The Natural Gas Industry (Econ Exam 3)
What three key regulatory authorities over commercial natural gas activities were conveyed to the Federal Power Commission (and to its successor, the Federal Energy Regulatory Commission) under the Natural Gas Act of 1938? In other words, what key activities and transactions was the FPC authorized to regulate? What important specific categories and types of potential natural gas regulation were not conveyed to the FPC under the Natural Gas Act, either explicitly or apparently implicitly?
"Sales for resale"(wholesale gas sales)in interstate commerce -This potentially included both "wellhead"prices as well as "city gate"prices, except that wellhead price regulation appeared to be specifically exempted. Prices charged for pipeline transportation services provided in interstate commerce Federal certification of interstate pipelines and other facilities used for sales and transportation in interstate commerce FPC DID NOT HAVE POWER OVER Wellhead prices Certification and price regulation of intrastate pipelines. Retail prices charged by LDCs to end-uses of gas. "Conservation"regulation addressing problems stemming from the "rule of capture", and discrimination in purchasing gas. Mandatory interstate transmission of gas
In the early 1980s, the interstate pipelines began seeking FERC approval of certain "Special Marketing Programs" (SMP) and the "Special Transportation Programs" (STP). Briefly explain the basic structure of these proposals and how their provisions attempted to address the gas marketability problem? In what way did the pipelines expect that these programs would help mitigate the gas marketability problems they were experiencing as a result of their "take or pay" contracts?
"Special Marketing Programs"(SMPs) provided for gas to be sold to selected customers at special low prices so that these customers will not switch from burning gas to fuel oil and, therefore, continue to pay some portion of the fixed costs of the pipeline but at a substantially reduced price. "Special Transportation Programs"(STPs)provided unbundled pipeline transportation service to select customers so that they could purchase their own gas at the wellhead from gas producers so long as they arranged for their gas suppliers to extinguish a corresponding volume of the pipeline's take-or-pay obligation. That is, part of the pipeline's take-or-pay obligation was shifted to the customers who were allowed to go shopping for their own deals among the gas producers.
What were the several major adverse economic effects and adverse behavioral responses that were caused by wellhead gas price regulation as it was actually implemented by the FPC? What several major pieces of empirical evidence are the best indications of the severe adverse economic misallocations and consequences caused by the FPC's policies to regulate the wellhead prices of natural gas during the 1960s and 1970s?
-Disincentive to explore new gas -price differences in intra/inter states -interstate gas shortages -footloose industries moved to gas fields -retail gas prices low, encouraged overconsumption
In 1992, the FERC issued its "Final" Order on Open Access and mandated that the pipelines do certain things to assure that pipelines did not unfairly discriminate in favor of their internal gas marketing affiliates compared to unaffiliated gas marketers? Briefly state 3 or 4 of some of the more important changes in gas pipeline policies and practices that FERC mandated the pipelines to adopt.
-Pipelines were ordered to terminate all bundled service and convert existing contracts into unbundled commodity sales and transportation charges. -Current pipeline customerswere given an opportunity to reduce or terminate their bundled purchasesfrom a pipeline during a "transition period". -Policies were adopted to provide for pipelines to recover "transition costs"associated with such things as terminating long-term bundled service contracts. -third party transporrt customers has equal rights -functionally separate gas marketing / pipeline companies with no special treatment -electronic bulletin board -geographic market centers
Briefly identify the major trends that have developed and shaped the U.S. and international natural gas industry in the new millennium since the year 2000.
-explosion in number of nat gas power plants -shale revolution -integration of markets and national security concerns -LNG -GHG emissions concerns
After the D.C. Circuit Court ruled on this complaint and the Supreme Court eventually reviewed the Circuit Court's decision and remanded the issues related to the SMPs and STPs back to FERC for further consideration, how did the FERC ultimately skillfully exercise its conditioning authority to help the pipelines satisfactorily alleviate their take-or-pay problems while getting the pipelines to do what FERC wanted them to do in terms of modifying their long-standing commercial business practices?
