APTD-1458
AN ANALYSIS
OF THE
REGULATORY ASPECTS
OF NATURAL GAS SUPPLY
(ABRIDGED REPORT)
U.S. ENVIRONMENTAL PROTECTION AGENCY
Office of Air and Water Programs
Office of Air Quality Planning and Standards
Research Triangle Park, North Carolina 27711
-------
APTD-1458
AN ANALYSIS
OF THE
REGULATORY ASPECTS
OF NATURAL GAS SUPPLY
(ABRIDGED REPORT)
by
Foster Associates, Inc.
110] Seventeenth Street, N.W.
Washington, D. C. 20036
Contract No. 68-02-0640
EPA Project Officer: Frank Collins
Prepared for
ENVIRONMENTAL PROTECTION AGENCY
Office of Air and Water Programs
Office of Air Quality Planning and Standards
Research Triangle Park, North Carolina 27711
March 1973
-------
The APTD (Air Pollution Technical Data) series of reports is issued by
the Office of Air Quality Planning and Standards, Office of Air and
Water Programs, Environmental Protection Agency, to report technical
data of interest to a limited number of readers. Copies of APTD reports
are available free of charge to Federal employees, current contractors
and grantees, and non-profit organizations - as supplies permit - from
the Air Pollution Technical Information Center, Environmental Protection
Agency, Research Triangle Park, North Carolina 27711 or may be obtained,
for a nominal cost, from the National Technical Information Service,
5285 Port Royal Road, Springfield, Virginia 22151.
This report was furnished to the Environmental Protection Agency by
Foster Associates, Inc., Washington, B.C. in fulfillment of Contract
No. 68-02-0640. The contents of this report are reproduced herein
as received from the contractor. The opinions, findings, and con-
clusions expressed are those of the author and not necessarily
those of the Environmental Protection Agency. Mention of company
or product names is not to be considered as an endorsement by the
Environmental Protection Agency.
Publication No. APTD-1458
11
-------
TABLE OF CONTENTS
I. CURRENT REGULATORY PICTURE AFFECTING NATURAL GAS SUPPLY 2
A. Background Information 2
B. State Regulation 8
C. Interior Department: Leasing of Federal Lands 11
D. Federal Power Commission 14
1. Producer Regulation 14
2. Pipeline Regulation 16
3. Exports and Imports 19
4. Synthetic Gas 22
E. Other Regulatory Controls 24
1. Departments of State, Defense and Commerce 24
2. Office of Coal Research 25
3. Price Commission 26
II. ALTERNATIVE REGULATORY STRATEGIES FOR INCREASING GAS SUPPLY 28
A. Sanctity of Contract Legislation 30
B. Decontrol Legislation 32
C. Legislation to Expand Federal Regulation 34
D. Modification of Producer Regulation 35
E. Acceleration of Offshore Leasing 39
F. Encouragement of Supplemental Gas Supplies 41
G. Means of Influencing Regulatory Policy 48
-------
ABRIDGED REPORT
Foster Associates has undertaken a study for the Environmental
Protection Agency to review the current regulatory picture affecting the
supply and distribution of natural gas and low sulfur fuel oil, to analyze
possible changes in this regulatory picture, and to appraise alternate
regulatory strategies which could bring about increased supplies of these
clean-burning fuels.
This abridged report deals only with the regulatory situation
pertaining to the supply of gas .•
For purposes of our analysis, we have generally treated natural
gas in two broad categories: conventional supply from wellhead production
within the contiguous Lower 48 States, and non-conventional sources of
supply. The latter include gas from Alaska (primarily the North Slope),
gas imports from Canada (by pipeline) and from overseas nations (by
tanker), and synthetic gas reformed from liquid hydrocarbons or coal.
These supplemental sources are for the most part in an incipient state
of development but are likely to become increasingly more important in
the years ahead. They raise, however, some regulatory considerations
not present with respect to more conventional supplies.
