CHAPTER 14 ALTERNATIVES AND NEW DIRECTIONS IN MARKETING NATURAL GAS
| Jurisdiction | United States |
(Apr 1988)
ALTERNATIVES AND NEW DIRECTIONS IN MARKETING NATURAL GAS
Hudson Gas Systems, Inc.
Washington, D.C.
Later this year, we celebrate a momentous occasion — the tenth anniversary of enactment of the Natural Gas Policy Act of 1978 (NGPA).1 This year is also the 50th anniversary of the Natural Gas Act.2 Those momentous events are helpful to keep in mind as we look to the future of how gas will be marketed and what type of problems those new directions will present for the practitioner.
For as a result of the NGPA, pipelines have utterly and irrevocably changed the way they do business — indeed they have even had to change the very business they engage in. Many of these changes will be coming to the local gas utilities over the next few years as well. And an entirely new industry of gas marketing companies has sprung into existence.
To understand how we got to where we are, it's helpful to remember how the world looked to the public policy experts back in 1978 when Congress voted to gradually remove federal
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price controls over natural gas at the wellhead. Back in those days, the focus of the public debate was really on two issues: the impact decontrol would have on development of new reserves; and what decontrol would do to prices of gas in the producing fields and at the residential burnertip. In a word it was the producers against the consumers. Thus, the debate was hot and heavy over how high decontrol would drive average wellhead prices and whether the production industry was sufficiently competitive to prevent producers from gouging the ever present "captive consumer" (usually portrayed as "poor Aunt Mary in Schenectady"). And analysts and lobbyists debated whether deregulation would somehow stave off that inevitable day when the ever shrinking reserve base would have to be replaced by nuclear generated electricity, synthetic gas manufactured from coal and naphtha, and supplies of liquefied natural gas (LNG) from such undependable nations as Algeria and Indonesia.3
On November 9, 1978, the debate was closed by President Carter signing the NGPA into law.
That's when the fun — or the mischief, depending on your perspective — really began. For the seeds of both our present difficulties and the future promise of gas marketing were sown in 1978.
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From 1978 to 1981, prices rose and drilling boomed. By 1981, it had become common to predict an enormous "fly up" of gas prices to come in 1985 when about half of all gas was to be decontrolled. Predictions of huge increases in wellhead prices were publicly accepted without serious dispute.4 By the early 1980s drilling finally reached levels last attained in the 1950s. And it appeared that the debate of 1978 was being finally and decisively answered by proving that higher field prices would indeed encourage drilling and increase supply.
But a funny thing happened on the way to decontrol.
I. Genesis of the New Natural Gas Industry: The Impact of "NGA Deregulation"
Pipelines and LDCs began to wake up to the fact that high prices not only increased supply, they also dampened demand.5 A major surplus was quickly created.
Before long, pipelines and LDCs discovered there were new entrants in the business of buying and selling gas; new entrants that had enormous pricing and operational
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flexibility. And these new entrants began to take markets away from the established gas merchants. The producer qua producer played largely the same role after the NGPA as under regulation: evaluating drilling prospects, packaging ventures, acquiring drilling rights, obtaining financing, and sinking the bit into the ground. Similarly, for the gas user: while there was greater flexibility in procuring gas, the gas was consumed in the same way it had been before decontrol.
But by 1983 or so, the old battle lines of consumers against producers began to seem increasingly irrelevant. Producers wanted markets; consumers wanted competitively priced gas. Hence by early 1985 (when decontrol began forcing wellhead prices down), it had become crystal clear that the most significant and longest lasting changes wrought by the NGPA were neither on producer revenues nor on Aunt Mary's heating bill, but on the parties in between the wellhead and the burnertip — the interstate pipelines and (soon to come) the local gas utilities. The real story was the revolution in the businesses in between the wellhead and the burner tip.
Why? The answer lies in the interplay between two factors, one legal, the other economic. The first change was in the extent of legal control of market entry, exit, and pricing imposed by the regulatory regime. The second change was an economic change in how value is added to a product or commodity as it moves through the economy.
