REGULATORY AND HISTORICAL BACKGROUND

The natural gas industry has undergone vast changes over the past three decades. Natural gas utilities were once heavily regulated, vertically integrated monopolies. In recent years, the industry has opened up to market competition.

The Federal Energy Regulatory Commission (FERC) regulates interstate transactions of natural gas and transmission companies, since transmission companies engage in the interstate transportation of natural gas. FERC’s administration of the natural gas industry is pursuant to some of the following legislation: The Interstate Commerce Act, The Natural Gas Act of 1938, Natural Gas Policy Act of 1978, The Outer Continental Shelf Lands Act, The Public Utilities Regulatory Policies Act of 1978, The Powerplant and Industrial Fuel Use Act. The Public Utilities Regulatory Act of 1978, National Environmental Policy Act, Department Of Energy Organization Act. The Natural Gas Wellhead Decontrol Act (NGWDA) of 1989, and the Energy Policy Act of 1992. For example, FERC regulates both the construction of pipeline facilities and transportation of natural gas in interstate commerce. Thus, companies constructing and operating interstate pipelines must first obtain certificates of public convenience and necessity from FERC. In addition, FERC approval is required to abandon facility use, as well as to set rates for these services. Conversely, the activities of local distribution companies (LDC) are generally intrastate in nature, and therefore, are regulated by State regulatory agencies, generally pursuant to State legislation. In Ohio, the Public Utilities Commission of Ohio (PUCO) regulates both natural gas and electric LDCs.

Due to the inherent nature and capital investment requirements of the business, the entire natural gas industry was regarded as a natural monopoly to be managed through extensive economic regulation by State and Federal governmental agencies. The Federal government first regulated the industry through the Natural Gas Act (NGA), passed in 1938. The NGA’s regulation included federal control on the wellhead price of natural gas, as a means to protect consumers relying on a monopoly service. This regulatory policy was abandoned due to the energy shortages in the 1970’s, since the price controls on natural gas created an economic disincentive to develop new wellhead supply. As discussed in the Natural Gas Industry Overview section, since the 1970’s the regulatory policy has shifted from the model of traditional economic regulation to the model of market competition.

Under the traditional economic regulatory model, natural gas services were tied together and offered to consumers as a single bundled product. End-users could only purchase natural gas from their LDC, and the LDC sold the natural gas for a bundled price that included the cost of the commodity as well as the cost of transmission and distribution services utilized to deliver the commodity from the wellhead to the end-user. This bundled price that LDCs charged end-users was generally determined by the State regulatory agency, in Ohio the PUCO, that included a recovery of prudent costs incurred by the LDC in providing the service and an allowed rate-of-return. LDCs generally purchased the natural gas commodity from interstate pipelines as a bundled service that included the cost of the commodity and the cost of transportation to move the commodity on the interstate pipeline from the wellhead to the LDC’s point of receipt. Moreover, the LDC was generally part of a single, vertically integrated, and regulated holding company that often owned all the assets along the delivery chain, including the natural gas production, gathering, transmission, and distribution assets. Thus, end-users had no choice related to procuring natural gas.

The energy crisis of the 1970’s, which included natural gas shortages and curtailments, provided the impetuous for major changes in the industry. With Ohio in the forefront, the nation searched for pragmatic public policy solutions to help ease the shortage of natural gas. In 1973, the PUCO established the self-help program to bring choice to Ohio end-users. As originally designed and implemented, the natural gas self-help program enabled larger end-users to develop new gas production wells and to use the delivery system of Ohio’s LDCs to move the gas from the production fields to their facilities. In 1978, Congress began to eliminate wellhead price controls, and ultimately President George Bush signed The Natural Gas Decontrol Act of 1989 that eliminated all remaining federal control over the wellhead price of natural gas. The elimination of price controls on the wellhead price of natural gas resulted in an increase in the price of the natural gas commodity, encouraging new domestic production, which ultimately resulted in abundant supply and low natural gas prices. During the early 1980s, with abundant natural gas supplies and low wellhead prices, consumers of natural gas, including end-users and LDCs, and natural gas producers wanted to directly transact business with each other. Consumers of natural gas were limited to purchasing natural gas from transmission companies who provided the merchant function of purchasing the commodity from producers and delivering and selling the natural gas commodity to LDCs for resale to end-users. The transformation of the industry continued with FERC issuing Orders 436, 500, and 636 containing significant policy changes that created the foundation for and eventually culminated in today’s robust competitive natural gas market.

Starting in 1986, FERC issued Order 436, which required transmission pipeline companies to offer interstate transmission services to users on a first-come, first-served basis, to the extent that the transmission pipeline had the capacity available. Order 436 also imposed rate conditions designed to provide an economic incentive for pipelines to become open-access operators and to transport as much gas as possible. However, Order 436 did not impose a requirement that the pipelines offer access to transmission services in a manner comparable to the access available to affiliate companies. Order 500, issued in 1987, reconfirmed the regulations provided in Order 436, and added a cost-recovery mechanism for those transmission pipelines left holding take-or-pay supply contracts no longer performable by the implementation of Order 436. Despite the open-access requirements of Order 436, pipeline companies retained a competitive edge since they could provide service with greater reliability by being able to combine delivery services, such as transportation and storage services. To remedy this, FERC issued Order 636 in 1992. Order 636 required pipelines to provide all subscribers for service, including affiliated companies, with comparable access to transmission services. Order 636 also mandated that pipeline companies unbundle their services, that is separate the service into components, individually priced, and made available separately, and to offer these services entirely on a first-come, first-served basis. Finally, Order 636 mandated that transmission companies could no longer perform the merchant function, which is the gas procurement for resale to LDCs and other end-users. If the pipeline company chose to continue providing the merchant sales function, the pipeline company could only do so through a separate business unit and obtain transportation services from the pipeline like all other users. This generally resulted in the transfer of the merchant function from the transmission company to an affiliated LDC, and LDCs assumed responsibility to negotiate their own gas supply arrangements with producers or gas suppliers and to determine the amount of unbundled pipeline services needed.

Thus, in recent years, the industry has moved away from an environment in which a single, regulated utility supplies all the services to end-users, and has moved to an environment based on competitive market mechanisms. In this competitive environment, the various components involved in the delivery of natural gas to the end-user’s burner-tip, such as the commodity, pipeline capacity, storage, and banking services, are unbundled. Further, unregulated non-utility providers are permitted to serve customers, and under certain circumstances, the sale by utilities of the natural gas commodity is also free from economic regulation. Thus, customers have the choice to select their supplier, shop for competitive services, and arrange for the delivery of natural gas to their burner tip by selecting from a portfolio of unbundled services based on individual unique needs.