7/29/2019 Natural Gas Distribution & Transmission http://slidepdf.com/reader/full/natural-gas-distribution-transmission 1/29 Natural Gas Distribution Distribution is the final step in delivering natural gas to customers. While some large industrial, commercial, and electric generation customers receive natural gas directly from high capacity interstate and intrastate pipelines (usually contracted through natural gas marketing companies), most other users receive natural gas from their local gas utility, also called a local distribution company (LDC). LDCs are regulated utilities involved in the delivery of natural gas to consumers within a specific geographic area. There are two basic types of natural gas utilities: those owned by investors, and public gas systems owned by local governments. Local distribution companies typically transport natural gas from delivery points located on interstate and intrastate pipelines to households and businesses through thousands of miles of small-diameter distribution pipe. The delivery point where the natural gas is transferred from a transmission pipeline to the local gas utility is often termed the 'citygate', and is an important market center for the pricing of natural gas in large urban areas. Typically, Utilities take ownership of the natural gas at the citygate, and deliver it to each individual customer's meter. This requires an extensive network of small- diameter distribution pipe. The U.S. Department of Transportation‟s Pipeline and Hazardous Materials Safety Administration reports that there are just over 2 million miles of distribution pipe in the U.S., including city mains and service pipelines that connect each meter to the main. Because of the transportation infrastructure required to move natural gas to many diverse customers across a reasonably wide geographic area, distribution costs typically make up about half of natural gas costs for households and small volume customers. While large pipelines can reduce unit costs by transmitting large volumes of natural gas, distribution companies must deliver relatively small volumes to many more different locations. According to the Energy Information Administration (EIA), transmission and distribution costs represented about half of a typical residential natural gas customer‟s monthly gas utility bill in 2009, with costs of the physical natural gas commodity itself representing the other half. Delivery of Natural GasInstalling Small Diameter Distribution PipeSource: Duke Energy Gas Transmission Canada
Natural Gas DistributionDistribution is the final step in delivering natural gas to customers. While some large industrial,commercial, and electric generation customers receive natural gas directly from high capacityinterstate and intrastate pipelines (usually contracted through natural gas marketing companies),most other users receive natural gas from their local gas utility, also called a local distribution
company (LDC). LDCs are regulated utilities involved in the delivery of natural gas to consumerswithin a specific geographic area. There are two basic types of natural gas utilities: those ownedby investors, and public gas systems owned by local governments.Local distribution companies typically transport natural gasfrom delivery points located on interstate and intrastatepipelines to households and businesses through thousands of miles of small-diameter distribution pipe. The delivery pointwhere the natural gas is transferred from a transmissionpipeline to the local gas utility is often termed the 'citygate', andis an important market center for the pricing of natural gas inlarge urban areas. Typically, Utilities take ownership of thenatural gas at the citygate, and deliver it to each individualcustomer's meter. This requires an extensive network of small-
diameter distribution pipe. The U.S. Department of Transportation‟s Pipeline and Hazardous Materials Safety Administration reports that there are just over 2 million miles of distribution pipe in the U.S., including city mains and servicepipelines that connect each meter to the main.
Because of the transportation infrastructure required to movenatural gas to many diverse customers across a reasonablywide geographic area, distribution costs typically make upabout half of natural gas costs for households and smallvolume customers. While large pipelines can reduce unit costsby transmitting large volumes of natural gas, distributioncompanies must deliver relatively small volumes to many more
different locations. According to the Energy Information Administration (EIA), transmission anddistribution costs represented about half of a typical residential natural gas customer‟s monthlygas utility bill in 2009, with costs of the physical natural gas commodity itself representing theother half.
The delivery of naturalgas to its point of enduse by a distributionutility is much like thetransportation of natural gas discussedin the transportation section. However,distribution involvesmoving smaller volumes of gas atmuch lower pressuresover shorter distancesto a great number of individual users.Smaller-diameter pipealso is used totransport natural gasfrom the citygate toindividual consumers.
The natural gas is periodically compressed to ensure pipeline flow, although local compressor stations are typically smaller than those used for interstate transportation. Because of the smaller volumes of natural gas to be moved, as well as the small-diameter pipe that is used, the pressurerequired to move natural gas through the distribution network is much lower than that found in thetransmission pipelines. While natural gas traveling through interstate pipelines may becompressed to as much as 1,500 pounds per square inch (psi), natural gas traveling through thedistribution network requires as little as 3 psi of pressurization and is as low as ¼ psi at thecustomer‟s meter. The natural gas to be distributed is typically depressurized at or near thecitygate, as well as scrubbed and filtered (even though it has already been processed prior todistribution through interstate pipelines) to ensure low moisture and particulate content. Inaddition, mercaptan - the source of the familiar rotten egg smell in natural gas - is added by theutility prior to distribution. This is added because natural gas is odorless and colorless, and the
familiar odor of mercaptan makes thedetection of leaks much easier.
Traditionally, rigid steel pipe was used toconstruct distribution networks. However, newtechnology is allowing the use of flexibleplastic and corrugated stainless steel tubing inplace of rigid steel pipe. These new types of tubing allow cost reduction, installationflexibility and easier repairs for both localdistribution companies and natural gasconsumers.
Another innovation in the distribution of natural gas is the use of electronic meter-reading systems. The natural gas that isconsumed by any one customer is measured
by on-site meters, which essentially keep track of the volume of natural gas consumed at thatlocation. Traditionally, in order to bill customers correctly, meter-reading personnel had to bedispatched to record these volumes. However, new electronic meter-reading systems are capableof transmitting this information directly to the utility. This results in cost savings for the utility, whichare in turn passed along to customers.
Components of Residential Natural Gas Prices Source: Energy Information Administration-2008
Distribution Compressor Station Source: Duke Energy Gas Transmission Canada
Although the majority of residential and small commercial customers still tend to purchase'bundled' natural gas from utilities, the increasingly important role of natural gas marketers, as wellas the innovation fueled by increasing competition in the marketplace, is leading to innovativeways of supplying natural gas to small volume users as well as new bundled service options, suchas home security systems. Please visit our section to learn more about natural gas marketing inresidential markets.
Distribution and Safety
Local distribution companies, like the larger interstate and intrastate pipelines, maintain thehighest safety standards to ensure that preventable accidents are avoided, and problems with thedistribution network are remedied in a timely fashion. Many of the safety programs maintained byutilities are quite similar to those of interstate pipeline companies. Safety measures at the locallevel include:
Leak Detection Equipment – Utilities have in place sophisticated leak detectionequipment, designed to pick up on leaks of natural gas from the distribution network.Utilities also add odorants to the natural gas to make it easier to detect a leak.
Safety Education Programs - Utilities typically run natural gas safety seminars in
schools, community centers, and through other organizations to ensure customers arewell versed in natural gas safety procedures and know what to do in the event of a leak or emergency.
Technicians on Call - Utilities maintain fleets of technicians on call 24 hours a day,seven days a week to respond to customers' problems and concerns.
Emergency Preparedness - Utilities participate in community and local emergencypreparedness programs, educating and preparing for emergency events such as naturaldisasters.
One Call Systems - Provides customers, contractors, and excavators with a single phonenumber to call before commencing excavation or construction, to ensure that thepipelines, and other buried facilities are not damaged. A national “call-before-you-dig”phone number of “811” was adopted in 2008 with the support of utilities, communities,emergency responders and government officials.
These are but a few of the safetymeasures maintained by localdistribution companies. Especiallyimportant for the safe distribution of natural gas, particularly in denselypopulated areas, is the education of customers. By teaching natural gasusers the safe use of natural gas,what to do in an emergency, and howto detect leaks, distributioncompanies ensure that the distributionof natural gas will remain one of the
safest forms of energy transmission.For more information on natural gassafety in your area, contact your natural gas utility. For information onnatural gas pipelines including pleasevisit the Department of Transportation‟s Office of Pipeline
Safety .
