
different kinds of storage and transportation products to perform each
function. Thus, each alternate product must be examined in the context
of its ability to provide competitive discipline on the operation of an
applicant's storage facility. Depending on the market structure, SCE
asserts that some facilities or products may only be able to perform
one of the three storage functions while others might serve all of
these functions. In addition, SCE stresses that the Commission also
must be willing to examine whether, and the extent to which, an
exercise of market power in the storage market may ultimately result in
supracompetitive prices elsewhere in the gas markets, i.e., other
geographic markets or other products.
    42. Enstor urges the Commission to provide more clarity as to what
is, and is not, a good alternative, and how a market-based rate
applicant can demonstrate the same. In addition, Enstor seeks further
Commission amplification on whether an alternative is ``available.''
For example, Enstor asks in regards to LNG terminals in service, will
availability depend on the terminals' capacity or their deliverability?
    43. EEI supports the Commission's proposal to include alternatives
to storage in its market-power analysis. EEI submits that this analysis
is fact specific and should be applied in the context of the region of
the country and the users that would be supplied by the proposed
storage services. With regard to released capacity as a competitive
alternative to storage, EEI asserts that the applicant should be
required to demonstrate that there is a viable market in released
capacity. In making this determination, EEI urges the Commission to
rely on historic information on the extent of trading in released
capacity on a relevant pipeline because such information is a better
indicator of substitutes for storage service than a theoretical
analysis of possible releases in the future.
    44. With respect to quantifying firm transportation capacity that
could be available to compete with an applicant's storage service, DTE
recommends that all firm transportation capacity on all pipeline
systems that serve the applicant's geographic market that is not
committed to meeting the state-mandated obligation of LDCs to serve
captive customers be considered as available to compete with the
applicant's storage services, particularly during swing periods when
deliverability is most critical. DTE explains that capacity not under
LDC contract is generally held by marketers, end users, and producers
who are in a position to divert gas on short notice from contractual
primary delivery points to higher-valued markets in response to rapidly
changing market conditions.
    45. Given that non-LDC shippers are in the best position to respond
to swings in the market and control where gas is delivered, DTE
recommends that firm transportation capacity be quantified on a
shipper-by-shipper basis for the purpose of calculating swing period
deliverability market shares and a Herfindahl-Hirschman Index (HHI).
Under this approach, each pipeline shipper would be considered a
potential competitor to the applicant. On the other hand, DTE claims
that market-power studies should not assume that pipelines control
deliverability and can use shipper deliverability to respond to market
swings in a manner and time period that is competitive with storage.
That is, pipeline deliverability should not be quantified and assigned
to each individual pipeline for the purpose of calculating market
shares and HHIs. Pipelines are purely transporters and are not in a
position to divert gas on short notice to higher valued markets in
response to changes in market conditions.
    46. DTE agrees with the Commission's statement in the NOPR that to
the extent an LDC holds pipeline capacity in order to meet state-
mandated service obligations to captive customers, it is not likely
that such pipeline capacity would be available to respond to market
needs nor would it be a good substitute for storage capacity and
deliverability. Similarly, DTE urges the Commission to exclude storage
capacity and deliverability associated with storage fields owned by
LDCs and used to meet state-mandated service obligations to captive
customers from market share and HHI calculations contained in market-
power studies submitted by applicants seeking market-based rates. DTE
states that like firm transportation used to meet LDC market needs,
firm storage capacity and deliverability associated with storage fields
owned by LDCs are committed to meet captive retail customer needs and
should not be considered available to the market to meet changing
economic conditions.
Commission Determination
    47. As we have stated above, we intend to continue to evaluate
requests for market-based rates for storage on a case-by-case basis. An
applicant is required to identify ``the specific products or services
and the suppliers of those products and services that provide good
alternatives to the applicant's ability to exercise market power.\21\ A

good alternative has been defined as one that is available soon enough,
has a price that is low enough, and has a quality high enough to permit
customers to substitute the alternative for the applicant's service.
The burden is on the applicant to ``show how each of the substitute
services in the product market are adequate substitutes to the
applicant's service in terms of quality, price, and availability.''
\22\ Therefore, we will not endorse any particular method for
determining the substitutability of a product here, but rather base our
determination on the record developed in individual proceedings.
Regarding Enstor's request that we clarify whether the availability of
LNG terminal service will depend on the terminal's capacity or
deliverability, we find that both elements would be relevant in
analyzing the availability of LNG supply.
---------------------------------------------------------------------------

    \21\ Policy Statement at 61,230-231.
    \22\ Id.
---------------------------------------------------------------------------

    48. In order for an applicant to show that non-storage products are
a good alternative to storage, they must demonstrate that for peak
demand periods customers will be able to choose the non-storage product
as a comparable substitute for storage services offered by the
applicant. This demonstration must show that in terms of quality,
timeliness, and price that non-storage products will be able to serve
customers' needs as well as storage service. For example, an applicant
may be able to demonstrate that pipeline capacity in combination with
spot market purchases and appropriate financial market instruments,
such as futures contracts, can reasonably be expected to be available
at prices competitive with storage service so that it can act as a
substitute for storage gas purchased, stored and/or redelivered when
needed. Applicants may also be able to show that available park and
loan services or liquid market-center spot markets provide sufficient
liquidity during peak periods to constitute an adequate substitute to
storage for balancing purposes or to serve peak demand.
4. Additional Revisions to Market-Power Test
a. Inclusion of Other Gas Supply Alternatives in the Product Market
Comments
    49. In addition to the pipeline capacity and LNG supply identified
by the Commission in its NOPR, Duke urges the Commission to recognize
that other gas supply alternatives may be available in a given market,
such as financial instruments, that can compete with storage. Duke
explains that storage allows a consumer of natural gas to manage price
risk by allowing the consumer to choose a price at which to buy natural
gas, store it, and then withdraw that gas as needed. According to Duke,
there are an increasing number of financial instruments that can be
used to manage this same natural gas price risk. Williston Basin claims
that other types of alternatives may exist as well, and accordingly
market-based rate applications should be looked at individually, to
determine what types of alternatives are available.
Commission Determination
    50. As discussed above, we will continue to evaluate requests for
market-based rates on a case-by-case basis. An applicant may propose to
include other non-storage products as alternatives to storage services
to the extent it can demonstrate the proposed alternatives can be
delivered into the relevant geographic market and otherwise meet the
criteria of a good alternative.
b. Modification to HHI Threshold
    51. Under the Policy Statement, the Commission's initial screening
tool for significant market power is the HHI, a formula that focuses on
the relevant market's concentration as an indicator of the potential of
an applicant to act together with other sellers to raise prices.\23\
The Commission uses an HHI of 1,800 as an indicator of the level of
scrutiny to be given to an applicant for market-based rates. An HHI at
this level indicates that there are four to five good alternatives to
the applicant's service in the relevant market. An HHI below 1,800
suggests limited market concentration with less potential for any
participant to exercise significant market power. However, an HHI above
1,800 suggests a higher level of concentration, and will cause the
Commission to increase its scrutiny of other factors such as the
applicant's market share, ease of entry into the market, the relative
size of the applicant's capacity, and/or the sustainability of a
potential attempt by the applicant to exercise market power.\24\
---------------------------------------------------------------------------

    \23\ The HHI is the sum of the squared market shares. For
example, in a market with five equal size firms, each would have a
20 percent market share. For that market, HHI = (20)2 +
(20)2 + (20)2 + (20)2 +
(20)2 = 400 + 400 + 400 + 400 + 400 = 2,000.
    \24\ Policy Statement at 61,235-36.
---------------------------------------------------------------------------

