Authorization of Natural Gas Pipeline Construction: Moving Decisions from Regulators to the Marketplace
By John Decker
INTRODUCTION
Natural gas, one of the nation's central sources of primary energy, is underused. Today, natural gas accounts for more than one-fifth of all primary energy consumed in the United States and one-half of all energy consumed in U.S. homes. Because of regulatory barriers, however, natural gas is underused by some one trillion cubic feet (tcf) each year.
Because natural gas is in many respects a better energy source, not simply an alternative fuel, underuse is costly. Increasing natural gas consumption would yield significant economic, environmental and geopolitical benefits for the United States. First, switching to a less expensive energy alternative would improve the economy. Costs of production will drop for those businesses where natural gas is a factor input. In the residential sector, increased natural gas usage could save consumers up to $140 million in the year 2000. In addition, because natural gas is a relatively clean-burning fuel, increased use will benefit the environment. To reduce greenhouse gas emissions, the U.S. Environmental Protection Agency (EPA) has advocated greater reliance on natural gas until further development of non-fossil energy sources. Furthermore, taking greater advantage of the abundant domestic natural gas supply would lessen U.S. dependence on foreign oil. By raising consumption of natural gas by 0.9 tcf per year, U.S. oil consumption would decrease by an estimated 300,000 to 400,000 barrels per day.
After a brief introduction to the natural gas industry and the relevant regulatory regime, this Note analyzes the U.S. pipeline construction authorization process and the rate-making system for pipeline services. To draw conclusions about the future direction of pipeline construction authorization, the analysis works through seven regimes for governing pipeline construction. Four of the regimes are currently in use: traditional certification under section 7 of the Natural Gas Act; optional expedited certification (OEC); blanket construction authorization; and certification pursuant to section 311 of the Natural Gas Policy Act. Three others are proposed: Federal Energy Regulatory Commission (FERC) Order No. 555; the House version of the Comprehensive National Energy Policy Act (H.R. 776); and the Senate version of the same bill (S. 2166).
A. Fundamental Goals of Natural Gas Pipeline Regulation
To increase use of natural gas, the nation must improve its infrastructure for transporting the gas—the national network of natural gas pipelines. This Note focuses on attempts to expand pipeline capacity. The manner of government approval of the increased capacity strongly implicates the efficient use of this non-renewable natural resource.
The analysis rests on the premise that financial signals from a competitive market more efficiently guide construction decisions than do the commands of government regulators. In a competitive market, economic profits signal investors to build efficiently. The indisputable monopoly characteristics of natural gas pipelines, however, prevent a competitive outcome. Unchecked, these characteristics would produce barriers to entry into the natural gas market, hamper market response to price signals and provide a measure of monopoly power to pipeline operators. Yet regulation by government command presents much the same problem because it prevents entry in response to price signals. Accordingly, the United States must develop a regulatory system that simultaneously allows investors—not regulators—to decide the location and capacity of new pipelines and also protects both producers and ultimate consumers from the exercise of monopoly power by pipeline owners.
B. The Industry's Players: Producers, Pipelines, Local Distributors and Consumers
Four major groups act together in the natural gas industry: producers; pipeline companies (pipelines); local distribution companies (LDCs); and consumers. Producers remove natural gas from the ground and sell it to pipelines, to LDCs or to consumers. Natural gas purchased by a pipeline is resold to LDCs or consumers. Buying gas for resale, the “merchant function” of pipelines, has been the pipelines' traditional role. For gas purchased directly by LDCs or consumers, the pipelines merely serve as transporters and never take legal title to the gas.
In either their merchant or transporter function, the pipelines provide two levels of service, firm and interruptible. Under firm service, the party to receive the gas pays the pipeline for the right to receive a certain volume of gas. In other words, firm customers reserve a certain volume of the pipeline for their use, and the pipeline must deliver this volume of gas if the customers demand it. Interruptible customers, on the other hand, purchase gas from the pipeline or producer only from available excess capacity on the pipeline. Not guaranteed service, interruptible customers must have an alternative source of fuel, usually oil. Since interruptible customers switch between fuel sources, they will only buy available excess natural gas when its price is lower than the alternative.
