CHAPTER 13 THE QUANDARY OF A REGULATED PIPELINE IN A DEREGULATED GAS MARKETING ENVIRONMENT
| Jurisdiction | United States |
(Apr 1988)
THE QUANDARY OF A REGULATED PIPELINE IN A DEREGULATED GAS MARKETING ENVIRONMENT
Davis, Graham & Stubbs
Washington, D.C.
Table of Contents
Introduction
1. A Description of Natural Gas Sales Service Rendered By Natural Gas Pipelines
2. The Pipeline As A Merchant of Choice
3. The Pipeline's Current Difficulties in Retaining Its Merchant Role
4. The Pipeline Marketing Affiliate As A Response To the Pipeline's Threatened Merchant Role
5. The Pipeline's Role as Transporter
a. Section 7 transportation as a non-viable option to open access
b. Open access transportation issues
(i) Transportation rate issues
(ii) Treatment of gathering capacity
(iii) Storage
(iv) Exchange gas
(v) Balancing issues
Conclusion
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Introduction
On March 1, 1988, Commissioner Charles G. Stalon of the Federal Energy Regulatory Commission (FERC or Commission), at an informal discussion before the Gas Committee of the National Association of Regulatory Utility Commissioners, predicted future roles of various players in the gas industry and the economic nature of the business generally as follows:
(a) Gas will be treated as a commodity, "like pork bellies";
(b) It will sell on commodities exchanges;
(c) Producers will be responsible for assuring adequate long term supplies of gas;
(d) Pipelines will be common carriers; and
(e) Local distribution companies (LDCs) will be responsible for assembling necessary gas portfolios which will involve an additional risk to those companies.
To some this reads like the age of enlightenment, to others like Dante's inferno. But this prediction of the new face of the gas industry is not an unrealistic one if one gives full effect to the federal regulations and policies which Commissioner Stalon has done so much to create. What is notable in that prediction, by virtue of its absence, is any mention of a role for pipelines as merchants or resellers of gas. What is most alarming about it to many who labor daily with the mechanics of the pipeline and utility business is the notion that natural gas will become a commodity, "like pork bellies."
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This paper argues that natural gas pipelines provide an important role within the marketplace in providing a long term and reliable gas supply and sales service. That service involves far more than selling a commodity. Providing that service efficiently in the modern market environment requires integrated resource planning and operation, as well as the free play of competition.
There is a strong market demand for pipeline resale services. This demand no doubt will survive whatever increasing transportation service which pipelines will provide. And while undoubtedly the role of the pipeline is evolving, it is evolving principally in response to changing market conditions. For regulation to foreclose the pipeline's resale role, despite this market demand, would be a disservice to all sectors of the natural gas industry. Yet, the current odds are that regulation will do just that, and will produce the brave new world which Commissioner Stalon describes. We need to reevaluate whether this makes sense.
Evolution is usually presumed to be a positive development, and there should be little doubt about the need to loosen some of the rigidities within the industry that were created by historical regulation and which have served to hinder competitive forces. Open access may well be one of those changes whose time has come. Yet, the future vitality of the natural gas industry will depend upon each sector of the industry — producer, marketer, pipeline, LDC and consumer — identifying and
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assuming its natural role in the risk and opportunity continuum of the marketplace. The implementation of open access must be considered in that context, because history has taught us that regulation, however well intended, often produces a "cure" which is worse than the perceived problem.
The first and foremost example of this was the 1954 decision of the U.S. Supreme Court in Phillips Petroleum Co. v. Wisconsin1 which imposed regulation by the Federal Power Commission under the Natural Gas Act over wellhead sales for resale of natural gas in interstate commerce. After a period of severe gas shortage which was brought about directly by that wellhead regulation, the Congress in 1978 enacted the Natural Gas Policy Act of 1978 (NGPA).2 This statute was a positive development, and began a phased deregulation of the price of natural gas production, which is today in its advanced stages. Yet, despite the NGPA's phased deregulation of production and its relaxed regulation of certain pipeline operations (such as transportation), the interstate pipelines (and the LDCs served by them) today find themselves more heavily regulated than ever before. This little appreciated fact obviously cuts against the grain of the deregulation trend in the gas industry. Why this anomaly?
