THE IMPACT OF THE ELECTRIC INDUSTRY RESTRUCTURING ON THE NATURAL GAS INDUSTRY

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 1C
THE IMPACT OF THE ELECTRIC INDUSTRY RESTRUCTURING ON THE NATURAL GAS INDUSTRY
Karen Ostrander-Krug
Welborn Sullivan Meck & Todey, P.C.
Denver, Colorado

INTRODUCTION

The restructuring of the electricity industry will significantly impact the natural gas industry. This impact may be positive or negative, and will depend in large part on how and when the restructuring occurs. One point is certain, oil and gas producers should be aware of the issues that impact them most in order to influence decisions made by legislators and regulators. Keep in mind, oil and gas producers are both consumers of electricity and suppliers of fuel for electric generation. Our industry wears both hats in this debate.

Electric restructuring, as it is envisioned today, is the unbundling of generation from transmission and distribution. Generation is envisioned to be competitive and deregulated while transmission and distribution would remain regulated. In 1992, Congress passed the Energy Policy Act ("EPAct"), which provided the single most important boost to the prospects of introducing competition in electricity supply in the history of the industry by giving wholesale buyers new access to seek alternate suppliers and relieving independent producers from certain regulatory restrictions. In 1996, the Federal Energy Regulatory Commission ("FERC") passed Orders 888 and 889, to "remove impediments to competition in wholesale trade and bring more efficient, lower cost power to the nation's electricity customers."¹ This federal action has been followed by serious consideration in 35 states to take the introduction of competition even further — to the retail customer.

The key is to minimize any negative impact on the natural gas industry by ensuring restructuring accomplishes vigorous competition at the generation level in a timely manner (our "consumer" objective. The two most significant issues for natural gas will be the environmental laws and their enforcement and stranded costs. How these are decided at each state will impact our industry. It will impact the demand for and price of natural gas. It will also impact our

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operating costs including costs for marginal wells. This will ultimately impact the royalties we will pay.

REGULATORY BACKGROUND

A. FEDERAL

The natural gas industry is far ahead of the electric industry with restructuring. Figure 1 illustrates the restructuring of both industries on a time line. The natural gas industry began its restructuring in 1978, as discussed by Mr. Johnson, with the deregulation of natural gas prices. It continued to restructure over the next twenty years, implementing non-discriminatory open access and unbundling of supply (into transmission, distribution, commodity, etc.). This restructuring resulted in the development of the transportation system and marketers as we know them today, explained by Mr. Harpole. Natural gas restructuring focused on the industrial and commercial customers and the development of transportation services for these customer classes. Today, however, the industry has begun to focus on retail sales with emphasis on the residential customer and several states are implementing plans.

The electric industry, on the other hand, also began to deregulate in 1978 with the Public Utility Regulatory Policy Act ("PURPA") which stimulated development of cogeneration in the U.S. However, the electric industry just recently (in 1992 with EPAct and in 1996 with FERC Orders 888 and 889) opened up wholesale markets to competition.

The following is a summary of major federal legislation affecting the electric power industry:

Tennessee Valley Authority Act of 1933

(Public Law 73-17)

Under this law, the Federal Government provided electric power to states, counties, municipalities, and nonprofit cooperatives. It was the steady continuation of Federal responsibility adopt navigation, flood control, strategic materials for national defense, electric power, relief of unemployment, and improvement of living conditions in rural areas. The Tennessee Valley Authority (TVA) was also authorized to generate, transmit, and sell electric power. With regard to the sale of electric power, the TVA is authorized to enter into contracts up to 20 years for sales to governmental and private entities, to construct transmission lines to areas not otherwise supplied with electricity, to establish rules and regulations for power sales and distribution, and to acquire existing electric facilities used in serving certain areas.

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Figure 1

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Public Utility Holding Company Act of 1935 (PUHCA)

(Public Law 74-333)

PUHCA was enacted to break up the large and powerful trusts that controlled the Nation's electric and gas distribution networks. PUHCA gave the Securities and Exchange Commission the authority to break up the trusts and to regulate the reorganized industry in order to prevent their return.