Community Emergency Response Team - CheckingGas Meters
Source: Federal Emergency Management Agency
Overview of Natural Gas |Natural Gas - From the Wellhead... |Business Ov
The Transportation of Natural GasThe efficient and effective movement of natural gas fromproducing regions to consumption regions requires an
extensive and elaborate transportation system. In manyinstances, natural gas produced from a particular well willhave to travel a great distance to reach its point of use. Thetransportation system for natural gas consists of a complexnetwork of pipelines, designed to quickly and efficientlytransport natural gas from its origin, to areas of high naturalgas demand. Transportation of natural gas is closely linkedto its storage: should the natural gas being transported notbe immediately required, it can be put into storage facilitiesfor when it is needed.
There are three major types of pipelines along thetransportation route: the gathering system, the interstate
pipeline system, and the distribution system. The gatheringsystem consists of low pressure, small diameter pipelinesthat transport raw natural gas from the wellhead to theprocessing plant. Should natural gas from a particular wellhave high sulfur and carbon dioxide contents (sour gas), aspecialized sour gas gathering pipe must be installed. Sour gas is corrosive, thus its transportationfrom the wellhead to the sweetening plant must be done carefully. Review the treatment andprocessing of natural gas.
Pipelines can be characterized as interstate or intrastate. Interstate pipelines are similar to in theinterstate highway system: they carry natural gas across state boundaries, in some cases clear across the country. Intrastate pipelines, on the other hand, transport natural gas within a particular state. This section will cover only the fundamentals of interstate natural gas pipelines, however the
technical and operational details discussed are essentially the same for intrastate pipelines.
Interstate Natural Gas Pipelines
The interstate natural gas pipeline networktransports processed natural gas fromprocessing plants in producing regions tothose areas with high natural gasrequirements, particularly large, populatedurban areas. As can be seen, the pipelinenetwork extends across the entire country.Interstate pipelines are the 'highways' of natural gas transmission. Natural gas that
is transported through interstate pipelinestravels at high pressure in the pipeline, atpressures anywhere from 200 to 1500pounds per square inch (psi). This reducesthe volume of the natural gas beingtransported (by up to 600 times), as well aspropelling natural gas through the pipeline.
This section will cover the components of the interstate pipeline system, the construction of
Source: Duke Energy Gas TransmissionCanada
Interstate Natural Gas Pipelines Source: National Energy Technology Laboratory, DOE
Constructing natural gas pipelines requires a great deal of planning and preparation. In addition to actually building thepipeline, several permitting and regulatory processes mustbe completed. In many cases, prior to beginning thepermitting and land access processes, natural gas pipelinecompanies prepare a feasibility analysis to ensure that anacceptable route for the pipeline exists that provides theleast impact to the environment and public infrastructurealready in place.
Assuming a pipeline company obtains all the requiredpermits and satisfies all of the regulatory requirements,construction of the pipe may begin. Extensive surveying of the intended route is completed, both aerial and land based,to ensure that no surprises pop up during actual assembly of the pipeline.
Installing a pipeline is much like an assembly line process, with sections of the pipeline beingcompleted in stages. First, the path of the pipeline is cleared of all removable impediments,
including trees, boulders, brush, and anything else that may prohibit the construction. Once thepipeline's path has been cleared sufficiently to allow construction equipment to gain access,sections of pipes are laid out along the intended path, a process called 'stringing' the pipe. Thesepipe sections are commonly from 40 to 80 feet long, and are specific to their destination. That is,certain areas have different requirements for coating material and pipe thickness.
Once the pipe is in place, trenches are dugalongside the laid out pipe. These trenchesare typically five to six feet deep, as theregulations require the pipe to be at least 30inches below the surface. In certain areas,however, including road crossings and bodiesof water, the pipe is buried even deeper. Once
the trenches are dug, the pipe is assembledand contoured. This includes welding thesections of pipe together into one continuouspipeline, and bending it slightly, if needed, tofit the contour of the pipeline‟s path. Coating isapplied to the ends of the pipes. The coatingapplied at a coating mill typically leaves theends of the pipe clean, so as not to interferewith welding. Finally, the entire coating of thepipe is inspected to ensure that it is free from
defects.
Once the pipe is welded, bent, coated, and inspected it can be lowered into the previously-dugtrenches. This is done with specialized construction equipment acting to lift the pipe in a levelmanner and lower it into the trench. Once lowered into the ground, the trench is filled in carefully,to ensure that the pipe and its coating retain their integrity. The last step in pipeline construction isthe hydrostatic test. This consists of running water, at pressures higher than will be needed for natural gas transportation, through the entire length of the pipe. This serves as a test to ensurethat the pipeline is strong enough, and absent of any leaks of fissures, before natural gas ispumped through the pipeline.
Surveying the Right-of-Way Source: Duke Energy Gas Transmission Canada
'Stringing' the Pipe Source: Duke Energy Gas Transmission Canada
Laying pipe across streams or rivers can beaccomplished in one of two ways. Open cutcrossing involves the digging of trenches onthe floor of the river to house the pipe. Whenthis is done, the pipe itself is usually fitted witha concrete casing, which both ensures thatthe pipe stays on the bottom of the river andadds an extra protective coating to preventany natural gas leaks into the water. Alternatively, a form of directional drilling maybe employed, in which a 'tunnel' is drilledunder the river through which the pipe may bepassed. The same techniques are used for road crossings - either an open trench isexcavated across the road and replaced oncethe pipe is installed, or a tunnel may be drilled underneath the road.
Once the pipeline has been installed and covered, extensive efforts are taken to restore thepipeline's pathway to its original state, or to mitigate any environmental or other impacts that mayhave occurred during the construction process. These steps often include replacing topsoil,fences, irrigation canals, and anything else that may have been removed or upset during theconstruction process. For more information on natural gas pipeline construction, visit the websiteof the Interstate Natural Gas Association of America.
Pipeline Inspection and Safety
In order to ensure the efficient andsafe operation of the extensivenetwork of natural gas pipelines,pipeline companies routinely inspecttheir pipelines for corrosion anddefects. This is done through the use
of sophisticated pieces of equipmentknown as „smart pigs.‟ Smart pigs areintelligent robotic devices that arepropelled down pipelines to evaluatethe interior of the pipe. Smart pigs cantest pipe thickness, and roundness,check for signs of corrosion, detectminute leaks, and any other defectalong the interior of the pipeline thatmay either impede the flow of gas, or pose a potential safety risk to theoperation of the pipeline. Sending a
smart pig down a pipeline is fittingly known as 'pigging' the pipeline.
In addition to inspection with smart pigs, there are a number of safety precautions and proceduresin place to minimize the risk of accidents. In fact, the transportation of natural gas is one of thesafest ways of transporting energy, mostly due to the fact that the infrastructure is fixed, andburied underground. According to the Department of Transportation (DOT), pipelines are thesafest method of transporting petroleum and natural gas. While there are in excess of 100 deathsper year associated with electric transmission lines, according to the DOT's Office of PipelineSafety in 2009, there were 0 deaths associated with transmission pipelines, and 10 deathsassociated with distribution systems. To learn more about pipeline safety, visit the DOT's Office of Pipeline Safety.
Lowering Pipe Source: Duke Energy Gas Transmission Canada
Pig - Pipeline Inspection Tool Source: Duke Energy Gas Transmission Canada
A few of the safety precautions associated with natural gas pipelines include:
Aerial Patrols - Planes are used to ensure no construction activities are taking place tooclose to the route of the pipeline, particularly in residential areas. Unauthorizedconstruction and digging is the primary threat to pipeline safety, according to INGAA
Leak Detection - Natural gas detecting equipment is periodically used by pipeline
personnel on the surface to check for leaks. This is especially important in areas wherethe natural gas is not odorized.
Pipeline Markers - Signs on the surface above natural gas pipelines indicate thepresence of underground pipelines to the public, to reduce the chance of any interferencewith the pipeline.
