(As filed October 30, 1998)
File No. 70-9333
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________
FORM U-1/A
Amendment No. 1
to
JOINT APPLICATION OR DECLARATION
UNDER THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
_________________________________________________________
Sempra Energy Frontier Pacific, Inc.
101 Ash Street 555 West Fifth Street, Suite 2900
San Diego, California 92101 Los Angeles, California
90013-1001
(Names of companies filing this statement and
addresses of principal executive offices)
_____________________________________________________
None
(Name of top registered holding company parent)
______________________________________________________
Richard D. Farman Stephen L. Baum
President and Chief President and Chief
Executive Officer Executive Officer
Pacific Enterprises Enova Corporation
555 West Fifth Street, 101 Ash Street
Suite 2900 San Diego, California 92101
Los Angeles, California
90013-1001
(Names and addresses of agents for service)
The Commission is requested to send copies of all notices,
orders and communications in connection with
this Application or Declaration to:
Donald C. Liddell, Esq. Richard M. Farmer, Esq.
David L. Huard, Esq. Andrew F. MacDonald, Esq.
Pacific Enterprises William C. Weeden
633 West Fifth Street, Thelen Reid & Priest LLP
Suite 5200 40 West 57th Street
Los Angeles, California New York, New York 10019
90071
<PAGE>
The Application or Declaration heretofore filed in this
proceeding is hereby amended and restated in its entirety to read
as follows:
ITEM 1. DESCRIPTION OF PROPOSED TRANSACTION.
-----------------------------------
1.1. Introduction and Description of Applicants' Business.
----------------------------------------------------
Sempra Energy ("Sempra") is an exempt holding company
pursuant to Section 3(a)(1) of the Public Utility Holding Company
Act of 1935, as amended (the "Act"). Sempra owns all of the
common stock of Pacific Enterprises ("Pacific") and Enova
Corporation ("Enova"), which are also exempt holding companies
pursuant to Section 3(a)(1) of the Act.1/ Through a subsidiary,
Frontier Pacific, Inc. ("Frontier Pacific"),2/ Sempra is
proposing to acquire up to 90.1% of the membership interests of
Frontier Energy LLC ("Frontier"), a North Carolina limited
liability company formed to construct and operate a small gas
distribution system in North Carolina. The remaining membership
interests in Frontier would be acquired by Frontier Utilities of
North Carolina, Inc. ("Frontier Utilities"), a North Carolina
corporation and an indirect, majority-owned subsidiary of ARB,
Inc., a closely-held California corporation.3/
---------------
1/ See Sempra Energy, 67 SEC Docket 994 (June 26, 1998).
Pacific (formerly Pacific Lighting Corporation) is exempt by
order issued pursuant to Section 3(a)(1). See Pacific Lighting
Corporation, 1 S.E.C. 275 (1936). Enova claims an exemption
under Section 3(a)(1) pursuant to Rule 2. See File No. 69-393.
2/ All of the issued and outstanding common stock of Frontier
Pacific is currently held by Sempra Energy, LLC, a California
limited liability company whose membership interests are, in
turn, held directly by Pacific and Enova. Prior to the date of
the Commission's order in this proceeding, the stock of Frontier
Pacific will be transferred to Sempra.
3/ ARB, Inc. is not now a "holding company" or an "affiliate" of
any "holding company" or "public-utility company," as those terms
are defined under Section 2 of the Act.
<PAGE>
Pacific's predominant subsidiary, Southern California Gas
Company ("SoCalGas"), purchases, transports and distributes
natural gas in southern California. At December 31, 1997,
Pacific reported consolidated total assets of $4.977 billion, of
which approximately $3.154 billion consisted of net gas plant.
For the year ended December 31, 1997, Pacific reported $2.738
billion in operating revenues (including revenues from
transportation-only customers) and $184 million in net income.
Enova's principal subsidiary, San Diego Gas & Electric
Company ("SDG&E"), provides electric and natural gas service in
San Diego and surrounding areas. At December 31, 1997, Enova
reported consolidated total assets of $5.2 billion, of which
approximately $2.49 billion consisted of net electric plant and
$449 million consisted of net gas plant. For the year ended
December 31, 1997, Enova reported operating revenues of $2.2
billion (81.6% from electricity sales and 18.4% from gas sales
(including revenues from transportation-only customers)), and
$252 million in net income.
Sempra's non-utility subsidiaries include Sempra Energy
Utility Ventures ("Sempra Ventures"), which is currently managing
the development and construction of the Frontier gas system and
other "green field" local gas distribution systems in the United
States and Canada, and Sempra Energy Trading Corp. ("Sempra
Trading"), which is engaged in marketing and trading physical and
financial energy products, including natural gas, power and oil.
Sempra Trading is the successor to AIG Trading Corporation, which
was acquired by Pacific and Enova in December 1997. In August
1998, Sempra Trading completed its acquisition of CNG Energy
Services Corp., the wholesale gas marketing and trading arm of
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Consolidated Natural Gas Company, as a result of which Sempra
Trading is now among the ten largest gas marketers and traders in
the United States.
SoCalGas and SDG&E derive substantially all of their gas
requirements from sources outside of California. Approximately
58% of their combined system gas requirements are met from
production in the Permian Basin, which is located in west Texas,
and the San Juan Basin, which is located primarily in New Mexico
and Colorado in the "Four Corners" area. Most of the gas
produced in these supply basins is delivered to California by El
Paso Natural Gas Company ("El Paso") and Transwestern Pipeline
Company ("Transwestern") under long-term transportation
agreements. SoCalGas and SDG&E purchase their gas under a variety
of long-term, short-term and daily contracts from producers in
the two supply basins, as well as from gas marketers and brokers,
including Sempra Trading. Sempra Trading also purchases most of
the gas it sells in southern California from production in the
Permian and San Juan Basins.
1.2 Description of Frontier and Its Properties.
------------------------------------------
By order issued January 30, 1996, Frontier Utilities was
granted a final certificate of public convenience and necessity
(the "Certificate Order") from the North Carolina Utilities
Commission ("NCUC") to construct, test, market, own and operate a
new natural gas distribution system in a four-county area in
northwestern North Carolina comprised of Surrey, Watauga, Wilkes
and Yadkin Counties (the "Four-County Area").4/ Subsequently,
---------------
4/ In the Matter of Application of Frontier Utilities of North
Carolina, Inc. for Certificate of Public Convenience and
Necessity, NCUC Docket No. G-38, January 30, 1996 (Order Granting
Final Certificate), 166 PUR 4th 565. The order was affirmed on
appeal by the Supreme Court of North Carolina on a challenge by
Piedmont Natural Gas Company, Inc., whose competing proposal the
NCUC had rejected. State of North Carolina v. Piedmont Natural
Gas Company, Inc., 488 S.E. 2d 591 (N.C. Sup. Crt. 1997).
3
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by order dated August 16, 1996,5/ the NCUC added Ashe and
Allegheny Counties, which are located in the same region, to
Frontier Utilities' certificated territory, and by order dated
March 27, 1997,6/ granted Frontier Utilities a certificate of
convenience and necessity to construct and operate a gas
distribution system in Warren County, which is to the east of the
Four-County Area. By further order dated March 9, 1998 (the
"Financing Order"), the NCUC approved various proposals by
Frontier Utilities and Frontier relating to financing of
construction of a gas system in the Four-County Area and Warren
County, including the participation of Frontier Pacific as an
equity investor in Frontier, and the transfer by Frontier
Utilities to Frontier of the certificates to serve the Four-
County Area, as well as Ashe, Allegheny and Warren Counties.7/
Copies of Frontier Utilities' application to the NCUC and the
Financing Order are attached hereto as Exhibits D-1 and D-2,
respectively.
Frontier commenced construction in the Four-County Area
during the second quarter of 1998. Construction in Warren County
will commence at a later date, subject to receipt of further NCUC
approvals. When complete, the Four-County Area system will
consist of approximately 140 miles of transmission mains,
including a 40-mile lateral tap off the interstate pipeline
----------------
5/ In the Matter of Commission Proceeding to Implement G.S. 62-
36A(b1), NCUC Docket No. G-100, Sub. 69 (August 16, 1996). This
was a generic proceeding in which the NCUC implemented a new law
that required that the NCUC grant certificates to provide gas
service to all unfranchised areas in North Carolina or, in the
absence of any applications for such certificates, that the NCUC
assign to the incumbent utilities in the state franchises
covering all such uncertificated areas. Because of their
proximity to the Four-County Area, the franchises for Ashe and
Allegheny Counties were assigned to Frontier Utilities.
6/ In the Matter of Frontier Utilities of North Carolina, Inc.
for Certificate of Public Convenience and Necessity, NCUC Docket
No. G-38, Sub. 1, March 27, 1997 (Order Awarding Certificate and
Approving Rates).
7/ Order Approving Final Financing Plan, Transfer of
Certificates, and Security Bond and Preliminarily Approving Debt
Financing, NCUC Docket Nos. G-38, Sub 3 and G-40 (March 9, 1998).
Although Frontier has indicated that it intends to build out a
system in Ashe and Allegheny Counties at such time as it becomes
feasible to do so, the financing plan approved by the NCUC does
not include the system to be built in those counties.
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facilities of Transcontinental Gas Pipe Line Corp. ("Transco"),
and at least 320 miles of distribution mains. Initially,
Frontier will purchase all of its gas requirements from Sempra
Trading pursuant to the terms of an agreement, dated September
17, 1998, from production in the San Juan and Permian Basins.
Although Frontier will have the right to purchase gas from other
suppliers in the future, it is anticipated that it will continue
to derive at least 50% of its supplies from these two supply
basins. Gas will be delivered to Frontier by Transco under a
long-term transportation contract. Frontier is projecting that,
by the end of the fifth year following commencement of
construction, it will serve 13,250 residential, 1,054 small
commercial, 300 poultry farm, and 55 large commercial and
industrial customers. (Exhibit D-1, p. 10). As a public utility
under North Carolina law, Frontier will be subject to regulation
by the NCUC as to rates, service, securities issuances and other
matters.
The Certificate Order contains various findings and
conclusions as to technical issues, the financial feasibility of
the Four-County Area system, and the public interest to be
served. Two of the central issues in the proceeding concerned
the optimum size of the Four-County Area system and the
likelihood that customers would convert from propane and heating
oil to natural gas. These issues were critical in the NCUC's
evaluation of Frontier Utilities' proposal, which assumed that
the proposed system could support traditional financing, and of
the competing proposal made by Piedmont Natural Gas Company, Inc.
("Piedmont"), an existing franchised gas utility company in North
Carolina, which was made contingent upon the availability of
"expansion funds" provided for under North Carolina law.8/ With
regard to the financial feasibility of Frontier Utilities'
proposed system in the Four-County Area, the NCUC considered a
----------------
8/ See N.C. Gen. Stat. Section 62-158 (Michie, 1997).
5
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detailed market study prepared by an independent consultant
(Heath and Associates) which evaluated the potential customers
and loads in the Four-Country Area and the likelihood of
converting these customers to gas at the rates and rate designs
proposed by Frontier Utilities. During the hearings, witnesses
for Heath and Associates and Frontier Utilities were cross-
examined at length concerning the data used and assumptions made
in the Heath and Associates study and an earlier study prepared
by Frontier Utilities. Despite certain discrepancies between the
Health and Associates study and Frontier Utilities' initial study
as to likely number of customers, the configuration of the
system, conversion rates and other matters,9/ the NCUC concluded
that "the market study performed by Heath and Associates provides
a fair and unbiased assessment of the potential customers and
loads resulting from an extensive rural distribution system in
the Four-County area at the rates that Frontier proposed to
offer." (Certificate Order, p. 19).
1.3 Description of Frontier's Ownership Structure and
-------------------------------------------------
Management Plan.
---------------
It is contemplated that Frontier Pacific and Frontier
Utilities will each acquire 50% of the membership interests of
Frontier, and that the economic interests of the members will
equal their membership interests.10/ Under the Financing Order,
the NCUC authorized the equity investments by the members of
Frontier, including cash and in-kind contributions of pipeline
----------------
9/ Heath and Associates forecast that the gas system would have
8,553 customers in year 10 and sales of 4 million dekatherms per
year. Certificate Order, p. 13. Frontier Utilities offered
testimony showing that it would be economically feasible to serve
an additional 5000 customers outside of the areas included in the
Heath and Associates analysis.
10/ An organizational chart showing the ownership structure of
Frontier and its members is set forth at page 5 of Frontier
Utilities' Application for Approval of Financing Plan (Exhibit D-
1 hereto).
6
<PAGE>
and other property, totaling approximately $12 million. In
addition, the NCUC has given its preliminary approval for $40
million in debt financing by Frontier.