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By eliminating regulation over "first sales" of the gas commodity beginning in 1978, Section 601 of the NGPA brought into existence a new industry of gas marketing companies. While the existence of surplus supplies facilitated this development, the evolution of non-utility gas merchants results far more from the removal of Natural Gas Act regulation and the corresponding ability of non-jurisdictional gas marketers to respond flexibly and responsibly to rapid changes in market forces. For in 1978, Congress did not simply establish a schedule for price decontrol; Congress also removed non-price controls over most gas. This "Natural Gas Act" deregulation took place separately and apart from "price" deregulation.6
In retrospect, non-price decontrol was the more significant. The key to the legal change was thus the phrase "first sale" as defined by Section 2(21) of the Natural Gas Policy Act. Under Section 2(21), "first sales" can be made by anyone other than an interstate or intrastate pipeline or a local distribution company. But, try hard as they might, pipelines and LDCs cannot, by definition, make first sales. Under Section 601 of the NGPA, first sales of most gas supplies are no longer subject to the Natural Gas Act. They are thus "NGA-deregulated." In practice, that means that any
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sale of this gas by anyone other than a pipeline or a local gas utility is NGA-deregulated.
A few examples show the importance of this distinction. When a producer sells gas to a local distribution company, that sale is a "first sale" under the NGPA. Most first sales of gas are now free of all federal regulation under the Natural Gas Act: neither certificates nor abandonment is required. And if the gas is also gas that has been price-deregulated under the NGPA, it is also free from price controls. Similarly, if a new business entity, an independent marketing company, buys deregulated gas from other producers, the marketer is free to resell the gas to the local distribution company on the same basis: no certificates, no abandonment, and no price controls.
Thus, the sale can begin whenever agreed to by the parties. The price is known in advance and is set at whatever level the parties agreed upon. And of course the parties' obligation to buy and sell the gas terminates at the expiration of the contract.
But look what happens if that same molecule of deregulated gas is bought by an interstate pipeline to become part of its system supply. Before the pipeline resells that gas to the same local utility, it must get a certificate from the FERC in accordance with Part 157 of Title 18 of the Code of Federal Regulations, specifically Sections 157.5 through 157.22. Any changes in the price of the gas must be reflected
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in a rate schedule filed in accordance with Part 154 of Title 18 of the Code of Federal Regulations, Sections 154.1 through 154.86. The pipeline must provide 30-day prior notice to the public of any proposed changes in the price. In the past, the price usually remained in effect for the next six months.7 Any person may object to the proposed price change and seek an adjudicatory hearing. The FERC may, on its own motion, suspend the effectiveness of the proposed price change for up to five months. To top it off, the FERC can change the price, retroactively, by ordering refunds, perhaps years after the sale. And before the pipeline may stop the transaction, it must seek and obtain abandonment authorization under Section 157.18 of Title 18 of the Code of Federal Regulations, and in conjunction with this must file Exhibits T, U, V, W, X, Y, and Z.8
In effect, the pipeline must provide public notice to the world that its markets can be captured over the next six months by anyone willing and able to offer customers gas at just a few cents below the PGA level.
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Now the most astounding thing of all is this: for the service of putting together a portfolio of gas supply contracts, in effect holding ten years or more of reserves in inventory and for matching them with the market, the pipeline makes not one penny on the price of the gas. The only profit the pipeline is allowed to earn relates essentially to the cost of providing transportation, gathering, and storage of the gas. This rate will of course include an allowable part of the administrative overhead involved in buying and selling the gas — for example, the salaries of the people engaged in that part of the business. But the pipeline must resell the commodity itself at cost. Compare that with the producer or the reseller who can try to buy low and sell high and thereby be compensated for the risk taken and the services provided.
II. The Pipelines' Search for Pricing and Operational Freedom.
In this new world of competition from unregulated "first sellers" such as producers and marketers, pipelines began a search for sufficient operational and pricing flexibility to survive as gas merchants.
First came off-system sales. These were designed to move surplus gas supplies on an interruptible basis into new, off-system markets. But the price proposed for...
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