Gas Sampling - Routine sampling of the natural gas in pipelines ensures its quality, andmay also indicate corrosion of the interior of the pipeline, or the influx of contaminants.
Preventative Maintenance - This involves the testing of valves and the removal of surface impediments to pipeline inspection.
Emergency Response - Pipeline companies have extensive emergency response teamsthat train for the possibility of a wide range of potential accidents and emergencies.
The One Call Program - All 50 states have instituted what is known as a 'one call'program, which provides excavators, construction crews, and anyone interested in digging
into the ground around a pipeline with a single phone number that may be called whenany excavation activity is planned. This call alerts the pipeline company, which may flagthe area, or even send representatives to monitor the digging. The national 3-digit number for one call is “811.”
While large interstate natural gas pipelines transport natural gas from the processing regions tothe consuming regions and may serve large wholesale users such as industrial or power generation customers directly, it is the distribution system that actually delivers natural gas to mostretail customers, including residential natural gas users.
Industry and Market StructureThe natural gas industry is an extremely important segment of
the U.S. economy. In addition to providing one of the cleanestburning fuels available to all segments of the economy, theindustry itself provides much valuable commerce to the U.S.economy. Below is a brief description of the structure of thenatural gas industry and market, as well as links to informationon the make-up of the various segments of the natural gasindustry, and recent statistics regarding the supply of naturalgas. To learn about the processes associated with the naturalgas supply chain, click here.
To jump ahead to specific topics in this section, click on thelinks below:
Overview of Industry Structure - discusses howdifferent market participants interact to bring suppliesof natural gas to the market.
Industry Makeup - discusses the composition of theindustry.
Natural Gas Market Overview - discusses the naturalgas market, and the forces that affect the interaction of supply and demand for natural gas.
Market Activity -provides a snapshot of recent wholesale market activity as reported by
The structure of the natural gas industry has changed dramatically since the mid-1980's. In thepast, the structure of the natural gas industry was simple, with limited flexibility and few options for
natural gas delivery. Exploration and production companies explored and drilled for natural gas,selling their product at the wellhead to large transportation pipelines. These pipelines transportedthe natural gas, selling it to local distribution utilities, who in turn distributed and sold that gas to itscustomers. The prices for which producers could sell natural gas to transportation pipelines wasfederally regulated, as was the price at which pipelines could sell to local distribution companies.State regulation monitored the price at which local distribution companies could sell natural gas totheir customers.
Getting Natural Gas to Market - Prior to Deregulation and Pipeline Unbundling
Thus, the structure of the natural gas industryprior to deregulation and pipeline unbundlingwas very straightforward. However, with
regulation of wellhead prices, as well asassured monopolies for large transportationpipelines and distribution companies, therewas little competition in the marketplace, and incentives to improve service and innovate werefew. Regulation of the industry also led to natural gas shortages in the 1970s, and surpluses in the1980s. To review the history of natural gas regulation, click here.
The natural gas industry today has changed dramatically, and is much more open to competitionand choice. Wellhead prices are no longer regulated; meaning the price of natural gas isdependent on supply and demand interactions. Interstate pipelines no longer take ownership of the natural gas commodity; instead they offer only the transportation component, which is stillunder federal regulation. LDCs continue to offer bundled products to their customers, althoughretail unbundling taking place in many states allows the use of their distribution network for the
transportation component alone. End users may purchase natural gas directly from producers or LDCs.
One of the primary differences in the current structure of the market is the existence of natural gasmarketers. Marketers serve to facilitate the movement of natural gas from the producer to the enduser. Essentially, marketers can serve as a middle-man between any two parties, and can offer either bundled or unbundled service to its customers. Thus, in the structure mentioned above,marketers may be present between any two parties to facilitate the sale or purchase of naturalgas, and can also contract for transportation and storage. Marketers may own the natural gasbeing transferred, or may simply facilitate its transportation and storage. Essentially, a myriad of different ownership pathways exist for natural gas to proceed from producer to end user.
Simplified Structure of Industry after Pipeline Unbundling
The diagram shows a simplifiedrepresentation of the structure of the naturalgas industry after pipeline unbundling andwellhead price deregulation. It is important tonote that the actual ownership pathway of thegas may be significantly more complicated, asthe marketer or the LDC are not the finalusers. Either of these two entities may selldirectly to the end user, or to other marketersor LDCs.
The regulatory environment of the day has adramatic effect on shaping the structure of theindustry. To learn more about the currentregulatory environment for the natural gasindustry, click here.
The actions of the federal government and its related agencies and departments can also have asignificant impact on the structure and functioning of the natural gas industry. To learn more about
how government actions can affect the natural gas industry, click here.
Industry Makeup
Now that the basic structure of the natural gasindustry has been discussed, it is possible toexamine the business characteristics andrelevant statistics of each industry segment.
An excellent source for statistics andinformation on the natural gas industry and itsvarious sectors is the Energy Information Administration (EIA). The EIA was created in
1977 as the statistical arm of the Departmentof Energy, charged with developing energydata and analyses that help to enhance theunderstanding of the energy industry. Clickhere to view the EIA's homepage. For a goodoverview of relevant updated statistics relatedto the natural gas industry, view the EIA'ssummary statistics on natural gas here.
Below are some statistics (based on EIA data for the year 2007) on the makeup of the natural gasindustry. Follow the links to view the most up to date information on each sector:
Producers - There are over 6,300 producers of natural gas in the United States. These
companies range from large integrated producers with worldwide operations and interestsin all segments of the oil and gas industry, to small one or two person operations that mayonly have partial interest in a single well. The largest integrated production companies aretermed 'Majors', of which there are 21 active in the United States. For more information onthe production of natural gas in the United States, click here. Information on theproduction of natural gas is also available on EIA's website here.
Processing - There are over 530 natural gas processing plants in the United States,which were responsible for processing almost 15 trillion cubic feet of natural gas and
extracting over 630 million barrels of natural gas liquids in 2006. For more information onnatural gas processing, visit the Gas Processors Association here. For updated statisticson the processing of natural gas in the United States, click here.
Pipelines - There are about 160 pipeline companies in the United States, operating over 300,000 miles of pipe. Of this, 180,000 miles consist of interstate pipelines. This pipeline
capacity is capable of transporting over 148 Billion cubic feet (Bcf) of gas per day fromproducing regions to consuming regions. For more information on the natural gas pipelineinfrastructure in the United States, click here. To see a list of major pipeline companies,including links to their websites, visit the Federal Energy Regulatory Commission'swebsite here.
Storage - There are about 123 natural gas storage operators in the United States, whichcontrol approximately 400 underground storage facilities. These facilities have a storagecapacity of 4,059 Bcf of natural gas, and an average daily deliverability of 85 Bcf per day.The EIA maintains a weekly storage survey, monitoring the injection and withdrawal of stored natural gas. This survey gives a good indication of the status of the natural gasmarket, measuring the natural gas that is extracted or stored at any one time in responseto the demand for natural gas. To learn more about this survey, visit the EIA here. To viewmore statistics and information related to natural gas storage in the United States, clickhere.
Marketing - The status of the natural gas marketing segment of the industry is constantlychanging, as companies enter and exit from the industry quite frequently. As of 2000,there were over 260 companies involved in the marketing of natural gas. In this sameyear, about 80 percent of all the natural gas supplied and consumed in North Americapassed through the hands of natural gas marketers. The volume of non-physical naturalgas that passes through the hands of marketers is very large, and can be much greater than the actual physical volume consumed. This is an indication of vibrant, transparentcommodity markets for natural gas. For instance, in 1998, it is estimated that for everythousand cubic feet of natural gas consumed, about 2.7 thousand cubic feet passedthrough natural gas marketers. For more information on natural gas and energymarketers, visit the National Energy Marketers Association here.