Under Frontier's Operating Agreement (attached hereto as
Exhibit A-2), the economic interest of a member is defined as
that member's interest in the profits and losses of Frontier and
right to receive distributions from Frontier. The membership
interest of a member means that member's economic interest, plus
the right to participate in management of Frontier, including the
right to vote. The Operating Agreement specifically contemplates
that Frontier Pacific and Frontier Utilities may adjust or change
their respective economic and membership interests whenever
necessary in order, for example, to limit the percentage of
overall voting rights held by a member. Pacific and Enova are
seeking approval herein to acquire, indirectly through Frontier
Pacific, up to 90.1% of the membership interests of Frontier,
representing 90.1% of the voting interests in Frontier. This
will enable Frontier Utilities, should it choose to do so, to
maintain its percentage interest in Frontier's voting securities
at below 10%.
It is anticipated that the day-to-day operations of Frontier
will be under the control of its General Manager, who will be
located at Frontier's corporate headquarters in Elkin, North
Carolina. The General Manager will report to the President of
Frontier, who will be located in San Diego, California. It is
also anticipated that Frontier will be staffed by a combination
of current employees of the members of Frontier and their
respective affiliates and new hires from the local area in North
Carolina.
As previously indicated, Sempra Ventures is overseeing the
development and construction of the Frontier system. On an
ongoing basis, Sempra Ventures and other subsidiaries of Sempra
will provide Frontier with a variety of administrative and
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management services. Specifically, it is anticipated that
SoCalGas and SDG&E will provide services to Frontier in such
areas as payroll, tax, insurance, accounting, human resources
(compensation and benefits plan administration), regulatory
support, procurement/materials and quality assurance programs,
technical and design engineering, training and legal services.11/
Additional corporate support services, including finance and
general administrative support, will be provided to Frontier by
Sempra and Sempra Ventures. A fuller description of the kinds of
support services that Sempra Ventures, SoCalGas and SDG&E intend
to provide to Frontier is contained in Exhibit I hereto.
Thus, with the assistance and support of Sempra Ventures,
SoCalGas and SDG&E, Frontier will be able to enter the natural
gas business with an experienced management team in place. In
accordance with one or more service agreements, services provided
by Sempra Ventures and other utility and non-utility affiliates
of Sempra will be directly assigned, distributed or allocated to
Frontier by activity, project, program, work order or other
appropriate basis. Employees of the members and their
affiliates will record transactions utilizing the data capture
and accounting systems of Frontier. Such agreements are required
to be filed with the NCUC.
Under the September 17, 1998 agreement between Frontier and
Sempra Trading, Sempra Trading has agreed to supply Frontier's
full requirements of gas. The agreement sets forth price and
quantity terms, including a projection of Frontier's supply needs
through 2000, and provides that gas supplied by Sempra Trading
----------------
11/ Although there are some limitations on the types of
affiliate services that SoCalGas and SDG&E may provide to
Frontier under California's rules governing affiliate
transactions (see Item 3.3, below), SoCalGas and SDG&E would not
be barred from providing any of the services indicated.
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must be contractually sourced in the Permian and San Juan supply
basins for delivery at the Frontier/Transco interconnection in
Owen County, North Carolina.
Sempra Ventures, in conjunction with Sempra Trading and
Frontier's General Manager in North Carolina, will coordinate the
purchase, scheduling and delivery of natural gas, transportation
capacity and related financial risk management products. Such
coordination will involve the development of annual and monthly
gas acquisition plans for Frontier. In this connection, the
General Manager will have access to the information available
from electronic bulletin boards monitored by Sempra Trading12/
and will be able to communicate directly as necessary with
personnel of Sempra Ventures and Sempra Trading on a day-to-day
basis to schedule gas purchases and delivery based on anticipated
projections of customer growth on the Frontier system, weather
conditions, and market price volatility. Frontier's General
Manager and Sempra Trading will meet prior to the commencement of
each month to review options for supply purchases (i.e., long-
term supply contracts or daily or "spot" market purchases). Such
options will be evaluated in order to obtain the lowest cost of
gas for Frontier.
In addition, Sempra Trading will assist Frontier in making
nominations on the Transco system and other pipelines in
accordance with approved schedules with a view to minimizing any
penalties for over-utilization or under-utilization of the
Transco pipeline system. Frontier will provide gas supply
receipt information to Sempra Trading, which Sempra Trading will
use to compare against the confirmed nominations received from
----------------
12/ All interstate pipelines and many intrastate pipelines are
required to post information on capacity availability and related
services on electronic bulletin boards. Other market makers
(e.g., brokers) may also post information on electronic bulletin
boards as an aid to matching buyers and sellers. In some cases,
there is a subscription fee charged for access to electronic
bulletin boards.
9
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Transco. Sempra Trading may also purchase from SoCalGas released
capacity on the El Paso and Transwestern pipelines in
transactions that are posted on electronic bulletin boards in
accordance with FERC rules governing sales of released capacity.
Such released capacity may be used to transport gas flowing
either westward to California or eastward to Frontier's system.
The purchase, nomination, confirmation, transportation and
dispatch of gas for ultimate consumption is a seven-day-a-week,
24-hour per day operation. Under Gas Industry Standards Board
("GISB") protocols adopted by FERC and implemented through
pipeline tariffs,13/ most decisions and actions are based on a
two-day nominations schedule in which the first day is referred
to as the "nominations day" ("Nom Day") and the second day the
"flow day" ("Flow Day"). Under this nominations process, in
addition to monthly planning for base-load gas purchases, the
General Manager of Frontier will advise Sempra Trading prior to
10:00 a.m. Eastern Time each day (the Nom Day) of Frontier's
----
requirements for the following day (the Flow Day). Sempra
Trading will then determine what gas supply is available to meet
Frontier's requirements from the various supply basins which it
regularly monitors through its contacts with producers throughout
the United States and Canada. Sempra Trading will arrange to
purchase gas from producers from the common supply basins that
are accessible by Frontier and Sempra's other utility
subsidiaries, principally the San Juan and Permian basins, and
various hubs and market centers in the south and southwest.
----------------
13/ See Standards for Business Practices of Interstate Natural
Gas Pipelines, FERC Order No. 587, 61 Fed. Reg. 39,053 (July 26,
1996); order denying rehearing, FERC Order No. 587-A, 61 Fed.
Reg. 55,208 (October 25, 1996). The GISB standards govern
nominations, allocations, balancing, measurement, invoicing,
capacity release, and mechanisms for electronic communications
between pipelines and their customers. Like other interstate
pipelines, Transco has implemented these protocols through its
tariff sheets. See Transcontinental Pipe Line Corporation, 78
F.E.R.C. P 61,210 (March 3, 1997) and 79 F.E.R.C. P 61,172 (May 5,
1997).
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As available supply and available transportation capacity
are matched, there are several intra-day nomination and
confirmation opportunities which must be managed by Sempra
Trading to make the most economical supply of gas available to
Frontier and to address situations where supply or capacity
imbalances may have occurred. This intra-day nomination process
typically provides a gas utility company with opportunities to
redirect gas supply or capacity or renegotiate the terms of
contracts during the Nom Day, as well as to make spot market
purchases. The second day (the Flow Day) also provides
opportunities for nomination of additional supplies if required
by Frontier or for sales of gas to others if Frontier's demand
slackens. This intra-day balancing process will be made possible
through Frontier's access to Sempra Trading's large portfolio of
supplies and customers.
The nominations and intra-day balancing functions of a gas
company requires the availability of personnel 24 hours per day
who can manage contacts with producers and each of the pipelines
required to complete the transportation route, as well as with
various intermediaries (e.g., hub operators) who can accommodate
the exchange of gas from one supply basin to another or the
storage of gas for future use. Maintenance of the necessary
contacts and the coordination of these activities requires a
significant staff. For a utility the size of SoCalGas or SDG&E,
this staff could number 50 or more people. Even a small utility,
such as Frontier, would require a staff of between five to eight
full-time employees in its gas supply department. Through its
arrangements with Sempra Trading, Frontier will have access to
personnel who will perform these functions and, therefore, will
not need to incur the significant costs that would otherwise be
associated with building an in-house gas management capability.
11
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ITEM 2. FEES, COMMISSIONS AND EXPENSES.
------------------------------
The fees, commissions and expenses to be paid or incurred,
directly or indirectly, in connection with the Transaction,
inclusive of legal fees and expenses, are estimated at not more
than $100,000.
ITEM 3. APPLICABLE STATUTORY PROVISIONS.
-------------------------------
3.1 General Overview of Applicable Statutory
----------------------------------------
Provisions.
----------
Because Sempra is an exempt holding company, it will require
approval of the SEC under Sections 9(a)(2) and 10 of the Act to
acquire, directly or indirectly, 5% or more of the voting
securities of Frontier, which will become a "gas-utility company"
within the meaning of Section 2(a)(4) of the Act on or after the
date on which it commences making residential and small
commercial sales of gas. Further, following the acquisition of
10% or more of Frontier's voting securities, and the commencement
by Frontier of residential and small commercial sales, Frontier
will become a gas-utility subsidiary company of Sempra and
Frontier Pacific. However, because Sempra will not derive "any
material part of its income" from Frontier, and will remain
"predominantly" a California holding company, its "intrastate"
exemption under Section 3(a)(1) of the Act will not be
affected.14/ Frontier Pacific, which will be reincorporated in
North Carolina, does not own, directly or indirectly, 5% or more
of the voting securities of any other public-utility company.
---------------
14/ Under the Operating Agreement, Frontier Pacific will have a
50% economic interest in Frontier. Based on current projections,
the proportionate share of Frontier's income attributable to
Sempra is expected to account for far less than 1% of the
consolidated income of Sempra on a pro forma basis.
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The relevant standards for approval of an application under
Section 10 are set forth in subsections (b), (c) and (f) thereof.
Section 10(b) provides that, if the requirements of Section
10(f) are satisfied, the Commission shall approve an acquisition
under Section 9(a) unless the Commission finds that:
(1) such acquisition will tend towards interlocking
relations or the concentration of control of public-utility
companies, of a kind or to an extent detrimental to the
public interest or the interest of investors or consumers;
(2) in case of the acquisition of securities or
utility assets, the consideration, including all fees,
commissions, and other remuneration, to whomsoever paid, to
be given, directly or indirectly, in connection with such
acquisition is not reasonable or does not bear a fair
relation to the sums invested in or the earning capacity of
the utility assets to be acquired or the utility assets
underlying the securities to be acquired; or
(3) such acquisition will unduly complicate the
capital structure of the holding company system of the
applicant or will be detrimental to the public interest or
the interest of investors or consumers or the proper
functioning of such holding company system.
Section 10(f) provides that the Commission:
shall not approve any acquisition . . . unless it appears to
the satisfaction of the Commission that such State laws as
may apply in respect of such acquisition have been complied
with, except where the Commission finds that compliance with
such State laws would be detrimental to the carrying out of
the provisions of section 11.
Finally, Section 10(c) of the Act provides that,
notwithstanding the provisions of Section 10(b), the Commission
shall not approve:
(1) an acquisition of securities or utility assets, or
of any other interest, which is unlawful under the
provisions of Section 8 or is detrimental to the carrying
out of the provisions of Section 11; or
(2) the acquisition of securities or utility assets of
a public-utility or holding company unless the Commission
finds that such acquisition will serve the public interest
by tending towards the economical and the efficient
development of an integrated public-utility system.
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An "integrated public-utility system" is defined in Section
2(a)(29)(B), as applied to a gas utility system, to mean:
. . . a system consisting of one or more gas utility
companies which are so located and related that substantial
economies may be effectuated by being operated as a single
coordinated system confined in its operations to a single
area or region, in one or more States, not so large as to
impair (considering the state of the art and the area or
region affected) the advantages of localized management,
efficient operation, and the effectiveness of regulation:
Provided, That gas utility companies deriving natural gas
from a common source of supply may be deemed to be included
in a single area or region.
For the reasons set forth below, Sempra believes that the
requirements of Section 10(f) have been met; that its indirect
acquisition of Frontier's voting securities will satisfy the
integration standards under Sections 10(c) and 2(a)(29)(B); and
that there is no basis for the Commission to make any of the
negative findings enumerated in Section 10(b). As a preliminary
matter to the discussion that follows concerning the integration
standards of the Act, as applied to this transaction, however,
Sempra believes that it is important to understand the current
"state of the art" in the natural gas industry and to review the
dramatic changes that have occurred in the gas industry since
1935, and especially in the past decade.
3.2 Historical Perspective on the "State of the Art" in the
-------------------------------------------------------
Natural Gas Industry in the United States.
