Natural Gas Policy Act

NATURAL GAS POLICY ACT I S S U E B R I E F NUMBER I B 8 1 0 2 0 AUTHOR: Lawrence Kumins E n v i r o n m e n t and N a t u r a l R e s o u r c e s P o l i c y D i v i s i o n T H E L I B R A R Y OF C O N G R E S S CONGRESSIONAL RESEARCH SERVICE MAJOR I S S U E S S Y S T E M D A T E O R I G I N A T E D 02/19/81 D A T E U P D A T E D 01/20/83 F O R A D D I T I O N A L I N F O R M A T I O N C A L L 287-5700 0120 CRS- 1 ISSUE DEFINITION The Natural Gas Policy Act of 1978 (NGPA) culminated decades of dispute over natural gas policy and was the "centerpiecew of President Carter's National Energy Act. Now there are many issues of both regulatory ana legislative concern under discussion. These items were unanticipated by the framers of this difficult and delicate compromise. Generally speaking, they all stem from the fact that oil prices more than doubled in 1979 and 1980. The N G P A 1 s framers set wellhead gas prices within the new law's framework in such a way that they would converge on oil equivalent prices -- a s they were 1985. As events unfolded, the then perceived -- in real dollar terms by statutory pricing schedules that the new law contained became out of context with oil prices just a year after NGPA was passed. Additionally, there are a significant number of other unanticipated matters related to the nature of the regulated gas pipeline industry and its interaction with NGPA that came to bear. By 1982, dissatisfaction with NGPA was becoming more vocal. Interstate gas pipelines were complaining about high wellhead prices in some cases, a s well a s a variety of provisions in Contracts with producers which they found disadvantageous. Consumer complaints were being heard because of large increases in residential gas bills. And producers voiced concerns about the low (relative to oil) prices of some classes of old gas, a s well a s the price caps on " n e w w gas. At issue are a large number of regulatory agency issues and legislative changes, which could have the effect of raising prices paid by consumers. On the other hand, there could well be a trade-off among some o r all of these items, involving enhanced domestic gas supply, with attendant benefits measured in terms of economics and national security. BACKGROUND AND POLICY ANALYSIS The Natural Gas Policy Act of 1978 (NGPA) was enacted a s o n e of five major energy bills which made up the National Energy Act, but it was unquestionably the most controversial and most difficult to enact. That was because the Should the NGPA attempted to end a debate that had gone on for 25 years: Federal Government regulate the prices a t which natural gas producers sell gas to interstate natural gas pipelines? The Natural Gas Act of 1938 (15 U.S.C. 717) (NGA) ordered the Federal Power Commission (FPC) to regulate the sale of natural gas in interstate commerce for resale. Until 1954, the Federal Power Commission, now called the Federal Energy Regulatory Commission (FERC), regulated only the interstate natural gas pipeline companies that purchased and carried gas from the producing companies, most of which were primarily oil companies, for sale to the distributing gas utilities that were subject to regulations by State utility commissions. In that year, however, the Supreme Court decided, in Phillips Petroleum Corp. v. Wisconsin (347 U.S. 672), that sales by natural gas producers to pipelines were "sales for resalew within the meaning of the Natural Gas Act, and that producers' sales should be regulated by the FPC. The FPC attempted to carry out this mandate first on a company-by-company basis in traditional utility fashion, and then by setting ceiling prices for CRS- 2 sales in designated producing regions based on average costs of production. But a severe shortage of natural gas for customers outside the producing States was caused in the early 1970s by the unwillingness of producers to commit new finds to regulated pipelines when intrastate buyers could pay higher unregulated prices. The FPC attempted to set much higher incentive prices o n a nationwide basis during the 1970s, but growth of intrastate markets and fall-off i n new gas discoveries perpetuated the shortage. The FPC was fought in court both by consumer interests opposed t o the escalating prices that resulted and by the producers, who thought the prices were too low. Meanwhile, the natural gas industry began to consider possible alternate sources of natural gas supply, such a s LNG (liquefied natural gas) from overseas, methane from coal gasification, imports of natural gas by pipeline from Canada and Mexico, synthetic natural gas manufactured from liquid petroleum products, generation of methane from animal wastes and biomass, and other new or exotic sources of natural gas. The common feature of this myriad of new sources was that they presented than higher costs than did conventional natural gas -- even than unregulated gas in the intrastate market, and most of them suffered from technological, supply security, and lead-time. problems. Because they lacked adequate supplies of natural. gas to serve all the customers on their lines, the interstate natural gas pipelines were forced to design and implement, under guidance from the FPC, "curtailment plansH which designated priorities among those users who would lose service when there was too little gas in the pipe. In general, electric utilities and industrial users using natural gas as fuel were deemed the lowest priority, and commercial, public and residential users were deemed the highest. Beginning in 1971, curtailments of natural gas worsened every year. Supply and deliverability problems caused notable curtailments during the very cold 1976-77 winter. Proposals to modify or end producer regulation for natural gas sales had been made in every Congress since such regulation was imposed by the 1 9 5 4 Supreme Court decision, but the healthy growth of the natural gas industry kept the issue from the front burners. With the start of the natural gas shortage, however, this changed. In the 9 2 d , 9 3 d , and 94th Congresses, major debates took place, but no basic statutory reform was enacted. The debates were passionate a s producer interests and consumer interests championed their concepts of fairness and economic necessity, and conflicting legislation was adopted in the Senate and House without success in compromising the differences. Natural Gas Policy Actions of the 95th Congress The 95th Congress' first substantive enactment was emergency natural gas legislation to deal with