A Standards of Conduct Approach to Separating Commodity Marketing & Transportation Businesses

1. A Standards of Conduct Approach to Separating Commodity Marketing & Transportation Businesses Shelley Corman Enron Gas Pipeline Group May 2000

2. OVERVIEW • What are Standards of Conduct? • Key Standards of Conduct Concepts • Examining the Gas & Electric Experience • Relevance to Oil Pipelines • Contemporary Issues • Video Examples

3. STANDARDS OF CONDUCT • Rules for arms-length dealings between regulated utilities (pipes & wires businesses) and their marketing affiliates (affiliates involved in selling commodities over those pipes & wires) • Enacted in conjunction with gas & electric restructuring (unbundling) • Key to meaningful open access; functional separation (alternative to divestiture)

4. STANDARDS OF CONDUCT • Wide range of enforcement tools for violations (e.g. divestiture, disgorgement, restrictions on merchant affiliates, piercing the corporate veil/single entity, refunds, fines and possible criminal investigation) • Do not replace DOJ/FTC authority under Federal antitrust laws or private actions for damages • Do not replace other statutory non-discrimination provisions

5. KEY STANDARDS OF CONDUCT CONCEPTS • No Preference to affiliate • No Disclosure to affiliate of any information received from non-affiliated shippers • Contemporaneous Disclosure of transportation information available to affiliate • Independent Functioning of Operating Employees • Separate Books and Records

6. FERC GAS RULES • FERC rule (Order 497) has been in effect more than 10 yrs. • Applies to an interstate pipeline (natural gas company) with an affiliate that sells natural gas and conducts transportation transactions on the pipeline. Considered an affiliate if 10% or more voting interest. • Standards are purposefully broad. • Civil penalties of $5,000 per day, per violation for knowing violations, potential criminal investigation, and restrictions on ongoing business. • Several high profile FERC enforcement actions.

7. FERC ELECTRIC RULES • Rules adopted in Order 889 in December 1997. • Applies to a public utility that owns, controls, or operates transmission in interstate commerce. • Applies to conduct between the utility’s transmission operation and wholesale merchant functions (within the same legal entity or affiliate). • Regulations are parallel to gas rules. • Practical difference is that gas pipelines are fully unbundled; electric utilities still allowed to sell bundled sales service (native load). • Under Federal Power Act violations are subject to $5,000 per day, per violation, potential criminal prosecution and additional restrictions on business/mergers. • Lots of complaints, little FERC enforcement to date.

8. STATE GAS & ELECTRIC RULES • State attorneys general have authority to prevent anticompetitive practices under state law • State agencies or legislatures have added specific standards of conduct rules to address expanding retail competition • Unique state issues • Use of names or logos • Joint advertising • Providing lists of retail suppliers • Sharing office space, elevators • Provider of last resort • Enron’s Model Code of Conduct

9. KN INTERSTATE GAS TRANSMISSION • Cycling of employees to marketing affiliate and back again means that employees were effectively shared in violation of standards. • Transferring an employee one time is permitted by its regulations, but multiple transfers are not permitted. • Existence of regional teams comprised of transportation employees and marketing affiliate personnel facilitates improper sharing of transportation data.

10. NGPL V. AMOCO COMPLAINT • Amoco filed complaint alleging marketing affiliate violations • Commission conducted audit and issued audit report • Order following audit concluded that Natural violated regulations concerning marketing affiliates, posting and capacity allocation. • Remedies included: • civil penalties $8.8 million ($4.4 suspended) • further organizational separation • specific capacity allocation provisions

11. NGPL V. AMOCO CASESpecific Violations Separation of Functions • Attended planning meetings together • Found certain planning employees to be “shared” operating employees Information Sharing • Shared computerized capacity model • Provided affiliate with capacity data upon request • Shared employee who receives data by definition, divulges to the marketing affiliate