For both firm or interruptible service, the pipeline collects gas at the wellhead. From the wellhead, the gas flows to either LDCs or consumers at the city gate. Most gas flows to LDCs who then distribute the gas to their customers—households that depend solely on the gas for their supply of heat in the winter as well as large industrial users that switch between gas and oil depending on price and availability. However, some large industrial users connect directly to a pipeline and thus bypass the LDC.
C. The Basic Federal Regulatory Regime: FERC and the Natural Gas Act of 1938
The Natural Gas Act of 1938 (NGA) divides control over the natural gas industry between the federal government, represented by the Federal Energy Regulatory Commission (FERC), and the states. FERC's jurisdiction extends over “the transportation of natural gas in interstate commerce, ... the sale in interstate commerce of natural gas for resale ... and ... natural-gas companies engaged in such transportation or sale.” States control those natural gas transactions that take place solely within one state.
Section 7(c) of the NGA governs both the construction of natural gas facilities and the sale or transport of natural gas in interstate commerce. Section 7(c) states:
No natural-gas company ... shall engage in the transportation or sale of natural gas, subject to the jurisdiction of the Commission, or undertake the construction or extension of any facilities therefor ... unless there is in force with respect to such natural-gas company a certificate of public convenience and necessity issued by the Commission authorizing such acts or operations.
Section 4 of the NGA governs the rates pipelines may charge for their services, either as a merchant or transporter of natural gas. Section 4 provides:
All rates and charges made, demanded, or received by any natural-gas company for or in connection with the transportation or sale of natural gas subject to the jurisdiction of the Commission ... shall be just and reasonable, and any such rate or charge that is not just and reasonable is declared to be unlawful.
Additionally,
[n]o natural-gas company shall, with respect to any transportation or sale of natural gas subject to the jurisdiction of the Commission, (1) make or grant any undue preference or advantage, or (2) maintain any unreasonable difference in rates, charges, services, facilities, or in any other respect, either as between localities or as between classes of service.
In sum, if a natural gas company sees an opportunity to build a new pipeline, it must first obtain a certificate of “public convenience and necessity” from FERC. Once approved and completed, the pipeline may recover fees for its services, provided that the fees are “just and reasonable” and without “undue prejudice” or “unreasonable difference.”
Natural gas, one of the nation's central sources of primary energy, is underused. Today, natural gas accounts for more than one-fifth of all primary energy consumed in the United States and one-half of all energy consumed in U.S. homes. Because of regulatory barriers, however, natural gas is underused by some one trillion cubic feet (tcf) each year.
Because natural gas is in many respects a better energy source, not simply an alternative fuel, underuse is costly. Increasing natural gas consumption would yield significant economic, environmental and geopolitical benefits for the United States. First, switching to a less expensive energy alternative would improve the economy. Costs of production will drop for those businesses where natural gas is a factor input. In the residential sector, increased natural gas usage could save consumers up to $140 million in the year 2000. In addition, because natural gas is a relatively clean-burning fuel, increased use will benefit the environment. To reduce greenhouse gas emissions, the U.S. Environmental Protection Agency (EPA) has advocated greater reliance on natural gas until further development of non-fossil energy sources. Furthermore, taking greater advantage of the abundant domestic natural gas supply would lessen U.S. dependence on foreign oil. By raising consumption of natural gas by 0.9 tcf per year, U.S. oil consumption would decrease by an estimated 300,000 to 400,000 barrels per day.
After a brief introduction to the natural gas industry and the relevant regulatory regime, this Note analyzes the U.S. pipeline construction authorization process and the rate-making system for pipeline services. To draw conclusions about the future direction of pipeline construction authorization, the analysis works through seven regimes for governing pipeline construction. Four of the regimes are currently in use: traditional certification under section 7 of the Natural Gas Act; optional expedited certification (OEC); blanket construction authorization; and certification pursuant to section 311 of the Natural Gas Policy Act. Three others are proposed: Federal Energy Regulatory Commission (FERC) Order No. 555; the House version of the Comprehensive National Energy Policy Act (H.R. 776); and the Senate version of the same bill (S. 2166).
A. Fundamental Goals of Natural Gas Pipeline Regulation
To increase use of natural gas, the nation must improve its infrastructure for transporting the gas—the national network of natural gas pipelines. This Note focuses on attempts to expand pipeline capacity. The manner of government approval of the increased capacity strongly implicates the efficient use of this non-renewable natural resource.
