California Embarks on Risky Process - Gas and Electricity Price Volatility Likely Ahead
The California Public Utility Commission (CPUC) has embarked on an operational and market experiment that could lead to substantial volatility this summer in both the natural gas and electricity markets across Southern California. In an order issued on May 28, the CPUC rejected a settlement supported by most market participants regarding Southern California Gas (SoCalGas) and its use of operational flow orders (OFO). The proposed settlement would have created a more graduated scale of penalties that are assessed for failure to comply with an OFO.
Instead, the CPUC adopted a proposal supported by Southern California Edison (SCE), which, for this summer, reduces the number of penalty levels and reduces the maximum penalty from $25 to $5 per dth. The CPUC did so in the hope that this untested proposal or experiment will result in stable gas and electric prices this summer. The CPUC apparently believes that the higher penalties result in higher delivered gas prices, which drives up the cost of electricity by driving up the fuel costs for gas-fired electric generators. However, this experiment may also subject the Southern California region to more volatile natural gas and electricity prices during this summer than the region suffered through last summer. While those market participants that can profit from such volatility may benefit if the experiment fails, the gas and electric ratepayers will be the ones who suffer. Worse, this experiment has the potential to cause severe operational issues for SoCalGas.
What Put California in This Mess?
Every pipeline needs to balance the demands on its system so that it may maintain a pressure that allows continued operations. The goal is to match the receipts and deliveries into each section of the pipeline’s system on a daily, or even hourly, basis so that operating pressures are properly maintained. One tool a pipeline uses is to require its customers to nominate on a daily basis the expected deliveries to the system and then to balance those deliveries with the amount of gas the customer takes from the system on that day. The flexibility a pipeline can offer its customers depends on the operating characteristics of the pipeline and the expected demands on a given day. When a pipeline’s system is disrupted, or the demands on its system are at an extreme, the flexibility it can offer is greatly diminished.
SoCalGas traditionally used storage on its system, primarily the Aliso Canyon storage facility, as a buffer that allowed it to provide its customers greater flexibility with respect to matching their daily receipts and deliveries. However, in 2015 the Aliso Canyon facility suffered a leak which has led the CPUC to substantially limit its operations. Then, in October of 2017, a major transmission line on the SoCalGas system, Line 235-2, ruptured. SoCalGas currently anticipates returning Line 235-2 to limited service on June 8, but will then begin work on a closely related line, Line 4000, the following day. It is far from certain that this date will hold, because SoCalGas, beginning in February, has provided eight different estimated dates for the completion of the work on Line 235-2 that have ranged from April 2 to June 21. However, until both of these lines are brought back to full service, the delivery capability of the system will remain constrained. When these unplanned constraints on the system’s operations are combined with a day of high utilization, SoCalGas will likely be unable to offer its customers the level of flexibility that they enjoyed prior to the problems at Aliso Canyon.
What’s a Pipeline to Do?
One tool a pipeline uses to maintain operations is the issuance of an OFO. OFOs are issued when the pipeline expects to experience an imbalance between the gas it is receiving and delivering on its system. The OFO requires shippers to match receipts and deliveries within tighter tolerances than are otherwise allowed when an OFO is not in effect. SoCalGas received authority to not only impose OFOs on its system, but to also penalize its customers that failed to comply. Going into the summer of 2018, if SoCalGas declared what it called a Low OFO, its customers were required to match daily receipts and deliveries within a tolerance level announced in the OFO notice. And if they failed to do so, they would be subject to penalties based on the stage of the OFO that SoCalGas had announced. The penalties increased at each stage so that by raising the stage of the OFO, SoCalGas could financially encourage compliance. The following table provides the escalating penalties as the OFO stages increase and the penalty imposed if an Emergency Flow Order (EFO) is declared.
| Stage | Daily Imbalance Tolerance | Noncompliance Charge ($/dth) |
|---|---|---|
| 1 | Up to +/-25% | $0.25 |
| 2 | Up to +/-20% | $1.00 |
| 3 | Up to +/-15% | $5.00 |
| 4 | Up to +/-5% | $25.00 |
| 5 | Up to +/-5% | $25.00 + G-IMB daily balancing standby rate |
| EFO | Zero | $50.00 + G-IMB daily balancing standby rate |
Summer of 2018
The summer of 2018 was the first that SoCalGas experienced with constraints on Aliso Canyon and without Line 235-2 being available. Set forth below is a chart showing the number of OFOs by stage level that SoCalGas issued between June 1 and September 30, 2018.
