CHAPTER 1 A PERSPECTIVE ON TOMORROW: THE CHANGING STRUCTURE AND REGULATORY ENVIRONMENT OF THE NATURAL-GAS INDUSTRY
| Jurisdiction | United States |
(May 1987)
A PERSPECTIVE ON TOMORROW: THE CHANGING STRUCTURE AND REGULATORY ENVIRONMENT OF THE NATURAL-GAS INDUSTRY
President, ARTA Inc.
Seattle, Washington
Introduction:
Permanent Devolution in the Gas Industry
The natural-gas industry has been only one among several traditional public utilities and other economically regulated industries, that have experienced sweeping changes over the past few years in both market structure and the relationship between government and business. While deregulation of wellhead gas prices has obviously been one of the motive forces for change in the gas business, "deregulation" as such accounts for only a portion of the profound transformations that have been taking place in banking and other financial services, airline, rail, and truck transportation, telecommunications, and electricity, as well as natural gas. The details of change in the various industries are exceedingly diverse, and some of the industries named are still "pervasively regulated" by any measure. Yet there are common currents that have imparted a common direction to their motion.
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What all these cases share is not a decisive retreat on the part of public authority, but —
(a) the creation of space in the market for new services and old services in new forms, especially through the "unbundling" and rebundling of old service elements previously offered only in a small variety of packages that were most convenient for monopolistic vendors to administer and regulatory commissions to supervise; and
(b) a more affirmative view of competition both among enterprises in the industry in question and between different industries. Even in those industries where considerable rate-regulation remains, competition is increasingly recognized as the paramount measure and means of assuring the "public convenience and necessity" with respect to the goods and services offered, and the "justness and reasonableness" of their prices.
There is evidently no ready-made, one-word label for this transformation. Lacking anything better, I propose to call it a "devolution" — essentially a disaggregation, decentralization, and downward delegation of authority.
In North America's natural-gas industry, the nexus of contemporary devolution has been the regulatory and corporate unbundling of gas marketing from gas transportation. The process began with the curtailment schedules and purchased-gas-adjustment ("PGA") mechanisms instituted by federal and state regulators in response to market developments of the early 1970s. Until the mid-1980s, however, both the economic logic that distinguishes transport from marketing and the inevitability of their institutional separation was almost totally unrecognized. It was probably not until 1983 or 1984, indeed, that any analyst or critic could see clearly enough to articulate the simple insight which, I believe, will govern regulation of natural-gas companies in the coming era. A March 1987 decision of the Ontario Energy Board stated the ruling principle with rare elegance:
"The monopoly to transport gas is a natural monopoly. The monopoly to sell gas is a created monopoly."
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The implications of this insight are vast: Virtually all of the new and confounding or challenging issues in natural-gas industry organization and regulatory law now pertain either to —
(a) the tension between competition in the buying and selling of methane as a commodity, and the market power that stems from control of gas-transport and storage facilities; or
(b) the incongruity between this natural economic distinction and the operation of inherited business organizations and regulatory institutions, which were created before the division became obvious and overwhelming as it is today.
The Technical and Economic Fundamentals.
The beginning of wisdom about natural gas is a recognition of certain physical and economic characteristics of the commodity and the industry, which do not depend upon its corporate structure or regulatory environment. Some of these are hoary truisms; others, though obvious today, are violently at odds with the assumptions from which most gas-industry executives, regulators, and experts reasoned a decade ago.
First, neither "consumers" nor "society" needs natural gas, or any other primary fuel. Mankind's energy demands are only fleetingly for particular fuel forms: the basic wants of modern society are for light, heat, motive power, and simple hydrocarbon building blocks for assembling into a vast number of organic chemicals. Natural gas is employable and indeed now employed in all of these end-use roles, but in each of them, proved technology and, in most cases, equipment that is now available "right off the shelf", permit the ready substitution of other fuels. Gas will hold a particular market or submarket only when, where, and if it is the cheapest source of energy for the particular purpose, taking into consideration transformation efficiencies and the capital costs of using the alternatives.
Second, the competitive market value of natural gas in North America is now determined, and will be determined for as far into the future as it makes sense to plan, in the competition among energy
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forms for "B-fuels" markets, "low-priority" employments such as industrial and electric-utility boiler fuel; large-scale space- and water-heating; distillation, smelting or drying of materials, and the like. These are the applications in which the object of demand is calories at the lowest net price, and where many users already possess fuel-switching capability. Vigorous interfuel competition for these markets means that no gas price can long be sustained that exceeds the net cost of burning residual oil or coal, with due consideration for the differences in capital costs for the fuel-burning equipment.
Third, natural gas is a standardized, fungible commodity — a mixture that is chiefly methane but which may contain other gases, typically ethane, propane, and/or nitrogen, in proportions that give it a uniform burning quality. Users thus have no reason for concern about the geographic origin of gas, the identity of its producer, or its contractual history prior to the final sale. The opportunities for product differentiation are therefore limited to the seasonal pattern and "firmness" of delivery, and to the structure of retail prices.
Fourth, methane is one of the more abundant commodities in the earth's crust. Although the natural resource is in principle finite, the supply is economically open-ended. Methane occurs in diverse geological environments, whose known number continues to increase. It can be found by means of a substantial and growing number of exploration strategies, and recovered at a continuous range of costs by a great variety of physical arrangements.
Fifth, the production of natural gas in North America is exceedingly decentralized geographically and sectorally. It is carried on by thousands of business organizations of vastly different sizes and natures from a huge number of fields of greatly varying size by means of a wide assortment of field hardware. Consumption is similarly dispersed, diverse, and fragmented.
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Sixth, methane can be moved great distances at modest cost by several alternative transport modes: in the gaseous state, under great pressure as a "dense-phase fluid" (which is as compact as a liquid and compressible like a gas), cryogenically as liquefied natural gas ("LNG"), or chemically transformed into methanol fuel.
Finally, the long-line gas-transmission infrastructure of North America is essentially complete, linking all the major producing and consuming areas through an interconnected network of pipelines. The most important segments of this network (the corridor stretching from Louisiana and Texas into the mid-Atlantic states, for example) are substantially overbuilt. The transmission capacity of this system can nevertheless be further expanded where necessary with relatively inexpensive local debottlenecking and new interconnections, and even further through greater use of "transport-by-exchange" than has thus far been customary in the industry. A crucial implication of this situation is that marginal transaction and transport costs are close to zero for most gas movements, no matter how far apart the nominal points of production and consumption might be.
These features together severely limit the market power that companies or individuals are capable of exercising on a sustained basis, and the ability of federal and state regulators to shape markets or set prices. They imply that gas markets are naturally competitive, and that it would require exceptional (and highly unlikely) efforts on the part of pipelines and distribution companies to defend extensive realms of market power. No customer or class of customers can be held permanently captive to gas or to a given utility or pipeline: given a few years to adjust, nobody really needs gas except the gas companies.
The features listed also imply that, left alone, delivered gas prices will swing with the seasons and with the prices of competing fuels, but that wellhead prices can not long exceed the prices, in heating value, of the lowest-cost substitute available for low-priority fuel uses. And they mean that, no matter how restricted the supply might appear at any instant of time, consumers need only demonstrate a willingness
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to incur modest cost increases in order to evoke a dramatic expansion of the economically deliverable commodity. The future is therefore unlikely to contain gas "shortages" like those of the 1970s, or "surpluses" like those of the 1980s, unless wrongheaded legislators and regulators work assiduously and cleverly to recreate such...
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