The Ratepayer Advocate is currently participating in proceedings to consider a proposal by Public Service Electric and Gas Company ("Public Service") to transfer its natural gas contracts to an unregulated affiliate (the "Affiliate"), and enter into a sole source "Requirements Contract" with the affiliate to provide the natural gas supplies needed to serve Public Service’s basic gas supply service ("BGSS") at market-based prices. The Public Service proposal was filed with the Board of Public Utilities ("Board") in August, 2000 and is currently under consideration in hearings before the Office of Administrative Law. On June 6, 2001 the Ratepayer Advocate filed the written testimony of Paul Chernick, an expert on electric and natural gas markets and deregulation, and Richard LeLash, an expert on natural gas issues in response to the Public Service proposal.

The Ratepayer Advocate opines that the Public Service proposal could create undue market power in New Jersey’s natural gas and electric markets, resulting in decreased reliability and unreasonably high prices for consumers. The Ratepayer Advocates also believes that the Public Service proposal is in violation of specific policies and mandates contained in the New Jersey Electric Discount and Energy Competition Act of 1999 ("EDECA"), including provisions (1) requiring that BGSS remain fully regulated by the Board; and (2) prohibiting undue preferences to utility affiliates. Most importantly, this transfer of assets would occur at a time when a competitive natural gas marketplace has not evolved and consumers would be let to deal with an unregulated monopoly. The following is an executive summary of the testimony filed by the Ratepayer Advocate on June 6, 2001.

Testimony of Paul Chernick

The Public Service proposal could be detrimental to Public Service customers, as well as other New Jersey energy consumers, in the following ways.

C A few years ago, the State of California deregulated its electric markets, in the process allowing its electric utilities to divest much of their electric generation capacity to unregulated entities. Beginning in May, 2000, a number of developments led to a shortage of electric generation capacity in California and the surrounding states. The tight supply conditions, exacerbated by profit-maximizing behavior of a few large market participants, resulted in steep price runups, power shortages, and rolling blackouts. The Public Service proposal could result in similar problems in New Jersey’s energy markets

C Based on available studies, it appears that there is a shortage of capacity on the interstate pipelines used to transport natural gas to New Jersey from producing areas in the Gulf Coast region and in Alberta, Canada. Public Service is proposing to transfer its contractual entitlements to these critical gas supply resources to unregulated entities. The proposed Requirements Contract would also give the Affiliate control of Public Service’s in-state "peaking" supplies, used to supply the last increments on demand on very cold days, and its rights to curtail supplies to interruptible customers.

C As a result of the proposed transactions, crucial gas supply resources would be controlled primarily by the Affiliate and an unknown number of major non-utility suppliers. This is likely to concentrate control of gas supply capability, especially in norther New Jersey and southern New York, allowing the Affiliate to exercise market power. The result, could be high prices and decreased reliability, such as has occurred in California.

C An existing Public Service affiliate controls a significant share of electric generation in the region served by the PJM power pool. With the proposed new Affiliate controlling a significant share of the gas supply required to fuel gas-fired power plants, Public Service affiliates could manipulate market prices for electricity.

C The transfer would ultimately leave Public Service customers without any entity responsible for assuring reliable supplies of natural gas.

C The transfer would restrict the Board’s options for meeting its statutory obligation to assure that reliable and reasonably priced BGSS remains available to consumers.

C Public Service is proposing to make the transfer without competitive bidding to determine the full value of the transferred resources. Ratepayers would not be adequately compensated for the supply resources which are proposed to be transferred to the Affiliate.

Based on the above conclusions any consideration of transferring Public Service’s contracts to any other entity should be deferred until the following conditions have been met.

C The Board has determined how it wishes to structure BGSS service in the longer term and how, if at all, Public Service’s supply resources would be used to provide, support or stabilize that service.

C Public Service has conducted studies of the effects of the proposed transfer on competition and market power in both the regional gas market and the regional electric market, and the Board has been able to determine that the transfer will not harm competition or result in higher retail rates in either market.

C The Board has established a mechanism for ensuring that adequate capacity will be available to serve Public Service’s firm gas customers, and has determined that such mechanism is adequate to provide a high reliability of gas supply.

C The value of these resources proposed to be transferred has been determined by a Board-directed audit.

Public Service’s proposal is both contrary to the policies of EDECA and detrimental to consumers, for the following reasons.

C Under EDECA, consumers are entitled to fully regulated BGSS as a backstop against the exercise of market power in a natural gas marketplace that is not yet fully competitive. Public Service’s proposal would violate EDECA and place essential gas supply resources in the hands of an unregulated monopoly, which would effectively eliminate the Board’s ability to assure reliable, reasonably priced gas supplies for BGSS customers.

C EDECA specifically provides that BGSS must be provided by the utilities at cost-based rates until at least December 31, 2002. Thereafter, if the Board determines that utility-provided BGSS is no longer in the public interest, BGSS can be provided by non-utility suppliers based on actual costs or the results of a competitive bidding process directed by the Board. Under the Public Service proposal, industrial and commercial customers, and later residential customers, would be provided with BGSS at essentially unregulated prices, based on neither actual costs nor the results of competitive bidding. Further, the minimum prices proposed to be charged to BGSS customers incorporate unjustified and improperly noticed rate increases. BGSS customers would lose the benefits of storage, hedging, and margin revenues that are currently flowed back to ratepayers.

C The Public Service affiliates would gain opportunities to earn windfall profits, using resources developed over the years at ratepayer expense.

C Contrary to Public Service’s statements, the Board cannot rely upon the competitive market to protect consumers against unreasonable prices. At present, competitive options are very limited for smaller natural gas customers.

C The proposal would be, for all practical purposes, irreversible. The Board would have no practical ability to transfer the procurement function back to the utility operation if necessary to provide service to consumers, as the resources needed to provide BGSS would have been irrevocably transferred to the Affiliate and other non-utility suppliers.

C Public Service’s proposal unreasonably discriminates against market participants other than the Affiliate, in apparent violation of the Board’s Interim Affiliate Relations Standards.

C Public Service has recently amended its proposal to include a number of measurers to promote the development of a competitive market. These could all be implemented without the proposed contract transfer and Requirements Contract. Having Public Service, rather than the Affiliate, promote competition has the advantage of maintaining price protection for consumers, while a competitive market develops, and retaining the Board’s ability to implement additional measures, if needed.

For these above reasons, the Board should adopt the following recommendations.

C The Board should reject the proposed contract transfer and Requirements Contract. The Board should specifically find that these proposed transactions are in violation of EDECA and imprudent with respect to gas supply procurement.

C Public Service should be directed to implement measures to encourage competition while it retains control of its essential natural gas supply resources. These measures could include capacity release programs, economic incentives, and a BGSS pilot program such as those proposed as part of the Joint Position.

C A transfer should be considered only after a robust competitive natural gas marketplace has developed, and the Board is assured that Public Service’s control of its gas supply resources is no longer needed to assure reliable and reasonably priced BGSS, otherwise consumers will be serviced by an "unregulated monopoly."

C In order to avoid an undue preference to Public Service affiliates, and to assure that ratepayers receive the full value of any transferred resources, any transfer should be subject to competitive bidding.

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