the massive curtailments that then afflicted the Nation, caused a s much by pipelines' inability to deliver gas quickly enough to deal with record-setting cold weather a s by the unavailability of natural gas supply. The larger issues of producer regulation policy were avoided in the interest of haste and because the newly inaugurated Carter Administration had promised a major legislative proposal on the topic a s part of the National Energy Plan submitted in April 1977. President Carter's message transmitting the proposed legislation emphasized that natural gas was a declining resource to be husbanded. The essence of his proposal was that "new natural gas" in both interstate and CRS- 3 IB81020 UPDATE-01/20/83 intrastate markets be subject to a ceiling price of the 3tu equivalent of domestic crude o i l delivered t o refineries, t h e n about $1.75 per thousand A geological definition w a s a t t e m p t e d , to distinguish new cubic feet (Mcf). natural gas from that natural gas which had already been discovered o r was in production. T h e producing industry uniformly condemned t h e proposal a s an extsnsion of regulation a t confiscatory p r i c e s , lower than prices then a v a i l a b l e in intrastate markets. Consumers likewise attacked i t , o n the basis that the ceiling price w a s higher t h a n could b e justified by t h e costs incurred by producers; but they were happier with i t t h a n the producers were. Paradoxically, had i t been enacted, a l l o t h e r things being e q u a l , new natural g a s prices would n o w be deregulated and much higher than they are. The President's proposal also included provisions granting higher prices t o gas from high-cost s o u r c e s , a n d allocating the c o s t of the n e w natural g a s a n d high-cost g a s to industrial users. Elsewhere i n the National Energy P l a n , in the portion that became the Powerplant a n d Industrial F u e l U s e Act o f 1 9 7 8 , the President proposed that natural gas u s e be taxed a n d regulated o u t of existing industrial boiler-fuel applications and electric utility applications, a n d that a ban be instituted o n n e w applications. T h e House of Representatives, through t h e formation o f a n Ad Hoc Energy Committee, moved rapidly a n d enacted the President's plan almost intact. T h e r e were minor modifications expanding t h e new g a s definition i n the natural gas portion of the p l a n , and outright n e w gas deregulation w a s voted o n and defeated. T h e S e n a t e , however, divided the plan for r e f e r r a l to standing committees. A deadlocked S e n a t e Energy Committee, s p l i t 9-9 o n both the P r e s i d e n t ' s plan a n d then on new gas deregulation, reported the President's bill without recommendation. When a n early tabling v o t e indicated that new gas deregulation would pass i n s t e a d , its o p p o n e n t s mounted a filibuster, and President Carter threatened to veto any deregulation measure. But cloture was i n v o k e d , so opponents began a novel f i l i b u s t e r by demanding roll-call votes o n hundreds of amendments. Many c o m p r o m i s e efforts were t r i e d a n d f a i l e d , a n d the filibuster w a s finally broken when Vice President Mondale a n d majority leader Byrd succeeded i n adopting a rule c h a n g e making dilatory amendments out o f order. President Carter apparently did not want t h e rest of his energy proposals held hostage to his g a s proposal. T h e Senate swiftly enacted a Pearson-Bentsen substitute bill deregulating n e w g a s after 2 years of price ceilings equivalent t o distillate f u e l oil prices. New g a s was defined more broadly than in t h e House bill. A conference t o resolve the differences between the two a p p r o a c h e s w a s begun, with numerous compromise proposals surfacing among moderate g r o u p s of conferees and then sinking a f t e r taking f i r e from both extremes. Most o f the shots from the consumer s i d e dealt with the cost of d e r e g u l a t i o n , the billions o f d o l l a r s of additional producer revenues compared to modest increases in new natural g a s reserves that were predicted. Most o f t h e shots from t h e gas industry s i d e Concerned the need to produce additional natural g a s t o displace f o r e i g n o i l , a n d the burdens of Federal regulation. President Carter gradually c a m e to a g r e e t o support eventual deregulation a f t e r a n initial period o f regulation i n both interstate and i n t r a s t a t e A d e a l w a s narrowly s t r u c k , f i r s t among markets a t rising ceiling prices. the evenly divided Senate conferees and t h e entire Energy Committee, a n d then with the House conferees. After a n a r d u o u s drafting p r o c e s s by conference s t a f f , s o m e last-minute shifts of position by s o m e who had opposed a n d some w h o had supported the compromise, and a S u p r e m e Court d e c i s i o n in a natural gas c a s e which a d d e d to the COntrOVersy surrounding i t , the conference r e p o r t CRS- 4 was slgned. New issues and circumstances had arisen during the lengthy conference process which affected the general support of ~ h ecompromise: concerns about the enforceability of the extraordinarily complex bill; concern about the image growing abroad that the United States was unable to resolve its energy policy difficulties; and a growing surplus of natural gas reserves in producing regions, which had been prompted by the high intrastate prices and which was softening those prices and leading some producer interests to support the compromise in order to have access to the supposed pent-up demand in the interstate market. But the interstate market itself had quietly changed: Many industrial customers who had suffered due to curtailments had discovered that they could do without large amounts of the natural gas they had been buying through conservation practices, and a large number had switched to fuel oil, which had been relatively stable in price since the Arab oil embargo of 1973 and was predicted to be developing a glut on the world market. They were not eager to break their oil contracts and return to natural gas when they were still a t the bottom of the curtailment priorities, when they were told that their use would be phased out, when incremental pricing would keep gas prices near oil price levels, and when long-term service of natural gas depended on better resources than many thought existed. The compromise was truly that -- a creation of the moderate .elements of both