Comments
    52. INGAA and KM urge the Commission to adopt an HHI level of 2,500
rather than the 1,800 that it currently employs as a benchmark for
measuring market concentration. INGAA asserts the current level is far
too conservative and is inconsistent with standards recommended by the
Antitrust Division of the Department of Justice (DOJ) for analogous oil
pipeline cases.
    53. KM asserts that the Commission's reliance on the 1,800 HHI
level inappropriately relies on the DOJ's and the Federal Trade
Commission's (FTC) Horizontal Merger Guidelines (Merger Guidelines)
which apply to merger cases where two companies are merging and the
number of competitors is reduced. KM argues that the 1,800 threshold is
too conservative as applied to potential new storage entrants seeking
market-based rates because, in this situation, the number of
competitors will be increasing and the Commission will exercise
regulatory oversight. KM also points out that the Commission applies
the 2,500 threshold to oil pipelines where there is no merger issue and
the adoption of that threshold was supported by DOJ in filed comments.
Similarly, KM argues the Commission should adopt a 2,500 HHI threshold
for applicants seeking market-based rate authority for gas pipelines
where continued regulation of an industry rather than a merger is at
issue. KM also asserts that adherence to the 1,800 HHI threshold is at
odds with the actual DOJ and FTC enforcement decisions regarding
horizontal merger review, where it states that out of 11,263 challenges
initiated by the agencies, only 175 involved markets with HHIs under
2,500.\25\
---------------------------------------------------------------------------

    \25\ Citing Federal Trade Commission and the U.S. Department of
Justice, Merger Challenges Data, Fiscal years 1999-2003, December
18, 2003.
---------------------------------------------------------------------------

    54. Finally, KM asserts that in today's markets, purchasers of
storage capacity are generally large LDCs or even larger and more
powerful marketing arms of large producers and the presence of this
buyer power is not accounted for in the Commission's HHI analysis.
According to KM, use of a higher initial screen would partially take
into account other factors such as buying power.
Commission Determination
    55. We are not persuaded by the commentors' arguments that there is
a need to change the HHI threshold level. Significantly, as recognized
by KM and INGAA, the 1,800 HHI level is not a bright-line test below
which an applicant would automatically qualify for market-based rates,
or above which an applicant would be excluded from market-based rates.
Rather, the Commission uses the 1,800 HHI level as

an indicator of the level of scrutiny to be given to the applicant. As
explained in the Policy Statement, if the HHI is above 1,800 the
Commission will give the applicant closer scrutiny because the index
indicates that the market is more concentrated and the applicant may
have significant market power. Conversely, an HHI below 1,800 would
result in less scrutiny of the applicant's potential to exercise
significant market power because it would indicate that the market is
less concentrated.\26\ The Commission has applied this policy in its
analysis of individual cases and has approved market-based rates for
several applicants with HHIs above 1,800 after examining other
competitive factors. For example, in Avoca Natural Gas Storage
(Avoca),\27\ the Commission approved market-based rates despite an HHI
for deliverability of 4,100 in the relevant New York/Pennsylvania
market, specifically noting the small size of Avoca's market share and
the apparent ease of entry into the market as factors mitigating the
market concentration reflected in the HHI.\28\
---------------------------------------------------------------------------

    \26\ Policy Statement at 61,235.
    \27\ 68 FERC ] 61,045 (1994).
    \28\ The Commission reached a similar result analyzing storage
services in Steuben Gas Storage Co., 72 FERC ] 61,102 (1995); New
York State Electric and Gas Corp., 81 FERC ] 61,020 (1997); N.E. Hub
Partners, L.P., 83 FERC ] 61,043 (1998); Seneca Lake Storage, Inc.,
98 FERC ] 61,163 (2002); and Honeoye Storage Corp., 91 FERC ] 62,165
(2000).
---------------------------------------------------------------------------

    56. We disagree with INGAA's and KM's assertion that the 1,800 HHI
level is too conservative. First of all, it is not true that applicants
seeking market-based rates will always increase the number of
competitors in a market. For example, a storage provider may apply for
market-based rates for existing cost-based service. More importantly,
we believe that use of the more conservative approach will ensure that
the impact of other competitive factors will be given careful scrutiny
when the market is relatively concentrated (less than four or five good
alternatives). In addition, contrary to KM's assertion, we have not
adopted a generic 2,500 HHI level in analyzing whether an oil pipeline
has market power.\29\ Moreover, the use of HHI levels in determining
whether an oil pipeline has market power in individual cases reflects
the specific competitive circumstances affecting oil pipelines.
Specifically, oil pipelines face competition not only from other oil
pipeline providers but also from other modes of delivering oil such as
rail, barges and trucks.\30\ In general, there are not similar
alternative modes of delivering or storing natural gas. Further, as
common carriers, oil pipelines operate in a different regulatory
context.
---------------------------------------------------------------------------

    \29\ Market-Based Ratemaking for Oil Pipelines, Order No. 572,
FERC Stats. & Regs. ] 31,007 at 31,192 (Oct. 28, 1994) (``[T]he
Commission is not proposing any particular HHI level, such as 1,800
or 2,500, as a screen or presumption, rebuttable or otherwise. All
factors must be considered in determining whether an oil pipeline
lacks significant market power.'').
    \30\ Id. at 31,191.
---------------------------------------------------------------------------

    57. Additionally, we do not agree with KM that a higher initial
screen is appropriate to take into account the fact that purchasers of
storage capacity are generally large LDCs or marketing arms of large
producers. First of all, the purchasers of storage services are not
always large LDCs and marketers and to implement an analysis premised
on the assumption that they are is not appropriate. Under the Policy
Statement we consider issues related to buyer power separately (outside
the context of the HHI threshold) which permits the Commissions to
consider the specific facts presented in a case. We find this approach
superior to the approach advocated by KM.
c. Entry and Other Competitive Factors
Comments
    58. Duke asserts that while the inclusion of currently available
competitive alternatives in the definition of the market for the
purposes of calculating market concentration and market share values,
as advocated above, is a good starting point, such a revision alone,
while necessary, will not address the barriers to development faced by
markets with little existing gas supply infrastructure. To promote the
development of additional storage infrastructure in these areas, Duke
urges the Commission to shift the overall focus of its market-based
rate analysis away from requiring evidence of an existing market to an
analysis of the extent to which a new entrant increases the potential
gas supply options available to market participants. Duke states the
Commission's market-based rate policy should focus on: (1) Whether the
new entrant adds new storage options to the market, and (2) whether
there are further opportunities for additional entrants to take similar
risks and develop competitive storage. Duke urges the Commission to
adjust its existing approach to focus less on the status of existing
competition and more upon the potential benefits of adding additional
storage by: (1) Making it clear that applicants may rely upon evidence
of potential developments of storage in circumstances where there is
little or no existing competition, or (2) by making a generic
determinations concerning the potential competitiveness of particular
areas of the country.
Commission Determination
    59. The Commission believes that the analytical framework for
establishing market-based rates set forth in the Policy Statement
already adequately accommodates other competitive factors such as the
ability of other entities to enter the market. In the Policy Statement,
the Commission specifically recognized that having a large market share
in a concentrated market does not constitute market power if ease of
entry and other competitive factors can prevent the applicant from
exercising significant market power.\31\ In a recent order in Rendevous
Gas Services, L.L.C., the Commission granted market-based rates for hub
transportation service based on the ease of entry into the market
center and the fact that the proposed pipeline was a new entrant with
no captive customers.\32\ Similarly, when requesting market-based rates
for storage services, an applicant is permitted to establish that it
lacks market power by demonstrating that if it increases its price,
ease of entry by other providers into the market will make such a price
increase unprofitable. Moreover, in response to Duke's assertion that
we should focus more on the benefits of new entry than market
concentration statistics, we recognize that there are significant
benefits to competition and customers from new storage and note that,
under our policy, HHI calculations of market concentration are used as
a screening tool and are not dispositive of whether we will grant a
request for market-based rates. Instead, we will consider all relevant
factors, including the benefits of new entry, in determining whether to
approve market based rates. The Commission will evaluate such proposals
on a case-by-case basis.
---------------------------------------------------------------------------