-1-
-------
I. CURRENT REGULATORY PICTURE AFFECTING NATURAL GAS SUPPLY-/
Conventional domestic production of natural gas is affected by
various forms of state regulation, by leasing policies of the Interior
Department, and most importantly by Federal Power Commission controls
over gas transported and sold for resale in interstate commerce. Non-
conventional sources of gas supply are also subject to FPC controls to a
substantial degree (insofar as interstate commerce is involved). However,
in addition, imports of gas involve the Departments of State and Defense;
synthetic gas reformed from hydrocarbon liquids involves the Oil Import
Administration and Oil Policy Committee to the extent the underlying
feedstocks are imported oil or oil products subject to import restric-
tions; and coal gasification involves the Interior Department's Office
of Coal Research.
Finally, the Price Commission has provided another tier of
regulation which seems likely to be extended in some form beyond the
present expiration date of April 30, 1973.
A. Background Information
Before describing the different regulatory authorities which
affect the supply of gas, some background information may be helpful
respecting the different types of supply and how they reach the consumer.
At present, gas sold in the United States comes either from
domestic natural gas production or from imports. In 1973, still another
I/ The contents of this Report are current as of December 15, 1972.
-2-
-------
source -- synthetic gas --is scheduled to arrive on the scene for the
first time.
Domestic production of natural gas currently comprises about
961 of the nation's consumption. The gas is produced from many thousands
of wells (accounting for the term "wellhead" production) in thousands of
fields primarily in the Southwest states of Texas, Louisiana, Mississippi,
New Mexico, Oklahoma, Kansas and Arkansas -- with smaller amounts of pro-
duction in the Rocky Mountain states, the Appalachian states, California,
Ohio and Michigan, and Alaska. Some gas is produced in association with
oil, although approximately 701 of the production today is "non-associated"
(not produced in conjunction with oil). Production activities are pre-
ceded by leasing of the land involved (from private owners, states or the
Federal Government), exploration and drilling to determine the location of
hydrocarbon deposits and by developmental drilling to determine the extent
of deposits.
Once gas is produced at the well, it is typically gathered in
small diameter lines for delivery and sale to long-distance pipeline com-
panies or other buyers with lines extending into the field. Prior to
delivery, the gas is usually processed to recover various by-products
(such as light oils, natural gasoline, and other petroleum gases including
«
ethane, propane and butane) and to remove any significant impurities.
Thereafter, gas is transported various distances by pipelines
for sale to two principal types of customers: privately and municipally
owned distributors which purchase the gas for resale, and companies which
purchase the gas for direct consumption. The latter are primarily electric
-3-
-------
power plants or industrial plants located along or near the pipeline route.
Sales to distributors are made at the city gate, i.e., the point or points
at which the long-distance pipeline connects with a local distribution
system. From the city gate, gas is transmitted and sold by distributors
to individual residential, commercial and industrial customers at the
burner tip.
The degree to which domestically-produced gas is regulated
depends on whether it is sold in intrastate or in interstate commerce
for resale. Production sold in interstate markets is subject to regula-
tion from the wellhead to the burner tip. The Federal Power Commission
(FPC) exercises price control over sales at the wellhead to interstate
pipelines and over sales by interstate pipelines to distributing companies
for resale. Transportation of gas in interstate commerce is also regulated
by the FPC. In consuming areas, nearly all states regulate the price and
conditions of service by natural gas distributors to ultimate consumers.
Intrastate gas is not subject to FPC jurisdiction but to varying
degrees of state regulation. However, FPC wellhead price regulation of
production for interstate markets has a significant influence in major pro-
ducing states on the relative proportions of supply sold for intrastate and
for interstate consumption and on the price of intrastate gas.
In addition, domestic production -- whether consumed in inter-
state or intrastate markets -- is affected by certain other types of regu-
lation, including state conservation laws and federal leasing policies.
In the latter category, Department of Interior leasing of Outer Continental
Shelf lands for oil and gas exploration and production has had and will
-4-
-------
continue to have a significant impact on the supply of natural gas avail-
able for interstate markets.