sides -- and a rough coalition of the extremes on both sides formed to oppose it. Some producers favored i t , others opposed it, and potent lobbies for deregulation found themselves unable to take a firm position one way or another. Most gas pipelines and distributors accepted it with reservations about the incremental pricing provisions, realizing that these would make regaining their lost industrial customers much more difficult. The drawn-out agony of the process of compromise, the earlier filibusters, the public expectation that Congress would enact significant energy legislation, and the constant badgering from both sides, had led many Members to lean towards passage, if only to get the divisive issue behind them and turn to other The proponents of things, including the 1978 election, then 6 weeks away. the compromise were quick to capitalize on this mood by threatening to refuse to consider any other proposals should the compromise be defeated. The President fervently campaigned for the bill, citing its forecasted benefits in strengthening the dollar and the economy, and permitting interstate access to a huge "gas bubblew of surplus intrastate gas. The Senate acted first, refusing recommittal of the compromise by a wide margin and then passing the bill, 57-42 o n Sept. 27, 1978. The House vote was likely to be much closer, so the leadership wanted to combine the gas bill with the other four parts -- all also substantially changed from the original proposals -- that made up the National Energy Act, and permit o n e vote on the package. The key vote concerned the rule to combine the various bills for a single vote. It passed by a single vote, 208 to 207. Without their combination into a package, it is highly likely that some of those who favored the rule would have opposed the gas bill a s an independent enactment. President Carter signed the Natural Gas Policy Act into law on Nov. 9 , 1978, and it became P.L. 95-621. Natural gas had been the subject of the first and last enactments of the 95th Congress. The Provisions of the Natural Gas Policy Act of 1978 CRS- 5 A s F a s s e d , the NGPA was an extremely c ~ m p l e x law, one w n i c h completely changed the FERC's previous regulatory system for priclng nacural gas at che wellhead. Title I of the NGPA included the wellhead pricing provisions. Numerous and there categories of natural gas production were defined in Subtitle A , was some dispute about how many categories had actually been created. Their prices were set in the statute, and increased according to differing formulas reflecting escalator and inflation factors. Subtitle B provides that regulation for some, but not all, categories would end on Jan. 1 , 1985, subject to being reimposed a t the discretion of Congress after a period of six months for a period of a s long a s eighteen months. The major categories of natural gas created, by the numbers of the sections of the NGPA which created them, were: - - Section 1 0 2 , new natural gas. Intended to include genuine new discoveries of gas resources, which started its price path a t about $2.08 per Mcf and rose a t the rate of inflation plus about 4% per year, until all gas committed under this category is deregulated in 1985. -- Section 103, new onshore production wells. Intended to include extension wells expanding known natural gas deposits, which started its price path a t about $2.00 per Mcf, rose by inflation alone, and will be deregulated in 1985 -- except for that part sold interstate and from wells deeper than 5000 feet. - - Section 1 0 4 , flowing interstate gas. Covers gas which was already being sold to interstate pipelines prior to consideration of the NGPA, and priced according to the previous standards ($1.45 was the highest ceiling) plus inflation, and not deregulated. The section also contains language permitting F E R C to set other rates that are "just and reasonable," as do section 106 and section 109. -- Section 1 0 5 , other natural gas under contract. Primarily flowing intrastate gas, limited to the lower levels of the contract price or the section 1 0 2 price to prevent full operation of contractual escalator clauses, plus inflation. - - Section expiration of higher of the higher of the 1 0 6 , rollover gas or gas resold to the same purchaser upon the earlier contract. Limited rollover and resold gas to the earlier price of $.54 per Mcf for interstate g a s , and to the contract price or $1.00 per Mcf for intrastate gas. -- Section 1 0 7 , high cost gas. Identified certain potential sources of natural gas believed to cost significantly more to develop than others: gas from Devonian shales, geopressured acquifers, coal seams, and wells deeper than 15,000 feet. These four categories of gas, deregulated in December 1979, and other categories identified by the FERC, could receive special incentive prices. This has particularly been applied to "tight sands" gas, gas from relatively nonporous reservoirs. -- Section 1 0 8 , stripper well gas. Invented a distinction to benefit owners of small natural gas wells, starting their prices a t about $2.22 escalted by about 4% inflation, but not deregulating them. -- Section 1 0 9 , all other categories, and specifically Alaskan -gas from the Prudhoe Bay Unit. Priced in accordance with the section 1 0 4 provisions, and not deregulated. CRS- 6 IB81020 UPDATE-01/20/83 Title 1 1 of the NGPA established the incremental pricing provisions, requiring the FERC to apply incremental pricing to industrial boiler fuel facilities served directly or indirectly by interstate pipelines within one year, and to expand that rule to apply to other industrial applications by six months later. The F E R C was given much leeway in implementing incremental pricing in order to achieve the statutory objective: the maximum allocation of the higher cost of new and high-cost natural gas sold in interstate commerce to industrial customers without causing industrial customers to switch from natural gas to other fuels. Title I11 of the NGPA created permanent authorities similar t o the temporary emergency authorities of the Emergency Natural Gas Act passed in January 1977, allowing the President to declare a gas supply emergency, allocate gas among pipelines, and from others who volunteer, to areas of shortage. Title IV granted agricultural users of natural gas a higher priority during curtailments than any but residential, small commercial, and t o be other critical users. Title V presented the administrative mechanism primarily reviewing State agency determinations