    \31\ Policy Statement at 61,235.
    \32\ Rendevous Gas Services, L.L.C., order issuing certificates,
112 FERC ] 61,141; reh'g. denied, 113 FERC ] 61,169 (2005). See also
Avoca, 68 FERC ] 61,045 (1994); Steuben Gas Storage Co., 72 FERC ]
61,102 (1995); New York State Electric and Gas Corp., 81 FERC ]
61,020 (1997); N.E. Hub Partners, L.P., 83 FERC ] 61,043 (1998);
Seneca Lake Storage, Inc., 98 FERC ] 61,163 (2002); and Honeoye
Storage Corp., 91 FERC ] 62,165 (2000).
---------------------------------------------------------------------------

d. Definition of Geographic Market
Comments
    60. DTE states that while the Commission's NOPR takes the important
step of presenting an expanded definition for storage substitutes, the
NOPR does not clarify how an applicant seeking to demonstrate a lack of
market power

should define its geographic market. DTE seeks Commission guidance as
to how to define the relevant geographic storage market in order to
provide more certainty to an applicant seeking market-based rates for
new storage capacity in more competitive markets needing new capacity
or improved service flexibility. DTE recommends that, in developing a
geographic market definition for a market power study, the Commission
should base its geographic market definition on the ability of storage
customers to access storage providers in various regions. In addition,
DTE argues that customer access to alternative storage providers can be
confirmed by reviewing the applicant's potential shippers or shippers
accessed by comparably located and situated storage providers, for
example, as shown in a shipper index.
Commission Determination
    61. In the Policy Statement, the Commission provided guidance on
defining the geographic market. In general, the relevant geographic is
the geographic area containing those suppliers that can affect any
attempt by the applicant to exercise market power. Since we are not
changing the geographic definition in the Final Rule, the Policy
Statement's guidance regarding the geographic market is still
applicable.
e. Treatment of Affiliate Capacity
    62. In Sec.  284.503(b)(4) we proposed to codify our current
practice \33\ that capacity on pipeline systems owned or controlled by
the applicant's affiliates should not be considered among the
customers' alternatives and should be included in the market share
calculated for the applicant.
---------------------------------------------------------------------------

    \33\ See Policy Statement, 74 FERC ] 61,076 at 61,234 (1996).
---------------------------------------------------------------------------

Comments
    63. A number of commentors request that the Commission amend its
proposed regulations in Sec.  284.503(b) to eliminate the requirement
that the capacity of a market-based rate applicant's affiliates is
automatically to be included in the market share calculated for the
applicant.\34\ They argue that this requirement is unnecessary in light
of the Commission's Standards of Conduct for Transmission Providers
promulgated in Order No. 2004 which requires interstate pipelines to
function independently from their affiliates.\35\ For example, Dominion
submits that Order No. 2004 is a comprehensive and effective regulatory
regime governing the relationship between a pipeline and its energy
affiliates such that there is no realistic possibility for an
interstate pipeline with storage and its affiliates with storage assets
to collude to exercise market power in the provision of storage
services. Additionally, INGAA states the Commission's rules regarding
price transparency, and the requirement that an open-access pipeline
must make all capacity publicly available, under the terms, conditions,
and rates specified in the tariff, provide further assurances that a
storage applicant cannot control or manipulate the capacity of its
affiliated companies.
---------------------------------------------------------------------------

    \34\ Comments of INGAA, Dominion, Duke, NiSource Pipelines,
Dominion LDCs and Jefferson Storage.
    \35\ Standards of Conduct for Transmission Providers, Order No.
2004, 105 FERC Stats. & Regs., Regulation Preambles ] 31,155 (2003),
order on reh'g, Order No. 2004-A, FERC Stats. & Regs. ] 31,161
(2004), order on reh'g and clarification, Order No. 2004-B, FERC
Stats. & Regs. ] 31,166 (2004), order on reh'g and clarification,
Order No. 2004-C, FERC Stats. and Regs. ] 31,172 (2004), order on
reh'g., Order No 2004-D, 110 FERC ] 61,320 (2005).
---------------------------------------------------------------------------

    64. Several commentors also maintain that the notion that capacity
held by an affiliated company cannot provide a competitive alternative
is inconsistent with the Commission's open-access policies.\36\
Specifically, they assert that under the Commission's open-access
regime, an interstate pipeline cannot control storage capacity that is
subscribed. Rather, they submit it is the shipper with the contractual
rights who determines when or if the capacity is used and if, when and
to whom it is released. The Dominion LDCs assert that the Commission
itself has concluded that current regulatory controls minimize the
ability of pipelines to use market power to force captive customers to
enter into longer term contracts than would be required in a
competitive market.\37\ Thus, the Dominion LDCs assert the Commission
should find that a pipeline has neither the legal ability to withhold
existing capacity nor an incentive to refuse to build new capacity, and
that this, together with the fact that pipeline activity to act with an
affiliated LDC to exercise market power by withholding capacity would
violate other Commission rules and be actionable, leads to the
conclusion that a pipeline and its affiliated LDC are unlikely to be
able to jointly exercise market power.
---------------------------------------------------------------------------

    \36\ Comments of INGAA, Duke, Dominion and Dominion LDCs.
    \37\ Citing Order No. 637, 101 FERC ] 61,127 at 61,522.
---------------------------------------------------------------------------

    65. These commentors conclude that there is not sufficient
justification for requiring a pipeline to include the capacity of its
affiliates when calculating market share. In recognition of the effect
of shipper control over contracted pipeline capacity, INGAA urges the
Commission to establish a rebuttable presumption that such capacity is
properly considered as a substitute for the storage service at issue in
a market-based storage rate application, assuming the capacity
otherwise meets the ``substitutability'' criteria. Duke states that
only storage and transportation capacity controlled by the affiliates
of a storage applicant should be aggregated with the capacity of the
applicant's proposed storage facility for the purposes of the market
concentration measure and the market share calculated for the
applicant. At a minimum, these commentors urge the Commission to
eliminate the per se rule, and evaluate on a case-by-case basis whether
affiliated capacity presents a competitive alternative. Several
commentors claim that adoption of the proposed rule will discourage
otherwise meritorious storage applicants and undermine the Commission's
goal of stimulating the construction of vital new storage
infrastructure.\38\
---------------------------------------------------------------------------

    \38\ Comments of INGAA, Dominion and the NiSource Pipelines.
---------------------------------------------------------------------------

    66. To the extent the Commission does not delete this requirement,
INGAA requests that the Commission clarify proposed Sec.  284.503(b)(4)
that reads in pertinent part, that ``[a]vailable capacity * * * owned
or controlled by affiliates of the applicant in the relevant market
shall be clearly identified and may not be considered as alternatives
competing with the applicant'', to clarify that while the pipeline
affiliate's capacity is to be included in the market share calculated
for the applicant, it should also be reflected in the total market
share for the geographic area.
    67. On the other hand, Falcon urges the Commission to recognize
that the storage services being evaluated for market power may well be
affiliated with the ``storage surrogate'' services permitted to be
considered in the evaluation. Falcon maintains that the Commission
should provide for additional safeguards to prevent the affiliated
storage providers from exercising market power in such a situation and/
or avoid, through separate treatment and analysis of the affiliated
services, the actual market power or market share associated with the
alternative affiliated services and providers.

Commission Determination
    68. The requirement that the capacity of a market-based rate
applicant's affiliates is to be included in the market share calculated
for the applicant is consistent with our established practice and is
supported as discussed below.
    69. We disagree with commentors' claim that the fact that the
Commission has adopted Standards of Conduct for Transmission Providers
which require interstate pipelines to function independently from
affiliates removes the necessity of requiring that the capacity of the
applicant and its affiliates be combined. While affiliates are required
to act independently under the Commission's rules, this does not mean
that affiliates will compete for the same service or product in a given
market. As recognized by the Supreme Court in Copperweld Corporation v.
Independence Tube Corporation, ``[a] parent and its wholly-owned
subsidiary have a complete unity of interest. Their objectives are
common, not disparate; their general corporate actions are guided or
determined not by two separate corporate consciousnesses, but one. * *
* With or without a formal `agreement,' the subsidiary acts for the
benefit of the parent, its sole shareholder.'' \39\
---------------------------------------------------------------------------

    \39\ 467 U.S. 752, 771 (1984) (holding that a parent and its
wholly-owned subsidiary were incapable o conspiring with each other
for purposes of section 1of the Sherman Act).
---------------------------------------------------------------------------

    70. We are also not persuaded by commentors arguments that only
affiliate capacity that is not held under firm contracts should be
attributable to the applicant. This proposal ignores the fact that
pipelines control the conditions under which transportation and storage
services are provided through the operation of their systems. We are
not willing to create situations in which the pipeline, the dominant
owner of capacity, does not have an incentive to build new capacity
because it or an affiliate can benefit from an artificial shortage of
capacity. As noted in Order No. 637, the Commission has carefully
tailored its regulations so that pipelines will not have an incentive
to use their monopoly power to create scarcity.\40\ We see no
compelling reason to deviate from that policy here. For these reasons,
we find it is appropriate to attribute affiliate capacity to the
storage provider even though the capacity is contracted for by a
shipper under a firm contract. We have made revisions to Sec.
284.503(b)(4) of the regulations to clarify our intent.
---------------------------------------------------------------------------