Local Distribution Companies - There are about 1,200 natural gas distributioncompanies in the U.S., with ownership of over 1.2 million miles of distribution pipe. Whilemany of these companies maintain monopoly status over their distribution region, manystates are currently in the process of offering consumer choice options with respect totheir natural gas distribution. To learn about the status of distribution restructuring acrossthe United States visit the EIA here. To learn more about natural gas distributioncompanies and their regulatory structure, visit the National Association of RegulatoryUtility Commissioners here. The American Gas Association is also an excellent source for information on LDCs.
Natural Gas Market Overview
The nature of the natural gas market is similar to other competitive commodity markets: pricesreflect the ability of supply to meet demand at any one time. The economics of producing naturalgas are relatively straightforward. Like any other commodity, the price of natural gas is largely afunction of demand and the supply of the product.
When demand for gas is rising, andprices rise accordingly, producerswill respond by increasing their exploration and productioncapabilities. As a consequence,production will over time tend toincrease to match the stronger demand. However, unlike manyproducts, where production can beincreased and sustained in a matter of hours or days, increases innatural gas production involve muchlonger lead times. It takes time toacquire leases, secure requiredgovernment permits, do exploratoryseismic work, drill wells andconnect wells to pipelines; this cantake as little as 6 months, and in some cases up to ten years. There is also uncertainty about thegeologic productivity of existing wells and planned new wells. Existing wells will naturally declineat some point of their productive life and the production profile over time is not known with
certainty. Thus, it takes time to adjust supplies in the face of increasing demand and rising prices.To learn more about factors that affect the supply of natural gas, click here.
The supply response to prices was demonstrated emphatically following the winter of 2000-2001as producers substantially increased production investments and activities in response to higher prices. Likewise higher prices (and the U.S. recession) also reduced demand for natural gas. Thesupply and demand responses led to a new equilibrium in 2002 between supply and demand atmarket clearing prices far below the 2000-2001 peak.
In an environment of falling gas prices, the converse will betrue. Producers will respond to lower natural gas prices over time by reducing their expenditures for new exploration andproduction. Production decline in existing wells will decreaseproductive capacity. At the same time, the lower prices willincrease the demand for natural gas. This, in turn, willultimately result in upward pressure on gas prices. Thisrelationship between changes in the price of natural gas andvariations in the supply of and demand for natural gas issometimes referred to as the "natural gas market cycle."
In the short term, and in relation to existing producing wells,the supply of natural gas is relatively inelastic in response tochanges in the price of natural gas. Contrary to some views,producers do not routinely shut in wells when natural gasprices are low. There are several economic drivers thatprovide an incentive for producers to continue producing even
in the face of lower prices.
First, if production is halted from a natural gas well itmay not be possible to restore the well's production due to reservoir and wellborecharacteristics.
Second, the net present value of recapturing production in the future may be negativerelative to producing the gas today -- i.e., it may be better to produce gas today than towait until the future to produce the gas. If a producer chooses not to operate a well, thelost production cannot be recovered the next month but is instead is deferred potentially
Natural Gas Volatility and Price Levels at Henry Hub Source: Energy Information Administration, Office of Oil and Gas;
years in the future. There are no guarantees that the prices for gas in the future are goingto be higher than prices today.
Third, some gas is produced in association with oil, and in order to stop the flow of naturalgas, the oil production must be stopped as well, which may not be economic.
Finally, a producer may be financially or contractually bound to produce specific volumesof natural gas.
Producers and consumers react rationally to changes in prices. Fluctuations in gas prices andproduction levels are a normal response of the competitive and liquid North America gas market.While the price of the natural gas commodity fluctuates, it is this inherent volatility that providesthe signals (and incentives) to both suppliers and consumers to ensure a constant move towardssupply and demand equality.
Because the natural gas market is so heavily dependent on the interaction of supply and demand,it is important to have knowledge of the factors that affect these two components. To learn moreabout the supply and demand of natural gas in the United States, click on the links below:
Natural Gas Demand Natural Gas Supply
The History of RegulationRegulation of the natural gas industry in theUnited States has historically been a tumultuousride, resulting in dramatic changes in theindustry over the past 30 or more years. Thissection will outline the major historical regulatoryevents related to the natural gas industry, andshow how the current structure of the industry inthe U.S. is the product of a long regulatoryevolution.
Today, competitive forces are being relied uponmore heavily to determine market structure andoperation. However, this has not always beenthe case. Almost all aspects of the natural gasindustry were regulated at one point - a situationwhich led to tremendous difficulties in theindustry, including the natural gas shortagesexperienced in the 1970s. To learn more aboutthe current regulatory environment, click here.
This section provides a timeline of important regulatory events regarding the natural gas industry.Click on the links below to skip ahead to later sections:
The Early Days of Regulation
The Beginnings of Federal Regulatory Involvement The Natural Gas Act of 1938
The Phillips Decision - Wellhead Price Regulation The Effects of Wellhead Price Control - 1958-1978 The Natural Gas Policy Act of 1978
The Natural Gas Wellhead Decontrol Act of 1989 FERC Order No. 636
Click here to view a condensed timeline of important regulatory developments.
The Early Days of Regulation
The regulation of natural gas dates back to the very beginnings of the industry. In the early days of the industry (mid-1800s) natural gas was predominantly manufactured from coal, to be deliveredlocally, generally within the same municipality in which it was produced. Local governments,seeing the natural monopoly characteristics of the natural gas market at the time, deemed naturalgas distribution a business that affected the public interest to a sufficient extent to merit regulation.Because of the distribution network that was needed to deliver natural gas to customers, it wasdecided that one company with a single distribution network could deliver natural gas morecheaply than two companies with overlying distribution networks and markets. However, economictheory dictates that a company in a monopoly position, with total control over its market and theabsence of any competition will typically take advantage of its position, and has incentives tocharge overly-high prices. The solution, from the point of view of the local governments, was toregulate the rates these natural monopolies charged, and set down regulations that prevented
them from abusing their market power.
As the natural gas industry developed, so did the complexity of maintaining regulation. In the early1900s, natural gas began to be shipped between municipalities. Thus natural gas markets wereno longer segmented by municipal boundaries. The first intrastate pipelines began carrying gasfrom city to city. This new mobility of natural gas meant that local governments could no longer oversee the entire natural gas distribution chain. There was, in essence, a regulatory gap betweenmunicipalities. In response to this, state level governments intervened to regulate the new'intrastate' natural gas market, and determine rates that could be charged by gas distributors. Thiswas done by creating public utility commissions and public service commissions to oversee theregulation of natural gas distribution. The first states to do so were New York and Wisconsin,which instituted commissions as early as 1907.
The Beginnings of Federal Regulatory Involvement
With the advent of technology that allowed the long distancetransportation of natural gas via interstate pipelines, newregulatory hurdles arose. In the same sense that municipalgovernments were unable to regulate natural gas distributionthat extended beyond their areas of jurisdiction, the stategovernments were unable to regulate interstate natural gaspipelines. Between 1911 and 1928, several states attemptedto assert regulatory oversight of these interstate pipelines.However, in a series of decisions, the U.S. Supreme Courtheld that such state oversight of interstate pipelines violatedthe interstate commerce clause of the U.S. Constitution.
These cases, known as the 'Supreme Court CommerceClause' cases, essentially stated that interstate pipelinecompanies were beyond the regulatory power of state-levelgovernment. Without any federal legislation dealing withinterstate pipelines, these decisions essentially left interstatepipelines completely unregulated; the second regulatory gap.
However, due to concern regarding the monopoly power of interstate pipelines, as well as conglomeration of the
industry, the federal government saw fit to step in to fill the regulatory gap created by interstatepipelines.
In 1935, the Federal Trade Commission issued a report outlining its concern over the marketpower that may be exerted by merged electric and gas utilities. By this time, over a quarter of theinterstate natural gas pipeline network was owned by only 11 holding companies; companies that
also controlled a significant portion of gas production, distribution, and electricity generation. Inresponse to this report, in 1935 Congress passed the Public Utility Holding Company Act to limitthe ability of holding companies to gain undue influence over a public utility market. However, thelaw did not cover the regulation of interstate gas sales. Click here to view the Public Utility HoldingCompany Act as it exists today.