used by F E R C in regulation standards for court of the category a given well falls in -- and provides review of the NGPA. Title V I coordinates the NGPA with the Natural G a s Act of 1938, the prior statutory basis for gas regulation, much of which applied to pipeline operations, accounting, and other aspects of the gas industry which were not affected by the NGPA. -- Natural Gas Conservation Since the NGPA's passage, and partly a s a result of the NGPA, demand for natural gas has changed markedly. The conservation among residential and commercial users has been remarkable, so that even with many conversions from fuel oil and many new hook-ups, the total deliveries to these sectors have slightly. The prospect i s that additional stayed stable or declined conservation will be achieved, and most observers attribute the conservation to higher prices. Some gas i s used for pipeline operation, and this amount will not change much. Industrial users who must use natural gas because of its unique properties or chemical constituents and natural gas users in the agricultural and food--processing chains have a higher priority for gas when curtailments occur than boiler fuel users. Their use has expanded since the NGPA, but they have also achieved much conservation and they have been affected by poor economic conditions. They are very sensitive to the long-term implications of gas supply and sensitive to price stability, since their plants are long-term investments, and they would have no alternative fuel. The outlook is for continued but cautious growth in this sector of natural gas use, not growth a t the boom levels seen in the 1960s. T h e key sector in natural gas demand i s the large group of industrial users who use natural gas in boilers of different sizes and alternate fuel capabilities. These users are highly sensitive to natural gas price levels, and less sensitive to the long-term supply. Their alternate fuel i s generally oil, mostly residual fuel oil. As they use more natural gas, their use of oil falls. The portion of industrial natural gas use in this category is not precisely known, but i s a t least half of the industrial demand -- the half which can rise and fall most rapidly, with the largest effects on oil imports, and with th-e-greatestflexibility when curtailments are necessary. They have the lowest priorities for gas during curtailments, generally in order of the size of their boilers. CRS- 7 IB8i020 UPDATE-,Ol/20/83 It is the demand of this market that wiil determine what the marginal gas supply will be in the next f e w y e a r s , and policies toward gas prices and imported oil w i l l largely determine this demand level. Stimulating and serving this demand by making natural g a s relatively cheap and available to these users o v e r the next f e w years may reduce oil i m p o r t s , but it may a l s o exhaust more quickly the conventional supplies that we now depend o n , requiring earlier availability of the supplemental supplies, or threatening the long-term service of higher-priority u s e r s , and it may f o r c e higher prices upon other users. In f a c t , what i s happening a t this juncture is that - o n some g a s pipeline systems that have made inopportune decisions regarding t h e price and ancillary terms o f gas purchases from producers there has been significant conversion to cheaper heavy fuel oil by industrial consumers. And the trend t o residential gas conversion has abated a s well. share while T h e s e pipeline systems a r e faced with a declining market remaining contractually obligated t o expensive gas that will not sell i n today's more competitive market. F o r t h i s reason, there appears to be something of a current oversupply of deliverable, albeit expensive, gas. - -- S o m e Recent Developments Effecting the Natural Gas Situation T h e r e have been two developments since N G P A 1 s passage that have shaped the institutional framework in which the g a s market functions. O n e is the amendment of t h e Powerplant and Industrial Fuel Gas Act of 1 9 7 8 to permit existing gas-fired electric plants to burn gas during the remainder of their existence. T h i s was accomplished a s a n amendment to the 1 9 8 1 budget which use authorization b i l l in June 1981. T h i s means that utilities a b o u t 20% of t h e nations gas now -- will continue unrestrained use. -- a n d i s now before t h e The other matter -- which i s still unresolved Supreme Court -- regards incremental pricing, Title I1 of the law. Incremental pricing allocates high-priced g a s to industrial consumers up t o the point t h a t they pay the equivalent of oil fuel prices. NGPA originally envisioned b o i l e r fuel users being initially targeted for price increases up to the equivalant of relatively c h e a p high sulfur heavy fuel oil. S u b s e q u e n t l y , under P h a s e 1 1 , more industrial users would be covered, a n d their prices would rise t o parity with relatively expensive middle distillate. -- Phase I o f incremental pricing affecting boiler fuel users of more than 300 Mcf per d a y became effective Nov. 1 , 1979. Phase 1 1 , affecting smaller i n d u s t r i a l users to the extent necessary to cover 95% o f industrial gas use, was t o become effective 6 months later. A great deal of concern w a s expressed by industrial users and others that incremental pricing would lead to higher i n d u s t r i a l fuel prices a t a time o f inflation and recession. The protection afforded residential users by incremental pricing was a l s o challenged o n t h e basis that, as incremental pricing forced industrial users f r o m natural g a s , the system costs of the pipelines a n d distributors would be allocated to t h e remaining customers. In a d d i t i o n , the cost increases o f manufactured g o o d s would be paid by their buyers. Legislation was introduced t o repeal T i t l e I1 i n its entirety. But instead, the House of Representatives exercised the legislative veto provided i n NGPA a n d voted overwhelmingly to veto the regulations implementing Phase I1 incremental pricing. T h i s both left the statute intact and Phase I in operation. -- of high T h i s veto l e t industrial g a s prices remain a t the equivalant sulfur residual fuel oil and limited incremental pricing to a relatively CRS- 8 narrow p o r t i o n of i n d u s t r y . ? h a s e I , as i t r e m a l n s i n effect, r l i t t l e m o r e t h a n w o u l d otherwise b e t h e c a s e . Whereas the law mandate t h a t gas be incrementally priced to industrial users d i s t i l l a t e p r i c e s , t h e v e t o means t h a t r e l a t i v e l y few u s e r s are i n c r e m e n t a l p r i c i n g a t b u r n e r t i p p r i c e s o f a b o u t $ 4 . 