SoCalGas OFOs by Stage (June 1 - Sept. 30, 2018)
Not only was flexibility on the SoCalGas system limited, but the weather also played a part on the demands placed on its system as gas-fired electric plants came online to provide power for air conditioning across the region. The chart below compares the average and high temperatures for Los Angeles/Oxnard as reported by NOAA for the days on which no OFO was in place and for the days during which any stage of an OFO was in force.
Average and High Temps for No OFO and Any OFO Days
As a result of the penalties imposed that summer, SCE and a consortium called the Southern California Generation Coalition, consisting of utilities that own, operate, and are responsible for obtaining fuel for natural gas-fired electric generation facilities in the SoCalGas service territory, filed a complaint seeking to lower the penalty amounts for Stages 4 and 5 to be the same $5 penalty as for Stage 3. In a decision issued on May 28, 2019, the CPUC rejected a proposed settlement put forth by SoCalGas that was supported by everyone but SCE, and which would have created three more graduated stages between Stages 3 and 4. Instead, the CPUC adopted the reduced penalty schedule originally requested by SCE for the coming summer, starting on June 1 and ending on September 30.
The Hope and the Risks
SCE maintained that because of the volatility in gas prices and the penalties it has incurred under the 2018 OFO penalties, it would need to pass on to its ratepayers in 2019 almost $1 billion in unanticipated costs for fuel to produce its electricity. The CPUC did not want to see a repeat of this supposed problem in 2019. It said that it was adopting the proposed reduction in the OFO penalties because it believed they would “maintain price stability while imposing a financial penalty significant enough to incentivize appropriate behavior” during OFO situations. The graph below, which is based on daily pricing provided by our friends at S&P Global, shows that when an OFO is declared, the price difference between the SoCalGas border price and the SoCalGas citygate certainly seems to grow.
SoCalGas OFO's and Price Differentials
# Included pricing data provided by S&P Platts
There is a substantial risk, though, that this desired result will not be achieved and that this unproven experiment fails. If it does, the experiment could cause even more volatile gas prices, and therefore more volatile electricity prices, and even higher penalties this summer. These risks were clearly articulated in filings opposing the reduced penalties made by SoCalGas and the Western Power Trading Forum, a non-profit trade association dedicated to enhancing competition in Western electric markets to reduce the cost of electricity to consumers throughout the region while maintaining the current high level of system reliability:
- The reduction in charges for Stages 4 and 5 means SoCalGas loses the ability to use three distinct stages to effectively incentivize customers to remain in balance;
- If customers are not sufficiently incentivized, then the reliable operation of the system could be negatively impacted, and SoCalGas may have no other recourse but to call an Emergency Flow Order (“EFO”), which has a $50 penalty associated with it;
- While SCE and the other electric generators complain that gas and electricity prices spiked in 2018 along with the OFOs, these coincident increases in gas prices provided needed market signals that help to stabilize the SoCalGas system by reducing gas demand by increasing prices, which meant that EFOs were not needed;
- Marketers that are able to anticipate the issuance of an EFO will naturally seek to “optimize the value of their flowing supplies” by increasing their gas prices by nearly the $50+/Dth penalty that shippers would face under an EFO.
As California moves into the heat of this summer, it would be to SoCalGas’s benefit in its fight to restore Aliso Canyon to its full capability to demonstrate that the reduced penalties are not effective and to issue the occasional EFO. If this occurs, the CPUC’s goal of reducing the penalties to suppress price volatility may backfire and if the markets anticipate the use of EFOs on high stress days like those experienced last summer, the result may be even higher prices than were experienced last summer, even if an EFO is not declared. As of now, it certainly looks like this could be a volatile summer for gas and electric prices in California.
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