This paper analyzes the adverse consequences of this heightened regulation of the interstate pipelines, and discusses
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its effect on pipeline resale service obligations. It describes how those service obligations in many instances cannot be efficiently discharged by the drive to unbundle them into discrete components. Unbundling forecloses efficient resource planning and integrated pipeline operations, upon which basis, to date, pipelines have rendered reliable, economic, and efficient service.
Regulation also has it difficult, if not impossible, for the interstate pipelines to compete with deregulated first sellers of natural gas in the new increasingly deregulated marketplace because it has not given pipelines the tools to do this, most notably the ability to freely and selectively discount sales rates.
The paper concludes that much of the restructured regulation of the interstate pipelines is unnecessary and indeed a mistake, and argues that, to the contrary, the best regulation of the gas industry is that which allows the free market to operate under voluntary and enforceable contractual relationships, in which the role of regulation is to assure fair and nondiscriminatory practices by all players.
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1. A Description of Natural Gas Sales Service Rendered By Natural Gas Pipelines
A fundamental distinction must be drawn in the industry vernacular between the provision (and abandonment) of natural gas sales service and the sale and delivery of natural gas molecules as a fungible commodity.3 Natural gas may be considered a commodity within the many special meanings of the law, and, in particular, is considered a "good" within the meaning of the Uniform Commercial Code.4 But for the sale or transportation of that commodity to have value requires much more.
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Its value depends on the uniformity of its quality, its receipt and delivery as needed over wide geographical areas and in varying volumes and dependent on changing variables. Most critical, however, is that its receipt and delivery have essential reliability. Reliability is critical to natural gas service because, unlike electric power, it cannot be interrupted and then quickly resumed in most applications. The rate of delivery of natural gas depends on customer needs which vary from hour to hour, day to day, and season to season. With few exceptions, it is a commodity which must be received into, and delivered from a planned, integrated, capital-intensive and nonambulatory grid of pipeline and distribution systems.5 In this respect, at least, natural gas differs markedly from grain, soybeans, oil, and coal and, indeed, pork bellies. The physical and legal confluence of these essential factors define not merely a commodity, but a service.6 Because of the great public
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importance of that service, it is defined and protected by statute and the common law.7 That is a practical, legal and political fact which may not be fully appreciated and understood by the purely economic lexicon.
Natural gas service rendered by the interstate pipelines has the following typical characteristics:
(a) Service to heat sensitive and seasonal loads. In 1986 while 39% of the volumes ultimately served by natural gas pipelines were consumed by users having fuel switching capability, 99% of the end users served by those pipelines comprised a core market having loads which are heat sensitive and seasonal in nature, typical of residential and commercial customers.8 This low load factor, heat sensitive load, defines the predominant core market of the LDCs served by the pipelines, and it is the load for which the pipelines were designed, and for which they make their unique service contribution. Pipelines must be able to absorb massive hourly, daily, and seasonal load swings which far exceed what is possible under their supply contracts. In other words the total
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daily and seasonal loads of the pipeline's customers do not match the available total daily supply of the pipeline's suppliers.
(b) Reliable service. Pipelines have a legal obligation under Section 7 of the Natural Gas Act to render safe and reliable natural service to gas consumers at the lowest cost consistent with the public interest.9 Deregulated first sellers of natural gas and commodity traders have no such legal obligation, unless that obligation is imposed by private contract. Pipelines meet their legal service obligation by packaging and aggregating supply, and by integrating that supply with system storage (including line pack), transmission capacity, and market diversity. That is a function for which pipelines were certificated and constructed, and provides them with a high reliability of service which is demanded by the marketplace to support base load
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gas service to local distribution companies. This reliability is achieved by centralized planning, engineering design and operational control...
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