The Natural Gas Act of 1938
In 1938, the federal government became involved directly in the regulation of interstate naturalgas with the passage of the Natural Gas Act (NGA). This act constitutes the first real involvementof the federal government in the rates charged by interstate gas transmission companies.Essentially, the NGA gave the Federal Power Commission (the FPC, which had been created in1920 with the passage of the Federal Water Power Act) jurisdiction over regulation of interstate
natural gas sales. The FPC was charged with regulating the rates that were charged for interstatenatural gas delivery, as well as limited certification powers. The NGA specified that no newinterstate pipeline could be built to deliver natural gas into a market already served by another pipeline. In 1942, these certification powers were extended to cover any new interstate pipelines.This meant that, in order to build an interstate pipeline, companies must first receive the approvalof the FPC.
The rationale for the passage of the NGA was the concern over the heavy concentration of thenatural gas industry, and the monopolistic tendencies of interstate pipelines to charge higher thancompetitive prices due to their market power. While the NGA required that 'just and reasonable'rates for pipeline services be enforced, it did not specify any particular regulation of prices of natural gas at the wellhead.
To learn more about the Natural Gas Act, click here.
The Phillips Decision - Wellhead Price Regulation
As mentioned, the NGA instituted no specific regulatory oversight of sales of natural gas fromproducers to the pipelines: wellhead prices were unregulated. However, in Supreme Court casesduring the early 1940s, it was determined that wellhead prices were subject to federal oversight if the selling producer and the purchasing pipeline were affiliated companies. However, the FPCcontended that if the natural gas producer and pipeline were unaffiliated, natural market forcesexisted that would keep wellhead prices competitive.
In 1954, however, this all changed with theSupreme Court's decision in PhillipsPetroleum Co. v. Wisconsin (347 U.S. 672(1954)). In this decision, the Supreme Courtruled that natural gas producers that soldnatural gas into interstate pipelines fell under the classification of 'natural gas companies' inthe NGA, and were subject to regulatoryoversight by the FPC. This meant thatwellhead prices - that is, the rate at whichproducers sold natural gas into the interstatemarket - would be regulated much the sameas natural gas that was sold by interstatepipelines to local distribution utilities.
The Phillips decision had a complicated and far-reaching effect on the natural gas industry. Inregulating wellhead prices, the FPC instituted a traditional 'cost-of-service' rate makingdetermination. This system of setting rates relied on the cost of providing the service, rather thanthe market value of that service. This meant that prices were set to allow companies to chargeprices high enough to cover the actual costs of producing natural gas, plus a 'fair' profit. Whereregulating pipelines had been possible with this method due to the relatively small number of interstate pipeline companies, the large number of different natural gas producers meant thatregulating producers was an extreme administrative burden for the FPC. Three eras of producer regulation ensued each with its own difficulties, until finally wellhead price control culminated inthe natural gas shortages of the 1970s.
From 1954 to 1960, the FPC attempted to deal with producers and their rates on an individualbasis. Each producer was treated as an individual public utility, and rates were set based on eachproducer's cost of service. However, this turned out to be administratively unfeasible, as therewere so many different producers and rate cases that a tremendous backlog developed at theFPC. For example, in 1959, there were 1,265 separate applications for rate increases or reviews,the FPC was only able to act on 240 cases.
Due to this enormous backlog, the FPC in 1960 decided to set rates based on geographic areas.The U.S. was divided into five separate producing regions, and the FPC set rates for all wells in aparticular region. The FPC set interim ceiling prices based on the average natural gas contractprices paid during 1959-1960 for a particular area. The FPC intended on using these interimceiling prices until it could determine a 'just and reasonable' rate that it could apply to all naturalgas sales from a particular region. However, the process for determining area wide rates tookmuch longer and was much more difficult than anticipated, and by 1970 rates had been set for only two of the five producing areas. To make matters worse, for most of the areas, prices wereessentially frozen at 1959 levels. The problem with determining rates for a particular area basedon cost-of-service methodologies was that there existed many wells in each area, with vastlydifferent production costs.
By 1974, the FPC had determined that area wide pricing was unfeasible. In an effort to find asystem of wellhead price regulation that worked, the FPC adopted national price ceilings for thesale of natural gas into interstate pipelines. Realizing that the prior price ceilings, based on thecost-of-service approach, were much lower than the market value of interstate natural gas, theFPC set a national price ceiling of $0.42 per million cubic feet (mcf) of natural gas. Although thisprice ceiling doubled the prices that had been set during the 60s, it was still significantly less thanthe market value of the natural gas being sold. This system of price controls was in place until thepassage of the Natural Gas Policy Act (NGPA) in 1978.
All three of these systems of price control discussed above had disastrous effects on the naturalgas market in the United States. The artificially low price ceilings that had been set since 1954had a number of outcomes in the market, coming to bear in the late 60s and 70s. Because the setrates for natural gas were below the market value of that gas, demand surged. The low prices of natural gas, as set by the FPC, meant that consumers were receiving good value for their money.This combined with the oil price surges experienced during the OPEC crisis in the 70s madenatural gas an even more attractive fuel.
However, at the same time, there was little incentive for natural gas producers to devote themoney required to explore for and produce new natural gas reserves. The selling price for naturalgas was so low, it simply wasn't worth it for the producers. Producers also saw little incentive tosearch for new reserves. While the price at which they could sell interstate gas was fixed, thefinding and development costs for establishing new reserves was as variable and unpredictable asever. Producers saw little reason to engage in the exploration of new reserves that would costmore to find than they could be sold for under FPC wellhead price control.
However, the FPC only regulated producer wellhead prices for natural gas destined for theinterstate market, leaving natural gas sales within the intrastate market relatively free of regulation. So while demand was surging nationwide, economic incentives did not exist for
producers to ship their gas across state lines. They could sell it at a much higher price to intrastatebidders. In 1965, a third of the nations proved reserves were earmarked for intrastate consumers;by 1975, almost half of the proved reserves were committed to intrastate consumers.
This resulted in natural gas reaching consumers in the producing states, while the consumingstates were experiencing natural gas supply shortages. In fact, in 1976 and 1977, many schoolsand factories in the Midwest were forced to close, due to a shortage of natural gas to run their facilities. Meanwhile, in the producing states, virtually no shortage was felt, due to the thrivingintrastate market satisfying natural gas demand in these states. This led to certain 'curtailment'policies, advocated by the FPC and state utility regulators. These policies essentially set aschedule of priority, directing distributors and transporters to curtail supplies to certain customerswho were deemed 'low priority'. However, these policies resulted in numerous litigation suits andFPC proceedings that turned out to be extremely complicated and time consuming. Realizing that
something must be done at the federal level to reduce the strain of these supply shortages anddemand surges, Congress enacted the Natural Gas Policy Act in 1978.
The Natural Gas Policy Act of 1978
In November of 1978, at the peak of the natural gas supply shortages, Congress enactedlegislation known as the Natural Gas Policy Act (NGPA), as part of broader legislation known asthe National Energy Act (NEA). Realizing that those price controls that had been put in place toprotect consumers from potential monopoly pricing had now come full circle to hurt consumers inthe form of natural gas shortages, the federal government sought through the NGPA to revise thefederal regulation of the sale of natural gas. Essentially, this act had three main goals:
Creating a single national natural gas market
Equalizing supply with demand Allowing market forces to establish the wellhead price of natural gas
This act attempted to accomplish these goals by statutorily setting 'maximum lawful prices' for thewellhead sale of natural gas, as well as breaking down barriers between intrastate and interstatenatural gas markets. The FPC, the federal body with regulatory oversight of the natural gasmarket, was abolished and replaced with another body, the Federal Energy RegulatoryCommission (FERC), under the Department of Energy Organization Act of 1977. Under theNGPA, FERC was given jurisdiction over the same areas as the FPC, with the exception of the
import and export of natural gas, which was the jurisdiction of the new Department of Energy.