-----------------------------------------
Although natural gas has been used as a fuel for thousands
of years, the growth of the natural gas industry in the United
States can be traced in large part to the development of pipeline
systems through which large volumes of natural gas could be
transported from the wellhead (i.e., the gas producing areas) to
distant markets.15/ In the early days of the U.S. natural gas
---------------
15/ A more detailed history and analysis may be found in
"Regulation of the Natural Gas Industry," Ed. by American Gas
Association (Matthew Bender, 1997), Volume 1.
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<PAGE>
industry (1870-1930), natural gas was seldom transported more
than 50 to 75 miles. In some areas, gas produced as an incident
to oil drilling operations was simply burned, or "flared," in the
oil fields, rather than being piped to nearby cities or towns.
Eventually, efforts were made to find commercial uses for this
"waste" gas, but the technological difficulties and cost of
transporting gas long distances were limiting factors. Thus, in
most communities where gas service was available, the source of
supply was from locally manufactured gas or from a nearby oil
field. The first iron pipeline was reportedly built in 1872 to
transport "waste" gas to Titusville, Pennsylvania, from nearby
oil fields, where it was used chiefly for street lighting and
some industrial applications. The first long distance, high
pressure, gas pipeline, consisting of two parallel 8-inch
wrought iron lines approximately 120 miles in length, was
constructed in 1891 by Indiana Natural Gas and Oil Company.
A. Developments in the 1920s and 1930s. As indicated,
-----------------------------------
prior to the 1930s, natural gas service to cities and towns was
quite often provided from only one local source or field. In
many cases, little was known about the extent of gas reserves in
a producing area, which tended to limit the willingness of
investors to commit the large amounts of capital required to
build pipelines to distant markets. By the 1920s, however,
technological advances had been made in the manufacture of large
diameter pipeline which could withstand high pressures. This
made it technologically and economically feasible to construct
long-distance gas pipelines which could move gas from the
developing oil fields in Texas, Oklahoma and other Southwestern
states to the population centers in the Midwest and eastern U.S.
This was the first significant change in the "state of the art"
in the gas industry.
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In the 1930s, the first of what we now know of as the
modern-day, long distance, pipelines were constructed to
transport the "casinghead" gas that was being produced in the
developing Texas oil fields to Midwest markets.16/ By 1934,
utilizing improved pipeline and compression technologies, some
150,000 miles of high-pressure transmission lines were in place.
Nevertheless, in 1935, when the Act was passed, the natural gas
pipeline industry consisted of only two long interstate lines
extending to the upper Midwest. For the most part, the pipeline
industry in the U.S. still consisted of relatively short lines
used to transport gas from local producing areas directly to
nearby markets. Natural gas was generally unavailable in the
more populous areas on the East Coast and in the Northeast, where
local distribution gas companies, or "LDCs," continued to
distribute low-Btu gas produced from coal.
For the most part, the interstate pipelines remained free
from federal regulation until 1938, when the Natural Gas Act
("NGA") was passed.17/ Under the NGA, the Federal Power
Commission ("FPC") was given broad authority to regulate
interstate pipelines under a public utility model. This
included, importantly, certificate authority over construction of
pipelines and authority to set "just and reasonable" rates for
sales of gas for resale (i.e., wholesale rates). For almost 50
years following passage of the NGA, there were few if any changes
in the basic structure of the natural gas industry or the
framework of federal regulation. The Federal Energy Regulatory
Commission ("FERC"), the successor to the FPC, has characterized
---------------
16/ In 1931, Natural Gas Pipeline Company of America ("NGPL")
completed a 24-inch line more than one thousand miles long
running from the producing areas in Texas to Chicago, and in
1936, Panhandle Eastern Pipeline Company completed a thousand
mile pipeline that terminated in Detroit.
17/ 52 Stat. 821-833 (1938), 15 USC Sections 717-717W, as amended.
In 1906, Congress had amended the Interstate Commerce Act to
specifically exclude pipelines for the transportation of natural
gas from the jurisdiction of the Interstate Commerce Commission.
30 Stat. 584 (1906). H.R. 5423, the original House bill
introduced in 1935 which contained the Public Utility Holding
Company Act and amendments to the Federal Power Act, also
included, as Title III, provisions which would have subjected the
interstate gas pipelines to federal regulation as common
carriers. During the hearings on H.R. 5423, however, Title III
was widely criticized as being unworkable, and was not reported
out of committee.
16
<PAGE>
the structure of the natural gas industry regulated under the NGA
during this period as "simple:"
The producers would sell their natural gas in the production
area to the interstate pipeline at Commission-determined
just and reasonable rates. The pipelines would transport
-----------------------------
their purchased gas and their own production to the city
--------------------------------------------------------
gate for sale to local distribution companies (LDCs) at
-------------------------------------------------------
Commission-determined just and reasonable rates which
-----------------------------------------------------
recovered both the pipelines' cost of gas and cost of
-----------------------------------------------------
transmission. In addition, the pipelines would sell gas to
------------
end users in non-jurisdictional sales with an appropriate
allocation of costs to the non-jurisdictional services.
Producer sales to LDCs or end users in the production area,
with the pipeline providing only the transportation, were
rare. The central features of the NGA-regulated natural gas
industry were Commission-determined just and reasonable
prices and interstate pipeline sales of gas for resale to
LDCs at the city gate at those prices in transactions that
combined or bundled into one package the pipelines' gas
supply and transmission costs. (Emphasis added.)
(Footnotes omitted.)18/
The "source of supply" of natural gas at the time the Act
was passed and for most of the next 50 years must be understood
in the context of the relationship that existed between the
pipelines and LDCs: the pipelines were in almost all instances
the exclusive suppliers to the LDCs, which had little opportunity
to contract with producers or other sellers. This was the "state
of the art" in the gas industry.
B. Developments After World War II. Although significant
-------------------------------
changes in the regulation of the industry were still many years
away, the natural gas pipeline industry underwent rapid expansion
in the decades after 1938, and especially following World War II,
when the steel pipe manufacturing capacity in the U.S., which had
been diverted to the war effort, was again available for pipeline
fabrication. Also in this period, significant new gas
discoveries were developed, particularly in West Texas and along
the onshore and offshore Gulf Coast areas. Significantly, it was
not until after World War II that the market for natural gas
-----
---------------
18/ See FERC Order No. 636, FERC Stats. & Regs. P30,939,
"Pipeline Service Obligations and Revisions to Regulations
Governing Self-Implementing Transportation; and Regulation of
Natural Gas Pipelines After Partial Wellhead Decontrol," 57 Fed.
Red. 13,267 at 13,270 (April 16, 1992), aff'd in part, United
Distribution Cos. v. FERC, 88 F.3d 1105 (D.C. Cir. 1996).
17
<PAGE>
developed to the point at which it could support gas exploration
and production on a stand-alone basis, separate and apart from
the economies associated with oil production.
When World War II ended, the consumption of natural gas was
still concentrated within the six principal gas-producing states
of Texas, Louisiana, California, Oklahoma, West Virginia and
Kansas, which, in 1945, produced 87% and consumed 68% of all the
natural gas marketed in the United States.19/ In the populous
Mid-Atlantic Region, including North Carolina, where there was
little or no indigenous supplies, natural gas was either not
available or at most mixed with manufactured gas to upgrade its
Btu content.
Proven reserves of natural gas in the U.S. totaled about 148
trillion cubic feet (TCF) at the end of 1945 and total annual
marketed production was only about four TCF, of which more than
half was produced in the four Gulf States. Thus, there were vast
reserves, mostly in the Southwest, available to support the
expansion of the interstate pipeline system. The primary
limiting factor was the lack of the pipeline capacity needed to
reach distant markets.
In 1947, Texas Eastern Transmission Corporation purchased
and converted to gas the "War Emergency" "Big Inch" and "Little
Big Inch" lines that were built during the war to transport oil.
During the same period, other companies secured the necessary gas
reserves and built large diameter pipelines to waiting markets,
while many of those already in existence extended their systems.
It was during this period in which the El Paso and Transwestern
pipelines were built to transport gas from west Texas to the
----------------
19/ See "Regulation of the Natural Gas Industry", supra n. 15,
at Section 3.02. Louisiana, Texas, Oklahoma and New Mexico still
account for approximately three-quarters of all domestic
production. See Energy Information Administration, Natural Gas
Annual - 1996, DOE/EIA-0131(96) (Washington, D.C., September
1997), p. 9.
18
<PAGE>
rapidly growing California market, and in which Transco built a
pipeline running from the Gulf Coast along the Eastern Seaboard
to New York City.
By 1966, natural gas service was available in all of the 48
contiguous States and the District of Columbia. The gas industry
was no longer a local business. The primary forces behind this
development were the surplus of reserves in the Southwest, the
low prices for such gas, the subsequent discovery and development
of additional reserves in the Southwest and elsewhere, and the
price advantage that natural gas enjoyed over other competing
fuels, such as heating oil and propane, in most uses. Some of
the price advantage that natural gas enjoyed over other fuels was
inherent in the efficiency of transporting gas in high pressure
pipelines with low associated labor costs.
As the LDCs converted from manufactured gas to natural gas,
they in effect exited the supply side of the business in favor of
becoming customers of the interstate pipelines. The pipelines
transported their own gas and gas produced by others, which the
pipelines purchased at the well-head, and re-sold such gas to
LDCs at the city-gate and to large industrial customers. This
development, particularly in the heavily populated areas along
the Eastern Seaboard, created a large and significant purchaser
group that had a vital interest in keeping the city gate price
for gas at levels where retail prices were competitive with other
fuels. For LDCs that had historically sold natural gas obtained
from local sources, such as in the Appalachian Mountain producing
basins and adjacent areas, the growth in demand after World War
II quickly outstripped the availability of local supplies. These
LDCs were among the first to seek gas from the more plentiful
producing areas in the Southwest.
19
<PAGE>
The 25-year period following World War II is sometimes
referred to as the "Golden Age of Growth" in the natural gas
industry. As indicated, during this period, there was a rapid
expansion of the interstate pipelines systems from the Southwest
and other producing areas in the West to Midwest and Eastern
markets. Also, it was during this period that the FPC extended
its jurisdiction and the comprehensiveness of its regulation in
the gas industry, including asserting jurisdiction over gas
production.20/ The FPC also developed comprehensive regulations
for the certification of pipeline construction and operation
pursuant to Section 7(c) of the NGA, as well as for rates and
terms and conditions of services provided by interstate
pipelines.
C. The 1970s - An Industry in Transition. In the 1970s,
-------------------------------------
the natural gas industry was suddenly faced with the prospect of
massive gas shortages, as gas demand in some markets
significantly outstripped available production. During this
period, the availability of natural gas to the interstate market
was so significantly restricted that the principal issue
presented to the FPC concerned the curtailment of deliveries by
the interstate pipelines. In a sense, the "state of the art"
became how to deal with the massive curtailments that threatened
the very survival of the industry. The shortages, however, were
not due to the unavailability of gas in the ground. Rather, at
the artificially constrained well-head price established by the
FPC, many producers were simply unwilling to produce gas for sale
into the interstate market and to make the capital investment
needed to develop new reserves. In response to the gas shortages
of the 1970s, Congress, in 1978, enacted a group of statutes
jointly referred to as the Natural Energy Acts. Among these acts
--------------
20/ See Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672
(1954).
20
<PAGE>
was the Natural Gas Policy Act of 1978 ("NGPA").21/ The NGPA
set in motion the process for gradual de-control of well-head
price regulation by the FERC. That process was completed in
1989, when Congress passed the Natural Gas Wellhead Decontrol
Act,22/ which eliminated all well-head price and non-price
controls.
Of particular importance to the current "state of the art,"
the NGPA also included provisions (Sections 311 and 312)
authorizing certain sales and transportation in intra- and
interstate commerce, which, as implemented through FERC
regulations, has effectively merged the intra- and interstate
transportation markets into a single "seamless" grid without
unnecessary jurisdiction or restrictions.
This began an extremely rapid change in the "state of the
art" which culminated in a revolutionary change in the previous
paradigm: the "common source of supply" for LDCs was no longer
purchasing gas from the pipeline at the city-gate at "just and
reasonable" rates established by the FERC. LDCs and other
purchasers could now contract directly with producers. The
pipelines were becoming nothing more than transporters of gas
owned by others.
D. The 1980s - the Move Towards Competition. The
----------------------------------------
implementation of Sections 311 and 312 of the NGPA began a move
to a more market-driven transportation sector for the natural gas
industry. Building upon the market-responsive goals of Section
311, the FERC issued a series of orders, beginning with Order No.
436 in 1985 23/ and culminating in Order No. 636 in 1992, that
---------------
21/ 92 Stat. 3350 (1978); 15 USC Section 3301, et. seq.
22/ 103 Stat. 157 (1989).
23/ FERC Stats. & Regs. P 30,665, "Regulation of Natural Gas
Pipelines After Partial Wellhead Decontrol," 50 Fed. Reg. 42,408
(October 18, 1985).