Imports of natural gas, comprising about 4% of U.S. consumption
in 1971, are obtained by pipeline chiefly from Canada and by tanker in
liquefied form from overseas nations. The bulk of the gas imported by
pipeline is further transported and sold in consuming markets in California,
the Pacific Northwest States, and the Great Lakes region. Smaller volumes
are also imported for consumption in Montana, New York state and Vermont.
Imports of liquefied natural gas (LNG) by tanker are made possi-
ble by the ability to convert natural gas from a gaseous to a liquid state
through cooling it to a temperature of about 260°F. By this process,
approximately 625 cubic feet of gas can be reduced to one cubic foot of
liquid. However, the necessity to maintain such a low temperature to
keep the gas in liquid form makes LNG tankers more costly than comparable-
sized tankers for transporting oil.
LNG imports thus far -- all to East Coast ports -- have been
small in volume. While shipments have been received on a spot tanker basis
since 1968, the first two long-term projects (20 years or more) were
approved only in 1972. With respect to the larger of these projects
(involving the importation of one billion cubic feet per day), deliveries
are not expected to begin until late 1975 at the very earliest because of
the time required to construct the necessary liquefaction facilities
abroad, LNG tankers, and terminal and regasification facilities in the
United States.
-5-
-------
The regulation of gas imports starts at the Canadian-U.S. border
in the case of pipeline imports and at the ship's unloading facilities in
the case of LNG imports. All imports require approval of the Federal
Power Commission which, in turn, consults with the Departments of State
and Defense regarding national security aspects. (Approval of the State
and Defense Departments is also required for the construction and operation
of any facilities at the border for importation or exportation of gas.) In
addition, as in the case of domestically produced gas, the FPC controls the
transportation and sale for resale of imported gas in interstate commerce,—
and local sales by distributors are subject to regulation by state bodies.
Synthetic gas (SNG) can be manufactured from liquid petroleum
feedstocks and coal. Proposals for some 40 plants to manufacture SNG from
liquid hydrocarbons have been announced in the past year and a half, with
one or two due to commence operations in 1973. Moreover, at least three
specific coal gasification projects have been announced. All of these pro-
jects contemplate a gaseous end-product of a quality suitable for introduc-
tion into pipeline transmission and local distribution systems.
The degree of regulation of SNG projects depends primarily on the
source of the feedstock and whether the final gas product will be sold in
interstate commerce. The projects announced to date contemplate the use,
to a substantial extent, of imported liquids as feedstock. Imported feed-
stocks (with some exceptions) are controlled by the provisions of the
Mandatory Oil Import Program (subject to the policy direction of the Oil
I/ As indicated on page 20, the extent of FPC authority over LNG import
projects is not yet clearly established.
-6-
-------
Policy Committee and day-to-day management of the Office of Oil and Gas,
Department of the Interior). SNG transported and sold in interstate com-
merce will be subject to FPC jurisdiction -- the breadth of which is
unsettled at this time. In addition, SNG projects will be subject to a
variety of state and local regulations, man)' concerned with environmental
safeguards.
As the above description indicates, the regulation of gas supply
in the United States depends on a number of factors -- including the source
of the gas, whether or not it is transported and sold for resale in inter-
state commerce, and, in the case of synthetic gas, the source and type of
underlying feedstock. Also, with respect to LNG and SNG, regulatory scope
and policies are currently evolving both within the agencies concerned and
the courts. With these qualifications, the major regulatory bodies and
their functions for the three types of supply -- domestic production,
imported gas, and synthetic gas -- are listed below.
-7-
-------
Domestic Gas Production
State conservation agencies Leasing of state lands .
Drilling and production practices .
Interior Department Leasing of federal lands .
Federal Power Commission Wellhead sales for resale in inter-
state commerce.
Transportation in interstate commerce.
Sales in interstate commerce for resale.
State public service commissions Rates and terms of sales by distributors.
Imports
Federal Power Commission Rates and terms of imports.
Transportation in interstate commerce.
Sales in interstate commerce for resale.
