Lessons from Deregulating the Gas Industry

(NOTE: The following article is reprinted from the Web site of the National Association for State and Community Services Programs (NASCSP), http:// www.nascsp.org. Author Robert Adams is director of the Weatherization Assistance Program Technical Assistance Center (WAPTAC),http://www.waptac.org.

Lessons from Deregulating the Gas Industry, December 1998,
By Robert Adams

Sacramento, California
California regulators last year allowed Pacific Gas and Electric Company (PGE) and other gas companies to set their gas rates each month, instead of annually. This change in the pricing of natural gas has resulted in higher rates being set during the winter months when demand is the greatest. (The Sacramento Bee)

Atlanta, Georgia
Atlanta Gas Light Company is defending its method for setting natural gas rates against a wave ofcriticism from consumers and state regulators. The company's new charges are based in part on how much gas a particular consumer would typically use on the coldest day of the year instead of how much is actually used. (The Atlanta Journal - The Atlanta Constitution)

Zion, Illinois
The Zion Nuclear Power Station, once representing the promise of what nuclear energy could be, was shut down in January 1998. This monolith became the latest tombstone in what is a growing graveyard of aging nuclear plants being retired prematurely as states deregulate their electric industries and natural gas emerges as the chief competition. (The Salt Lake Tribune)

It seems like only yesterday the structure of the natural gas industry was simple. Natural gas producers explored for and produced natural gas and sold it to pipeline companies. The pipeline companies transported the gas across the country and sold it to local gas utilities. The local utilities sold and distributed the gas to their customers. The federal government regulated the price gas producers could sell their gas to interstate pipeline companies. They also regulated the price pipeline companies could sell the gas to local utilities. State agencies regulated the price that local gas utilities could charge customers.

Today, much of this structure has changed. The introduction of competition has made the natural gas industry more responsive to customer needs, less regulated by government agencies, and more susceptible to market forces. Competition began as a result of several events beginning with Congress ending federal control over the price of gas at the well in 1978. This stimulated competition in the market and set in motion a series of public policy changes among those regulatory agencies with jurisdiction over natural gas distribution.

During the 1980s, wellhead natural gas prices began to fall, due in part to the dramatic drop in world oil prices. Consumers of natural gas, including local natural gas utilities, who traditionally purchased their gas from interstate pipelines, were eager to have direct access to the suppliers with less expensive gas.

Similarly, gas producers were eager to sell directly to customers. To help gas shippers purchase space in natural gas pipelines (the equivalent of guaranteeing gas supply and transport throughout the country), the Federal Energy Regulatory Commission (FERC) issued Order 636. This order ended the pipeline companies' "middle-man" role and enabled all natural gas suppliers tocompete for buyers on an equal footing with pipeline companies. Order 636 also required pipelinecompanies to "unbundle" their gas sales, transportation, and storage services and offer these services separately. Finally, gas sales and service were unbundled and the market was opened to unregulated gas suppliers.

These public policy changes introduced competitive forces that have resulted in savings for many natural gas customers. Average retail natural gas prices (after adjusting for inflation) decreased 26 percent between 1987 and 1995. A growing number of natural gas customers now have the opportunity to purchase natural gas service on an unbundled basis. Most large-volume natural gas customers, like electric power generation facilities and manufacturing plants, have found the transition to a more competitive environment relatively straightforward. An increasing number of commercial customers, such as hospitals and foodservice operations, also have access to "customer choice" options. While about 25 percent of commercial customers bought natural gas from a supplier of choice in 1996, that proportion could jump to at least 60 percent by the year 2000, according to the American Gas Association.

Many local natural gas utilities have requested permission from their public utilities commission (PUC) to further extend competitive benefits to residential customers. Under these programs, consumers may choose to buy their natural gas from the local utility or from a non-utility supplier, in much the same way as they select a long-distance telephone carrier. Regardless of who supplies the customer's gas, the local gas utility transports the fuel to the customer's home.

By early 1998, local gas utilities in 18 states and the District of Columbia had proposed or implemented residential customer choice programs giving 13.3 million households, or one-fourth of all residential natural gas customers nationwide, the chance to select their natural gas supplier by the year 2000. While it has been proven that commercial and industrial customers have benefited from competition, there is no guarantee that residential customers will save money by purchasing natural gas from a non-utility supplier. Bringing direct competition to residential customers entails a different set of public policy and operational challenges. Local natural gas utilities have an obligation to serve all residential customers in their service areas. Virtually all utilities are prohibited from terminating service during cold weather to customers who have not paid their bills. Gas utilities are also required by their regulators to pay gross receipts taxes, franchise taxes, assessments to governments, and the cost of social programs.