0 0 p e r Mcf. I 1 p l a n , s e e m i n g l y m a n d a t e d b y NGPA, w o u l d h a v e e f f e c t e d 95% of u s e and would have r e s u l t e d i n i n c r e m e n t a l p r i c e s of a b o u t $6.50. eally does appears to a t middle subject to The P h a s e industrial by t h e D.C. Court of Appeals in T h e l e g i s l a t i v e v e t o was o v e r t u r n e d The c o u r t r u l e d t h a t t h i s a c t i o n was u n c o n s t i t u t i o n a l , and J a n u a r y 1982. in conformity with the m a n d a t e d t h a t FERC p r o m u l g a t e a n e w P h a s e I 1 p l a n to the Supreme NGPA's i n t e n t . T h i s matter h a s b e e n s t a y e d , p e n d i n g a p p e a l If u p h e l d , P h a s e I1 w i l l e i t h e r be implemented or the basic law Court. amended. T h e G a s M a r k e t U n d e r NGPA When t h e p r i c e o f c r u d e o i l d o u b l e d , t h e f u n d a m e n t a l c h a r a c t e r of energy m a r k e t s c h a n g e d , l e a v i n g t h e r a t h e r i n f l e x i b l e NGPA p r i c i n g s t r u c t u r e b e h i n d . by 1985, W r i t t e n w i t h t h e g o a l o f e q u i l i b r a t i n g o i l and n a t u r a l gas p r i c e s a n d b r i n g i n g t h e m c l o s e r t o g e t h e r t h a n t h e y h a d b e e n d u r i n g t h e i n t e r i m , NGPA f e l l o u t of context with i t s i n i t i a l l e g i s l a t i v e i n t e n t . The changed economics of energy markets interacted with the l a w and New insights into the p r o d u c e d many u n i n t e n d e d a n d u n a n t i c i p a t e d r e s u l t s . gas m a r k e t w e r e g a i n e d , a n d these led to calls for remedial regulatory least "neww a c t i o n s b y FERC a n d , i n i t i a l l y , t o c a l l s f o r d e r e g u l a t i o n o f a t ( i f n o t a l l ) gas. The l a t t e r were r e p l a c e d , as t h e d i s c u s s i o n in the 97th C o n g r e s s e v o l v e d , w i t h c a l l s f o r a r e a d j u s t m e n t o f p r i c e s s o t h a t o i l a n d gas would be on a more e q u a l f o o t i n g and would r e a c h equivalancy quicker. Opposing t h e s e p r o p o s a l s were consumer groups, who became more v o c a l H.Res. 371 was regarding quite rapid price increases. Additionally, i n t r o d u c e d i n t h e House w i t h 226 co-sponsors t o e x p r e s s t h e s e n s e of the rate H o u s e t h a t FERC s h o u l d t a k e n o a d m i n i s t r a t i v e a c t i o n t o a c c e l e r a t e t h e a t w h i c h g a s p r i c e s were b e i n g d e c o n t r o l l e d . The s t a t u s a t t h i s j u n c t u r e f i n d s t h e a v e r a g e p r i c e o f gas n a t i o n w i d e at a b o u t $2.75 p e r Mcf, r o u g h l y h a l f t h e p r i c e o f c r u d e o i l o n a b t u equivalant Gas p r i c e d i n a c c o r d a n c e w i t h NGPA v a r i e s f r o m a f e w c e n t s p e r Mcf t o basis. U n d e r t h e NGPA o v e r $10, w i t h Canadian and Mexican i m p o r t s a t j u s t under $5. 1, 1 9 8 5 . p h a s e o u t of p r i c e c e i l i n g s , much g a s w i l l b e d e c o n t r o l l e d o n J a n . However, b e c a u s e n o t a l l c l a s s e s o f g a s w i l l be decontrolled, and because c o n t r a c t s between p r o d u c e r s and p i p e l i n e s w i l l l i m i t t h e amount of e s c a l a t i o n f o r some gas t h a t m i g h t o t h e r w i s e r i s e t o u n c o n t r o l l e d l e v e l s , b e t w e e n 40-60% effective controls in early of f l o w i n g o i l w i l l 'remain under c o n t r o l s o r 1986. under the law since its How t h e l a w , c h a n g e d e v e n t s , a n d d e v e l o p m e n t s e n a c t m e n t w i l l p l a y o u t -- v i e w e d w i t h t h e k n o w l e d g e a n d e x p e r i e n c e g a i n e d i n concerns regarding t h e t h e p a s t 4 y e a r s -- r e p r e s e n t s i n t e r e s t i n g p o l i c y f u t u r e of gas markets. What d o e s seem t o b e h a p p e n i n g now, a n d many economists following gas market developments feel that this is c h a r a c t e r i s t i c , i s t h a t p i p e l i n e s w i t h l a r g e amounts of g a s c o n t r o l l e d a t low p r i c e s t e n d t o pay v e r y h i g h p r i c e s f o r what u n c o n t r o l l e d g a s i s a v a i l a b l e t o contract them. They a l s o a p p e a r t o a l l o w t h e p r i c e s o f c o n t r o l l e d gas u n d e r t o t h e m t o r i s e f r o m l o w e r c o n t r a c t u a l p r i c e s t o maximum l a w f u l ones. The s i t u a t i o n can be characterized with this somewhat o v e r s i m p l i f i e d example: CRS- 9 Assume that half of all gas were to be deregulated and half were zo be c ~ n t r o l l e d at $2.50. Assume further that the market clearing price for gas were $5.00. What, then, would unregulated gas sell for? A great deal of current thought, particularly among economists, would have gas prices determined by pipelines competing for supply. They would bid unregulated gas prices up to the point where they could not sell any more -- that is to say, the point where their weighted average gas cost was at the market clearing price of $5.00. Thus, the half of gas supply which is not regulated in this example would sell for $7.50. This contradicts the old conventional wisdom, which held that pipelines would be unwilling to pay prices in excess of market clearing levels for new gas supply. The fact is that consumers -- the customers of pipelines -- are likely to be unwilling to pay above market clearing prices for whatever blend of gas pipelines have to provide. Knowing this, and having the ability to average or "roll in" various gas prices, pipelines will compete for gas supply and will bid gas up to the point where the rolled in price they charge their customers reaches the point where they can sell no more -- in other words, the market clearing consumer price. The other part of the "new economicsR which i s relevant for the policy debate i s a better understanding -- or a t least a new perception -- of how wellhead prices are determined. Earlier thinking had wellhead prices equilibrating with the btu equivalant price of crude oil, middle distillate, or o ~ of e the types of residual fuel oil, depending on which version of this thinking was being articulated. The current perception sees wellhead prices being determined a t the burner tip. This means that the market