State and Defense Departments National security aspects of imports .
State public service commissions Rates and terms of sales by distributors.
Synthetic Gas
Federal Power Commission Transportation and sales of SNG in
interstate commerce for resale.
State public service commissions Rates and terms of sales by distributors.
Other state and local bodies Zoning regulations.
B. State Regulation
Gas supply is affected by three basic types of state controls:
conservation regulation (applicable in greater degree to oil, but also to
gas) , leasing of lands (again applicable to both oil and gas) , and regula-
tion of local sales . In general , none of these areas of regulation are
deemed at this time to present any material barrier to the development of
supply. However, the extent to which public opposition in coastal states
is able to block leasing or drilling of potential petroleum-bearing lands
on environmental grounds could prove to be a major exception.
-8-
-------
Virtually all producing states exercise a variety of conserva-
tion regulations aimed primarily at preventing physical waste of oil and
gas. Another purpose is to protect correlative rights of property owners.
The regulations relate, among other things, to well completion techniques
and equipment; spacing of wells; pooling of tracts; unitization of reser-
voirs and portions thereof; limitation of production to reasonable market
demand; allocation of allowable production to pools and among wells in a
pool; secondary recovery operations; and protection against land and
water pollution as a result of oil and gas drilling and production.
State regulation of production through market demand prorationing
has primarily affected the production of oil (although oil prorationing has
little or no effect at this time because of the absence of excess producing
capacity). Gas supply has also been affected to the extent gas is "associ-
ated," i.e., produced with oil. However, most gas production today is
"nonassociated" and generally not subject to state production controls.
Producing states all have authority to lease state lands. In
general, leases are awarded at public auction to parties offering the
highest cash bonus, and provide for a fixed royalty to the state on all
oil and gas produced. In general, a basic objective of the states in the
past has been to lease lands in order to maximize revenues. In some states,
royalties from production on state lands are a significant source of
revenue. Except perhaps for local situations, there has been little
pressure to restrict leasing and development of potential oil and gas
lands. Recently, however, environmental considerations -- the threat of
oil spills in particular -- have caused various state legislatures and/or
-9-
-------
regulatory bodies to seek to halt or ban leasing and drilling activities
on certain offshore lands.
In California, for example, there has been no further leasing
and almost no drilling of state offshore lands since the major oil spill
in the Santa Barbara Channel in early 1969.
On the East Coast, similar pressures are now building up against
offshore leasing and drilling. For example, in New York, several bills
were introduced in the State Legislature this past year to ban oil and
gas well drilling in the Atlantic Ocean off Long Island and/or adopt other
measures aimed at environmental protection of offshore lands. Two of these
bills were passed by both houses of New York Legislature but subsequently
vetoed by Governor Nelson Rockefeller. One bill would have prohibited the
leasing of any offshore lands for oil or gas extraction within three miles
of the New York coastline (or such other boundary as may be ultimately
determined to be subject to state jurisdiction). In vetoing this bill,
Governor Rockefeller stated that the nation's growing energy needs may
make it desirable to permit drilling off New York shores at some future
time, and that the State Commissioner of Environmental Conservation has
adequate powers to insure that any such drilling will be consistent with
the need to protect the state's marine sanctuaries and recreational areas.
All but three states regulate the local sales of natural gas
within the state. This regulation extends both to rates and to various
conditions of service. In this last connection state regulatory agencies
have become increasingly involved during the past few years in actions
designed to respond to existing or expected natural gas shortages. These
-10-
-------
shortages have developed over wide areas of the nation due to inability of
an increasing number of interstate pipeline suppliers to maintain existing
levels of gas delivery to customers, coupled with the inability of nearly
all interstate pipelines to expand deliveries to meet demand growth in
market areas. For the most part, the state actions take the form of
approving limitations on new and increased service by local distributors
and, in the event of insufficient supply to meet existing gas requirements,
priorities of service to govern curtailments. However, a number of states
have also taken other measures both to conserve existing supplies of gas
and/or to encourage expansion of gas supply. Such measures include orders
banning promotional advertising; approval of higher rates to interruptible
and large industrial customers; encouragement to use alternate fuels;
efforts to augment domestic gas production by permitting distributors to
invest in exploration and development; support for coal gasification and
other R§D projects; directives to expand underground storage or other peak
shaving facilities; participation in hearings and/or proceedings before
the Federal Power Commission, other federal regulatory agencies and
Congress; and requirement of periodic supply reports by natural gas com-
panies within the state.