There are many similarities between the gas deregulation process and the electric utility restructuring. In many ways, these industries are inter-dependent as proven by the impact of gas deregulation on the electric industry. If it is true that for every action there is an opposite and equal reaction, the stories referenced above are merely the beginning of what we may learn are the impacts of natural gas deregulation. More importantly, do these stories portend the future impacts of restructuring the electric industry?

Residents in Sacramento, California anticipated huge savings on natural gas when Pacific Gas and Electric began operating gas sales and distribution in an unregulated environment. Freezing temperatures in Sacramento have forced many consumers to crank up their thermostats and some are experiencing higher than expected monthly gas bills because of new pricing policies allowed under deregulation.

Under the rate restructuring, the cost of gas should be higher in summer months when people use less fuel. This July a therm of gas cost 18.5 cents. In December, a therm costs 27.5 cents. The actual price of the gas is only 35 percent of a consumer's total gas bill. Gas companies may profit on transporting gas to consumers, a cost that is included in monthly bills. Mary Rodriguez, a spokeswoman for PG&E, said one of the reasons the change was adopted was to encourage energy conservation during the winter months.

The fluctuating rates also better reflect the actual price of gas, she added, which costs more for utility companies in the winter months. "It's supply and demand," said Rodriguez. "The more demand - you're going to see an increase in prices." "If you're going to save on your bill, conserving your gas usage is going to help," she said. Mindy Spatt, media director for The Utility Reform Network, said her consumer advocacy group opposed the rate structuring change when it was approved last year by the Public Utilities Commission. "We felt that the concept that people would be more aware of their usage with this sort of monthly change didn't really make sense," Spatt said. "The demand for gas is not elastic. It is not a luxury item. People are not using gas because they want to. They're using gas because they have to stay warm."

Georgia's new natural gas deregulation law promised to open competition and lower heating costs for residents. Atlanta Gas Light was approved to open its market. In fact, Atlanta Gas will eventually exit the business of selling gas and instead be responsible only for delivering gas sold by rival marketers. The Public Service Commission (PSC) no longer controls the price of natural gas and Atlanta Gas began selling its gas at decontrolled prices. The PSC is now considering whether to impose roll-back cost controls since it received hundreds of calls from consumers who are seeing bills 20 percent higher than last year's costs, even though most of the weather until this week had been unseasonably warm and gas usage low. The company is being accused of marking up gas costs to increase profits. "There is no basis for the suggestion that we are marking up these costs," said Atlanta Gas Light President Paula Rosput. "In fact, we actually fell short on the collection of these costs in the months of October and November."

Rosput went on to say that, "the timing couldn't have been worse" for deregulation because of the weather. "If the weather had been colder than normal, the average customer would have noticed a lower cost per unit of natural gas than last year."

When licensed in 1973 at the height of the Arab oil embargo, Zion, Illinois' nuclear power plant was the nation's largest. Its steam generators helped light up most of northern Illinois and southern Wisconsin. Now Zion's twin reactors are the 11th and 12th to be closed earlier than their planned decommissioning. Department of Energy analysts predict another 24 plants, or about a 25 percent of the country's nuclear capacity, could close before their licenses expire in the next 20 years. This prospect of more shutdowns raises difficult issues. "If natural gas prices really fall to amounts they are talking about, you are talking about a bloodbath in the nuclear industry," says James Hewlett, an economist for the Department of Energy's Energy Information Administration. Shutting down aging plants and cleaning up sites could cost billions of dollars to consumers, stockholders, and communities. In addition, the federal government is struggling to find a permanent waste site for the spent fuels that are driving up the utilities' storage costs and preventing them from razing closed plants.

The pressures of deregulation and the competition from lower cost generation capacity like natural gas are forcing utility executives nationwide to decide whether to seek renewals of the expiring nuclear licenses. Zion's owner, Commonwealth Edison, decided to close the plant rather than spend $400 million to replace its steam generators. Detroit Edison, in a long-range decision, announced it will close its Fermi II nuclear plant when its license to operate expires. The utility estimates that it will spend $3 billion in 2025 dollars to decommission the plant. Most state deregulation laws allow utilities to recover their huge investment in nuclear power as "stranded costs." These costs force ratepayers to continue paying for the plants in a trade-off for lower electric rates.

The restructuring of the electric industry is following many of the paths already traveled by the natural gas industry. Over and over the results are the same. Anticipated competition and lower prices never materialize in the way they are first envisioned. Stranded costs and unforeseen market conditions prevent true price reductions from occurring and residential customers seem to be the last to benefit from the restructuring, if at all. As energy conservation professionals and advocates for those families least represented at the bargaining table, we must continue to stay involved with utility restructuring. Our vigilance is needed to ensure that our constituency benefits from the new era of utility service and delivery.

Page Last Updated: December 7, 2005