The ceiling prices for wellhead gas set by the NGPA differed from the system put in place under the NGA. Under the NGPA, increased price ceilings were set, intended to provide economicincentives for producers to search for and produce new natural gas. These ceilings and themechanisms for increasing rates were set out in the statute, rather than relying on an independent
body to determine these rates. Under the NGPA, some of the price ceilings that were set,specifically those affecting wellhead sales of new production, were designed to be phased outover a series of years, with the goal of complete deregulation of wellhead prices by 1985.However, the NGPA also dictated that gas brought into production before the passage of the Actwould forever be subject to pre-NGPA regulations and price limits.
In addition to this new system for rate-setting, and the goal of deregulation of wellhead prices inseven years, the NGPA also served to break down the barriers between interstate and intrastatenatural gas. Under the NGPA, FERC was authorized to approve the transportation of natural gasby an interstate pipeline on behalf of intrastate pipelines and local distribution companies -avoiding some of the regulatory hurdles that had created such a schism between interstate andintrastate markets.
The NGPA was a fundamental first step in deconstructing the regulatory problems that had beencreated by the NGA. The market response to the provisions of the NGPA included:
Pipelines, accustomed to gas shortages in the past years, signed up for many long-termnatural gas contracts
Producers expanded exploration and production, drilling new wells and using the long-term sales contracts with pipelines to recover their investment
Average wellhead prices rose dramatically in the years following the NGPA Prices for end-users increased, but were mitigated by the pipelines, which blended the
cost of gas under new contracts with regulated gas under old contracts when selling their bundled product to their customers
Price increases led to decreased demand
Thus the NGPA allowed for more competitive prices at the wellhead. However, many members of the industry were unprepared for the corresponding drop in demand. The pipelines, used to theera of curtailment, were quick to sign up for long-term 'take-or-pay' contracts. These contractsrequired the pipelines to pay for a certain amount of the contracted gas, whether or not they cantake the full contracted amount. While the NGPA did spur investment in the discovery of newnatural gas reserves, the increasing wellhead price, mixed with the eagerness of pipelines todeliver as much natural gas as possible, led to a situation of oversupply.
Where it was necessary to curtail natural gas deliveries in the 60s and 70s due to high demandand low supply, the situation reversed in the period from 1980-85. Rising natural gas pricesresulted in the dropping off of some of the demand that had built up when the price for natural gaswas held below its market value. The resulting 'oversupply' scenario had a number of effects,including requiring the pipelines to make 'take-or-pay' payments to their suppliers despite no
longer needing the amount of natural gas that had previously been contracted. Customers of thepipelines, purchasing a 'bundled' product - including the natural gas itself and the transportation of that gas - lobbied for reduced natural gas prices. In addition, pipeline customers sought the rightto purchase their own gas from producers and transport it over the interstate pipelines, instead of purchasing the bundled product directly from the pipelines.
To learn more about the Natural Gas Policy Act, click here.
The Natural Gas Policy Act took the first steps towards deregulating the natural gas market, byinstituting a scheme for the gradual removal of price ceilings at the wellhead. However, there stillexisted significant regulations regarding the sale of gas from an interstate pipeline to local utilitiesand local distribution companies (LDCs). Under the NGA and the NGPA, pipelines purchasednatural gas from producers, transported it to its customers (mostly LDCs), and sold the bundledproduct for a regulated price. Instead of being able to purchase the natural gas as one product,and the transportation as a separate service, pipeline customers were offered no option topurchase the natural gas and arrange for its transportation separately.
Several events led up to the 'unbundling' of the pipelines' product. In the early 1980s, noticing thata significant number of industrial customers were switching from using natural gas to other formsof energy (for example, electric generators switching from natural gas to coal), several pipelinesinstituted what they called Special Marketing Programs (SMPs). Essentially, these programs,which were approved by FERC, allowed industrial customers with the capability to switch fuels theright to purchase gas directly from producers, and transport this gas via the pipelines. However,SMPs were found discriminatory by the District of Columbia Circuit Court of Appeals in several1985 cases. The court ruled that SMPs were discriminatory in that no other customer of thepipelines had the ability to purchase their own natural gas and transport it via pipeline. As a resultof this, SMPs were eliminated on October 31, 1985.
However, the practice of allowing customers to purchase their own gas, and use pipelines only astransporters rather than merchants, was not abandoned. In fact, it became part of FERC policy toencourage this separation by way of Order No. 436.
FERC Order No. 436
In 1985, FERC issued Order No. 436, which changed how interstate pipelines were regulated.This order established a voluntary framework under which interstate pipelines could act solely astransporters of natural gas, rather than filling the role of a natural gas merchant. This order provided for all customers the same possibilities that the SMPs of the early 1980s had affordedindustrial fuel-switching customers, thus avoiding the discrimination problems of the earlier SMPs.Essentially, FERC allowed pipelines, on a voluntary basis, to offer transportation services to
customers who requested them on a first come, first served basis. The interstate pipelines werebarred from discriminating against transportation requests based on protecting their own merchantservices. Transportation rate minimums and maximums were set, but within those boundaries thepipelines were free to offer competitive rates to their customers. Although the frameworkestablished by Order 436 was voluntary, all of the major pipeline systems eventually took part.
FERC Order No. 436 had a number of immediate effects, including:
Pipelines began offering transportation service to all customers Pipeline customers realized cost savings, in that the spot market prices of natural gas
were much lower than the prices offered for natural gas by the pipelines (due to the longterm 'take-or-pay' contracts that the pipelines were bound under)
The payments necessary under these 'take-or-pay' contracts increased for pipelines, as
few customers were willing to purchase higher priced gas from the pipelines Pipelines and producers were often forced into litigation to resolve issues surrounding
'take-or-pay' contracts
FERC Order No. 436 also had a number of longer term effects, including:
The transportation function became the primary function of pipelines, as opposed tooffering the bundled merchant service
A wide variety of natural gas purchasing and transportation patterns and practices
emerged due to the availability of choices to the end user
New pricing patterns emerged, known as 'netback' pricing, in which a reasonable pricewas set at the point of consumption, and that minus the cost of distribution, minus the costof transportation, gave the 'netback' price to the producer at the wellhead
The movement towards allowing pipeline customers the choice in the purchase of their natural gas
and their transportation arrangements became known 'open access'. Order No. 436 thus becamegenerally known as the Open Access Order.
While the general thrust of Order 436 was upheld in Court, several problems arose regarding the'take-or-pay' contracts under which the pipelines were still obliged. Given these problems, andunder remand from the D.C. Circuit Court of Appeals, FERC issued Order No. 500 in 1987. Thisorder essentially encouraged interstate pipelines to buy out the costly take-or-pay contracts, andallowed them to pass a portion of the cost of doing so through to their sales customers. The LDCsto which these costs were passed through were allowed by state regulatory bodies to further passthem on to retail customers. However, the open access provisions of Order No. 436 remainedintact.
Open access to pipelines also spurred the first appearances of natural gas marketers. To learn
more about natural gas marketing, click here.
The Natural Gas Wellhead Decontrol Act of 1989
As mentioned, under the NGPA, the deregulation of natural gas producers sale prices at thewellhead had begun. However, it wasn't until Congress passed the Natural Gas WellheadDecontrol Act (NGWDA) in 1989 that complete deregulation of wellhead prices was carried forth.Under the NGWDA, the NGPA was amended and all remaining regulated prices on wellheadsales were repealed. As of January 1, 1993, all remaining NGPA price regulations were to beeliminated, allowing the market to completely determine the price of natural gas at the wellhead.
The NGWDA stated that 'first sales' of natural gas were to be free of any federal price regulations.The Act defined 'first sales' as the sale of gas:
To a pipeline To a local distribution company To an end user Preceding the sale to any of the above Determined by FERC to be a first sale
Excluded from falling under the definition of a first sale were any sales of gas by pipelines andlocal distribution companies, including interstate pipelines.
