The Market Under Regulation
The current regulatory environment in which the natural gas industry operates is much less stringent and relies more heavily upon competitive forces than in the past. The last twenty years have seen dramatic changes throughout the industry, spurred by its ever-changing regulatory environment. However, despite the restructuring and deregulation of some portions of the natural gas supply chain, there still exist significant regulatory oversight of the industry in the transportation and distribution of natural gas. This oversight is necessary to ensure that those market participants that possess monopoly power in the industry do not abuse this power or distort the smooth and efficient functioning of the natural gas markets. To jump 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
Overview of Current Regulation
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 and marketers 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 the law; for instance, producers are required to obtain the proper authorization and permitting before beginning to drill, particularly on federally-owned land. However the prices they charged are a function 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, the access 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 transportation pipelines by the Federal Energy Regulatory Commission (FERC) has designated that interstate pipelines can serve only as transporters of natural gas. In the past, interstate pipelines acted as both a transporter of natural gas, as well as a seller of the commodity, both of which were rolled up into a bundled product and sold for one price. 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 natural gas themselves. Pipelines must also now offer access to their transportation infrastructure to all other 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 review the 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 Energy Regulatory Commission (FERC). FERC has jurisdiction over the regulation of interstate pipelines and is concerned with overseeing the implementation and operation of the natural gas transportation infrastructure. FERC obtains its authority and directives in the regulation of the natural gas industry from a number of laws; namely the Natural Gas Act of 1938, the Natural Gas Policy 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 an overview of important congressional committees and government departments that have jurisdiction over areas affecting the natural gas industry, as well as power to direct the future regulation of the industry. To view links to these committees, departments, and agencies charged with oversight of varying aspects of the natural gas industry, click here.
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 rely on their supply of natural gas from a single source (captive customers), and ensuring that the rates and prices set by an LDC are fair and equitable. State regulatory utility commissions have oversight 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 and regulations in place across the country. For more information on the regulation of natural gas distribution, visit the National Association of Regulatory Utility Commissioners here.
Regulation of distribution is currently undergoing a process of change, with the adoption by many states of programs aimed at exploring and instituting retail choice programs. These programs allow natural gas consumers more flexibility in arranging the delivery of their gas, including allowing many customers the option of purchasing their own natural gas, and using the distribution network of their LDC simply to transport that gas. For more information on the status of retail choice 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 the regulation of natural gas transportation. It was created in 1977 under the Department of Energy Organization Act. Although a government agency, FERC is designed to be independent from any undue political party influence or affiliation, as well as independent from any influence from the executive or legislative branches of government, and industry participants, including the energy companies over which it has oversight.
FERC is composed of five commissioners, who are nominated by the President of the United States, 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 these commissioners to act as FERC Chariman, who has the responsibility for setting a biweekly commission agenda. FERC operates by majority rule, which means that any Order must be approved 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 the commissioners on important matters. There are approximately 1,150 FERC staff, of which 400 focus on electric industry issues, 325 focus on hydro power issues, and 425 concentrate on oil and 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 fact that 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 abuse these 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 the use of consistent policies
- Where possible, promoting the introduction of well functioning competitive markets in place of traditional regulation
- Protecting customers and market participants through oversight of changing energy markets, including mitigating market power and ensuring fair and just market outcomes for all participants
In the natural gas industry, FERC regulates the rates and services offered by interstate pipeline companies, as well as certifying and permitting new pipeline construction and some closely related 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 environmental impacts. The certification of new pipeline developments is required under Section 7 of the Natural Gas Act. To learn more about the certification process, visit the FERCs website here.
There are essentially two types of issues faced by FERC: making company specific decisions, and making industry-wide decisions. Company specific issues can include applications for rate changes for one company’s transmission services, applications for changes in terms or conditions of 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 an application to expand a pipeline, construct a new one, or a complaint concerning unfair rates) to FERC. This filing is publicly posted, so that interested parties may have time to research and develop comments or viewpoints that they believe may help (or serve their purposes) in the decision making process. FERC staff members typically perform an analysis of the matter, and issue recommendations to the Commission. After FERC staff has reviewed the issue, it is time for the Commission to take action. FERC has fairly wide discretion with how it may decide to resolve issues; it may just make a decision without any further procedures, it may hold a trial-type hearing before an Administrative Law judge, or hold a technical 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 process used, 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 the best 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 is collecting information, ideas, and opinions regarding a certain matter. Notices of Proposed Rulemaking are generally intended to indicate the proposition of new regulations or policy changes. After issuing a NOI or NOPR, FERC then seeks comments from interested parties; essentially giving industry members, the public, trade associations, and any other interested parties the chance to explain their position to FERC. FERC then reviews and considers these comments before making a final decision. The final outcome of this process could be to issue an NOPR (after issues have been clarified under a NOI) to propose new regulations or policy changes, or to issue new regulations or policy changes (that were earlier proposed under a NOPR), usually in the form of a FERC Order, policy statement, or rulemaking. FERC also has the option of abandoning the initiative altogether.
Important FERC Regulations and Orders
There are several important regulations which serve to shape the current regulation of interstate pipelines. 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 FERC policy statements and Orders, but instead provide a brief overview of a couple of important Orders. To learn more about recent FERC actions in relation to the natural gas industry, visit FERCs 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 was voluntary; Order 636 made it mandatory
- Allows FERC to issue blanket certificates which allow pipelines to offer unbundled services for firm or interruptible service at market-based rates
- Allows for abandonment options for interruptible and short term firm transportation, and in certain instances longer term firm transportation services
- Sets a generic capacity brokering program for pipelines to release excess capacity (which includes 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 arisen after six years of operating under Order 636, and revise the regulatory structure in response to increased competition in the natural gas industry, and in the transportation of natural gas. Some important aspects of this order include:
- Suspended price ceilings for the sale of short term (less than one year) released capacity until September 30, 2002 (to respond to the formation of a significant ‘gray market’ in the sale of bundled capacity during peak periods by marketers and LDCs that essentially circumvented the ceilings set by Order 636)
- Changes the regulations regarding scheduling procedures, capacity segmentation, and the penalties imposed on pipelines in order to improve competition and efficiency in the interstate 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 transportation capacity
- Improves the reporting requirements, allowing for more transparency in market pricing and allow for more effective monitoring of the industry
For more information on FERC Order 637, visit the FERC website here.
FERC Order 639 – 1999
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 intended to ensure that the transportation of natural gas from facilities located on the OCS was offered on a non-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 (interstate pipelines) 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 is currently 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 to affiliates 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 transmission providers and their affiliated companies. FERC initiated discussion about the standards of conduct for transmission providers by issuing a Notice of Proposed Rulemaking in September of 2001. This proposed rulemaking deals primarily with standards for transmission providers (including interstate pipelines) dealing with affiliated companies, and the possibility that pipeline affiliated companies may receive preferential treatment, or allow pipeline companies to ‘circumvent’ certain regulations. Thus FERC intends to develop a clear set of regulations and rules regarding the conduct 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 learn more about this NOPR, and view the comments that have been submitted by various parties, visit the FERC website here.
The regulatory environment in which the natural gas industry operates is constantly changing, with small modifications and company specific issues being dealt with, as well as the institution and modification of broader, far reaching policy objectives and major rulemakings. In order to understand the regulatory forces that affect the natural gas industry, a constant eye must be kept on 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.