    \40\ Regulation of Short-Term Natural Gas Transportation
Services and Regulation of Interstate Natural Gas Transportation
Services, Order No. 637, FERC Stats. & Regs., Regulations Preambles
(July 1996-Dec. 2000) ] 31,091 at 31,270-71 (Feb. 9, 2000).
---------------------------------------------------------------------------

    71. As requested by INGAA, we clarify that the applicant's
affiliate's capacity that is included in the market share calculated
for the applicant should also be reflected in the total market share
for the relevant geographic area.
    72. Finally, we find that Falcons's concerns over affiliate
capacity are adequately addressed by the requirement that the capacity
of a market-based rate applicant's affiliates is to be included in the
market share calculated for the applicant.
f. Filing Procedures
    73. The Commission proposed to add a new subpart M to part 284 that
requires, among other things, that applications by storage providers
requesting market-based rates contain certain information. The
Commission stated it would continue its practice of approving market-
based rate proposals on a prospective basis only. We also noted that
approval of blanket certificate authority to provide open-access
storage services at market-based rates will subject the storage service
provider to the existing reporting requirements applicable to open-
access service providers under Sec.  284.13 of the Commission's
regulations.
Comments
    74. Sempra asserts that it is unnecessary to impose on market-based
rate storage providers the full panoply of 18 CFR Sec.  284.13
reporting requirements applicable to pipelines operating under cost-
based regulation, given that the requisite showing of absence of, or
mitigation of, market power has already been made. Instead, Sempra
urges the Commission to utilize a lighter-handed reporting regime
modeled after the electronic quarterly reports applicable to holders of
electric market-based rate authority. Sempra asserts that these are
sound requirements for the Commission to require of entities holding
market-based rate authority.
    75. Enstor submits that the Commission's statement that storage
operators cannot charge market-based rates until the Commission
determines that they lack market power or have established adequate
customer protections conflicts with our current policies implementing
section 311 of the NGPA. Enstor states that under the Commission's
current regulations, section 311 service providers may begin charging
(subject to refund) their proposed rates, including market-based rates,
upon the filing of a petition for rate approval with the Commission.
Enstor urges the Commission to reconcile this discrepancy and to leave
intact the current rate filing regime that governs section 311 service
providers in Sec.  284.123(b)(2)(i). Enstor also seeks express
clarification that nothing in the NOPR is intended to upset the current
150-day window within which the Commission must act on rate petitions
filed by section 311 service providers, or otherwise the proposed rates
are deemed fair and equitable.
    76. Enstor further requests that the Commission allow flexibility
in its proposed requirements for market-based rate filings under new
Sec.  284.503. While Enstor agrees that such information may be
necessary in certain circumstances, Enstor urges clarification in the
Final Rule that some or all of these procedural requirements may be
waived for good cause when an applicant files for market-based rates.
    77. Finally, Enstor urges the Commission to incorporate some sort
of time limitation for its review of rate filings in the Final Rule.
For example, Enstor states the Commission can adopt a five-month review
period, beginning from the date on which a complete rate application is
filed under proposed Rule 503, during which it could evaluate the
application and any responsive protests. At the end of the five-month
period, the proposed rates would be deemed approved in the absence of a
formal Commission ruling.
Commission Determination
    78. Regarding the applicability of Sec.  284.13 reporting
requirements, we disagree with Sempra that we should not impose these
requirements on storage providers granted market-based rates, but
rather impose a reporting regime modeled after the electric quarterly
reports. Under the Commission's Part 284 program, all open-access
transporters and storage providers are required to post or file with
the Commission transaction reports, quarterly index of customer
reports, and semi-annual storage reports. These reports are required of
all open-access service providers and provide crucial transparency.
This information allows both the Commission and market participants to
monitor the market and detect undue discrimination. Sempra has provided
no reasonable basis to exempt market-based storage service providers
from the Sec.  284.13 reporting requirements.
    79. As requested by Enstor, we clarify that section 311 service
providers may begin charging (subject to refund) their proposed rates,
including market-based rates, upon the filing of a petition for

rate approval with the Commission pursuant to Sec.  284.123(b)(2)(i)
and that the 150-day time frame in that section is applicable to such
requests. In Sec.  284.502, we are adopting regulations that provide
that applicants providing service under subpart C (transportation by
intrastate pipelines under section 311) of part 284 must file in
accordance with that section.
    80. However, we reject Enstor's additional request that we impose a
time limitation on our review of market-based rate filings by
interstate storage providers, after which time the proposed rate would
be deemed approved. It would be unreasonable to approve a market-based
rate proposal without a specific finding that the applicant lacks
market power. However, the Commission intends to process any request
for market-based rates as expeditiously as possible.
    81. Finally, the Commission clarifies, as requested by Enstor, that
it may file to waive the procedural requirements in Sec.  284.503 for
good cause shown.
g. Periodic Review
    82. Proposed Sec.  284.504 of the regulations requires storage
applicants receiving market-based rates on the basis of a market-power
analysis to file updated market-power analyses within five years of the
date of the Commission order granting authority to charge market-based
rates, and every five years thereafter. The Commission stated that
imposition of a periodic review is necessary to ensure that our grant
of market-based rates to an applicant remains just and reasonable.
Comments
    83. Several commentors including the majority of interstate
pipelines and independent storage providers urge the Commission to
eliminate its proposal for an automatic five-year market-power review
under Sec.  284.504 for storage operators that have demonstrated they
lack market power. These commentors assert that this requirement is
unduly burdensome, not necessary to protect customers and will deter
new storage development.\41\ Specifically, the commentors submit that
the current requirement that market-based rate grantees report any
changes in circumstances that are pertinent to their original absence-
of-market-power showing, along with ongoing reporting obligations under
existing regulations, are adequate to protect consumers. DTE also notes
that it is unaware of any abuse complaints submitted by customers of
storage companies granted market-based rate authority in the past that
would necessitate the imposition of a five-year market-power review
requirement.
---------------------------------------------------------------------------

    \41\ Comments of INGAA, Dominion, KM, DTE, Duke, SGR, Honeoye,
Bridgeline, Unicol, Falcon, SGR and Jefferson Storage.
---------------------------------------------------------------------------

    84. A number of these commentors assert that an automatic review is
unnecessarily burdensome in this context for the same reasons proffered
by the Commission in support of reliance on regular monitoring of
posted information and the NGA section 5 complaint processes for
market-based storage rates under new NGA section 4(f). For example,
Duke submits that if regular monitoring and the section 5 complaint
provisions are sufficient to protect consumers in instances where the
Commission presumes that a storage provider has market power under new
NGA section 4(f), these same provisions in addition to the Commission's
existing policy of conditioning its certificate authorization with a
notice of changed circumstance requirement are more than sufficient to
protect consumers in circumstances where the Commission has found the
applicant not to possess market power.
    85. If the Commission adopts an automatic review requirement,
several commentors urge the Commission to make clear that the new
requirement does not apply to projects that have previously received
market-based rate approval,\42\ arguing that any required periodic
review must be prospective only and not affect existing contractual
terms and conditions agreed upon in light of the Commission's initial
grant of market-based rate authority to a service provider.\43\ Duke
argues that placing a new periodic-review condition on existing market-
based rate authorizations would constitute an impermissible retroactive
revision of the certificate authorizations for the underlying
facilities, frustrate the investment expectations of the owners of
those facilities, and undermine investor confidence in the storage
market.
---------------------------------------------------------------------------

    \42\ Comments of Bay Gas, INGAA, EnCana, Bridgeline, and Unocal.
    \43\ Comments of INGAA, KM, and Haddington Ventures. SGR argues
that such a modification must be made in accordance with the Mobile-
Sierra doctrine, with the Commission determining, on the basis of
substantial record evidence, that the public interest requires such
modification.
---------------------------------------------------------------------------