FERC Order No. 636
While FERC Order No. 436 made the unbundling of pipeline services possible, the establishmentof transportation only services by a pipeline continued to be only voluntary. FERC Order No. 636completed the final steps towards unbundling by making pipeline unbundling a requirement.Issued in 1992, the Order states that pipelines must separate their transportation and salesservices, so that all pipeline customers have a choice in selecting their gas sales, transportation,and storage services from any provider, in any quantity. Order 636 is often referred to as the FinalRestructuring Rule, as it was seen as the culmination of all of the unbundling and deregulationthat had taken place in the past 20 years. Essentially, this Order meant that pipelines could nolonger engage in merchant gas sales, or sell any product as a bundled service. This Order
required the restructuring of the interstate pipeline industry; the production and marketing arms of interstate pipeline companies were required to be restructured as arms-length affiliates. Theseaffiliates, under Order 636, could in no way have an advantage (in terms of price, volume, or timing of gas transportation) over any other potential user of the pipeline.
FERC Order No. 636 is the culmination of deregulating the interstate natural gas industry. Distilled
to its main purpose, the Order gives all natural gas sellers equal footing in moving natural gasfrom the wellhead to the end-user or LDC. It allows the complete unbundling of transportation,storage, and marketing; the customer now chooses the most efficient method of obtaining its gas.
Order 636 also requires that interstate pipelines offer services that allow for the efficient andreliable delivery of natural gas to end users. These services include the institution of 'no-notice'transportation service, access to storage facilities, increased flexibility in receipt and deliverypoints, and 'capacity release' programs. No-notice transportation services allow LDCs and utilitiesto receive natural gas from pipelines on demand to meet peak service needs for its customers,without incurring any penalties. These services were provided based on LDC and utility concernsthat the restructuring of the industry may decrease the reliability needed to meet their owncustomers' needs. The capacity release programs allow the resale of unwanted pipeline capacitybetween pipeline customers. Order 636 requires interstate pipelines to set up electronic bulletin
boards, accessible by all customers on an equal basis, which show the available and releasedcapacity on any particular pipeline. A customer requiring pipeline transportation can refer to thesebulletin boards, and find out if there is any available capacity on the pipeline, or if there is anyreleased capacity available for purchase or lease from one who has already purchased capacitybut does not need it.
To learn more about FERC Order No. 636, click here.
To learn more about the structure of regulation as it exists today, and the effect that this regulationhas on industry, click here.
The Market Under Regulation
The current regulatory environment in which thenatural gas industry operates is much less stringentand relies more heavily upon competitive forces thanin the past. The last twenty years have seen dramaticchanges throughout the industry, spurred by its ever-changing regulatory environment. However, despitethe restructuring and deregulation of some portions of the natural gas supply chain, there still exist significantregulatory oversight of the industry in thetransportation and distribution of natural gas. Thisoversight is necessary to ensure that those marketparticipants that possess monopoly power in theindustry do not abuse this power or distort the smooth
and efficient functioning of the natural gas markets. Toump ahead in this section, click on the links below:
Overview of Current Regulation Regulation of Distribution FERC - Regulation of Interstate Pipelines FERC Processes Some Important FERC Regulations and Orders
Under the current regulatory environment, only pipelines and local distribution companies (LDCs)are directly regulated with respect to the services they provide. Natural gas producers andmarketers are not directly regulated. This is not to say that there are no rules governing their conduct, but instead there is no government agency charged with the direct oversight of their day
to day business. Production and marketing companies must still operate within the confines of thelaw; for instance, producers are required to obtain the proper authorization and permitting beforebeginning to drill, particularly on federally-owned land. However the prices they charged are afunction of competitive markets, and are no longer regulated by the government.
Interstate pipeline companies, on the other hand, are regulated in the rates they charge, theaccess they offer to their pipelines, and the siting and construction of new pipelines. Similarly,local distribution companies are regulated by state utility commissions, which oversee their rates,construction issues, and ensure proper procedure exists for maintaining adequate supply to their customers.
The current regulation of transportationpipelines by the Federal Energy Regulatory
Commission (FERC) has designated thatinterstate pipelines can serve only astransporters of natural gas. In the past,interstate pipelines acted as both atransporter of natural gas, as well as a seller of the commodity, both of which were rolledup into a bundled product and sold for oneprice. However, since FERC Order 636,interstate pipelines are no longer permitted to act as merchants and sell bundled products.Instead, they can only sell the transportation component, and never take ownership of the naturalgas themselves. Pipelines must also now offer access to their transportation infrastructure to allother market players equally, referred to as 'open access' to the pipelines. This allows marketers,producers, LDCs, and even end users themselves to contract for transportation of their natural
gas via interstate pipeline, on an equal and unbiased basis.
The current regulatory environment is the product of many years of regulatory evolution. To reviewthe history of natural gas regulation in the United States, click here.
This section will focus on the regulation of the natural gas industry by the Federal EnergyRegulatory Commission (FERC). FERC has jurisdiction over the regulation of interstate pipelinesand is concerned with overseeing the implementation and operation of the natural gastransportation infrastructure. FERC obtains its authority and directives in the regulation of thenatural gas industry from a number of laws; namely the Natural Gas Act of 1938, the Natural GasPolicy Act of 1978, the Outer Continental Shelf Lands Act, the Natural Gas Wellhead Decontrol Act of 1989, and the Energy Policy Act of 1992.
Because FERC obtains its direction and authority from legislation, it is important to get anoverview of important congressional committees and government departments that haveurisdiction over areas affecting the natural gas industry, as well as power to direct the futureregulation of the industry. To view links to these committees, departments, and agencies chargedwith oversight of varying aspects of the natural gas industry, click here.
Regulation of Distribution
The regulation of local distribution companies has much the same objective as regulation of
intestate pipelines, including avoiding the exercise of market power, protecting customers who relyon their supply of natural gas from a single source (captive customers), and ensuring that therates and prices set by an LDC are fair and equitable. State regulatory utility commissions haveoversight of issues related to the siting, construction, and expansion of local distribution systems. Although these general objectives generally hold across states, there are different processes andregulations in place across the country. For more information on the regulation of natural gasdistribution, visit the National Association of Regulatory Utility Commissioners here.
Regulation of distribution is currently undergoing a process of change, with the adoption by manystates of programs aimed at exploring and instituting retail choice programs. These programsallow natural gas consumers more flexibility in arranging the delivery of their gas, includingallowing many customers the option of purchasing their own natural gas, and using the distributionnetwork of their LDC simply to transport that gas. For more information on the status of retailchoice programs and unbundling of LDC services across the country, visit the Energy Information Administration here.
FERC - Regulation of Interstate Pipelines
The Federal Energy Regulatory Commission is an independent regulatory agency charged with
the regulation of certain aspects of the energy industry in the United States, including theregulation of natural gas transportation. It was created in 1977 under the Department of EnergyOrganization Act. Although a government agency, FERC is designed to be independent from anyundue political party influence or affiliation, as well as independent from any influence from theexecutive or legislative branches of government, and industry participants, including the energycompanies over which it has oversight.
FERC is composed of five commissioners, who are nominated by the President of the UnitedStates, and confirmed into office by the U.S. Senate. Each commissioner serves a five year term,and one commissioner's term is up every year. The President also designates one of thesecommissioners to act as FERC Chariman, who has the responsibility for setting a biweeklycommission agenda. FERC operates by majority rule, which means that any Order must beapproved by at least three of the five commissioners. FERC also has a significant staff, which is
responsible for administrative functions, as well as conducting research and advising thecommissioners on important matters. There are approximately 1,150 FERC staff, of which 400focus on electric industry issues, 325 focus on hydro power issues, and 425 concentrate on oiland natural gas issues.