clearing for will determine wellhead prices. energy -- whatever that may actually be Wellhead prices will then be the burner tip price, less the local distribution utility tariff, less the long distance pipeline tariff. If, for example, burner tip prices are set in competition with 1 % sulfur residual fuel, now about $27/bbl or roughly $4.25/million btu's (the equivalant of an Mcf of gas), this could back down to an implied wellhead price quite close to the present $2.75 average. -- Whatever the current or future market clearing gas price may be, in contemporary discussion regarding this figure it is often given in terms of a fraction of crude oil prices. For example, much current thought holds that the market clearing price either i s or should be about 70% of the crude price. The American Gas Association claims the current market clearing price to be about 60%. In any case, the current average wellhead price i s somewhat less than half current crude price equivalancy. The Natural Gas Market -- Developments During 1 9 8 2 1 9 8 2 has been a confusing year for energy prices generally. Oil prices, for example, rose fairly sharply during mid-year in the face of very soft demand, presenting something of a paradox. Now, natural gas prices appear to be following a similar pattern. Pipelines which heretofore had been hard pressed for new supplies made commitments for several types of higher-cost gas. Apart from higher-priced new, but still controlled gas (section 102), pipelines also bid for expensive gas in section 106 and section 107. Section 1 0 7 gas consists of uncontrolled deep gas (from zones below 15,000 feet) and other difficult-to-produce gas now controlled a t about $5.50. In toto, the average price of gas in both interstate and intrastate pipeline systems rose, approximating market clearing levels. On some pipeline systems, gas costs rose to above market clearing levels, which meant that some of the more price s e n s ~ t i v ez u s t o m e r s r e d u c e d 3r n a l t e d c o m p l e t e l y heir gas ~urchases. The r e s u l t h a s been a n a p p a r e n t s u r p l u s o f d e l i v e r a b l e g a s , w l t h numerous r e p o r t s of s h u t - i n w e l l s and w i t h s c a t t e r e d r e p o r t s o f g a s b e i n g f l a r e d . I n t h e f a c e of t h i s s e e m i n g o v e r s u p p l y , 1 9 8 1 t u r n e d i n t o a b a n n e r y e a r f o r gas reserve additions. R e s p o n d i n g t o r e c o r d d r i l l i n g a c t i v i t y , new reserves f o r t h e f i r s t time s i n c e 1968 exceeded production. 21.3 tcf of g a s was d i s c o v e r e d , e x c e e d i n g p r o d u c t i o n b y a b o u t 1 0 % . Now p r o d u c e r s appear to be least finding takers having d i f f i c u l t y marketing t h e gas they found, o r a t f o r t h e i r new g a s a t t h e p r i c e s t h e y l i k e l y a n t i c i p a t e d when drilling the w e l l s i n 1980 o r 1981. T h e r e a r e two r e a l i t i e s that appear t o have created this situation, wherein gas p r i c e s a r e r i s i n g and s u p p l i e s remain i n t h e ground. The first i s t h a t p i p e l i n e s h a v e c o m m i t t e d t h e m s e l v e s t o more g a s t h a n t h e y c a n absorb a t p r i c e s w h i c h -- o n a v e r a g e -- a r e e s c a l a t i n g r a p i d l y . Many p i p e l i n e s are f i n d i n g t h e m s e l v e s o v e r - c o m m i t t e d a n d , i n some i n s t a n c e s , t i e d i n t o take or p a y c o n t r a c t s , w h i c h r e q u i r e p a y m e n t f o r minimum a m o u n t s o f g a s r e g a r d l e s s o f These payments -- f o r g a s n o t whether t h e p i p e l i n e t a k e s t h e gas o r not. a c t u a l l y t a k e n -- a r e a u t o m a t i c a l l y p a s s e d o n t o e n d u s e r s t h r u t h e p u r c h a s e d pipelines have in their tariff gas adjustment clauses t h a t v i r t u a l l y a l l for gas provisions. Unit p r i c e s of g a s a c t u a l l y s o l d t h e r e f o r e r i s e t o pay that pipeline never delivered. T h i s raises t h e a v e r a g e c o s t o f g a s s o l d on system. A d d i t i o n a l l y , many pipelines formed their own production affiliates. prices for that gas Pipeline a f f i l i a t e d production i s allowed t h e highest sold in third-party, non-affiliated transactions, and this includes unregulated s e c t i o n 107 g a s too. Pipelines, i n the aggregate, have strong i n c e n t i v e s t o t a k e t h e i r own a f f i l i a t e s ' p r o d u c t i o n a n d g a s u n d e r t a k e o r p a y c o n t r a c t s i n p r e f e r e n c e t o o t h e r g a s t h a t may b e l o w e r p r i c e d . And o t h e r g a s production affiliates d o e s t e n d t o be l o w e r p r i c e d , b e c a u s e t a k e o r p a y a n d expensive t e n d t o be r e l a t i v e l y r e c e n t p h e n o m e n a a n d i n v o l v e t h e n e w e r , m o s t o f NGPA g a s . A l l t h i s t e n d s t o d e f i n e a cascading problem. G a s flowing i n the Nation's all the available p i p e l i n e s y s t e m now h a s e s c a l a t e d t o t h e p o i n t w h e r e n o t production can be sold. In backing out unsold supplies, pipelines can, and The i n some c a s e s a c t u a l l y d o , r a i s e t h e a v e r a g e u n i t p r i c e o f f l o w i n g g a s . h i g h e r p r i c e s mean l o w e r s a l e s , a n d t h i s c o u l d b e c o m e a r e c u r s i v e t h e m e . The s e c o n d r e a l i t y i s t h a t t h e m a r k e t clearing price for gas i s much l o w e r , i n r e l a t i o n t o o i l f u e l p r i c e s , t h a n most students of the industry What is ( p o l i c y m a k e r s i n c l u d e d ) t h o u g h t i t was w h e n NGPA was b e i n g c r a f t e d . becoming an i n c r e a s i n g l y c l e a r f a c t o f l i f e i s t h a t b u r n e r t i p p r i c e s have t o be c o m p e t i t i v e w i t h o i l f u e l s , s p e c i f i c a l l y r e s i d u a l f u e l . But burner tip p r i c e s embody b o t h l o n g - d i s t a n c e a n d l o c a l p i p e l i n e u t i l i t y t a r i f f s , a s w e l l a s the wellhead price of t h e gas. The l i k e l y burner t i p market clearing market p r i c e i s t h e Btu e q u i v a l a n t of r e s i d u a l f u e l , and t h e l i k e l y wellhead While t h i s i s c l e a r i n g p r i c e w i l l be t h i s l e s s t h e u t i l i t y t a r i f f s i n v o l v e d . s o m e t h i n g o f a n o v e r s i m p l i f i c a t i o n -- s i n c e n o t a l l u t i l i t y t a r i f f s a r e e q u a l ( t h e y