21
<PAGE>
mandated "open access" transportation. This shift in regulatory
policy sought to encourage competition within the natural gas
industry. Under revised regulations, most recently promulgated
in Order No. 636, many gas transactions that once required prior
approval from the FERC now can begin as soon as the pipeline and
shipper reach agreement. Transportation of natural gas in
interstate commerce still requires FERC authorization, but that
authorization usually takes the form of "blanket" certificate
approvals under the terms and conditions established in Order No.
636.24/
With the issuance of Order No. 636, the FERC completed the
process of transforming the supply end of the natural gas
industry into a fully competitive industry. The FERC's stated
policy goal was to promote competition among all natural gas
suppliers, including interstate pipelines to the extent that they
still act in a gas sales (or merchant) capacity. The FERC's
primary objectives were two-fold: to enhance competition in the
natural gas industry and to maintain an adequate and reliable
supply.
Under Order No. 636, pipelines were required to "unbundle,"
or separate, their merchant function from their transportation
function. The order requires that this unbundling take place at
an upstream point, near the production area. Pipelines are now
obligated to provide all transportation service on a basis that
----------------
24/ Under the FERC's regulations, there are two distinct types
of self-implementing transportation service. The first is
commonly referred to as "Section 311 Transportation." Under this
authority, interstate pipelines are authorized to commence
transportation service on behalf of any intrastate pipeline or
any LDC without any specific prior approval. The second type of
self-implementing transportation is referred to as a Section 7
"blanket" certificate service. " Blanket" certificates are issued
under Section 7 of the NGA and are available to interstate
pipelines and end-users. Regulations governing both sets of
transportation are included in Part 284 of the FERC's regulations
(18 CFR Part 284). The FERC's regulations define "transportation"
to include both storage and exchanges of natural gas.
22
<PAGE>
is equal in quality for all gas supplies, whether purchased from
the pipeline or from another gas supplier.25/ To assure
comparability in the quality of service, pipelines are required
to provide a variety of essential, or ancillary, transportation
services, such as storage, on a non-discriminatory basis, and to
implement capacity release programs so that firm shippers can
release their firm capacity on a short or long term basis.26/
In the six years since Order No. 636, the contracting
practices of LDCs and other purchasers have also changed
dramatically. Prior to Order No. 636, LDCs generally purchased
most of their gas under long-term, fixed-price, contracts.
Although there was less price volatility under these contracts,
the benefits of increased competition were lost. Since Order No.
636, active short-term markets have developed. Today, most LDCs
depend on short-term supply contracts, including daily and
sometimes intra-daily contracts with marketers and brokers
arranged at market centers, for a significant percentage of their
overall gas supply. Even the average length of long-term
contracts has shortened considerably. Similarly, LDCs'
---------------
25/ Although Order No. 436, issued in 1985, provided for open-
access, non-discriminatory, transportation service to enable LDCs
and others to purchase gas directly from producers at the
wellhead, the FERC subsequently concluded that firm
transportation made available by the pipelines to LDCs and others
was "inferior in quality to the firm transportation embedded
within the pipelines' bundled, city-gate, firm sales service," in
that there was no obligation on the pipelines' part to provide
transportation-only customers with other essential services and
facilities, such as storage, on a non-discriminatory basis.
Order No. 636, 57 Fed. Reg. at 13,272. In Order No. 636, FERC
mandated various changes in the terms and conditions that must be
offered by an open-access pipeline in order to assure that all
gas purchasers would receive comparable transportation service.
26/ Traditionally, LDCs and other shippers were required to
reserve, on a long-term basis, enough "firm" capacity on the
supplying pipeline to meet their maximum requirements. Pipeline
capacity utilization was inefficient because there was no
mechanism in place to allow for the shifting of reserved "firm"
capacity from one pipeline customer to another at times when it
was in excess of current needs. The capacity release mechanism
contemplated by Order No. 636 was intended to correct this
situation. It allows an LDC or other shipper (the "primary
shipper") to permanently or temporarily release and sell some or
all of its reserved "firm" capacity, which the pipeline must then
offer to others. Conversely, it provides a prospective purchaser
(the "replacement shipper") with access to "firm" capacity that
would otherwise not be available to it. Although the primary
shipper remains liable on its contract with the pipeline, it is
entitled to a credit to the extent released capacity is resold to
a replacement shipper. See Order No. 636, 57 Fed. Reg. at 13,284
- 13,286.
23
<PAGE>
contracting practices for transportation capacity have changed
dramatically. Today, most LDCs do not hold firm, long-term,
capacity for their total gas needs. They have the option to
obtain short-term capacity in the capacity release market, or
to obtain capacity indirectly by purchasing gas that is bundled
with transportation from marketers and other aggregators.27/
E. The Development of Market Centers, Hubs and Pooling
---------------------------------------------------
Areas. Another important feature of Order No. 636 was FERC's
-----
pronouncement that it would not allow actions that would inhibit
the natural development of market centers, hubs, and pooling
areas.28/ In a study issued by the FERC's Office of Economic
Policy in 1991,29/ which was cited in Order No. 636, the staff of
the FERC had reported on the growing importance of market centers
and recommended that there was a need to foster their
development. The FERC staff believed that market centers were
necessary to facilitate market-driven transactions between buyers
and sellers while at the same time making unnecessary the
---------------
27/ It is estimated that, based on full utilization of released
capacity by replacement shippers, 36% of all gas delivered to
consumers in the U.S. could have moved under short-term
arrangements obtained in the capacity release market. See Energy
Information Administration, "Deliverability on the Interstate
Natural Gas Pipeline System," DOE/EIA-0618(98) (Washington, D.C.,
May 1998), pp. 83 - 85. For a general background discussion of
the developments of short-term gas supply and transportation
markets, see "Regulation of Short-term Natural Gas Transportation
Services," FERC Notice of Proposed Rulemaking, 63 Fed. Reg.
42,982 (July 29, 1998).
28/ Market centers, hubs and pooling areas all serve a similar
purpose, namely, to facilitate transactions between gas buyers
and sellers through information exchanges, physical exchanges of
gas, providing transportation related services (e.g., storage,
parking), the aggregation of supplies by all merchants, etc.
Market centers may or may not be associated with any physical
facilities, but are situated so as to be easily accessed from
many parts of the country. They can be used to arrange storage
or transportation or other ancillary services. Hubs, in
contrast, operate as the physical transfer points where several
different pipelines are interconnected. At a hub, gas can be
physically rerouted from one pipeline to another. Pooling areas,
most often located in production areas, facilitate the
aggregation of supplies from many producers. Title to gas
frequently passes from the producers to the shippers (i.e., LDCs
or other purchasers) in the pooling areas.
29/ "Importance of Market Centers," Office of Economic Policy,
FERC (Washington, DC), August 21, 1991.
24
<PAGE>
construction of additional high-cost facilities. In the view of
the FERC staff, the organization of market centers would (i) help
to eliminate the traditional receipt point inflexibility of the
interstate pipelines by allowing shippers (i.e., buyers and
sellers) to receive and deliver gas at any point on the pipeline
where the receipt and delivery of gas is possible, (ii) provide
better responses to supply disruption, (iii) eliminate
difficulties in reselling long-term contracted gas, and (iv)
foster the development of market intermediaries (brokers and
traders), such as exist in other commodities markets, who would
facilitate transactions among buyers and sellers in the market.
Thus, the development, evolution and operation of market centers
and hubs is at the very heart of the current, and radically
different, "state of the art."
Of particular interest, the FERC staff identified several
natural market centers and hubs which will be instrumental in the
coordination of gas supply between SoCalGas and Frontier. These
include (i) the Blanco, New Mexico, market center near the
San Juan Basin; (ii) the Waha Hubs, near Midland, Texas, formed
at the point where the Transwestern and El Paso pipelines
interconnect with NGPL and numerous intrastate pipelines;
(iii) the Katy Hub, in east Texas; and (iv) the Henry Hub,
located in southern Louisiana.30/ At these market centers and
hubs, gas can be bought, sold, exchanged for gas at another
location, or stored. Services are provided by independent
brokers at such points to arrange deals, and producers or owners
---------------
30/ The FERC staff noted that the Waha hub is located at a point
that is within 70 miles of 2.74 Bcf per day of deliverable gas
production and nearly 1 Bcf per day of peak storage
deliverability. The staff noted that, at the Katy Hub alone, 23
pipelines (including Transco) are interconnected within a radius
of 70 miles of over 12 Bcf per day of deliverable gas production,
and that there is nearly 17 Bcf per day of working storage
capacity at the hub. Finally, at the Henry Hub in South
Louisiana, the staff noted that a total of 28 pipelines
interconnect within 50 miles of more than 19 Bcf per day of
deliverable gas production. See also "North American Gas Market
Centers 1994," produced by Hart's Gas Transactions Report.
25
<PAGE>
of gas at these centers often have significant marketing staffs
to maximize the value and liquidity of the commodity.
Pooling areas facilitate the transfer of title to gas at
both production and market points. Transco, El Paso, and
Transwestern all operate pooling areas on their systems. In
addition to the operation of pooling areas by interstate
pipelines, several marketing companies provide services by which
interested buyers and sellers can exchange gas at such pooling
points for a fee. At some market centers, hub services, such as
parking, loaning, wheeling, and, in some instances, title
transfer, are also available.31/
Why are market centers, hubs and pooling areas so vital to
the current "state of the art?" The importance of these creative
market mechanisms is clear. A producer in one producing basin
may, through such mechanisms, sell gas to a buyer several
pipeline systems away without the payment of additional
transportation costs, thus making gas produced in one basin more
competitive with gas produced in a geographically closer locale.
This represents a significant change from the days throughout
most of the last 50 years when LDCs typically bought all of their
gas at the city-gate from the interconnecting pipeline. As an
example, low cost San Juan Basin gas, combined with its tax
incentives and creative transactional mechanisms, can be priced
cheaper to a market in North Carolina than gas produced in the
Gulf Coast or the Alabama Black Warrior Basin, which are both
---------------
31/ "Parking" is essentially a short-term interruptible storage
service. "Loaning" is a service by which a party with gas will
provide the gas to another party with a specific date for the
return of such gas at either that location or another location
under mutually agreeable terms and conditions (in effect, the
inverse of parking). "Wheeling" is the provision of
transportation by a hub operator from one system to another
system. Finally, title transfer services allow parties to
exchange title to gas that is already within a pipeline system
for gas that is at a different point on the same pipeline system
or for gas that is on another pipeline system. No physical
movement occurs.
26
<PAGE>
physically closer to North Carolina. Such creative arrangements,
however, are dependent upon the existence of significant physical
interconnections and market centers between the production area
and ultimate delivery point. While these conditions may not
currently exist throughout all of the contiguous 48 States, they
do exist throughout the southern tier of States, both west and
east, all of which depend for a large percentage of their total
gas supplies upon production in the Southwest producing basins.
F. The Development of "High Deliverability" Storage.
------------------------------------------------
Another important development in the gas industry is in storage
technology and the development of a market for "un-bundled"
storage services. The ability to store gas has always been
critical to the economic and efficient operation of a gas system
because of the seasonal nature of demand, particularly by
residential customers. Most "seasonal" storage is in depleted
oil and gas fields, such as exist in the Appalachian region. In
the last five years, however, there has been significant new
development of so-called "high deliverability," or salt-dome,
storage caverns, which in some cases are owned and operated
independent of the pipelines. The importance of "high
deliverability" storage is not so much in the absolute volume of
the working storage capacity that they represent, but rather in
their operational characteristics, which allow for rapid
injection and withdrawals of gas ("cycling"). This provides LDCs
with considerably more flexibility in responding to changes in
demand without the need to maintain high inventory levels and
enables LDCs to take advantage of price volatility.32/
---------------
32/ See Energy Information Administration, Natural Gas 1996:
Issues and Trends, DOE/EIA-0560(96) (Washington, D.C., December
1996), p. 15; Energy Information Administration, Natural Gas
Annual - 1996, DOE/EIA-0131(96) (Washington, D.C., September
1997), p. 21.