    86. INGAA submits that the threat of revocation of market-based
rate authority in the middle of a contract term may present an
unacceptable level of risk to potential storage developers. In order to
minimize the uncertainty that would be created by a new periodic review
requirement, SGR argues the Commission must make it clear that any
review of a storage provider's market-based rate authorization will be
conducted under NGA section 5, with the Commission bearing the burden
of showing that the market-based rate authorization and the rates it
permits a storage provider to charge have become unjust and
unreasonable, and the further burden of establishing prospectively the
ratemaking methodology that would yield just and reasonable rates.
    87. If the periodic review is adopted, Honeoye and SGR propose that
the first such update should not be due until the later of 5 years
after the effective date of proposed Sec.  284.504 or the date the
relevant storage facilities are placed in commercial operation. Honeoye
also seeks confirmation that an existing holder of market-base rate
authority can comply with this requirement by demonstrating that the
facts that permitted the Commission to authorize market-base rates in
the first instance are still true.
    88. On the other hand, NGSA, EEI and PGC support the Commission's
proposal to require storage applicants granted market-based rates to
file an updated market-power analysis every five years. PGC asserts
that without such periodic reviews, the Commission is unable to perform
the regulatory oversight necessary to prevent unjust and unreasonable
rates against captive gas customers. EEI notes that there is a similar
requirement for electric utilities that sell at market-based rates, and
suggests this requirement is necessary to protect customers from
changes in the marketplace that may no longer justify market-based rate
authority.
    89. SCE also supports the Commission's five-year periodic report
requirement in Sec.  284.504 and submits that this review should also
consider any cost-of-service facilities and interconnected facilities
that could serve as substitutes for one another and should assess the
competitive functioning of the market and impose remedial measures such
as adjustments to mitigation measures or the complete withdrawal of
market-based rate authority as necessary to ensure just and reasonable
rates.
Commission Determination
    90. We will not impose a generic five-year reporting requirement on
storage providers granted market-base rates although we reserve the
option of imposing a reporting requirement in any individual case. We
have carefully considered the comments and have concluded that any
benefits that would be achieved by a generic requirement

are outweighed by the additional costs that such a generic requirement
would create. The Commission believes that existing reporting
requirements and its ongoing market monitoring programs generally give
us sufficient information to know whether storage markets where
applicants have been authorized to charge market-based rates remain
competitive, and the Commission has the ability to take appropriate
action if market-power issues arise.
    91. A central factor in the Commission's decision is the fact that
in the majority of cases where we have authorized market-based rates
for storage services, the applicant has not had a large presence in the
market. For example, the Commission has approved all requests for
market-based rates where the applicant was located in the production
area based on findings that HHIs in that geographic region are well
below 1,800 and the market shares of the applicants were small.\44\ In
consuming regions, such as the Northeast portion of the United States,
where there are fewer providers, some with large market shares whose
services are regulated, the Commission has approved requests to
implement market-based rates by considering factors other than market
concentration including the small size of the applicant's market
share.\45\ In these situations, we find that market-power concerns are
low. Additionally, in individual cases the Commission has imposed on
applicants permitted to charge market-based rates for storage services
the requirement to notify the Commission when there have been changes
of circumstances that affect the applicant's ability to exercise market
power,\46\ and we will codify this requirement in Sec.  284.504(b). For
storage providers with market shares of ten percent or less, we believe
that the notice of change of circumstance requirement, together with
the transparency provided by the existing reporting requirements in
Sec.  284.13, are adequate to permit the effective monitoring of
market-power concerns related to storage providers charging market-
based rates and enable the Commission to initiate section 5 proceedings
where appropriate.\47\ For storage providers with a market share
greater than ten percent, we intend to consider in individual cases
whether the specific facts and circumstances presented require
additional reporting. We believe that this approach achieves an
appropriate balance between the need to monitor for market power and
the goal of creating a regulatory environment that will promote
infrastructure.
---------------------------------------------------------------------------

    \44\ See, e.g., Caledonia Energy Partners, L.L.C., 111 FERC ]
61,095 (2005) (market share of working gas capacity and
deliverability each approximately two percent); Copiah County
Storage Co. 99 FERC ] 61,316 (2002) (market share of working gas
capacity and deliverability each less than two percent).
    \45\ See, e.g., Avoca Natural Gas Storage, 68 FERC ] 61,045
(19940. Steuben Gas Storage Co., 72 FERC ] 61,102 (1995) (market
share of working gas capacity and deliverability each less than four
percent); New York State Electric and Gas Corp., 81 FERC ] 61,020
(1997) (working gas capacity and deliverability each less than one
percent); N.E. Hub Partners, L.P., 83 FERC ] 61,043 (1998) (working
gas capacity and deliverability each less than five percent); Seneca
Lake Storage, Inc., 98 FERC ] 61,163 (2002) (working gas capacity
and deliverability each less than two percent); and Honeoye Storage
Corp., 91 FERC ] 62,165 (2000) (working gas capacity and
deliverability each less than two percent).
    \46\ See, e.g., Caledonia Energy Partners, L.L.C., 111 FERC ]
61,095 (2005) (requiring that Caledonia notify the Commission of
future circumstances affecting its present market power status
within ten days of acquiring knowledge of any such changes).
    \47\ This approach is similar to the Commission's proposal to
exempt sellers of wholesale electric power who own or control 500 MW
or less of generating capacity in aggregate from filing triennial
reviews. Market-Based Rates for Wholesale Sales of Electric Energy,
Capacity and Ancillary Services by Public Utilities, Notice of
Proposed Rulemaking, FERC Stats. & Regs. ] 32,602 at P 152 (2006).
---------------------------------------------------------------------------

    92. However, the Commission wishes to emphasize that the failure to
timely file a change in circumstance report or failure to comply with
reporting requirements as required by the regulations would constitute
a violation of the Commission's regulations. A storage provider would
be subject to disgorgement of profits and/or civil penalties from the
date on which the violation occurred. Such storage provider may also be
subject to suspension or revocation of its authority to sell at market-
based rates (or other appropriate non-monetary remedies). Additionally,
if subsequent experience with the changes enacted here demonstrates a
need for a generic five-year market-power analysis requirement, we
reserve the right to initiate such a change.
h. Cross Subsidies and Customer Protection Comments
    93. Xcel states that it is concerned that the proposed rule does
not sufficiently protect storage customers served by a storage provider
under cost-based rates from bearing costs associated with storage
services provided by the same provider at market-based rates. Xcel
explains that the temptation to increase revenues by misallocating
costs will be difficult to resist and difficult for customers and the
Commission to detect in a rate proceeding. Therefore, Xcel requests
that the Commission protect customers by modifying the regulations to
require storage service providers to account for costs incurred in
providing market-based rate storage services separately from cost-based
storage services. Xcel maintains this requirement is similar to the
Commission's policy of requiring pipelines to account separately for
the revenues received under negotiated rate agreements.
    94. Falcon asserts that pipeline and utility affiliated storage
providers (collectively, ``Affiliated Storage Providers'') have a
natural advantage over independents because of their ability to provide
a rate subsidy, bundling, or other preference, enabling them to charge
lower rates for their storage services and placing independent storage
providers at a distinct competitive disadvantage. Accordingly, Falcon
requests that the Commission take steps to minimize any subsidization
or preference afforded Affiliated Storage Providers by requiring
Affiliated Storage Providers to: (1) Unbundle storage and
transportation services, and (2) allocate the appropriate level of
fixed and variable costs to storage and transportation services. Absent
such actions, Falcon alleges that independent storage providers will
never be able to effectively compete on a ``level playing field'' with
Affiliated Storage Providers, to the detriment of the ultimate
consumer.
    95. Similarly, SGR submits that the broader availability of market-
based rate authority proposed in the NOPR could increase the
possibility that pipeline-owned storage could take advantage of a
liberalized market-power test to gain an unfair competitive advantage
over independent storage developers/operators. It argues that pipeline-
owned storage enjoys considerable advantages in the marketplace; given
the ability pipeline-owned storage has to share a customer base with
the pipeline, to benefit from operational integration with the pipeline
and to enjoy revenue support offered by pipeline transportation
services. If left unchecked, SGR submits that these advantages could
present insurmountable barriers to entry for independent storage
developers.
    96. UET asserts that moving from cost-based rates to market-based
rates for existing storage facilities and expansions of existing
storage facilities would be unfair to existing storage customers. For
example, UET submits that in many cases cost-based rates have paid for
facilities with the potential for cheap expansibility. If, as the
result of the proposed change in market-power analysis, the expansion
capacity is offered only at market-based rates, UET alleges that the
storage provider will

