Historical Perspective

Over the past two decades, the natural gas industry has been transformed from a completely regulated industry to one in which market forces play a dominant role. Gas wellhead price deregulation, open access to pipeline transmission services, and comprehensive rate unbundling are three major shifts in federal policy designed to replace direct regulation with market forces.

In recent history, however, the gas industry was governed primarily by regulation. Passage of the Natural Gas Act of 1938 allowed the Federal Power Commission (FPC), now the Federal Energy Regulatory Commission (FERC), to regulate the price interstate pipelines could charge distribution companies for gas. In 1954, FPC authority was expanded to include jurisdiction over the price producers could charge interstate pipelines. This ruling effectively brought all gas produced and sold in interstate commerce under federal regulation, allowing only intrastate gas to remain free of wellhead price control. As a result, growing gas demand produced higher intrastate gas prices because these gas prices were based on free-market conditions, not an artificially determined, regulated price level. For the interstate markets, it was truly a buyer's market during that time.

By the late 1960s, funding and development costs for gas had begun to exceed the artificially controlled price levels. As one would expect, the artificially low prices took a natural toll on industry investment and supply. For instance, in 1968, 19 Tcf of natural gas was consumed, but only 13 Tcf was found. By 1973, the gap between production and consumption was much wider: 22 Tcf was consumed while only 6 Tcf was found. Then, during the severe winter of 1976-1977, widespread shortages of natural gas developed in the Northeast and Midwest. While these shortages were most profoundly manifested in curtailments and interruptions, they did far greater long-term damage to the industry, as many would not trust future gas deliverability for years to come.

In 1978, Congress and President Jimmy Carter made deregulation of the natural gas industry a part of the National Energy Policy Act. They realized that pricing natural gas below its free market value distorted the market and prevented producers from obtaining an adequate return on their investment, thereby ultimately threatening consistent, reliable supply of natural gas to the nation. Thus, the 1978 Natural Gas Policy Act instigated the national-level decontrol of natural gas at the wellhead. Again, as expected, this decontrol has resulted in a dramatic increase in the responsiveness of gas exploration and production activity to standard market signals.

FERC, however, continues to regulate the interstate pipeline system. But, it has facilitated the unbundling of pipeline transportation and open access to pipeline transportation through FERC Orders Nos. 380, 436, 500, and 636. Along with wellhead deregulation, these orders have resulted in lower gas costs, as well as innovative and expanded gas services.

FERC Orders Nos. 380, 436, and 500 served to abolish minimum LDC commodity bill provisions in interstate pipeline sales tariffs and allowed LDCs and other pipeline customers to purchase gas from third parties. Order No. 436 also established the requirement for interstate pipelines to provide nondiscriminatory interruptible transportation and provided guidelines for partial automatic recovery of pipeline transition costs.

FERC Order No. 636 focuses on comprehensive unbundling of merchant and transportation services. Traditionally, interstate gas pipelines have combined, or bundled, both the merchant and transportation functions and linked gas producers with downstream markets. Since November 1993, however, the situation has changed. Although pipelines, through their marketing affiliates, may sell unbundled gas just as any other marketer, the vast majority of gas moved on interstate pipelines today is owned and managed by others.

Today LDCs can competitively seek the lowest priced wellhead gas for both long-term (firm) and short-term (spot market) contracts, pay the pipelines only for transportation services, and then deliver gas to customers on either a firm or interruptible basis. Larger customers may also purchase their own gas, directly from the wellhead or through market brokers, and use both the pipelines and LDCs as vehicles for transporting the gas to their facility. Facilities with competitive energy alternatives and favorable utilization load profiles, resulting from extensive base or off-season usage, can benefit greatly from the new era of deregulated gas markets.

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