27
<PAGE>
G. New Pipeline Construction. The nation's interstate
-------------------------
pipeline system, which experienced such dramatic growth in the
decades immediately following World War II, continues to expand
at a significant rate, in terms of both long-haul capacity and
interregional interconnections. Between 1990 and the end of
1997, capacity additions on the long-haul pipeline systems (viz.
the pipelines running from the production areas to end markets)
totaled 12.4 billion cubic feet (Bcf) per day, an increase of
about 17%, while interregional capacity additions totaled 11.4
Bcf per day, or about 15%, in the same period. More than 40
projects were completed in 1997 alone.33/ Several new expansion
projects have been announced to alleviate capacity constraints in
those few areas of the country where they still exist. Moreover,
as previously described, market centers and storage capacity are
becoming increasingly integrated into the pipeline network. In
summing up the current state of the nation's pipeline delivery
system, taking into account completion by the end of the year
2000 of projects that will expand transportation capacity from
the Rocky Mountain, New Mexico, and West Texas producing areas to
Midwest and Northeast markets, the Department of Energy has
observed that "the interstate natural gas pipeline network will
------------------------------------------------
come closer to being a national grid where production from almost
-----------------------------------------------------------------
any part of the country can find a route to customers in almost
---------------------------------------------------------------
any area." (Emphasis added).34/
--------
3.3 The Standards for Approval under Section 10(c).
----------------------------------------------
A. Section 10(c)(1). Section 10(c)(1) provides that the
----------------
Commission may not approve an acquisition that "is unlawful under
the provisions of Section 8 or is detrimental to the carrying out
----------------
33/ See Energy Information Agency, "Deliverability on the
Interstate Natural Gas Pipeline System," DOE/EIA-0618(98)
(Washington, D.C., May 1998), pp. 32 -34.
34/ Id. at p. 34.
28
<PAGE>
of the provisions of Section 11." In this case, the transaction
will not be unlawful under Section 8, as it will not lead to
common ownership of gas and electric properties serving the same
area in North Carolina. Nor will approval of the transaction be
detrimental to the carrying out of the provisions of Section 11,
which provides, in subsection (b)(1) thereof, that every
registered holding company and its subsidiaries shall limit their
operations "to a single integrated public-utility system . . . ."
Section 11(b)(1) permits a registered holding company to own one
or more additional integrated public-utility systems only if the
requirements of Section 11(b)(1)(A) - (C) (the "ABC clauses") are
satisfied. By its terms, however, Section 11(b)(1) applies only
to registered holding companies and therefore does not preclude
the acquisition and ownership of a combination gas and electric
system by an exempt holding company, such as Sempra, whose
ownership of both gas and electric operations in California is
permitted and subject to "affirmative state regulation." See WPL
Holdings, Inc., 40 SEC Docket 491 at 497 (February 26, 1988),
aff'd in part and rev'd in part sub nom., Wisconsin's
Environmental Decade v. SEC, 882 F.2d 523 (D.C. Cir. 1989),
reaffirmed, 49 SEC Docket 1255 (September 18, 1991); Dominion
Resources, Inc., 40 SEC Docket 847 (April 5, 1988). Accordingly,
as long as the acquisition of Frontier by Sempra would have the
integrating tendencies required by Section 10(c)(2), discussed
below, it is of no consequence that other existing properties of
Sempra (e.g., San Diego's electric system) would not form a part
of the same integrated system as Frontier's gas properties.
The Commission has also previously held that a holding
company may acquire utility assets that will not, when combined
with its existing utility assets, make up an integrated system or
comply fully with the ABC clauses, provided that there is de
29
<PAGE>
facto integration of contiguous utility properties and the
holding company is exempt from registration under Section 3(a) of
the Act following the acquisition.35/ In this case, Sempra is
requesting an order exempting it from the registration
requirements under the Act pursuant to Section 3(a)(1). Further,
there is and will continue to be following the transaction de
facto integration of Sempra's gas and electric utility properties
in southern California.
B. Section 10(c)(2). Under Section 10(c)(2), the
----------------
Commission must affirmatively find that the indirect acquisition
of the voting securities of Frontier by Sempra "will serve the
public interest by tending towards the economical and the
efficient development of an integrated public-utility system
. . ., " which, as applied to a gas system, is defined in Section
2(a)(29)(B). The indirect acquisition of Frontier by Sempra will
satisfy the integration standards of Sections 10(c)(2) and
2(a)(29)(B) for all of the following reasons:
. The indirect investment by Sempra in Frontier, and its
ongoing involvement with Frontier's operations, will be
instrumental to the development of a gas utility system
in an area in which natural gas service is not now
available.
. Frontier, SoCalGas and SDG&E will share a "common
source of supply" (the San Juan and Permian Basins) and
will be operated as a "single coordinated system."
. Frontier will achieve "substantial economies" in gas
supply through the increased buying power that it will
attain by being part of the larger Sempra system;
Frontier and its customers will also benefit by gaining
access to expertise and resources available in the
Sempra system in such areas as procurement/materials
management; finance and accounting; and gas system
engineering and construction management.
. Taking into account the current "state of the art": the
area or region served by Sempra's subsidiaries in
California and Frontier will not be "so large as to
impair . . . the advantages of localized management,
efficient operation, and the effectiveness of
---------------
35/ See Sempra Energy, 67 SEC Docket 994 at 998 (June 26,
1998), citing BL Holding Corp., 67 SEC Docket 404 at 408 (May
15, 1998); TUC Holding Co., et al., 65 SEC Docket 301 at 305-306
(August 1, 1997); and Gaz Metropolitain, Inc., 58 SEC Docket 190
at 192 (November 23, 1994).
30
<PAGE>
regulation." To the contrary, the day-to-day
operations of Frontier will be under the direction of
its General Manager. The management of Frontier will
be independent of, but coordinated with (in order to
promote efficient operation), Sempra's other
subsidiaries, and will be subject to effective local
regulation by the NCUC. This project enjoys the strong
support of the NCUC.
. Because of Frontier's size, Sempra will continue to
qualify for exemption under Section 3(a)(1) as an
"intrastate" holding company even after indirectly
acquiring Frontier's voting securities. Under these
circumstances, and because the acquisition of Frontier
will have the integrating features required by Sections
10(c)(2) and 2(a)(29)(B), the Commission should approve
the transaction.
1. Given the Existence of a Common Source of Supply and
----------------------------------------------------
Changes in the State of the Art in the Gas Industry,
----------------------------------------------------
the Commission Should Find that Sempra's Existing
-------------------------------------------------
Subsidiaries and Frontier Together Will Constitute an
-----------------------------------------------------
Integrated Gas System.
---------------------
Although the retail gas service areas of Frontier in
North Carolina and of SoCalGas and SDG&E in California are
separated by a substantial distance and are located in non-
contiguous States, such factors, by themselves, are not
determinative. On the contrary, it is clear that Section
2(a)(29)(B), which defines an "integrated" gas-utility system,
does not require that the States comprising the "single area or
region" even adjoin each other. In MCN Corporation, 62 SEC
Docket 2379 (September 17, 1996), for example, the Commission
approved an acquisition of an interest in a gas-utility company
in Missouri by an exempt gas-utility holding company whose
service area is located more than 500 miles distant in Michigan,
a non-adjoining State. Moreover, Section 2(a)(29)(B)
specifically contemplates that "gas utility companies deriving
natural gas from a common source of supply may be deemed to be
-------------------
included in a single area or region." (Emphasis added). Thus,
-----------------------------------
the Commission was given broad discretion to interpret the
"single area or region" standard in a flexible manner that should
take into account the tremendous changes that have occurred since
31
<PAGE>
1935 in the production and transportation of natural gas.
Likewise, in considering whether an "area or region" is so large
as to impair "the advantages of localized management, efficient
operation, and the effectiveness of regulation . . .," the
Commission is called upon to consider the "state of the art" in
the industry.
Because of the dramatic changes in the "state of the art" in
the gas industry that have taken place in recent years, the
distance between two LDCs has become much less relevant,
particularly when compared to the days when LDCs depended for
their supplies upon essentially local sources or upon the same
interconnecting pipeline, in its merchant capacity. Thus, based
on all of the facts and circumstances of this case, as more fully
developed below, the Commission should conclude that the gas
utility operations of SoCalGas and SDG&E in southern California
and those of Frontier in western North Carolina together will be
"confined to a single area or region in one or more States," and
that such area or region will not be "so large as to impair the
advantages of localized management, efficient operation and the
effectiveness of regulation." It is important to underscore that
such a conclusion is consistent with the literal terms of Section
2(a)(29)(B).
Moreover, in order to make the findings required by Sections
10(c)(2) and 2(a)(29)(B), as applied to the specific facts of
this case, the Commission need not address or decide the broader
question of whether an integrated gas market now exists
throughout all of the 48 contiguous States or even whether every
LDC that purchases its gas from the same supply basin could be
part of one integrated gas system.
Common Source of Supply: Historically, in determining
whether two gas companies share a "common source of supply," the
Commission has attached greatest importance to whether the gas
32
<PAGE>
supply of the two companies is derived from the same gas
producing areas (or basins), recognizing that the most
significant economies and efficiencies that two entities can
achieve is through the coordination and management of gas supply.
The Commission has also considered whether the two entities
receive gas deliveries from a common pipeline. However, the
Commission has properly found an integrated gas system to exist
where two entities take delivery from different pipelines which
originate in the same gas producing area and/or interconnect at
various points along the transportation route. See MCN
Corporation, supra, 62 SEC Docket at 2383-2384; American Natural
Gas Company, et al., 43 S.E.C. 203 at 205-207 n. 5 (1966);
Central Power Company, et al., 8 S.E.C. 425 at 431 (1941). These
decisions, and especially MCN Corporation, reflect the fact that
an LDC's gas supply is no longer purchased at the city-gate from
the interconnecting pipeline. The key factor to be considered by
the Commission, given the current "state of the art," is the
"common source of supply."
As indicated, SoCalGas and SDG&E currently derive
approximately 58% of their combined gas requirements from the
Permian and San Juan Basins. Initially, Frontier's full
requirements will be met by Sempra Trading from production in the
same two supply basins. Long term, it is expected that Frontier
will purchase at least 50% of its gas supplies from these basins.
Further, although SoCalGas and SDG&E and Frontier will take
delivery from different interstate pipelines (Transco in the case
of Frontier and El Paso and Transwestern in the case of SoCalGas
and SDG&E), those pipelines all transport gas that originates in
the Permian and San Juan Basins. The "common source of supply"
33
<PAGE>
is therefore in the Permian and San Juan Basins. In one case,
the method of transportation is Transco, and, in the other case,
El Paso and Transwestern.
The El Paso and Transwestern pipelines transport gas out of
the Permian and San Juan Basins for ultimate consumption in both
California and eastern U.S. markets.36/ Transco's interstate
pipeline does not itself extend into either such basin. However,
it intersects at various points in Texas with intrastate
pipelines (including the Oasis, Valero-TECO and Valero-Lone Star
pipelines), which transport gas from those basins to the Transco
system. San Juan and Permian Basin gas also moves through the
Henry Hub, on the Louisiana Gulf Coast, as well as the Katy Hub
in Texas, where Transco and other pipelines transport it to Mid-
Atlantic and East Coast markets. (See Exhibit E - Map of Gas
Pipelines and Producing Areas). Accordingly, there is
substantial evidence that SoCalGas, SDG&E and Frontier will share
a "common source of supply," roughly equidistant from each of
them.
It should be recognized that the concept of a "common source
of supply" has a very different meaning today than it did in
1935. In 1935 and for most of the 50 years that followed, LDCs
generally purchased natural gas at the city-gate directly from
the interstate pipeline that served them at FERC (and earlier
FPC) approved wholesale rates that reflected both the cost of the
commodity and the related cost of transportation. Hence, two
---------------
36/ In recent years, although production in the San Juan area
has increased significantly, the demand for both San Juan and
Permian Basin gas at the California border has declined due, in
part, to the increased availability in California of cheaper gas
from western Canada and the Rocky Mountain region. However, the
decline in demand for Permian and San Juan Basin gas in the
California market, which has led to significant capacity "turn-
backs" on the El Paso and Transwestern systems, has been largely
offset by growing demand elsewhere, primarily in eastern U.S.
markets. To meet this demand, El Paso and Transwestern have both
sought and received certificate authority from the FERC under
Section 7 of the NGA for expansions in the San Juan area that now
provide much better access from the eastern ends of their
respective systems to various market centers and hubs in Texas,
from which gas can be shipped to eastern U.S. markets. See El
Paso Natural Gas Company, 70 FERC P 61,295 (1995); Transwestern
Pipeline Company, 75 FERC P 61,107 (1996).
34
<PAGE>
LDCs serving non-contiguous areas could in most instances
demonstrate that they shared a "common source of supply" only if
they purchased their gas from the same pipeline, in its capacity
as both gas merchant and transporter. LDCs did not, and in most
instances could not, purchase their gas in upstream markets and
arrange separately with the pipeline for transportation. The
"single area or region" served was therefore defined in terms of
the pipeline delivery points (i.e., the city-gate), where the
LDCs purchased their gas, rather than in terms of the upstream
gas production areas or pipeline receipt points.