The analysis rests on the premise that financial signals from a competitive market more efficiently guide construction decisions than do the commands of government regulators. In a competitive market, economic profits signal investors to build efficiently. The indisputable monopoly characteristics of natural gas pipelines, however, prevent a competitive outcome. Unchecked, these characteristics would produce barriers to entry into the natural gas market, hamper market response to price signals and provide a measure of monopoly power to pipeline operators. Yet regulation by government command presents much the same problem because it prevents entry in response to price signals. Accordingly, the United States must develop a regulatory system that simultaneously allows investors—not regulators—to decide the location and capacity of new pipelines and also protects both producers and ultimate consumers from the exercise of monopoly power by pipeline owners.
B. The Industry's Players: Producers, Pipelines, Local Distributors and Consumers
Four major groups act together in the natural gas industry: producers; pipeline companies (pipelines); local distribution companies (LDCs); and consumers. Producers remove natural gas from the ground and sell it to pipelines, to LDCs or to consumers. Natural gas purchased by a pipeline is resold to LDCs or consumers. Buying gas for resale, the “merchant function” of pipelines, has been the pipelines' traditional role. For gas purchased directly by LDCs or consumers, the pipelines merely serve as transporters and never take legal title to the gas.
In either their merchant or transporter function, the pipelines provide two levels of service, firm and interruptible. Under firm service, the party to receive the gas pays the pipeline for the right to receive a certain volume of gas. In other words, firm customers reserve a certain volume of the pipeline for their use, and the pipeline must deliver this volume of gas if the customers demand it. Interruptible customers, on the other hand, purchase gas from the pipeline or producer only from available excess capacity on the pipeline. Not guaranteed service, interruptible customers must have an alternative source of fuel, usually oil. Since interruptible customers switch between fuel sources, they will only buy available excess natural gas when its price is lower than the alternative.
For both firm or interruptible service, the pipeline collects gas at the wellhead. From the wellhead, the gas flows to either LDCs or consumers at the city gate. Most gas flows to LDCs who then distribute the gas to their customers—households that depend solely on the gas for their supply of heat in the winter as well as large industrial users that switch between gas and oil depending on price and availability. However, some large industrial users connect directly to a pipeline and thus bypass the LDC.
C. The Basic Federal Regulatory Regime: FERC and the Natural Gas Act of 1938
The Natural Gas Act of 1938 (NGA) divides control over the natural gas industry between the federal government, represented by the Federal Energy Regulatory Commission (FERC), and the states. FERC's jurisdiction extends over “the transportation of natural gas in interstate commerce, ... the sale in interstate commerce of natural gas for resale ... and ... natural-gas companies engaged in such transportation or sale.” States control those natural gas transactions that take place solely within one state.
Section 7(c) of the NGA governs both the construction of natural gas facilities and the sale or transport of natural gas in interstate commerce. Section 7(c) states:
No natural-gas company ... shall engage in the transportation or sale of natural gas, subject to the jurisdiction of the Commission, or undertake the construction or extension of any facilities therefor ... unless there is in force with respect to such natural-gas company a certificate of public convenience and necessity issued by the Commission authorizing such acts or operations.
Section 4 of the NGA governs the rates pipelines may charge for their services, either as a merchant or transporter of natural gas. Section 4 provides:
All rates and charges made, demanded, or received by any natural-gas company for or in connection with the transportation or sale of natural gas subject to the jurisdiction of the Commission ... shall be just and reasonable, and any such rate or charge that is not just and reasonable is declared to be unlawful.
Additionally,
[n]o natural-gas company shall, with respect to any transportation or sale of natural gas subject to the jurisdiction of the Commission, (1) make or grant any undue preference or advantage, or (2) maintain any unreasonable difference in rates, charges, services, facilities, or in any other respect, either as between localities or as between classes of service.
In sum, if a natural gas company sees an opportunity to build a new pipeline, it must first obtain a certificate of “public convenience and necessity” from FERC. Once approved and completed, the pipeline may recover fees for its services, provided that the fees are “just and reasonable” and without “undue prejudice” or “unreasonable difference.”