1.Authorized pipelines to condition gas producers 'ability to transact directly with gas customers on the gas producer's agreeing to forgive one unit of take-or-pay liability for each unit of gas a customer purchased from a gas producer for transport by the pipeline. 2.Permitted pipelines to recover up to 50% of their take-or-pay costs through "direct billing"under fixed non-volumetric charges from pipeline customerswithout the having FERC first validate the "reasonableness" of these take-or-pay gas costs through a "prudency"review. The remainder had to be collected through the per-MCF commodity charges. FERC put a short fuseon the availability of these provisions. They were available to pipelines only until the end of 1988 (only about 16 months from the issuance of FERC's final order).
What/when did wellhead gasses become formally deregulated?
1989 Natural Gas Wellhead Decontrol Act, implemented in 1993
When the Maryland Peoples' Counsel complained about the SMP and STP programs approved by FERC and took FERC to court, how did the D.C. Circuit Court of Appeals rule in response to this complaint?
All SMPs and STPs violated the NGA prohibition against undue discrimination by allowing pipelines to exert increased monopoly power over captive customers in fundamental violation of the intent of the original NGA; All previously authorized SMPs and STPs were immediately vacated.
To the extent that some economists and others believed that it might actually be a good idea to regulate wellhead gas prices, what did they apparently believe (based on some of their explicit testimony before Congress and the FPC) about the economics of gas supplies and why such price regulation could be good for consumers and could be implemented without causing any serious gas shortages or major misallocations of gas resources? In other words, what key economic assumptions and models were likely dancing in the heads of these economists when they advised that wellhead gas price regulation could be a good idea if implemented "correctly"?
Based on Classic Cost-of-Service Utility Regulation Model, which uses historical accounting costs (user cost, speculative process). It says that finding cost =/= scarcity value, so you could separate pricing for "old" and "new" gas.
In what decade of the twentieth century did the construction of long-distance interstate natural gas pipelines rather suddenly expand to a commercially significant degree and displace a majority of local manufactured gas ("town gas") operations in major U.S. cities?
Between 1927 and 1931, about a dozen major pipelines were developed with diameters of about 20 inches and distances exceeding 200 miles each.
The Powerplant and Industrial Fuel Use Act (usually simply called the Fuel Use Act) also was passed as part of President Carter's National Energy Plan (NEP) in 1978. What were the key provisions of the Fuel Use Act? What eventually happened to the major provisions in the Fuel Use Act a decade later and why?
Congress restricted its use in industrial boilers and banned its use in any large new electric generation boilers and provided for its use to be gradually phased out of existing electric generation. The subsequent gas supply bubble that occurred in the early 1980s following the passage of the NGPA caused a major shift in the perception of the availability of natural gas and the FUA was repealed in 1987.
What economic factors and considerations caused both producer states and consumer states to have potentially strong interests (generally very different from one another) in regulating the activities of interstate pipelines? Consumer states?
Consumer States The advantages of natural gas over manufactured gas created pipeline "rents"that could be captured through cost-of-service regulation of "city gate" prices. Pipeline monopoly power seemed to warrant such maximum price regulation (many communities were served by only one major pipeline). Resulting political pressures: Federal regulation of "city gate" prices charged by interstate pipelines
Following all of the various administrative rule changes adopted by FERC in the 1980s and 1990s aimed at increasing the competitive structure of the gas industry, what became the key commercial and regulatory features of the structure of the natural gas industry and gas markets in the U.S. today? What prices and activities remained regulated by the FERC? What kinds of transactions were large gas customers now able to engage in that they were largely blocked from engaging in during previous decades? How did this new industry structure differ fundamentally from the "traditional" structure of the gas industry immediately following the passage of the NGPA in 1978?
Energy Policy Act of 2005 amended the NGA to clarify that the FERC has exclusive jurisdiction to certify the construction of LNG facilities with advice from states and localities. As a matter of current policy, FERC does not regulate the prices charged by an LNG facility for services nor impose a common carriage requirementon LNG facilities, but it is not statutorityprecluded from doing so in the future. The DOE authorizes the export of the gas subject to a"public interest" standard. The DOE's authorization is virtually automatic for gas exports to countries with Free Trade Agreements (FTAs) with the U.S. Exports to non-FTA countries may be more problematic.
In general terms, how did the pipelines' take-or-pay problems finally give the FERC commissioners the practical leverage they needed to pursue their regulatory reform agenda through administrative rules alone without their having to seek new statutory authority from Congress (which they likely would not have succeeded in securing). In broad terms, what is meant by an administrative agency's "conditioning authority" and what role did it eventually play in FERC's strategy to get the pipelines to do what the FERC commissioners wanted them to do, but may not have had the authority to directly order them to do?