C. Interior Department: Leasing of Federal Lands
The authority of the Interior Department to lease federal lands
derives from the Mineral Lands Leasing Act of 1920 (onshore lands) and the
Outer Continental Shelf Lands Act of 1953 (offshore lands). The CCS Act
provided for federal jurisdiction over the submerged lands lying seaward
of those granted to the states pursuant to the Submerged Lands Act of
-11-
-------
May 22, 1953 (which gave the coastal states jurisdiction over such lands
to a distance of three miles from their coast lines into the Atlantic and
Pacific Oceans and up to nine miles into the Gulf of Mexico if a state's
historic boundary prior to joining the Union had been more than three miles
from shore or if such a boundary had previously been approved by Congress).
The boundaries of the federal and state segments of the OCS have been the
subject of extensive litigation in the courts and, in several states, are
still not precisely defined.
With respect to onshore lands, leases are granted both by competi-
tive bidding and by a simultaneous filing system. In the latter case, with
a number of applications for the same lease filed simultaneously, the right
of priority is resolved by public drawing. However, when land is within
the known geologic structure of a producing oil or gas field, it may be
leased only by competitive bidding and in units of not more than 640 acres
to the qualified applicant offering the highest lease bonus. Royalty pay-
ments are usually 12.5%.
Regarding offshore lands, all oil and gas leases are issued on
a competitive bidding basis under the OCS Lands Act. The present system
involves cash bonus bidding by sealed bids, plus payment of a fixed
royalty (by law, not less than 12.5%). To date, all OCS leases have
required a royalty rate of 16-2/3%. Since passage of the OCS Act,
Interior's Bureau of Land Management has conducted 25 sales of offshore
oil and gas leases, including 11 drainage sales (in proven areas) and 14
general sales (in unproven areas). The pattern of sales has been sporadic,
with no general lease sales held in eight of the 19 years and one or two
-12-
-------
general sales held in the remaining years. In the aggregate, the sales
have netted the United States Government cash bonuses in excess of $5 bil-
lion. On an acreage basis, two-thirds of the lease sales have involved
lands adjacent to Louisiana. Thus far, the only other states involved to
any significant extent have been Texas and California.
A measure of the importance of the nation's offshore oil and
gas development is the fact that, between 1958 and 1971, production from
OCS lands rose from about 1% to over 121 of total U.S. production of both
natural gas and crude oil and condensate. (Including state offshore
lands, the respective proportions are about 181 and 16%.) Even more
important is the fact that only about II of OCS lands, or 7.4 million
acres out of a total of 682 million acres, has been leased to date by the
Federal Government.
The Interior Department currently plans to hold 10 general lease
sales in the Gulf of Mexico through 1975. This schedule has already been
somewhat delayed because of opposition from environmental groups. How-
ever, with 20% of the nation's total potential gas reserves projected to
underlie OCS lands (excluding Alaska), the leasing of these lands on a
regular and accelerated basis is imperative in order to provide the pro-
ducing industry with promising drillable prospects. There is also a need
to proceed with leasing of Atlantic OCS lands and to resume leasing of
Pacific OCS lands. Here, however, major roadblocks could be environmental
considerations and federal-state jurisdictional disputes.
-13-
-------
D. Federal Power Commission
The Federal Power Commission has extensive power to regulate the
transportation and sale for resale of natural gas in interstate commerce.
This power stems from the Natural Gas Act. Passed in 1938, the Natural
Gas Act was thought at first to apply only to natural gas pipelines. How-
ever, in 1954, the Supreme Court considerably widened its scope to cover
natural gas producers as well.