vary, f o r example, w i t h l e n g t h of h a u l from t h e g a s field) and resid -- t h e i s n ' t n e c e s s a r i l y t h e a l t e r n a t i v e , o r c o m p e t i t i v e , f u e l i n a l l cases that determines prices. And today example d e l i n e a t e s a set of economics t h e s e e c o n o m i c f o r c e s s e e m t o i n d i c a t e t h a t many t y p e s o f g a s p r i c e s a r e too h i g h t o be s o l d . Standing between t h e b u r n e r t i p and wellhead are the long-distance and local distribution pipeline utilicles. in ~ r d e rfor tne market zonditions a c the burner tip -- where prices are determined -- to a f f e c t wellhead prices, price signals must be transmitted through two independent entities -- the local distribution utility and the long-distance pipeline - - back to the also independent producer. This process is really new. In the past, gas pipelines typically could sell all the gas they could g e t , and they have never had to exercise the option of passing price signals back down the pipe to the wellhead. How well this will work is n o w in the process of being tested. Recent months have seen some price signals begin to get passed back down the pipe. One of the first signs of this has been the decline in the prices of d e e p (unregulated) section 1 0 7 gas. Some g a s i n this class reached the $ 1 0 mark, but many pipelines have had g r e a t trouble with the highest-priced g a s a n d have renegotiated contract prices o r otherwise gotten o u t of excessively expensive commitments o r a r e i n the process of doing so. During the summer o f 1 9 8 2 , producers selling new gas began to face great difficulty. Marketing gas a t prices a b o v e $3.00 became d i f f i c u l t , because pipelines were either overcommitted under pre-existing g a s contracts or could n o t a b s o r b gas which would raise their weighted average o r delivered price. In f a c t , pipelines that made commitments to higher priced g a s were i n no position t o take advantage of new offers of supply that might be priced below Whether or not pipelines a r e willing or earlier c o n t r a c t u a l . c o m m i t m e n t s . a b l e to renegotiate t h e higher of their g a s contracts to take advantage of what appears to be a near-term oversupply will be tested i n the months ahead. T o s o m e extent, this will provide a n indication of how well g a s markets work, with important implications for the price control debate. A bottom-line policy consideration s e e m s t o be developing. In the current market, wellhead prices i n the $2.75/Mcf a r e a seem to translate i n t o burner t i p prices a t a b o u t market clearing levels. If this i s actually true, then those favoring deregulation of wellhead prices could make a very convincing point -- that immediate decontrol would not r a i s e prices, a t least i n the current energy pricing environment. T h o s e opposing decontrol would likely a r g u e t h a t the pipeline industry has y e t to prove it can d e a l effectively with producers i n terms of keeping gas supply prices economically. They would question pipelines ability to contract a t the wellhead such that g a s can be delivered a t market clearing prices. It is likely that the next 6 to 1 2 months will yield a n indication of who is correct. Administrative Issues Before F E R C In t h e context of NGPA and prices being out o f step with those of o i l , there a r e a number of administrative matters under consideration a t F E R C which a r e relevant to the policy discussion. Among the more important a r e t h e following issues: * "Vintagingl' -- G a s in sections 1 0 4 , 1 0 6 , and small a m o u n t s in section the "spud" d a t e of the well. P r i c e s of section 1 0 4 g a s range from a b o u t $2.25 f o r old g a s down to 2 7 c e n t s per Mcf for " o l d e s t w g a s , for example. After some discussion of the pro's a n d c o n ' s of having such a wide dispersion of old g a s prices, F E R C i n order to collect issued a Notice of Inquiry (04/28/82) o n the matter information. It should be emphasized that this is not a r u l e m a k i n g , although i t could lead to one. The g o a l here i s to determine the wisdom of placing a l l old g a s i n o n e , higher priced class. This would raise the average price 109 is price controlled in several tiers based o n of gas substactially. The vintaging matter is often associated with what has come to be called the market ordering problem or market disorder. What has happened is that the old gas provides "a cushion" so that pipelines can acquire gas a t much higher prices than it could be sold for on its own. This gas can be made marketable by averaging its price in with old gas, so that the blend price is competitive a t the burner tip. This has led to purchases of unregulated section 107 gas at attention-focusing prices, some above $10.00. I t has likely led to repricing of other gas under contract a t below-ceiling prices, and to purchases of gas a t high-ceiling prices Which would be uneconomic without the "cushion." Additionally, intrastate pipelines assert that they a r e a t a comparative disadvantage relative to intrastate systems since they have had historically Hence, they are unable higher gas acquisition costs and less of a cushion. to bid successfully for new supply against the comparatively better cushioned interstates. This has become a regional issue of some concern. -- * Near Deep Gas With gas from zones below 15,000 ft. unregulated, FERC has issued a Notice of Proposed Rulemaking regarding gas from the 10,000 to 15,000 ft. zone. The proposal would raise the price of gas from these strata to 150% of its NGPA price. This would create incentive for deeper drilling - - where gas prospects are better -- and would create disincentives to drill all the way to 15,000 ft. simply to qualify for a higher price. * Gas Produced in Deep Water -- F E R C went through all the administrative procedures needed to raise the price of gas produced from waters 300-feet deep or deeper by 200% in excess of the statutory rate. However, the commission never brought the matter to a vote, and the issue i s now in limbo. * Cap on Sec. 1 0 7 gas -- There has been informal discussion about placing a floating ceiling on unregulated gas in this class, perhaps tying it to 70% of crude prices. This gas has sold for $10 in some cases. * Incremental pricing -- If the Phase I1 ruling i s sustained, the Commission may have to promulgate a new incremental pricing rule. Some preliminary study