reap the benefits of the cheap expansibility for which the customers
have paid.
    97. Finally, APS requests that the Commission take all available
steps to encourage the development of independent storage facilities in
the southwest including eliminating barriers to entry such as the
``bundled'' pipeline storage and transmission services being offered by
El Paso.
Commission Determination
    98. In granting market-based rates for pipelines that provide cost-
based services, the Commission intends to ensure that no subsidization
by existing cost-based shippers takes place. To date, when granting
market-based rates in these circumstances, the Commission has required
that the applicant separately account for all costs and revenues
associated with facilities used to provide the market-based
services.\48\ We intend to continue this practice and will codify in
new Sec.  284.504 of the regulations the requirement that pipelines
that provide cost-based services must separately account for all costs
and revenues associated with facilities used to provide the market-
based services. This will ensure that market-based services are not
subsidized by cost-based services, as well as ensure that pipeline-
owned storage is not afforded an unfair rate advantage over independent
storage providers.
---------------------------------------------------------------------------

    \48\ See, e.g., Gulf South Pipeline Co., 101 FERC ] 61,204
(2002); Koch Gateway Pipeline Co., 66 FERC ] 61,385 (1994).
---------------------------------------------------------------------------

    99. Regarding Falcon's request to require unbundling, we note that
our regulations already require that pipelines offer their customers
firm and interruptible storage on an open-access contract basis.\49\
Issues regarding whether a pipeline has sufficiently unbundled its
services in compliance with our policies should be raised in individual
pipeline proceedings.\50\
---------------------------------------------------------------------------

    \49\ See 18 CFR 284.1(a) of the Commission's regulations that
defines transportation as including storage. Thus, storage is
included within the nondiscriminatory access and other requirements
of Part 284 for interstate pipelines.
    \50\ APS' request that the Commission take steps to encourage
the development of independent storage facilities in the southwest
including eliminating the bundled pipeline storage and transmission
services being offered by El Paso is outside the scope of this
proceeding. This issue has been raised in El Paso's rate proceeding
in Docket No. RP05-422-000 and will be addressed there.
---------------------------------------------------------------------------

i. Additional Incentives
Comments
    100. As an alternate to market-based rates, Dominion urges the
Commission to consider offering incentives to promote the development
of new storage facilities reflecting the increased investment risk of
these projects, including: (1) Authorizing higher rates of return on
equity for new cost-of-service storage projects as compared to new
pipeline projects to reflect the increasingly riskier nature of
identifying new geologic structures and the shorter-term contracts that
customers are entering into; (2) allowing the authorized rate of return
for a new cost-of-service project to remain unchanged over the duration
of the initial shipper contract as revenue certainty is necessary to
provide good incentives for new investment; (3) offering regulatory
incentives to compensate for the enormous cost of purchasing base gas
for a new facility, particularly reservoir and aquifer types of storage
facilities, such as permitting the roll in of the costs of base gas
associated with a new incrementally-priced storage facility into its
system-wide rates in its next rate case with a five percent cap placed
on the increase to system rates from this roll-in; and (4) permitting
interstate pipelines to recover the prudently incurred development cost
of storage facilities that are cancelled or abandoned prior to being
placed into service, similar to the initiative being considered in the
rulemaking to promote the construction of new transmission facilities
in the electric utility industry.
Commission Determination
    101. The Commission agrees with Dominion that there may be
alternatives to market-based rates that would appropriately address the
risk faced by storage applicants. We note that the Commission's
policies already incorporate considerable flexibility in deriving cost-
based pricing options that are responsive to the market pressures faced
by jurisdictional companies. For example, in Order No. 637 the
Commission revised its regulatory policies to enable pipelines to file
for peak/off peak and term differentiated rates.\51\ In addition, rates
for storage services can be negotiated between the storage provider and
a shipper under the Commission's negotiated rate policies.\52\ The
Commission is willing to entertain requests to implement other cost-
based pricing proposals that may serve to add flexibility and
efficiency to storage services on a case-by-case basis.\53\
---------------------------------------------------------------------------

    \51\ See Regulation of Short-Term Natural Gas Transportation
Services, and Regulation of Interstate Natural Gas Transportation
Services, Order No. 637, FERC Stats. & Regs., Regulation Preambles
July 1996-Dec. 2000 ] 31,091 (Feb. 9, 2000).
    \52\ Alternatives to Traditional Cost-of-Service Ratemaking for
Natural Gas Pipelines and Regulation of Negotiated Transportation
Services of Natural Gas Pipelines, 74 FERC ] 61,076 (1996), reh'g
and clarification denied, 75 FERC ] 61,024 (1996), reh'g denied, 75
FERC ] 61,066 (1996); petition for review denied, Burlington
Resources Oil & Gas Co. v. FERC, 172 F.3d (D.C. Cir. 1998);
Modification of Negotiated Rate Policy, 104 FERC ] 61,134 (2003),
order on reh'g and clarification, 114 FERC ] 61,042 (1996).
    \53\ See, e.g., Saltville Gas Storage Company L.L.C., 109 FERC ]
61,200 (2004) (approving a modified Equitable method for designing
firm storage rates).
---------------------------------------------------------------------------

B. Energy Policy Act of 2005

    102. Section 312 of EPAct 2005 adds new NGA section 4(f), which
permits the Commission to authorize new natural gas storage projects
(i.e., projects placed in service after the passage of the Act) to
provide service at market-based rates notwithstanding the fact that the
applicant is unable to demonstrate that it lacks market power. New NGA
section 4(f) requires that, to authorize market-based rates, the
Commission must find that ``market-based rates are in the public
interest and necessary to encourage the construction of the storage
capacity in the area needing storage services'' and ``customers are
adequately protected.'' The Act further requires that the Commission
``ensure that reasonable terms and conditions are in place to protect
consumers'' and that the Commission ``review periodically whether the
market-based rate is just, reasonable, and not unduly discriminatory or
preferential.'' Intrastate pipelines also provide storage services, and
new NGA section 4(f)(1) extends the market-based rate authority to
intrastate pipelines subject to Commission authority under the Natural
Gas Policy Act of 1978.\54\ We discuss below the relevant aspects of
new NGA section 4(f).
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 3301-3432 (2000). We note that the Commission has
authorized Hinshaw pipelines to be treated the same as LDCs and we
intend the same here. See Certain Transportation, Sales and
Assignments by Pipeline Companies not Subject to Commission
Jurisdiction Under Section 1(c) of the Natural Gas Act, Order No.
63, FERC Stats. & Regs,. Regulations Preambles (1997-1981) ] 30,118
(Jan. 9, 1980).
---------------------------------------------------------------------------

1. Storage Capacity Eligible for Market-Based Rates
    103. New NGA section 4(f) states that the Commission may authorize
``market-based rates for new storage capacity related to a specific
facility placed in service after the date of enactment of the Energy
Policy Act of 2005.'' In the NOPR, the Commission posited that the
phrase ``placed in service after the date of enactment'' modifies the
term ``facility,'' not the term ``capacity,'' such that it is the
facility which must be placed into service after August 8, 2005,

