October 2009 Vol. 236 No. 10

From the Burner Tip

Gas Deregulation Valuable After 30 Year Transformation

Carol Freedenthal, Contributing Editor

Thirty years ago, with the passage of the Natural Gas Policy Act of 1978 (NGPA) as part of the much bigger National Energy Act, the long journey to deregulate natural gas sales in interstate commerce started!

Driven by the necessity to increase the U.S. natural gas supply, legislation was passed freeing gas from wellhead price controls for gas going into interstate markets and sales. Intrastate gas sales were essentially free-market priced and initial sellers could get what the market would bear. The government changes made natural gas a commodity to be freely traded in energy markets and opened up supplies of the much-needed fuel.

The history of natural gas regulation is long and strewn with political games. In 1938 when natural gas was just beginning to enter interstate markets with the development of seamless steel pipe for transporting the fuel from producing to consuming areas, Congress passed the Natural Gas Act giving federal jurisdiction to interstate transportation and wholesale gas sales. The next big regulatory ruling was the Supreme Court decision in 1954 (Phillips case) that gave the Federal Power Commission (FPC) jurisdiction to set wellhead gas prices for interstate sales.

The result was not only to control prices and make natural gas prices unresponsive to market forces but also to control who could make gas purchases from the wellhead. For interstate commerce, gas sales could only be made to individual pipelines and all contracts were for the life of the lease. This greatly controlled the ability of natural gas to find and secure larger markets. This was not a real problem until energy supplies became an important factor in commodity markets in the early 1970s when OPEC raised the prices significantly for crude oil.

While natural gas in intrastate markets could change prices to meet market conditions caused by the multifold increases in crude oil and crude oil products prices, natural gas in interstate markets could not similarly adjust. The FPC was slow to make price changes because of its workload and the politics involved. With interstate prices slow to respond, natural gas supplies in the early 1970s in the interstate markets were affected significantly and shortages occurred. Gas reserves in the U.S. were plentiful but because of the low prices no one wanted to produce and sell at below-market values.

Finally, in 1978 with the NGPA, Congress and the president made the bold move. Steps were put in place to decontrol natural gas in interstate markets. The Federal Energy Regulatory Commission took over from the FPC and during a 25-year period various rules and orders were made to complete the decontrol of interstate natural gas commerce. The last major orders were released in the early 1990s. All these orders had the effect of changing the natural gas industry from the wellhead to the consumer’s inlet, whether it was a commercial user or a city gate where sales were made to local distribution companies.

The original plan for the “open access” of natural gas was to go all the way from the interstate transportation to individual states and even to the distribution companies that deliver gas to individual homes, commercial and some industrial users. In the restructuring programs, sometimes referred to as “Residential Choice Programs”, individual states would decide whether they wanted to maintain the “system” approach to gas sales or open the market completely. The Energy Information Administration has tracked the progress in each state regarding these programs.

As of December 2008, four states have statewide unbundling with 100% eligibility for open sales through the system. Four other states have statewide unbundling but with limited or inactive programs. At the time, six states had statewide unbundling in the implementation phase that only allow 50% eligibility. Pilot programs and partial unbundling are in eight states while two states have discontinued the pilot programs. The remaining states have no unbundling.

States with unbundling allow the buyer to contract for supply and transportation from totally independent suppliers of the commodity and transportation. The less the amount of unbundling, the more the buyer has to deal with a local distribution company for the delivery and purchase of the gas.

This was a tremendous metamorphosis in the natural gas industry. Under the old system, the interstate pipelines not only were the only purchasers for interstate-destined gas but also controlled with, few exception, the entire auxiliary services such as treating and processing, storage, and marketing.

With decontrol, the pipelines became strictly transporters and had to “unbundle” all the other services they offered. The outgrowth of this was manifold with the development of marketing companies, natural gas processors, storage companies and other service companies, including financial, to help in the delivery of natural gas from the wellhead to the burnertip or, new to the gas business, the financial player!

In judging the impact of this monstrous transformation, it can only be called a huge success. The biggest benefit is that it made U.S. natural gas supplies more than adequate to meet current and future demand at reasonable prices. Since market demand or perceived demand sets the market price, producers responded with finding and developing additional gas supplies. The scarcity of gas supplies seen in the early 1970s has not re-occurred because of the changes made in the interstate business. Where previously there was a bifurcated market – interstate with scarce supplies and intrastate with excess – there now is only one natural gas market.

In addition, where previously natural gas buying and selling had to go through set channels – from producer to pipeline to major end-user or distribution company to local buyer – now the path is completely clear, depending on the open-access status in a given state where the consumer is located. Buyers can deal with anyone from local distribution companies or marketers to even the producer at the wellhead!

Some new supplies such as those from shale deposits and other tight sand-type formations might never have emerged unless gas prices were allowed to operate as any other basic commodity. The development of financial markets for futures and physical trading of gas would not have been possible without decontrolling interstate gas prices. While natural gas has stayed in the 22-Tcf range in recent years, the amount of gas traded for financial businesses can be as high as 10-12 times the physical market.

The growth of the natural gas service companies – or the middle-market operations – has proved to be a major part of the business, whether it is gas processing, storage, marketing or financial service companies. With these being individual, unbundled companies, they have provided countless opportunities for new businesses and jobs.

The natural gas transition was so successful that the FERC wanted to expand to electricity as well. While there is moderate success there too, enough differences exist between the natural gas and electric-generating industries that what was good for one is not necessarily good for the other. The mere fact that most electric generation today is close to the consuming region as opposed to natural gas coming from basins, in many cases very far from the user, makes an important difference between the two industries.

No question deregulation has been successful. There was no doubt that lifting the federal controls over natural gas prices would be a highly controversial action – so much that passage of the Act was delayed until after the November elections of that year! But its success in helping to maintain a sufficient supply of economically priced gas and allowing the customer many choices about where and how to get the gas and needed services for delivery is without question.

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