FERC believed it was legally precluded from simply imposing "open access" requirements on all pipelines. However, if a pipeline came to the FERC asking for approval of some sort of special program that would help it cope with it's take-or-pay obligations, FERC could condition its approval of such a program on the pipeline's acceptance of becoming an open-access pipeline.
Why were the interstate pipelines so eager to contractually assure reliable gas supplies in the late 1970s and very early '80s? What economic evidence is there that interstate pipelines competed very aggressively for gas supplies and consequently paid rather high prices for the relatively small percentage of the gas supplies that had been fully deregulated by the NGPA?
Having suffered from a decade of chronic gas shortages and complaints from LDCs and gas consumers interstate pipelines were inclined to move very aggressively to secure adequate long-term supplies. In bidding to secure these additional gas supplies, pipelines were mindful they could average the cost of this gas with old regulated gas in the WACOGwhen selling to the LDCs for residential and commercial customers. Therefore, pipelines with large amounts of less-expensive old gas were willing to pay exorbitant prices to secure newly unregulated gas. Some prices for unregulated gas were pushed as high as $10 per MCF in 1982. The average price paid for deregulated gas was $7.24 in 1982. Subsequent economic studies have estimated that a fully free-market gas price would have been about $4.05-4.63 per MCF.
As events unfolded in the early 1980s, what evolving trend in the broader energy and fuels markets occurred that aggravated and exacerbated the pipelines' ability to cope with their take-or-pay contract liabilities and created a "gas marketability" problem for the pipelines? What was "incremental pricing"
Large industrial customers had to pay retail prices based on "incremental pricing"of gas which meant that they were paying for the very highest-priced gas purchased by the pipelines. However, many of these large industrial customers could "bypass" the pipelines by switching to fuel oil. Especially as world oil prices declined after mid-1981, more and more large customers found it increasingly beneficial to fuel switch. Some LDCs were served by more than one pipeline and had the ability to switch some of their purchases away from pipelines with large take-or-pay liabilities. Interstate pipelines, the financial community, and FERC began getting worried about a "death spiral": as more customers switched fuels, the bills to the remainder would increase (due to the need to recover pipeline fixed costs), and even more customers would switch to other fuels.
What were the mutual interests and concerns of municipal governments and private gas distribution companies that gave rise to municipal "regulation" (frequently by bilateral contract) in the early days of gas industry development? What LDCs want from municipalities?
Local Distribution Companies (LDCs) wanted Long-term streetlighting contractsto support capital investments Eminent domain to lay local pipelines under streets and properties Exclusive neighborhood franchises were helpful in achieving economies of scale and further reducing investment risks
What did municipal governments want from private gas distribution companies?
Municipalities wanted Service to residents at reasonable prices Avoid duplication of subsurface local pipelines
What was the basic structure of a "take-or-pay" gas contract for wellhead gas? What basic feature of natural gas price regulation likely made the pipelines more complacent about entering into these high-priced take-or-pay contracts for additional gas supplies from gas producers?
Of all the wellhead contracts signed in the year following passage of the NGPA, 86.8%of them had "take-or-pay"terms obligating the pipelines to take certain minimum quantities under the contracts, or pay for the gas as if they did. With the aid of perfect hindsight,in bidding aggressively for long-term contracts and in accepting onerous take-or-pay obligations, the pipelines were too complacent about their ability to recover these costs from their direct-service industrial customers and LDCs.
What economic factors and considerations caused both producer states and consumer states to have potentially strong interests (generally very different from one another) in regulating the activities of interstate pipelines? Producer states?
Producer States Where one pipeline served a gas field, it could exert monopsony power. It could also discriminate in favor its production affiliate and exploit the "rule of capture". Gas exports out of state created competition between local consumers and distant consumers, driving up local consumer prices. Resulting political pressures: Minimum prices for gas suppliers Non-discrimination in purchasing by pipelines Limitations on gas exports out of state
FERC Commissioners Hesse and Stalon believed that competition in the market for natural gas as a commodity could be best increased by taking one key step in transforming the structure of the gas industry by compelling interstate pipelines to change their traditional business practices. What was this one key change in the pipelines' commercial behavior and practices that Hesse and Stalon wanted the interstate piplines to adopt? Why did they doubt the regulatory authority?