Pursuant to various sections of the Act, the FPC exercises rate,
certificate and abandonment authority over sales, transportation and facili-
ties constructed by natural gas companies for such purposes. The FPC also
has jurisdiction over gas imports and exports, as well as broad power to
issue rules considered necessary to carry out its functions under the Act.
1. Producer Regulation
Without question, the most difficult and controversial aspect of
FPC regulation has been its regulation of producer sales of natural gas at
the wellhead. Various regulatory methods have been attempted -- based for
the most part on cost computations for individual producers or for groups
of producers in particular producing areas of the nation. In terms of
eliciting supply sufficient to meet demand, these attempts must be pro-
nounced a failure. For well over a decade, the FPC virtually froze the
price of gas at levels fixed according to criteria bearing little or no
relationship to marketplace realities. The effect was twofold: to dis-
courage investment by producers in gas exploration and production, while
at the same time artificially inflating the demand for gas in relation to
other fossil fuels.
-14-
-------
The history of FPC wellhead regulation is complex but crucial to
an appreciation of the present gas supply picture and the current pressures
for amendment of the Natural Gas Act to remove or relax FPC control over
producer prices. Considered in retrospect, this history is subject to
criticism on several grounds. However, in all fairness, it must be remem-
bered that the FPC was suddenly faced in 1954 with the unwanted task of
regulating literally thousands of producers under a statute which seems
clearly not to have been written with that regulation in mind. In addi-
tion, price policies developed by the Commission in the early 1960's were
at least partly attributable to court decisions requiring it to "hold
the line" on producer rates.
From 1961 to 1968, FPC producer regulation was dominated by pro-
ceedings to determine rates on an area basis and, pending completion of
these proceedings, by the establishment of interim "in-line" rates to
govern certification of new sales. Under the methods developed for
arriving at "in-line" prices, the FPC succeeded for several years in
restricting rates for initial sales either to or below certain guideline
levels promulgated in 1960. Similarly, in the area rate cases, the FPC's
first decision in 1965 fixed rates for sales in the Permian Basin area
only slightly higher than the guidelines set at the beginning of the
decade; its second decision in 1968 established rates for the South
Louisiana area below the guidelines of 1960. The first decision was
eventually upheld by the Supreme Court which gave considerable weight
to the experimental aspect of the Permian Basin area case. The second
decision was also judicially upheld, although with "serious misgivings"
and the suggestion that the FPC modify its decision.
-15-
-------
Since 1968, faced with mounting evidence of a developing gas sup-
ply shortage, the FPC's regulation of producers has increasingly shifted
toward the adoption of remedial measures aimed at reversing the downward
trends in gas supply and encouraging higher levels of exploration for gas.
These measures have included decisions permitting higher area rate levels,
exemption of small producers from nearly all regulatory requirements,
encouraging pipelines to advance money to producers for exploration and
development of new gas supplies and, more recently, permitting temporary
sales at rates in excess of area ceilings to pipelines requiring emergency
supplies to maintain present deliveries to their customers. Many of these
actions, however, have been appealed to the courts, and their validity
remains uncertain at this time.
The most recent, and perhaps most far-reaching, measure taken by
the FPC in response to the growing shortage of domestic gas supply was its
adoption last summer of a new optional procedure for certificating new gas
sales by producers at rates in excess of area ceilings (Order No. 455,
issued August 3, 1972). The new procedure, which is subject to several
restrictions as to its use, essentially contemplates a one-time review of
new gas sales contracts in an effort to reduce uncertainty respecting future
rates. The FPC action was immediately appealed to the courts as tantamount
to deregulation, and the outcome of this litigation is undoubtedly a year
or more in the future.