12. Recent Kinder Morgan Consent Agreement • It is FERC Enforcement’s position that Kinder Morgan violated the NGA, NGPA and marketing affiliate rules by: • Sharing transportation and shipper information through reports and meetings on a routine basis • Having employees with dual roles • Failing to offer discounts to similarly situated shippers and failing to post discounts • Failing to keep separate books and records as a result of their payroll allocation system • Failing to maintain waiver log • Having affiliates provide transportation services for which they had no authority (balancing service, re-selling capacity) • Failing to have separate transportation and gathering

13. Remedies in Kinder MorganConsent Agreement • Kinder Morgan anticipated to sell all marketing affiliates • Must notify FERC if they acquire new companies • In any event, cannot enter new transactions with marketing affiliate • Civil Penalty of $5 M and customer refunds of $675K • Commission barred from bringing administrative, criminal or civil claims

14. Relevance to Oil Pipelines • FERC has jurisdiction over interstate oil carriers • No formal oil pipeline standards of conduct • But underlying statutory requirements are similar to other FERC-regulated entities • Statutory Obligations under ICA (similar to NGA) • Non-discrimination (ICA § 2 & 3) • Just & reasonable rates (ICA § 1) • Rates must be published (ICA § 6) • Confidential shipper information (ICA § 15) • Other Requirements for Dealings between Pipeline Carrier and Unregulated Businesses • Elkins Act • FERC Uniform System of Accounts (18 CFR 352) -special records for affiliate transactions

15. Confidential Information • Unlawful for a carrier to disclose to any person other than the shipper, without the consent of the shipper, any information concerning the nature, kind, quantity, destination, consignee, or routing of any property tendered or delivered to the carrier that may be used to the detriment or prejudice of the shipper or may improperly disclose his business transactions to a competitor • Violations subject to penalty for each offense of not more than $1000. ICA § 15 (13) & 15 (14)

16. No Discrimination • Carrier that directly or indirectly, by any device, demands or receives from any person more or less for any related service than it demands or receives from any other person for like and contemporaneous service for transportation of a like kind of traffic under substantially similar circumstances and conditions, is guilty of unjust discrimination. ICA § 2. • Unlawful for carrier to make, give, or cause any undue or unreasonable preference or advantage to any particular person or description of traffic, in any respect whatsoever; or to subject any particular person or description of traffic to any undue or unreasonable prejudice or disadvantage in any respect whatsoever. ICA § 3(1). • Willing violation subject to $5000 fine and up to 2 years imprisonment. ICA § 10.

17. Elkins Act • Violation not to file a tariff • Violation not to charge filed rate • Violation not to provide service in accordance with tariff • Prohibits rebates • Penalties of not less than $1000, not more than $20,000, imprisonment not exceeding two years & forfeit three times rebate 49 USC §§ 41-43

18. Uniform System of Accounts • Affiliated Transactions - Other than Service Under the Tariff • The records and supporting data of all transactions with affiliates companies shall be maintained in a separate file & must be made available within 15 days of a request. • Must be able to demonstrate that charges are similar to arms-length transactions. 18 CFR 352, § 1-13 • Separate account for receivables from affiliated companies 18 CFR 352, §13

19. Contemporary Code of Conduct Issues • “No Conduit” Concept • Are corporate employees truly providing a corporate function? • Common computer systems and LANs • Employee transfers • Shared office space /shared file rooms • Task forces/due diligence Teams

20. Possible EOTT Issues • GP employees allocation of time/salaries to marketing and transportation functions • How do shared employees avoid information sharing concerns? • Location in new building. To what extent do employees, contract files need to be kept separate? • Computer system access. Is password protection enough?

21. Guidelines for Separation of Marketing and Transportation Functions • Use tariff for transportation transactions • Don’t give or ask for information on other shippers or their shipments • Information & system firewalls • Document procedures for keeping information separate • Think about regulator perceptions -- is there perceived advantage?