When an applicant petitions a regulatory agency to grant it some "relief" that the agency is able to grant—but not obligated to grant—the agency can grant the requested relief but impose voluntary "conditions" that the agency might not otherwise be able to directly impose on the regulated entity. What the FERC wanted was for all pipelines to be "open access"—i.e., to offer unbundled transportation service to all LDCs and large industrial gas customers. AUTHORITY problems: 1. legal barrier and 2. practical economic barrier (pipeline bankruptcies)
What was "supplemental gas"? Name some broad categories of such projects? Why did many people think that pursuing these expensive projects might be a good thing to do? Did they have much practical impact? Why or why not?
alternative and very expensive sources of gas. categories: Liquified natural gas High-BTU coal gasification projects Gas from Alaska and the Canadian Arctic Essentially, advocates of regulation believed that the supplies of natural gas were largely insensitive to price and that there were large economic rents to be captured for consumers through wellhead price regulation. The overall result of regulated low old gas prices, shortages, and high-cost incremental supplies of "supplemental gas"was almost surely not in the best interest of consumers
Why were the supplies of so-called "old gas" thought to be price-inelastic? For what reasons was this belief fundamentally mistaken?
because the "old gas" wells had already been sunk. Therefore, economic regulation could be used to re-distribute the rents with very little supply consequence. Ignored ability to expand "old" wells through variety of methods - not as inelastic as they thought
In the earliest days of the gas industry, what was the source of the gas that was typically distributed by the local gas distribution companies (LDCs)? How was it produced?
gas was seldom natural gas; it was so-called "town gas", typically manufactured by heating coal in an oxygen-deprived environment Gas manufactured from coalwas a bit of a witch's brew: -50% hydrogen -25% carbon monoxide -25% methane
As late as about 2010, it appeared that the U.S. was headed toward becoming a net importer of natural gas with the marginal supply being Liquefied Natural Gas (LNG) being imported from abroad. What unexpected development in the U.S. gas industry turned this situation around so that the U.S. is now a net exporter of natural gas?
shale revolution
In the mid-1980s, President Reagan made significant new appointments of FERC Commissioners including the appointments of Martha Hesse as Chairman of the FERC and Charles Stalon as a commissioner. These new FERC commissioners formed a philosophical majority in favor of rolling back federal regulation in the gas industry to the maximum extent possible and fostering the emergence of much greater competition in the natural gas commodity markets. In broad terms, what commercial activities in the gas industry did these new FERC commissioners believe should be made more competitive, and what aspects did they believe would likely have to remain subject to continuing price regulation by the FERC?
the FERC that wanted to make pipelines "common carriers"and make the commodity gas markets more fully competitive. But forcing them to become "common carries" was illigal However, if a pipeline came to the FERC asking for approval of some sort of special program that would help it cope with it's take-or-pay obligations, FERC could condition its approval of such a program on the pipeline's acceptance of becoming an open-access pipeline.
In constructing the compromise legislation that eventually was enacted as the Natural Gas Policy Act of 1978, did Congress adopt a fairly straightforward course of "deregulating" the gas industry? Briefly explain the ways in which the NGPA simultaneously both increased and diminished federal regulation of the gas industry. Over the subsequent decade, what regulatory institution played the lead role in aggressively pursuing wellhead gas price deregulation and the restructuring of the natural gas industry to inject more competition into its various commercial activities?
•The NGPA extended the regulatory reach of the FERC in several ways: Extended FERC authority to intrastate gassales Authorized FERC to impose specific federal price regulation principles on state regulation of retail sales of gas: "High-priority"customers (residential and small commercial) were to pay the weighted average of old and new wholesale gas prices (the "WACOG") Prices to lowest priority users (industrial customers and electric utilities) were to be based on "incremental pricing" Simultaneously, the NGPA phased-out regulation for most, but not all, wholesale gas production prices: A small amount of "high cost"gas was immediately deregulated; All regulation was to be removed from 50-60 percent of gas by 1985; All regulation was to be removed from another 20-30%of gas by 1987; About20% was to be regulated forever subject to specific escalation rates on the price ceilings (in other words, might or might not ever be effectively deregulated depending on market conditions compared to escalation rates on price ceilings).