Federal Power Act of 1935 (Title II of PUHCA)

(Aug. 26, 1935, ch. 687, Title II, 49 Stat. 838)

This Act was passed to provide for a Federal mechanism, as required by the Commerce Clause of the Constitution, for interstate electricity regulation.

Rural Electrification Act of 1936

(Public Law 74-605)

This Act established the Rural Electrification Administration (REA) to provide loans and assistance to organizations providing electricity to rural areas and towns with populations under 2,500. REA cooperatives are generally associations or corporations formed under State law. The predecessor to this Act was the Emergency Relief Appropriations Act of 1935, which performed the same function.

Bonneville Project Act of 1937

(Public Law 75-329)

This Act created the Bonneville Power Administration (BPA), which pioneered the Federal power marketing administrations. The BPA was accountable for the transmission and marketing of power produced at Federal dams in the Northwest. In 1953, the BPA first guaranteed the bonds of and a market for small energy facilities built and financed by public utility districts.

Reclamation Project Act of 1939

(Aug. 4, 1939, ch. 418, 53 Stat. 1187)

This Act requires that rates for electric power generated at Federal hydroelectric projects be adequate to recover the power-related share of construction costs, to include interest charged at a rate of not less than 3 percent.

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Flood Control Act of 1944

(Dec. 22, 1944, ch. 665, 58 Stat. 1187)

This Act formed the basis for the later creation of the Southeastern Power Administration (SEPA)^a in 1950 to sell power produced by the U.S. Army Corps of Engineers in the Southeast; and the Alaska Power Administration (APA)^b in 1967 to both operate and market power from two hydroelectric plants in Alaska; the Eklutna Project and the Snettisham Project. Although the Southwestern Power Administration's (SWPA)^c authority after World War II came from the Flood Control Act of 1944, it was established using the Executive Branch's emergency war powers authority to satisfy the growing demands from weapons development and domestic needs. This Act also demands that rates for electric power be enough to recover the cost of "producing and transmitting such electric energy."^d

First Deficiency Appropriation Act of 1949

(Public Law 81-71)

The Act authorized the Tennessee Valley Authority to construct thermal-electric power plants for commercial electricity sale.

Energy Supply and Environmental Coordination Act of 1974 (ESECA)

(Public Law 93-319)

This Act allowed the Federal Government to prohibit electric utilities from burning natural gas or petroleum products.

DOE Organization Act of 1977

(Public Law 95-91)

In addition to forming the Department of Energy, this Act provided authority for the establishment of the Western Area Power Administration (WAPA)^e and transferred power marketing responsibilities and transmission assets previously managed by the Bureau of Reclamation to WAPA. WAPA's authority was extended through the Hoover Power Plant Act of 1984. This Act also transferred the other four power marketing administrations (PMA)—the Southeastern Power Administration, the Southwestern Power Administration, the Alaska Power Administration, and the Bonneville Power Administration—from the Department of the Interior to the Department of Energy.

National Energy Act of 1978

(Public Law 95-617 — 95-621)

This Act was signed into law in November 1978 and includes five different statutes: the Public Utility Regulatory Policies Act (PURPA), the Energy Tax Act (Public Law 95-618), the National

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Energy Conservation Policy Act (Public Law 95-619), the Powerplant and Industrial Fuel Use Act (Public Law 95-620), and the Natural Gas Policy Act (Public Law 95-621). Passed as a result of the Arab oil-producing nations' ban on oil exports to the United States, its general purpose was to ensure sustained economic growth while also permitting the economy time to make an orderly transition from the past era of inexpensive energy resources to a period of more costly energy.

Public Utility Regulatory Policies Act of 1978 (PURPA)

(Public Law 95-617)

PURPA was passed in response to the unstable energy climate of the late 1970s. PURPA sought to promote conservation of electric energy. Additionally, PURPA created a new class of non-utility generators, small power producers, from which, along with qualified co-generators, utilities are required to buy power.

Energy Tax Act of 1978 (ETA)

Public law 95-618)

This Act, like PURPA, was passed in response to the unstable energy climate of the 1970s. The ETA encouraged conversion of boilers to coal and investment in co-generation equipment and solar and wind technologies by allowing a tax credit on top of the investment tax credit. It was later expanded to include other renewable technologies. However, the incentives were curtailed as a result of tax reform...