In contrast, today, most LDCs do not purchase their gas
supply from the pipeline serving them. Instead, LDCs, and many
industrial customers as well, purchase gas directly from
producers (or independent marketers or other middlemen), and
contract separately for transportation on the pipeline that
serves them, as well as on other upstream pipelines that
transport gas out of the producing basins.37/ Although
transportation costs and pipeline capacity constraints are
economic factors which may limit an LDC's ability to contract for
gas produced in any particular supply basin, the legal
impediments no longer exist, and LDCs, no matter where they are
located, are entitled to non-discriminatory transportation
service. The transportation arrangements entered into by two
different LDCs are unimportant for purposes of determining
whether or not they share a "common source of supply," inasmuch
as the pipelines that serve them are no longer the suppliers in
any event. The relevant inquiry should instead be whether the
two LDCs purchase substantial quantities of gas produced in the
same supply basins, and whether that gas is "deliverable" (i.e.,
---------------
37/ By 1995, the Department of Energy could report that
interstate pipeline gas sales were "virtually non-existent," and
that transportation (as opposed to sales) accounted for 74% of
all deliveries to industrial customers by local companies (LDCs
and intrastate pipelines). See Energy Information
Administration, Natural Gas 1996: Issues and Trends, DOE/EIA-
0560(96) (Washington, D.C., December 1996), p. 17.
35
<PAGE>
whether there is sufficient transportation capacity available in
the marketplace to assure delivery on an economic and reliable
basis).38/
State of the Art in the Gas Industry: As previously
described, the natural gas industry has undergone fundamental
changes, with the pronounced trend in the past decade towards
increased competition in gas supply and the development of a
seamless natural gas delivery system throughout most of the
United States.39/ This trend is the direct result of several
developments, including, most importantly, de-control of gas
prices at the well-head; the "un-bundling" of the commodity and
transportation functions of interstate pipelines; the
construction of significant new pipeline capacity, which has
eliminated transportation bottlenecks in most parts of the
country; the emergence of gas brokers and marketers and
development of an efficient gas futures market, which now enable
LDCs and other large gas purchasers to manage price volatility
and secure gas supplies without regard to its physical source;
and increased inter-basin competition for sales to the market,
due in part to the effects of imports into the U.S. of low-cost
Canadian gas.40/ It is important to stress that the paradigm for
---------------
38/ "Deliverability" may be defined in terms of the physical
capacity of the U.S. natural gas pipeline network, as well as of
the contractual structure governing the transportation of gas on
that system, which is largely the product of Order No. 636. See
Energy Information Administration, "Deliverability on the
Interstate Natural Gas Pipeline System," DOE/EIA-0618(98)
(Washington, D.C., May 1998), p. 79.
39/ As previously indicated, although there is substantial
evidence that a fully integrated natural gas market now exists
throughout most of the United States, that is not a question that
this Commission would need to address in order to make the
findings required by Sections 10(c)(2) and 2(a)(29)(B), as
applied to the specific facts of this case.
40/ Canadian production, as a percentage of total U.S.
consumption, increased in each of the ten years prior to 1996.
In 1995, net imports of gas (mostly from Canada) accounted for
13% of all U.S. consumption. The western region of the U.S.
received by far the largest share (41%) of all Canadian imports.
See Energy Information Administration, Natural Gas Monthly,
DOE/EIA-0130(96/10) (Washington, D.C., November 1996).
36
<PAGE>
the gas industry today is fundamentally and irreversibly
different than earlier this century.
The Commission has already taken notice of these and other
regulatory and technological changes that have reshaped the
natural gas industry. See "The Regulation of Public-Utility
Holding Companies," Report of the Division of Investment
Management (June 1995), pp. 29 - 31. In light of such changes,
the Division of Investment Management has recommended that the
Commission continue to interpret the "single area or region"
requirement of Section 2(a)(29) flexibly to take into account
technological advances, and that the focus of the SEC's inquiry
under Section 10(c)(2) should be on whether a proposed
acquisition would promote the economic and efficient development
of a utility system and on whether the resulting system would be
subject to effective regulation. Id. at 72 -74.
As discussed above, the traditional source of supply for
both California and the Mid-Atlantic states is in the producing
basins in the Southwest. The primary producing basins in the
Southwest that can be accessed by both the Mid-Atlantic region
and California include the Permian and San Juan Basins. Today,
because LDCs in most States (including California and North
Carolina) can purchase gas in these Southwest producing basins
(or purchase gas pegged to production in those areas) from a
producer or marketer at the city-gate off of the interstate
pipeline system, there is significant competition for markets
between producers in the San Juan and Permian Basins and
producers in other U.S. and Canadian basins. For the California
market, for example, gas produced in western Canada and the
Overthrust producing areas in the Rocky Mountain region now
provides stiff competition for the Southwest basin supplies.
This basin-to-basin competition and the development of additional
37
<PAGE>
interstate pipeline capacity through the construction of the Kern
River pipeline and the expansion of Pacific Gas Transmission
Company and Northwest Pipeline Corporation from Canada have, in
fact, caused 2 Bcf/day of excess pipeline capacity to the
California market.
The competition for the California market by other producing
basins and pipelines was directly responsible for significant
"turn-backs" on the El Paso and Transwestern systems in the mid-
1990s.41/ It was in response to this competition and the need to
find new customers for the "turned-back" capacity that El Paso
and Transwestern have both expanded their systems out of the San
Juan Basin in order to move gas to eastern markets, such that,
today, there are periods when the net flow of gas out of the San
Juan Basin is to the east rather than to the west. These actions
were also driven by certain operational characteristics of San
Juan Basin production which require producers to maintain high
production levels without regard to demand in the California
market.42/ Further, El Paso and Transwestern have incentives to
discount transportation for gas transported to new markets in the
---------------
41/ Under Order No. 636, the "restructuring rule," the "firm"
sales contracts between a pipeline and its customers were
converted into the rights to receive "firm" transportation. As
these "firm" transportation contracts expire, however, some LDCs
will elect to reduce or release that "firm" capacity that they
previously reserved. Such capacity "turn-backs" have led to the
situation in some parts of the country where available "firm"
pipeline capacity exceeds customer commitments. Unless a
pipeline can remarket "turned-back" capacity, it faces a
potential loss of revenues. Following the adoption of Order No.
636, two of the largest capacity "turn-backs" were on the El Paso
and Transwestern systems. As indicated, those companies
responded to this situation by altering the utilization of
existing pipeline capacity to move gas out of the Southwest
producing areas to eastern markets, where such gas would be
competitive with other available supplies. For a more detailed
of discussion of the impact of pipeline capacity releases and the
industry's response, see Energy Information Administration,
Natural Gas 1996: Issues and Trends, DOE/EIA-0560(96)
(Washington, D.C., December 1996), ch. 2.
42/ San Juan Basin gas is produced from coal seam formations.
The technology used to produce gas from coal seam formations
requires maintaining a steady state of production. The
significant tax benefits granted to coal seam gas is an
additional incentive for maintaining high production levels.
38
<PAGE>
east, thus limiting delivery costs. As a result, San Juan Basin
gas can be priced at a rate below its competitors in most other
basins even with additional delivery costs.
The Attorney General of the State of California addressed
the integrated pipeline market from an economic perspective in
its Opinion on Competitive Effects of Proposed Merger between
Pacific Enterprises and Enova Corporation, submitted to the
California Public Utilities Commission ("CPUC") on November 20,
1997.43/ The Attorney General used a correlation and
co-integration analysis to determine that FERC actions have
created a network of transmission suppliers connecting purchasers
at the wholesale level with middlemen and well operators at the
production level. The Attorney General concluded that, from an
economic perspective, markets are integrated where the price of
supplies remain closely linked (taking into account
transportation and other transaction costs) and that there is
"direct" evidence that prices at delivery points within the four
basin area (including the Permian and San Juan Basins) remain
co-integrated within arbitrage bounds on a nearly national grid
basis.
Due to the restructured natural gas transportation market,
gas can be moved from the San Juan and Permian Basins to both
California and North Carolina physically as well as contractually
in a variety of ways. As discussed above, both Transwestern and
El Paso access the Permian and San Juan Basins and have
traditionally moved their gas west to California. SoCalGas is
the largest holder of capacity on both of those systems and
purchases a significant portion of its supply portfolio from
those two basins. However, as indicated, natural gas from the
---------------
43/ The Attorney General's Opinion has been filed as Exhibit D-9
in File No. 70-9033.
39
<PAGE>
San Juan and Permian Basins also moves east and north to serve
Midwest and Mid-Atlantic markets.
Both El Paso and Transwestern interconnect at numerous
points in West Texas with major intrastate Texas pipelines
including the Valero, Oasis, and other pipelines. Through these
intrastate pipelines, gas is physically transported to the
eastern half of the State of Texas where the intrastate pipelines
connect with, among others, Transco. Thus, gas can and does
physically flow from the Southwest producing basins which provide
the principal supply of gas to SoCalGas and to the developing
North Carolina market represented by Frontier.44/
While physical delivery is possible from the common supply
basins to both SoCalGas and Frontier, more flexible and efficient
transactions are available utilizing marketing tools created by
the FERC in Order No. 636. As previously indicated, one of the
more important outgrowths of FERC Order No. 636 has been the
development of market centers, hubs and pooling points, which
allows LDCs operating in a much larger area or region of the
country to realize the operating economies and efficiencies from
coordinated gas supply that were once thought to be achievable
only by contiguous or nearly contiguous gas companies supplied by
the same interstate pipelines. In fact, the opportunities to
achieve operating economies may be even greater where the two
companies seeking to combine have significantly different load
profiles (e.g., non-coincident seasonal peaks, substantially
different customer mix, different projected growth patterns,
etc.).
---------------
44/ Further, El Paso and Transwestern interconnect with NGPL,
the first major interstate pipeline company constructed in the
United States, in west Texas through NGPL's major western
trunkline. NGPL also accesses Gulf Coast reserves through its
eastern trunkline which is connected by a major crossover through
Oklahoma and north Texas to its western trunkline. On its
eastern trunkline, NGPL interconnects at two points with Transco.
40
<PAGE>
2. Coordinated Operation of Gas Properties.
---------------------------------------
As described in Item 1.3, above, Frontier initially
will purchase all of its gas requirements from Sempra Trading
from gas sourced in the Permian and San Juan Basins. Sempra
Trading will also manage Frontier's gas transportation and
storage arrangements. In this regard, it is important to note
that Sempra Trading holds capacity on the Transco system and is
among the largest purchasers of hub services (i.e., parking,
loaning and wheeling) from SoCalGas. Hence, through Sempra
Trading, Frontier will have access to a complete portfolio of gas
supply, transportation, storage and related services. In
addition, Sempra Ventures, SoCalGas and SDG&E plan to provide
various other types of administrative, technical and operating
services to Frontier. These arrangements are indistinguishable
from those that the Commission considered in MCN Corporation.
Sempra Trading also sells significant volumes of gas to
SoCalGas and SDG&E and to their respective transportation-only
customers,45/ most of which it purchases in the San Juan and
Permian Basins. Since January 1, 1997, Sempra Trading (and its
predecessor, AIG Trading Corp.) has sold approximately 22 million
MMBtu of gas directly to SoCalGas, and several times that amount
to transportation-only customers of SoCalGas. Although this
accounts for only a small percentage of the total through-put on
the SoCalGas system (930 Bcf in 1997), it represents, by
comparison, several times the estimated volumes of gas that will
be required by Frontier when its system is fully developed. In
the future, Sempra Trading will be able to achieve substantial
economies by coordinating gas purchases in the two supply basins
---------------
45/ In 1997, 65% of all gas delivered on the SoCalGas system was
customer-owned. SoCalGas only provides the transportation
service for these customers. Sempra Trading, which is based in
San Diego, has aggressively pursued this market segment.
41
<PAGE>
to meet the combined requirements of its three public utility
affiliates, as well as of its other customers. Further, SoCalGas
and SDG&E will continue to purchase significant volumes of gas
from Sempra Trading to the extent that Sempra Trading is able to
supply such gas at the lowest price then available to SoCalGas
and SDG&E in the marketplace.
In MCN Corporation, it was indicated that CoEnergy Trading
Company, MCN Corporation's gas marketing subsidiary, which
already provided a portion of the gas requirements of the smaller
of MCN Corporation's two gas utility subsidiaries in Michigan,
also intended to supply a portion of the needs of the new
partnership being formed in Missouri at such time as the gas
purchasing needs of the partnership became significant enough for
economic efficiencies to arise by having CoEnergy Trading Company
buy gas on its behalf.46/ The Commission held in MCN Corporation
that these arrangements were sufficient to satisfy the "single
coordinated system" requirement of Section 2(a)(29)(B).47/ In
the present case, Sempra Trading initially will supply Frontier's
full requirements from gas sourced in the San Juan and Permian
Basins at delivered prices which include transportation cost,
transaction costs and balancing services required to meet all
daily, monthly, and seasonal load swings. Although Frontier
(like the new partnership in MCN Corporation) will always be able
to purchase gas from unaffiliated suppliers in the future, it is
anticipated that, because Sempra Trading purchases significant
quantities of gas in the Permian and San Juan Basins for sale to
existing customers in both California and the mid-Atlantic
---------------
46/ See MCN Corporation, 62 SEC Docket at 2382, n. 6
47/ Id. at 2384.