2. Pipeline Regulation
Pipeline rates have been determined by the FPC from the outset by
the traditional utility rate base method which involves calculation of a
-16-
-------
total cost of service for a particular company during a specified test
period and translation of that cost of service into jurisdictional rates
through various cost allocation and rate design techniques. Unlike the
situation regarding producer regulation, use of the cost of service
approach for determining pipeline rates is widely accepted, although the
computation of individual cost components and determination of the rate
of return level are frequently heavily contested in pipeline rate proceed-
ings. Yet, except for gas produced by a pipeline itself (or purchased by
a pipeline from an affiliated producing company), these disputed costing
matters have had little bearing on the overall availability of gas supply.
In the case of pipeline-produced gas, the FPC recently decided to permit
pipelines to include such gas in their cost of service at area rate levels
rather than at estimated cost of production, at least with respect to gas
produced from leases acquired by pipelines since October 1969. The object
of the change was to encourage pipelines to increase their search for and
production of natural gas.
In the realm of rate design -- i.e., how to assign overall cost
of service to rates for different classes of sales -- the methods applied
by the FPC over the years have undoubtedly contributed to the overall back-
ground underlying the present gas demand-supply picture. Specifically,
the Commission adopted policies in the late 1950's and early 1960's which
had the effect of shifting the burden of costs away from sales to indus-
trial and boiler fuel customers. The end result was to greatly acceler-
ate the industrial demand for gas. The FPC is now reconsidering its rate
design precedents with a view toward discouraging the use of gas for large
volume industrial and boiler fuel purposes.
-17-
-------
The FPC also exercises certificate regulation over the construc-
tion and operation of pipeline facilities for new or expanded service.
Construction proposals are appraised in terms of four basic criteria:
existence of a market for the service proposed, adequacy of reserves to
support the proposed service, economic feasibility of the project, and
financeability. In many cases, these criteria are satisfied with little
difficulty, and certificates are issued without opposition or hearing.
In some cases, the FPC has delayed certification until the pipeline
applicants have perfected their evidence with respect to markets and
reserves. In other cases, however, problems have arisen, and major pro-
jects have been denied by the Commission. Reasons for denial, among
others, have included lack of immediate need for the service proposed, the
desirability of exploring less costly alternatives, unnecessary duplication
of existing facilities, insufficient data to meet the FPC's certificate
criteria, and adverse impact on the price of supplies in the field. Not-
withstanding these denials, an essential fact to be kept in mind is that
no area of this country within economic reach of a pipeline (with the possi-
ble exception of isolated communities) has gone without gas for lack of
FPC approval to build pipeline facilities.
More recently, the FPC has asserted the authority to control
curtailment of deliveries by pipeline companies -- a matter of increasing
importance as more and more interstate lines are confronted with the pros-
pect, or reality, of insufficient supply to meet contractual obligations.
The basic problem for the FPC is to provide for a fair allocation of sup-
plies among all customers of an interstate pipeline in times of gas short-
age. However, since the FPC lacks authority over the rates of pipeline
-18-
-------
sales to direct industrial customers, its authority to control allocation
of supplies to such customers was challenged in the courts. The Commission
claimed this authority by virtue of its jurisdiction over transportation of
gas in interstate commerce. Without jurisdiction over all of a pipeline's
sales, including sales to direct industrial customers, the FPC charged
that serious inequities in gas distribution could occur -- with direct
industrial customers demanding full contract service while homes, schools,
hospitals and other "human needs" customers would suffer a cutback in
service. The Supreme Court upheld the Commission's approach.
3. Exports and Imports
Exportation and importation of gas into the United States require
FPC approval under Section 3 of the Act. At the present time, exports of
gas from this country are relatively insignificant, amounting only to
30 billion cubic feet in 1971 (excluding some 50 billion cubic feet annually
of LNG exported from Alaska to Japan), compared with imports of 932 billion
cubic feet. Imported gas is derived from two principal sources: by over-
land pipeline chiefly from Canada, and by tanker in liquefied form from
overseas nations. In addition, some LNG has been imported on a spot basis
via tanker trailer from Canada. However, the volumes involved here are
extremely small, and such shipments are not considered to constitute any-
thing more than sporadic supplies available from time to time to meet peak
day needs in certain localized markets (principally in New England).