rather than the storage capacity. Noting that the statute does not
define the term ``specific facility,'' the Commission proposed to
interpret that term to consider a new cavern, reservoir or aquifer that
is developed after August 8, 2005, as a facility potentially qualifying
for market-based rates under the Act. However, the Commission requested
comments on alternative constructions of the Act. Moreover, the
Commission also invited comments concerning how, if the Act is
construed differently, the Commission may adequately protect other
customers already receiving service under cost-based authorizations
that pre-date the Commission's new NGA section 4(f) authority.
Comments
    104. A number of commentors argue that the statutory language
concerning the capacity eligible for market-based rates under section
4(f) is ambiguous and open to alternative interpretation. Thus, they
assert the Commission has discretion in implementing the language.
    105. INGAA argues that the Commission interprets new NGA section
4(f) too narrowly, so as to exclude new storage capacity resulting from
the expansion of existing fields or reservoirs. INGAA submits
interstate pipelines and pipeline affiliates, which own substantial
amounts of existing storage capacity, should be allowed to apply for
market-based rates to develop either new or expanded storage fields.
Northern concurs with INGAA and argues that a broader statutory
interpretation is necessary. DTE maintains that there is no reason to
treat expansion facilities any differently than entirely new storage
fields. Duke adds that the best assurance against the exercise of
market power is the creation of a competitive marketplace and that
granting market-based rate treatment to only entirely new storage
facilities may place existing storage at a significant disadvantage and
discourage the expansion of existing storage.
    106. Williston Basin argues that there is no material distinction
between expanding existing storage facilities and developing a new,
separate storage facility, and that the Commission's interpretation
might unnecessarily influence companies to choose construction of a new
facility over expansion of an existing facility. Northern asserts that
the risks involved in developing new storage capacity, whether at a new
or existing facility, are greater than those involved in constructing
new pipeline capacity and justify the use of market-based rates. It
states that a broader interpretation of the subject provision will
recognize the risk of storage expansions and provide a proper incentive
for developers.
    107. Northern maintains that existing storage customers served by a
pipeline will not be harmed by including expansions of existing
capacity because customers' existing storage service will not be
affected by the expansion. In this vein, Williston Basin asserts that,
in the case of an expansion of existing storage facilities, existing
customers under cost-based authorizations can be adequately protected
if the incremental capacity and associated costs are accounted for
separately and addressed in each storage service provider's next rate
proceeding.
    108. KM states that granting market-based rates to expansions of
capacity will remove economic distortions associated with limiting this
provision to new storage fields. KM asserts that it is faster and more
cost-effective to expand existing storage facilities rather than to
construct new storage facilities and that such expansions should be
placed on equal footing with greenfield projects.
    109. Other commentors support the interpretation of the Act
proposed in the NOPR.\55\ AGA argues that broadening the definition of
``facility'' would largely benefit interstate pipelines, and
potentially harm existing customers of cost-based storage service. AGA
asserts that the Commission's policies should not encourage storage
owners to invest in reshaping the operations of existing storage
facilities in order to maximize the scope of market-based services.
APGA agrees, and contends that the NOPR's interpretation is required by
the language in the statute and is reasonable because there is no
reason to provide financial incentives to a storage provider for an
expansion of a facility that has already been constructed. PGC agrees
arguing that interpreting section 4(f) to apply only to new facilities
is most consistent with the goal of increasing storage capacity.
---------------------------------------------------------------------------

    \55\ AGA, Falcon, EnCana, Enstor, NGSA, PGC, and SCE.
---------------------------------------------------------------------------

    110. Falcon requests that the Commission ensure that new gas
storage projects that are developed by Affiliated Storage Providers do
not receive any direct or indirect subsidy from their affiliated
companies. NGSA and EnCana assert that if the provision is interpreted
to permit storage services made possible by incremental capacity at an
existing, cost-based facility to be priced on a market basis, there
would be no set of conditions that would adequately protect customers
against the risk of abuse.
    111. Beyond the risk of cross-subsidy, EnCana is also concerned
that there is nothing to prevent a storage service provider with both
cost-based rate facilities and market-based rate facilities from
placing its marketing emphasis on the market-based rate side in order
to ensure that those storage services are fully subscribed at the
highest possible rate, while, at the same time, deemphasizing the sale
of their regulated cost-based services, which are theoretically
underwritten by the regulated ratepayers. ESGI asserts that, in order
to provide safeguards against such practices, the Commission would need
to vigilantly review the provider's marketing efforts in section 4 rate
cases.
    112. Enstor contends that allowing expansion capacity at existing
storage facilities to qualify for market-based rate treatment under
section 4(f) would place new storage projects (many of which are
developed by independent operators) at a competitive disadvantage
relative to market incumbents such as interstate pipelines. Enstor
argues that allowing virtually all new capacity to fall within the
scope of section 4(f) would enable interstate pipelines to use their
cost-based transportation monopoly to subsidize new services offered
under this authority.
    113. The NiSource Pipelines assert that the Commission's
interpretation of the phrase ``specific facility placed in service
after the date of enactment to mean ``a new cavern, reservoir or
aquifer that is developed after August 8, 2005'' is not consistent with
the gas industry's or the Commission's own definition of that term,
which defines ``in service'' to mean when the facilities are actually
placed into service. NiSource advocates that the Commission revise its
interpretation to incorporate the more appropriate definition of ``in
service.''
Commission Determination
    114. The meaning of new NGA section 4(f) is ambiguous. Early drafts
of bills stated that the Commission could authorize a natural gas
company ``to provide storage and storage-related services at market-
based rates for new storage capacity placed in service after the date
of enactment of the Energy Policy Act of 2005, notwithstanding the fact
that the company is unable to demonstrate that it lacks market power *
* *.'' \56\ Under these early versions of the Act, it was clear that
all new storage capacity would have been eligible for

market-based rates. However, in the final bill, the phrase, ``related
to a specific facility'' was added so that the subject language read,
``to provide storage and storage-related services at market-based rates
for new storage capacity related to a specific facility placed in
service after the date of enactment of the Energy Policy Act of 2005 *
* *'' \57\ The addition of the specific facility language indicates
that it is the facility, not the storage capacity, that must be placed
in service after the date of the Act.\58\
---------------------------------------------------------------------------

    \56\ S. 10, 109th Cong. sec. 382 (2005).See also, H.R. 6, 109th
Cong. sec 382 (with engrossed amendment as agreed to by the Senate,
June 28, 2005); H.R. 6, 109th Cong. sec. 382 (as passed and ordered
to be printed by the Senate, July 14, 2005).
    \57\ H.R. Rep. No. 109-190, at 97 (2005) (Conf. Rep.).
    \58\ See Jama v. Immigration & Customs Enforcement, 543 U.S.
335, 343 (2005) (noting the `` `grammatical `rule of the last
antecedent,' according to which a limiting clause or phrase * * *
should ordinarily be read as modifying only the noun or phrase that
it immediately follows.'' ' (quoting Barnhart v. Thomas, 540 U.S.
20, 26 (2003)).
---------------------------------------------------------------------------

    115. Congress, however, provided no definition of the term
facility. Upon review of the comments and further consideration, the
Commission concludes that a more traditional interpretation of
``facility'' than that posited in the NOPR may be more consistent with
Congressional intent and existing precedent, and better serve to
further the Commission's goal of facilitating the development of new
natural gas storage capacity. The Commission recognizes that
significant and substantial enhancements to storage capacity can be
achieved at existing fields and finds that it is unnecessary to exclude
service from such expansions from consideration for market-based rates
by narrowly interpreting the term ``facility'' in the context of
section 4(f). For purposes of implementing the certification
requirements of section 7(c) of the NGA, the Commission defined
``facilities'' broadly, in exclusionary terms--everything except
``auxiliary installations'' and certain facilities constituting
replacement facilities are ``facilities'' for which a natural gas
company must obtain a certificate.\59\ Applying that same definition
here, in the context of section 4(f), would be consistent with our
longstanding practice in applying that term under the NGA and therefore
consistent with the rule that Congress is deemed to be aware of
existing administrative interpretations when amending a particular
statute that contains such interpretations.\60\ This definition would
enable storage providers to seek market-based rates for service
associated with capacity related to any ``specific facility'' requiring
certification placed in service after the date of the Act, be it a new
storage cavern or a facility which expands capacity at an existing
cavern or reservoir. However, to receive such authorization, the
storage provider will still need to satisfy the other requirements of
section 4(f) discussed below. In addition, such rates will only be
found to be in the public interest if the storage provider demonstrates
that the market-based services will not be subsidized by existing
customers and that customers receiving cost-based service from expanded
facilities will be adequately protected.
---------------------------------------------------------------------------

    \59\ See 18 CFR 2.55 (2005).
    \60\ See Bragdon v. Abbott, 524 U.S. 624, 645 (1998) (when
administrative and judicial interpretations have settled the meaning
of an existing statutory provision, repetition of the same language
in a new statute indicates, as a general matter, the intent to
incorporate its administrative and judicial interpretations as
well).
---------------------------------------------------------------------------