42
<PAGE>
region, including SoCalGas and SDG&E, and holds capacity on the
Transco system, it will be able to achieve substantial economies
by combining the needs of Frontier with those of SoCalGas and
SDG&E and their respective transportation-only customers that
Sempra Trading now serves.
Finally, the operations of Sempra's three public utility
subsidiaries will be coordinated through joint planning and the
free exchange of ideas and information that customarily takes
place in any corporate family. In particular, it is expected
that Frontier personnel will have ready access to personnel of
SoCalGas and SDG&E through routine daily communications, joint
management meetings, system-wide training programs and the like.
While the frequency and importance of such intra-system contacts
are difficult to estimate, it is nevertheless predictable that,
over time, Frontier will become fully integrated into the
corporate culture created by Sempra.
3. Frontier will Realize Significant Economies and
-----------------------------------------------
Efficiencies from its Affiliation with the Much Larger
------------------------------------------------------
Sempra System.
-------------
Section 10(c)(2) requires that the Commission find that
a proposed acquisition will produce economies and efficiencies.
Although some of the anticipated economies and efficiencies will
be fully realized in the longer term, they are properly
considered in determining whether the standards of Section
10(c)(2) are met. See American Electric Power Co., 46 SEC 1299,
1320-21 (1978). Further, although some potential benefits cannot
be precisely estimated, they too are entitled to consideration.
As the Commission has stated, "[s]pecific dollar forecasts of
future savings are not necessarily required; a demonstrated
potential for economies will suffice even when these are not
precisely quantifiable." Centerior Energy Corp., 35 SEC Docket
769 at 775 (April 29, 1986). Finally, there is no requirement in
Section 10(c)(2) that the specific dollar estimates of future
43
<PAGE>
savings be large in relation to the gross revenues of the
companies involved. See American Natural Gas Company, supra, 43
S.E.C. at 206-207.
In this case, there can be little doubt that significant
benefits will be realized by Frontier as a result of becoming a
part of the much larger Sempra system, particularly in the areas
of gas supply, increased purchasing power, and the ability to
utilize the expertise and resources available from Sempra's other
subsidiaries. Exhibit I hereto outlines specific areas in which
the affiliation of Frontier with Sempra is likely to produce
substantial economies and efficiencies over time, and dollar
estimates of such savings. Sempra has estimated that Frontier
will realize total start-up cost savings of $1.8 million due to
its integration into the Sempra system and ongoing annual
operating cost savings of at least $300,000 per year. On a
yearly basis, Sempra estimates that Frontier will save
approximately 19% on its operating costs due to the affiliation.
The total estimated savings are quite significant relative to the
size of the transaction. Projected annual operating savings
appear to be greater than those in the SEC's MCN Corporation
decision, which involved an investment in a gas system of roughly
comparable size to the Frontier system.
It should be emphasized that the savings that will be
realized by Frontier will not be at the expense of California
utility customers of SoCalGas and SDG&E. In this connection, the
CPUC recently adopted affiliate transaction rules that permit
corporate support services provided both to a California utility
and to its affiliates, including affiliates outside California.
See Opinion Adopting Standards of Conduct Governing Relationships
Between Utilities and Their Affiliates, CPUC Decision No. 97-12-
088, 1997 Cal. PUC LEXIS 1139 (December 16, 1997). For example,
the CPUC rule permits such shared services as: payroll, taxes,
44
<PAGE>
shareholder services, insurance, financial reporting, financial
planning and analysis, corporate accounting, corporate security,
human resources (compensation, benefits, employment policies),
employee records, regulatory affairs, lobbying, legal, and
pension management. Decision No. 97-12-088, App. A, mimeo, p.
11. All of the services described on Exhibit I are permitted
under the CPUC's rules. To ensure that the use of shared
services does not result in cross-subsidization, the CPUC
specifically required that "[a]ny shared support shall be priced,
reported and conducted in accordance with the Separation and
Information Standards set forth herein, as well as other
applicable Commission Pricing and Reporting requirements." Id.
In the same decision, the CPUC adopted extensive accounting rules
to prevent cross-subsidization. Id. at 14.
In addition to the specific estimates of savings that are
provided above, Frontier will also avoid the cost of hiring the
five to eight gas buyers/capacity specialists who would be needed
if Frontier were to internalize the gas procurement function
rather than contract with Sempra Trading for its full
requirements and related services (i.e., scheduling nominations
and balancing services). The cost of hiring five trained
specialists, plus a secretary, including all payroll overheads,
would conservatively aggregate at least $750,000 per year.
Although there is obviously an offsetting cost associated with
outsourcing the gas procurement function to Sempra Trading, it is
believed that Frontier will achieve a significant net benefit
from the arrangements contemplated.
4. The System Formed by the Affiliation of Sempra and
--------------------------------------------------
Frontier will not be So Large as to Impair the
----------------------------------------------
Advantages of Localized Management, Efficient
---------------------------------------------
Operation, and the Effectiveness of Regulation.
----------------------------------------------
45
<PAGE>
The resulting integrated gas system to be formed by adding
Frontier's gas system to the substantially larger SoCalGas and
SDG&E systems will not be "so large as to impair (considering the
state of the art and the area or region affected) the advantages
of localized management, efficient operation, and the
effectiveness of regulation." As in MCN Corporation, this case
involves the development and financing of a small, start-up, gas
distribution system designed to serve a predominantly rural
population. As described in greater detail in Item 1.3, the day-
to-day operations of Frontier will be under the direct
supervision of its General Manager. Its operations, however,
will be coordinated with those of SoCalGas and SDG&E in order to
provide operating efficiencies and savings. Local regulation is
and will continue to be effective. In fact, every aspect of
Frontier's development and financing has been or will be
specifically considered by the NCUC, beginning with the NCUC's
selection of Frontier's proposal for the new gas system over a
competing proposal submitted by an existing North Carolina gas
company. While Sempra will bring to the table much needed
skills and expertise in the areas of construction and gas supply
management, pipeline technology and maintenance, procurement,
operating expertise, and marketing, among others, Frontier will
maintain its separate corporate identity and local presence and
have its own management and work force.
5. The Indirect Acquisition of Frontier's Voting
---------------------------------------------
Securities Will Have No Effect on Sempra's Current
--------------------------------------------------
Exemption under Section 3(a)(1).
-------------------------------
Frontier will be a small utility compared to SoCalGas and
SDG&E and will account for only a de minimis amount of Sempra's
income. (see fn. 14, above). The acquisition and ownership of
46
<PAGE>
its voting securities by Sempra will therefore have no impact on
the continuing entitlement of Sempra to its exemptions under
Section 3(a)(1) of the Act. Given that there is substantial
evidence that the acquisition will have integrating features
(e.g., common source of supply, local management, realization of
substantial economies and efficiencies through coordinated
operation, strong local support and effective local regulation)
and that exempt holding companies, like Sempra, are not subject
to the strict integration standards of Section 11(b)(1), the
Commission should have little reason to interpret the integration
standards of Section 10(c)(2) and Section 2(a)(29)(B), as applied
to this transaction, in a narrow or restrictive manner. In other
recent cases involving acquisitions by exempt holding companies,
such as Gaz Metropolitan, Inc., et al., TUC Holding, et al., and
MCN Corporation, the Commission has exhibited a willingness to
interpret the integration standards of Section 10(c)(2) flexibly,
focusing instead on the demonstrated benefits of the transaction
from the perspectives of both investors and consumers. It should
do the same here.
3.4 Section 10(b).
-------------
Section 10(b) provides that, if the requirements of Section
10(f) are met, then the Commission shall approve a proposed
acquisition unless it finds that the transaction would have any
one of several enumerated adverse effects. In this case, there
is no basis for the Commission to make any adverse findings under
Section 10(b).
A. Section 10(b)(1). Section 10(b)(1) was intended to
----------------
avoid "an excess of concentration and bigness" in the utility
industry at the expense of competition while preserving the
"opportunities for economies of scale, the elimination of
duplicative facilities and activities, the sharing of production
capacity and reserves and generally more efficient operations"
47
<PAGE>
afforded by certain acquisitions. See American Electric Power
Co., Inc., 46 S.E.C. 1299, 1309 (1978). The transaction proposed
herein will not add meaningfully to the size of Sempra, which is
much larger than Frontier and will derive only a de minimis part
of its income from Frontier's operations. The approximately
15,000 residential, industrial and commercial customers that
Frontier projects having at the end of its fifth year of
operation represents about one-quarter of 1% of the approximately
6 million retail and industrial gas customers (including
transportation-only customers) that SoCalGas and SDG&E now serve
in California. On the other hand, the transaction will benefit
Frontier's customers and create a modestly larger and more
diverse asset and customer base, which will create opportunities
for operating efficiencies.
Further, although the transaction proposed herein will
result in creating a link between SoCalGas and SDG&E, on the one
hand, and Frontier, on the other, it will not lead to the type of
concentration of control over utilities, unrelated to operating
efficiencies, that Section 10(b)(1) was intended to prevent.48/
In fact, far from limiting or restricting competition, the
transaction proposed herein is the outgrowth of proceedings in
North Carolina in which the NCUC carefully evaluated competing
proposals to construct and operate a gas system in the Four-
County Area. Finally, although the management interlocks that
will be created are necessary and desirable in order to integrate
Frontier fully into the Sempra system, Frontier will have its own
local management team and work force.
---------------
48/ See Section 1(b)(4) of the Act (finding that the public
interest and interests of consumers and investors are adversely
affected "when the growth and extension of holding companies
bears no relation to economy of management and operation or the
integration and coordination of related operating properties . .
. .").
48
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B. Section 10(b)(2). The Commission may not approve the
----------------
proposed transaction if it determines pursuant to Section
10(b)(2) that the consideration (including fees and expenses of
the transaction) to be paid, indirectly, by Sempra in connection
with the transaction is not reasonable or does not bear a fair
relation to investment in and earning capacity of the utility
assets underlying the securities being acquired. In this case,
the equity investments by Frontier Pacific and Frontier Utilities
in Frontier, a newly-formed entity with no preexisting business,
have been expressly approved by the NCUC, which has also
conducted extensive hearings on the overall economic feasibility
of Frontier at the rates and rate design proposed by Frontier.
The amounts to be invested were the result of direct, arms'-
length, negotiations between private investors, and no fees to
outside investment bankers will be paid.
C. Section 10(b)(3). Section 10(b)(3) requires the
----------------
Commission to determine whether the transaction will unduly
complicate the capital structure of Sempra or will be detrimental
to the public interest, the interest of investors or consumers or
the proper functioning of the Sempra holding company system. The
intent of these requirements is to assure the financial soundness
of the holding company system, with particular regard to the
proper balance of debt and equity.
The transaction proposed herein will have a virtually
undetectable impact on the capitalization and earnings of Sempra,
and will not introduce any complexity into Sempra's capital
structure. With regard to the latter, the debt and other
obligations incurred or to be incurred by Frontier will not be
recourse, directly or indirectly, to either SoCalGas or SDG&E.
49
<PAGE>
Moreover, as set forth more fully in the discussion of the
standards of Section 10(c)(2), supra, and elsewhere in this
Application or Declaration, the transaction will create
opportunities for Frontier to achieve substantial savings,
chiefly in the areas of coordinated gas supply and economies
associated with greater buying power and the availability of
managerial and technical expertise that will be needed by
Frontier. The transaction will therefore be in the public
interest and the interest of investors and consumers, and will
not be detrimental to the proper functioning of the resulting
holding company system.
3.5 Section 10(f).
-------------
Frontier has obtained the required NCUC approvals for the
equity investment by Frontier Pacific. The requirements of
Section 10(f) have therefore been satisfied.
ITEM 4. REGULATORY APPROVALS.
--------------------
The construction and financing of Frontier's gas
distribution system is subject to the jurisdiction of the NCUC,
which has issued various approvals referred to in Item 1. No
other State or Federal commission has jurisdiction over any
aspect of the transaction.
ITEM 5. PROCEDURE.