FERC oversees those industries in which member companies have significant market power over their sectors; for example natural gas pipelines are considered 'natural monopolies' due to the factthat in many areas, a single pipeline infrastructure has control over all of the transportation of natural gas to that area. FERC is charged with regulating to ensure that companies do not abusethese monopoly positions; and its regulatory objectives include:
Preventing discriminatory or preferential service Preventing inefficient investment and unfair pricing Ensuring high quality service Preventing wasteful duplication of facilities Acting as a surrogate for competition where competition does not or cannot exist
Promoting a secure, high-quality, environmentally sound energy infrastructure through theuse of consistent policies
Where possible, promoting the introduction of well functioning competitive markets inplace of traditional regulation
Protecting customers and market participants through oversight of changing energymarkets, including mitigating market power and ensuring fair and just market outcomes for
In the natural gas industry, FERC regulates the rates and services offered by interstate pipelinecompanies, as well as certifying and permitting new pipeline construction and some closelyrelated environmental issues. In order to build new pipelines, or expand existing infrastructures,pipeline companies must show to FERC how the new or expanded pipeline will serve the public
interest, that it is economically feasible, and that it does not have significant environmentalimpacts. The certification of new pipeline developments is required under Section 7 of the NaturalGas Act. To learn more about the certification process, visit the FERCs website here.
FERC Processes
There are essentially two types of issues faced by FERC: making company specific decisions, andmaking industry-wide decisions. Company specific issues can include applications for ratechanges for one company's transmission services, applications for changes in terms or conditionsof transportation contracts, and complaints filed by another industry member, including utilities,project sponsors, trade associations, or any other interested party.
The process for dealing with a company specific issue is relatively
straightforward. An application or complaint is filed (whether it is anapplication to expand a pipeline, construct a new one, or a complaintconcerning unfair rates) to FERC. This filing is publicly posted, sothat interested parties may have time to research and developcomments or viewpoints that they believe may help (or serve their purposes) in the decision making process. FERC staff memberstypically perform an analysis of the matter, and issuerecommendations to the Commission. After FERC staff has reviewedthe issue, it is time for the Commission to take action. FERC hasfairly wide discretion with how it may decide to resolve issues; it may just make a decision without any further procedures, it may hold atrial-type hearing before an Administrative Law judge, or hold atechnical conference or 'paper' hearing. Alternate dispute resolution,
like mediation and arbitration, may also be used. For minor matters,the power to make a decision may be delegated to a FERC staff member (usually an Office Director). However, whatever the processused, the Commission has the final say; although FERC decisions
may be appealed in the Federal Court of Appeals.
Industry wide issues and decisions may be much more complicated than company specific issues.Because issues and regulations that affect the entire industry are being contemplated, the number of interested parties can be very high, and countless opposing viewpoints may exist. It is the job of FERC to consider all different points of view, and issue a decision based on what it believes is thebest course of action for the industry in general.
FERC first addresses industry wide matters by issuing a Notice of Inquiry (NOI), or a Notice of
Proposed Rulemaking (NOPR). Notices of Inquiry are generally intended to indicate that FERC iscollecting information, ideas, and opinions regarding a certain matter. Notices of ProposedRulemaking are generally intended to indicate the proposition of new regulations or policychanges. After issuing a NOI or NOPR, FERC then seeks comments from interested parties;essentially giving industry members, the public, trade associations, and any other interestedparties the chance to explain their position to FERC. FERC then reviews and considers thesecomments before making a final decision. The final outcome of this process could be to issue anNOPR (after issues have been clarified under a NOI) to propose new regulations or policychanges, or to issue new regulations or policy changes (that were earlier proposed under aNOPR), usually in the form of a FERC Order, policy statement, or rulemaking. FERC also has the
There are several important regulations which serve to shape the current regulation of interstatepipelines. Below is a brief description of a few FERC Orders that impacted the way in which
interstate pipelines conduct business. This is by no means a comprehensive list of major FERCpolicy statements and Orders, but instead provide a brief overview of a couple of importantOrders. To learn more about recent FERC actions in relation to the natural gas industry, visitFERCs website here.
FERC Order 636 - 1992
FERC Order 636 involves the restructuring of interstate pipeline services. The main objectives of this order include:
Requiring interstate pipelines to 'unbundle' their service, essentially separating the sale of natural gas from the transportation. Under FERC Order 436, pipeline unbundling wasvoluntary; Order 636 made it mandatory
Allows FERC to issue blanket certificates which allow pipelines to offer unbundledservices for firm or interruptible service at market-based rates
Allows for abandonment options for interruptible and short term firm transportation, and incertain instances longer term firm transportation services
Sets a generic capacity brokering program for pipelines to release excess capacity (whichincludes setting rate ceilings for the sale of released capacity)
For more information on FERC Order 636, visit the FERC website here.
FERC Order 637 - 2000
FERC Order 637 involves the regulation of short term pipeline services, and the regulation of
interstate pipelines. Essentially, this order served to address some of the issues that had arisenafter six years of operating under Order 636, and revise the regulatory structure in response toincreased competition in the natural gas industry, and in the transportation of natural gas. Someimportant aspects of this order include:
Suspended price ceilings for the sale of short term (less than one year) released capacityuntil September 30, 2002 (to respond to the formation of a significant 'gray market' in thesale of bundled capacity during peak periods by marketers and LDCs that essentiallycircumvented the ceilings set by Order 636)
Changes the regulations regarding scheduling procedures, capacity segmentation, andthe penalties imposed on pipelines in order to improve competition and efficiency in theinterstate transportation of natural gas
Removes economic biases associated with the right of first refusal for pipeline services,
while at the same time protecting the ability of captive customers (with no other options for meeting their natural gas supply needs) to resubscribe to long-term transportationcapacity
Improves the reporting requirements, allowing for more transparency in market pricingand allow for more effective monitoring of the industry
For more information on FERC Order 637, visit the FERC website here.
This order involved the regulation of the movement of natural gas in the Outer Continental Shelf (OCS) of the United States, under the Outer Continental Shelf Lands Act. This order was intendedto ensure that the transportation of natural gas from facilities located on the OCS was offered on anon-discriminatory, open access basis. Some important issues in this Order include:
The establishment of a regulatory regime for the Outer Continental Shelf that provides for
greater market transparency similar to the regulation of interstate pipelines, requiring all Dictates that all gas service suppliers on the OCS are subjected to the same regulatory
environment, whether they fall under the jurisdiction of the Natural Gas Act (interstatepipelines) or not
Sets reporting requirements for OCS gas service providers, requiring that the provider disclose information regarding the facilities it operates, its affiliates, existing customer contracts or information on its conditions of service and rates charged, although there iscurrently legal dispute as to whether FERC has the power to demand the reporting of certain sensitive information
This allows FERC to ensure that service is non-discriminatory, particularly with respect toaffiliates of gas service providers in the OCS region
For more information on FERC Order 639, visit the FERC website here.
NOPR - Standards of Conduct for Transmission Providers
An important issue currently facing FERC is the regulation of the interaction of transmissionproviders and their affiliated companies. FERC initiated discussion about the standards of conductfor transmission providers by issuing a Notice of Proposed Rulemaking in September of 2001.This proposed rulemaking deals primarily with standards for transmission providers (includinginterstate pipelines) dealing with affiliated companies, and the possibility that pipeline affiliatedcompanies may receive preferential treatment, or allow pipeline companies to 'circumvent' certainregulations. Thus FERC intends to develop a clear set of regulations and rules regarding theconduct of transmission providers, particularly in their dealings with affiliated companies.
The process for setting standards of conduct for transmission providers gives a good indication of
the number and range of interested parties who are concerned with FERC regulation. To learnmore about this NOPR, and view the comments that have been submitted by various parties, visitthe FERC website here.
The regulatory environment in which the natural gas industry operates is constantly changing, withsmall modifications and company specific issues being dealt with, as well as the institution andmodification of broader, far reaching policy objectives and major rulemakings. In order tounderstand the regulatory forces that affect the natural gas industry, a constant eye must be kepton the status of regulation.
To get the most up to date information on current issues facing FERC with respect to natural gas,visit FERC's website here.