is now ongoing a t the staff level regarding what type of Phase I1 plan may be brought forward. Legislative Issues The 97th Congress has been disinclined to take up the natural gas regulation issue with any vigor. Hearings were held by the Senate Energy Committee in November 1981 and March 1982. Similarly, the House Synthetic and Fossil Fuels Subcommittee held hearings i n July and August 1982. Little in the way of consensus, much less legislation, emerged from these hearings. Two similar pieces of legislation, H.R. 5866 (Gramm) and S. 2074 (Johnston) seem to capture the essence of thought of those seeking deregulation. The main provisions of those bills are: * Repeal of the Powerplant and Industrial Fuel constrains natural gas use; Use Act of 1978, which * Repeal of incremental pricing; * 3-year phaseout of all price ceilings, aimed a t converging gas prices on 7 C % of crude oli equivaiancy by Jan. 1 , 1985. post-1985 prlce controls; itemoves all F E R C authority f o r * Capping high cost gas (section 107) at 70% of crude equivalancy; * Facilitating intrastate pipelines access to Outer Areas now primarily reserved for interstate pipelines; Continental * A variety of provisions aimed a t giving pipelines legislative to deal with disadvantageous producer contracts. Shelf authority The only item on the natural gas agenda that actually came close to a vote 371. This represented a statement by the this Congress was H.Res. anti-deregulation forces that NGPA should not be administratively tampered with. As such, it encapsulates the pro-regulation sentiment at this time: preserve the status quo. H.Res. 371 was intended to be a device to bring political pressure to bear on FERC, halting the progress of administrative procedures oriented toward raising the price of old gas, specifically that in section 104. It was introduced with 226 co-sponsors, but was never acted upon. In spite of this, those opposing administrative measures raising gas prices cite the measure as indicative of the wsense of Congress" that NGPA's statuatory pricing structure should not be tampered with. LEGISLATION H.Res. 371 (Dingell et dl.) Expresses the sense of the Mouse that the Federal Energy Regulatory Commission should take no action to accelerate the decontrol of wellhead natural gas prices. H. J.Res. 4 6 7 (Corcoran) Provides for the expiration of the waiver of laws granted for the Alaska natural gas transportation system unless the Federal Energy Regulatory Commission issues, on or before Dec. 1 5 , 1983, a final certificate of public convenience and necessity for the approved transporation system. Prohibits any Federal financial assistance for the transportation system after approval of this resolution. Introduced Apr. 29, 1982. H.R. 5645 (Hartel et al.) Amends the Natural Gas Policy Act of 1978 to declare unenforceable any take-or-pay clause of any contract which is entered into on or after enactment of this Act and which i s applicable to any first or subsequent sale of natural gas. Introduced Mar. 1 , 1982; referred to Committee on Energy and Commerce. H.R. 5646 (Hetel et al.) Amends the Natural Gas Policy Act of 1978 to declare unenforceable indefinite price escalator clauses in natural gas contracts. Applicable to any first or subsequent sale of natural gas. Introduced Mar. 1 , 1982; referred to Committee on Energy and Commerce. H.R. 5866 ( ~ r a m m ) - Xepeals the Powerplanc and Industrial Fuel Use Act of i978. Terminates the incremental pricing requirements of the Natural Gas Policy Act of 1978. Repeals provisions of the Public Utility Regulatory Policies Act of 1978 relating to retail policies for natural gas utilities. Provides for the decontrol of natural gas. Introduced Mar. 1 7 , 1982. H.R. 5923 (Collins, J., by request) Amends the Federal Energy Administration Act of 1974 and the Department of Energy Organization Act with respect t o the disclosure of energy information obtained from Federal agencies. Repeals specified energy information reporting requirements under the Energy Supply and Environmental Coordination Act of 1974, the Federal Energy Administration Act of 1974, the Department of Energy Organization Act, the Powerplant and Industrial Fuel Use Act of 1978, and the Emergency Energy Conservation Act of 1979. Introduced Mar. 23, 1982. H.R. 5 9 5 4 (Mottl et al.) Amends the Natural Gas Policy Act of 1978 to repeal provisions providing for the decontrol of natural gas prices. Introduced Mar. 24, 1982. H.R. 6331 (Young, R., et al.) Amends the Natural Gas Policy Act of 1978 to: (1) eliminate the monthly (2) allow increase in such indexing of wellhead natural gas prices; and prices prior to the expiration of natural gas price controls only to the extent justified by increases in the cost of producing natural gas. Introduced June 3 , 1982. H.R. 6 8 5 0 (Young, R.) Amends the Natural Gas Policy Act of 1978 to provide for continuation of price controls beyond 1985. Eliminates the monthly indexing of wellhead natural gas prices. Allows increase i n such prices prior to the expiration of natural gas price controls only to the extent justified on the basis of increases in the cost of producing natural gas. Introduced July 2 2 , 1982. S.Res. 331 (Chafee et al.) Expresses the sense of the Senate that the Federal Energy Regulatory Commission should take no action to accelerate the decontrol of wellhead natural gas prices. Introduced Mar. 3 , 1982. S. 2074 (Johnston et al.) Repeals the Powerplant and Industrial Fuel Use Act of 1978. Amends the Public Utility Regulatory Policies Act of 1978 to repeal provisions relating to retail policies for natural gas. Provides for the deregulation of committed or dedicated natural gas under the Natural Gas Policy Act of 1978. S. 2292 (Metzenbaum et al.) Amends the Federal Power Act to require the Federal Energy Regulatory Commission t o approve, upon application by a public utility and after examination of the propriety of the costs involved, the inclusion in the wholesale rate base of construction work in progress with respect to: (1) construction of pollution control facilities; o r (2) conversion of oil or gas-fired facilities. Provides that public utility charges based upon costs associated with other construction unreasonable. S. 2358 work in prograss shall be considered (McClure by request) Authorizes the Federal Energy Regulatory Commission to assess and collect* common carriers for fees from natural gas companies, public utilities, and services and privileges rendered under its regulatory programs. A D D I T I O N A L REFERENCE SOURCES