---------
The Commission has published a notice under Rule 23 with
respect to the filing of this Application or Declaration, and no
hearing has been requested. Sempra and Frontier Pacific request
that the Commission's Order be issued as soon as practicable, and
that there should not be a 30-day waiting period between issuance
of the Commission's order and the date on which the order is to
become effective. Sempra and Frontier Pacific hereby waive a
50
<PAGE>
recommended decision by a hearing officer or any other
responsible officer of the Commission and consent that the
Division of Investment Management may assist in the preparation
of the Commission's decision and/or order, unless the Division
opposes the Transaction.
ITEM 6. EXHIBITS AND FINANCIAL STATEMENTS.
---------------------------------
(Previously filed, except as noted).
A - EXHIBITS.
--------
A-1 Articles of Organization of Frontier Energy LLC.
A-2 Operating Agreement of Frontier Energy LLC.
D-1 Application of Frontier Utilities of North
Carolina and Frontier Energy LLC for Approval of
Final Financing Plan, to Transfer Certificates,
and for Approval of Waiver of Security Bond (NCUC
Docket Nos. G-38, Sub. 3 and G-40).
D-2 Order of the NCUC in Docket Nos. 38, Sub. 3, and
G-40, dated March 9, 1998.
E Map of natural gas service areas of SoCalGas,
SDG&E and Frontier, common supply basins, major
interstate pipelines and market centers and hubs.
(Paper format filing).
F-1 Opinion of counsel to Sempra Energy. (Filed
herewith).
F-2 Opinion of special North Carolina counsel to
Sempra Energy. (Filed herewith).
H Proposed form of Federal Register notice.
I Description of Economies and Efficiencies and
Estimated Dollar Savings.
B. FINANCIAL STATEMENTS.
--------------------
FS-1: Pacific Enterprises Consolidated Balance
Sheet as of March 31, 1998 (incorporated by
reference to the Quarterly Report on Form
51
<PAGE>
10-Q of Pacific Enterprises for the fiscal
quarter ended March 31, 1998, in File No. 1-
0040).
FS-2: Enova Corporation Consolidated Balance Sheet
as of March 31, 1998 (incorporated by
reference to the Quarterly Report on Form 10-
Q of Enova Corporation for the fiscal quarter
ended March 31, 1998, in File No. 1-11439).
FS-3: Pacific Enterprises Consolidated Statement of
Income for the quarter ended March 31, 1998
(incorporated by reference to the Quarterly
Report on Form 10-Q of Pacific Enterprises
for the fiscal quarter ended March 31, 1998,
in File No. 1-0040).
FS-4: Enova Corporation Consolidated Statement of
Income for the quarter ended March 31, 1998
(incorporated by reference to the Quarterly
Report on Form 10-Q of Enova Corporation for
the fiscal quarter ended March 31, 1998, in
File No. 1-11439).
ITEM 7. INFORMATION AS TO ENVIRONMENTAL EFFECTS.
---------------------------------------
The transaction does not involve a "major federal action"
nor will it "significantly affect the quality of the human
environment" as those terms are used in section 102(2)(C) of the
National Environmental Policy Act. The transaction that is the
subject of this Application or Declaration will not result in
changes in the operation of the Applicants or their respective
subsidiaries that will have an impact on the environment. The
Applicants are not aware of any federal agency that has prepared
or is preparing an environmental impact statement with respect to
the transaction.
52
<PAGE>
SIGNATURE
Pursuant to the requirements of the Public Utility Holding
Company Act of 1935, as amended, the undersigned companies have
duly caused this statement filed herein to be signed on their
behalf by the undersigned thereunto duly authorized.
SEMPRA ENERGY
By: /s/ Warren I. Mitchell
-----------------------
Name: Warren I. Mitchell
Title: Group President -
Regulated Business Units
FRONTIER PACIFIC, INC.
By: /s/ Eric B. Nelson
------------------
Name: Eric B. Nelson
Title: President
Date: October 30, 1998
53
<PAGE>
EXHIBIT INDEX
Exhibit Description
------- -----------
F-1 Opinion of counsel to Sempra Energy.
F-2 Opinion of special North Carolina counsel to
Sempra Energy.
Exhibit F-1
October 30, 1998
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Sempra Energy, et al.
Application on Form U-1
SEC File No. 70-9333
Dear Ladies and Gentlemen:
On behalf of Sempra Energy and Frontier Pacific, Inc. (jointly, the
"Applicants"), I have examined the Application on Form U-1, dated July 17, 1998,
under the Pubic Utility Holding Company Act of 1935 (the "Act"), filed by the
Applicants with the Securities and Exchange Commission (the "Commission") and
docketed by the Commission in SEC File No. 70-9333, as amended by Amendment No.
1, dated October 30, 1998, of which this opinion is to be a part. The
Application, as so amended, is hereinafter referred to as the "Application."
Capitalized terms not defined herein have the meanings set forth in the
Application.
As set forth in the Application, the Applicants propose to acquire
directly or indirectly up to 90.1% of the membership interests of Frontier
Energy LLC ("Frontier"), which will become a "gas utility company" within the
meaning of the Act (the "Proposed Transaction").
I am an attorney licensed in the State of California and am counsel for
the Applicants. I am familiar with the issuance of securities by Sempra Energy
and its associate companies. I have examined copies, signed, certified or
otherwise proven to my satisfaction, of the Application. In addition, I have
examined such other instruments, agreements and documents and made such other
investigation as I have deemed necessary as a basis for this opinion.
For the purposes of the opinions expressed below, I have assumed
(except, and to the extent set forth in my opinions below, as to the Applicants)
that all of the documents referred to in this opinion letter will have been duly
authorized, executed and delivered by, and will constitute legal, valid, binding
and enforceable obligations of, all of the parties to such documents, that all
such signatories to such documents will have been duly authorized, that all such
parties are duly organized
<PAGE>
Page 2
and validly existing and will have the power and authority (corporate,
partnership or other) to execute, deliver and perform such documents and that
such authorization, execution and delivery by each such party will not, and such
performance will not, breach or constitute a violation of any law of any
jurisdiction. Based upon the foregoing, I am of the opinion, insofar as the laws
of California are concerned that:
(a) all California laws applicable to the Proposed Transaction
will have been complied with.
(b) Sempra Energy is a corporation validly organized and duly
existing under the laws of the State of California.
(c) The Applicants will legally acquire the membership interests
of Frontier being acquired.
(d) Consummation of the Proposed Transaction will not violate
the legal rights of the holders of any securities issued by the Applicants or
any associate company thereof.
The opinion expressed above are subject to the following assumptions or
conditions:
(a) The Commission shall have duly entered an appropriate order
or orders granting and permitting the Application to become effective with
respect to the Proposed Transaction.
(b) The Proposed Transaction shall be effected in accordance
with required approvals, authorizations, consents, certificates and orders of
any state or federal commission or regulatory authority with respect to the
Proposed Transaction and all such required approvals, authorizations, consents,
certificates and orders shall have been obtained and remain in full force and
effect.
I hereby consent to the filing of this opinion as an exhibit to the
Application and in any proceedings before the Commission that may be held in
connection therewith.
Sincerely
/s/ Donald C. Liddell
Donald C. Liddell
DCL/mrr
EXHIBIT F-2
{Kilpatrick Stockton LLP letterhead}
October 30, 1998
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
RE: SEMPRA ENERGY, ET AL.
APPLICATION ON FORM U-1
SEC FILE NO. 70-9333
Dear Ladies and Gentlemen:
On behalf of Sempra Energy and the Applicant Frontier Pacific, Inc.
(jointly, the "Applicants"), we have examined the Application on From U-1, dated
July 17, 1998, under the Public Utility Holding Company Act of 1935 (the "Act"),
filed by the Applicants with the Securities and Exchange Commission (the
"Commission") and docketed by the Commission in SEC file No. 70-9333, as amended
by Amendment dated October30, 1998, of which this opinion is to be a part. The
Application, as so amended, is hereinafter referred to as the "Application".
Capitalized terms not defined herein have the meanings set forth in the
Application.
As set forth in the Application, the Applicants propose to acquire up
to 90.1% of the membership interest of Frontier Energy, LLC ("Frontier") which
will become a "gas utility company" within the meaning of the Act (the "Proposed
Transaction").
The attorneys signing this letter on behalf of Kilpatrick Stockton LLP
are attorneys licensed in the State of North Carolina and are counsel for the
Applicants regarding state regulatory matters. We have examined copies, signed,
certified or otherwise proven to my satisfaction, of the Application. In
addition, we have examined such other instruments, agreements and documents and
made such other investigation related to North Carolina state approvals,
certificates, and licenses as we have deemed necessary as a basis for this
opinion. We have also relied upon representations and statements of officials
and agents of Sempra Energy and Frontier Utilities of North Carolina, Inc.
regarding the Proposed Transaction that is the subject of the Application.
For the purposes of the opinions expressed below, we have assumed
(1)(a) that all of the documents referred to in this opinion letter will have
been duly authorized, executed and delivered by, and (b) will constitute legal,
valid, binding and enforceable obligations of all of the parties to such
<PAGE>
Securities and Exchange Commission
October 30, 1998
Page 2
documents, (2) that all such signatories to such documents will have been duly
authorized, (3) that all such parties are duly organized and validly existing
and will have the power and authority (corporate, partnership or other) to
execute, deliver and perform such documents, and (4)(a) that such authorization,
execution and delivery by each such party will not, and (b) that such
performance pursuant to such documents will not, breach or constitute a
violation of any laws of any jurisdiction. Based upon the foregoing, we are of
the opinion, insofar as the laws of North Carolina are concerned, that:
(a) All North Carolina laws applicable to the Proposed
Transaction will have been complied with.
(b) Frontier Energy, LLC and Frontier Pacific, Inc. are validly
organized and duly existing.
(c) The Applicants will legally acquire the membership interests
being acquired.
(d) Consummation of the Proposed Transaction will not violate
the legal rights of the holders of any securities issued by the Applicants or
any associate company thereof, to the extent any such rights are subject to
North Carolina law.
The opinions expressed above are subject to the following assumptions
or conditions:
a. The Commission shall have duly entered an appropriate order
or orders granting and permitting the Application to become effective with
respect to the Proposed Transaction.
b. The Proposed Transaction shall be effected in accordance
with required approvals, authorizations, consents, certificates and orders of
any state or federal commission or regulatory authority with respect to the
Proposed Transaction and all such required approvals, authorizations, consents,
certificates and orders shall have been obtained and remain in full force and
effect.
c. No act or event other than as described herein shall have
occurred subsequent to the date hereof which could change the opinion expressed
above.
<PAGE>
Securities and Exchange Commission
October 30, 1998
Page 3
In addition, we express no opinion regarding the effectiveness or
enforceability of any particular terms, commitments, warrantees, guarantees, or
other provisions of the underlying contracts, understandings, agreements, or
other documents between or among the parties to the Proposed Transaction that
may be separate or severable from the specific right and authority to acquire
the membership interest that are the subject of the Application and that are the
sole subject of this opinion letter. Further, this opinion herein is qualified
by and is subject to, and we render no opinion with respect to, the limitations
and exceptions to the enforceability of contracts and obligations generally,
including without limitation: (a) the effect of bankruptcy, insolvency,
reorganization, arrangement, moratorium, fraudulent transfer or conveyance,
preference, equitable subordination (whether arising under State laws or the
U.S. Bankruptcy Code), bulk sales or bulk transfer laws and other similar laws
relating to or affecting the rights of creditors generally; (b) the effect of
general principles of equity and similar principles, including, without
limitation concepts of materiality, reasonableness, unconscionability, good
faith and fair dealing and the possible unavailability of specific performance,
injunctive relief or other equitable remedies, regardless of whether considered
in a proceeding in equity or at law, and the effect of public policy; (c) the
enforceability of the indemnification and contribution provisions of the
Agreement and any ancillary agreements, (d) compliance or noncompliance with
antifraud provisions of applicable state and federal statutes, rules and
regulations concerning the issuance and sale of securities; and (f) the effect
of North Carolina, federal or other laws relating to usury or permissible rates
of interest or other charges for loans, forebearances or the use of money.
Our opinion is limited to the laws of the State of North Carolina and
we express no opinion with respect to the laws of any other state or
jurisdiction, including, but not limited to, federal securities, tax, trade
regulation, or antitrust laws or regulations, or to any local laws or
ordinances. By rendering our opinion, we do not undertake to advise you of any
changes in the law that may occur after the date hereof. These opinions have
been prepared at your request and they are intended solely for your use in
connection with the Proposed Transaction that is the subject of the Application
and may not be relied upon by any other party or entity.
<PAGE>
Securities and Exchange Commission
October 30, 1998
Page 4
We hereby consent to the filing of this opinion as an exhibit to the
Application and in any proceedings before the Commission that may be held in
connection therewith.
Very truly yours,
KILPATRICK STOCKTON LLP
/s/ Kilpatrick Stockton LLP
by M. Gray Styers, Jr.
MGSjr/tlf