    116. Regarding the NiSource Pipelines' concern over the
Commission's definition of ``in service,'' we clarify that our intent
is to define ``in service'' to mean when the facilities are actually
placed into service.
2. Market-Based Rates Are in the Public Interest and Necessary to
Encourage the Construction of Storage Capacity in the Area Needing
Storage Services
    117. Section 4(f) of the NGA states that in order to allow a
company to charge market-based rates under this section, the Commission
must determine that: ``market-based rates are in the public interest
and necessary to encourage the construction of the storage capacity in
the area needing storage services.'' \61\ In the NOPR, the Commission
stated that applicants for authorization under section 4(f) will bear
the burden of showing that in its specific circumstances, market-based
rates are necessary to encourage the construction of storage capacity
and that storage services are needed in the area. To make this showing,
the Commission suggested that the applicant could present evidence that
it had offered its capacity at cost-based rates through an open season
and was unable to obtain sufficient long-term commitments at those
cost-based rates. However, the Commission invited comments concerning
other ways a project applicant might make these showings.
---------------------------------------------------------------------------

    \61\ Energy Policy Act of 2005, Pub. L. 109-58, section 312, 119
Stat. 594, 688 (2005) (to be codified at 15 U.S.C. 717c(f)(1)(A)).
---------------------------------------------------------------------------

Comments
    118. AGA supports the suggestion that an applicant under this
section might demonstrate the need for market-based storage rates by
showing that the market failed to subscribe under long-term contracts
at cost-based rates offered through an open season. INGAA also supports
the Commission's suggestion, but suggests such a showing should not be
required. Rather, the Commission should allow the applicant substantial
discretion as to how to make the requisite showing based on the facts
of its project. EEI agrees that the applicant should have the burden to
show that market-based rates are necessary to encourage construction of
storage capacity; specifically, EEI urges the Commission to require an
applicant to show why such capacity cannot be developed under cost-
based rates. SCE asserts that in the event an applicant relies on a
failed open season as evidence of need, other parties must have the
opportunity to contest the open season's reasonableness.
    119. The NYPSC expresses concern that the NOPR did not discuss
``public interest'' as a standard separate and apart from ``need,'' as
the language of section 4(f) treats these as separate standards. The
APGA also states that the Commission must revise Sec.  284.505 to
require a specific public interest demonstration.
    120. NYPSC acknowledges that the ``public interest'' standard could
encompass a broad range of factors. It argues, however, that while the
Commission may find it is in the ``public interest'' to authorize
market-based rates to encourage the entrance of independent, third
party storage providers into the market, it may not be in the public
interest to encourage the construction of new storage facilities by a
pipeline with a dominant market share.
    121. Haddington Ventures asserts that the Commission should
recognize three distinct categories of new storage projects and treat
each differently under its section 4(f) policy. The three categories
are: (1) Independent storage projects owned by entities unaffiliated
with existing natural gas infrastructure subject to cost-based rate
regulation; (2) storage projects owned by entities affiliated with
existing natural gas infrastructure subject to cost-based rate
regulation, but which are not physically connected to such existing
infrastructure; and (3) storage projects owned by entities affiliated
with existing natural gas infrastructure subject to traditional cost-
based rate regulation to which such storage projects are connected or
upon which such storage projects otherwise rely.
    122. Haddington Ventures submits that the Commission's proposal
adequately addresses Category 2 projects, but should be adjusted to
better account for Category 1 and Category 3 projects. With regard to
Category 1 projects, Haddington Ventures asserts

that the consumer protection required will be satisfied by: (a) The
Commission's rate regulation of existing infrastructure, which
establishes a ceiling on the price that the facility owner can command
for storage, and (b) the relative ease of entry by potential
competitors.
    123. Haddington Ventures asserts that a Category 3 project should
be granted market-based rates only after the project has met the burden
of demonstrating that (a) no mechanisms remain that could be exploited
to unfairly advantage such projects, and (b) any safeguards imposed are
administrable. Category 3 projects should be required to demonstrate
annually and whenever material changes in the market or of the project
may undermine customer protections. In addition, Haddington Ventures
maintains that Category 3 projects that do not achieve the desired
level of return at market-based rates should not be allowed to fold the
costs of the project back into a regulated rate structure, except where
(a) a bona fide change of circumstances has occurred that eliminates
the original grounds for granting the market-based rate authority, and
(b) the Commission is satisfied that the regulated rate would be lower
than the market rate.
    124. Enstor takes a different approach, asserting that those that
oppose market-based rates should have the burden of showing that such
rates are not ``necessary to encourage the construction of the storage
capacity in the area needing storage services.'' Enstor proposes that
the Commission establish a presumption that storage capacity will not
be built in the absence of market-based rate authorization. Enstor
asserts that, in the alternative, if the Commission does not adopt such
a presumption, the objective financial criteria that the applicant's
lenders are requiring for the development of the particular project
should be the basis for the required determination of need.
Commission Determination
    125. In order to authorize market-based rates under section 4(f),
the Commission must determine that: (1) Market-based rates are in the
public interest; (2) market-based rates are necessary to encourage the
construction of the storage capacity; and (3) the area in which the
storage project is proposed needs storage services. We agree with the
NYPSC and APGA that the public interest requirement is a separate
standard under the Act and we have revised Sec.  284.505 accordingly.
The Commission will expect each applicant to address each of these
requirements in its applications explaining and supporting its
contentions with respect to each element.
    126. In determining whether market-based rates for a particular
project are in the public interest, the Commission will consider, among
other things, the risk of the project, and the investment required to
fund it. Generally, the Commission would expect that for market-based
rates to be in the public interest for services proposed under section
4(f), market-based rates would be necessary for the project sponsor to
secure financing and move forward with the project. In the Commission's
view, it is unlikely that market-based rate authorization would be
necessary, or in the public interest, to encourage relatively risk-free
expansions of storage.
    127. We also agree with the NYPSC and Haddington that another
factor to consider in determining whether market-based rates are in the
public interest is whether the applicant is a new independent storage
provider or an existing pipeline in the relevant market. In general, we
believe that an existing pipeline will face fewer difficulties in
securing financing for incremental expansions of existing storage
facilities. As a going concern with existing customers and financial
relationships, the risk associated with acquiring financing is lower
for incremental expansions than the risk associated with a greenfield
project undertaken by a new entrant in the market. Therefore, we
believe it may be more difficult for an existing pipeline to meet the
public interest standard than it will be for a new independent storage
provider.
    128. Ultimately, the Commission's finding that market-based rates
are in the public interest will reflect its consideration of all
aspects of 4(f) proposals, including, but not limited to, the risk
faced by the project sponsors, the extent to which additional capacity
is needed in the area of the project, and the strength of the
applicant's showing that the facilities would not be built but for
market-based rate treatment.
    129. In order to receive authorization to charge market-based rates
under section 4(f), each applicant must make a showing as to why
market-based rates are necessary to encourage the construction of the
storage capacity. As the Commission stated in the NOPR, one way that
the applicant could make such a showing is to present evidence that it
offered its capacity at cost-based rates through an open season and was
unable to obtain sufficient long-term commitments at those cost-based
rates. On the basis of the record, we believe such an open season is
the best means of demonstrating that cost-based rates will not be
sufficient. However we are open to applicants making another type of
showing. Applicants may also cite to other marketing factors to explain
why market-based rates are necessary. As suggested by SCE, parties will
have an opportunity to comment upon this evidence.
    130. The Commission will not establish a presumption that storage
capacity will not be built in the absence of market-based rate
authorization, as suggested by Enstor. The statute requires that the
Commission make an affirmative finding that market-based rates are
necessary to encourage the construction of storage. Also, in the
Commission's experience, storage has been built in the absence of
market-based rate authorization. Regarding Enstor's assertion that the
objective financial criteria that the applicant's lenders are requiring
for the development of the particular project should be the basis for
the determination of the necessity of the project, the Commission will
afford applicants significant discretion in demonstrating that market-
based rates are necessary to encourage the development of additional
storage. Enstor can cite to requirements imposed by its lenders if it
believes that such requirements justify the authorization of market-
based rates. The Commission cannot make a generic determination on such
issues, but must look at the positions of the parties in individual
cases.
    131. Applicants will also have to show that storage services are
needed in the area in which they are proposing a project. An applicant