With respect to Canadian gas, import authorization is not only
required from the FPC but also export authorization from the Canadian
National Energy Board. The NEB's policy is to approve for export only
-19-
-------
those volumes which are deemed excess to the quantities required to meet
the estimated level of Canadian consumption four years ahead for 25 years.
Such excess volumes are designated as "current surplus" available for
export. In November 1971, the NEB rejected three pending requests to
export gas to the U.S. for lack of any surplus available for export.
However, the NEB's current surplus calculation did not take into account
reserves in Canadian frontier areas where estimates of potential reserves
are relatively large and active exploration is underway at the present
time. Without substantial new reserve additions in Canada, it appears
highly unlikely -- given the NEB's current approach to determining
exportable surplus -- that there will be any appreciable increase in
U.S. imports of Canadian gas in the future.
FPC regulation of imported gas in liquefied form from overseas
nations is presently in an unsettled state. An initial question concerns
the extent of the Commission's jurisdiction in this area. A second ques-
tion involves the .standards to be applied in evaluating LNG projects, while
a third issue concerns the terms on which the imported supply is to be made
available to U.S. markets. In 1972, the Commission dealt with these ques-
tions for the first time in decisions approving two long-term import pro-
posals. In at least one case, however, the Commission's conclusions have
raised considerable uncertainty respecting the future of both imported LNG
and other high cost non-conventional sources of gas supply.
A major uncertainty stems from a condition imposed by the FPC in
the El Paso Algeria case -- involving the importation of 1 billion cubic
feet per day of Algerian LNG by three major East Coast pipelines -- requiring
-20-
-------
that the pipelines sell the supply after regasification on an incremental
rate basis (i.e., at the full cost of the expensive supplement, rather
than at a rate reflecting the "rolling-in" or averaging of all of the
pipeline's supply costs). All three pipelines have appealed this require-
ment to the courts. The concern is that incremental prices will either
preclude high-cost supplements from being fully marketed or else will
result in overwhelming administrative problems and inequities. The
issues are complex, and it is assumed that the FPC will give the matter
further study before carrying the precedent further.
The difference between incremental rates and rolled-in rates
depends on the pipeline involved, its sources and mix of gas, the size
and cost of the incremental supply, and other factors. The El Paso Algeria
case provides an illustration of the difference for the three East Coast
pipelines involved: Columbia Gas Transmission Corp., Consolidated Gas
Supply Corp., and Southern Natural Gas Co. Of the one billion cubic feet
per day of LNG to.be imported from Algeria, Columbia has contracted to
purchase 300 million a day (representing an estimated 9% of its total gas
supply in 1977), Consolidated will purchase 350 million daily (or 141 of
its total supply in 1977) and Southern Natural will also purchase 350
million (or about 201 of its total supply in 1977). Estimated average
costs of this supply rolled in with all other system supply at each pipe-
line's system gas (the point of entry of the LNG into the pipeline's
mainline system) are: 48.9*/Mcf for Columbia, 61.5*/Mcf for Consolidated
and 57.3*/Mcf for Southern Natural. (These estimated costs are 2.9*, 9.6*
and 10.1* higher, respectively, than the estimated average costs for each
-21-
-------
pipeline without the LNG supply.) By contrast, estijnated incremental
costs of the LNG at the same point are: 90.7£/Mcf for Columbia, 99.5£/Mcf
for Consolidated, and 94.7
-------
authority to construct facilities to connect synthetic gas to be produced
by a coal gasification plant which El Paso proposes to build in northwestern
New Mexico.
With respect to jurisdictional issues, a recent FPC Opinion dis-
claiming jurisdiction over reformer plant facilities and sale of synthetic
gas -- but clarifying Commission jurisdiction over the transportation and
sale for resale of such gas when mixed with natural gas in the lines of an
interstate transmission company -- appears to have removed much of the
uncertainty. This is an important holding for companies planning SNG pro-
jects from the standpoint of depth of evidence and procedures required to
obtain FPC approval. Any simplification of this process will undoubtedly
tend to facilitate SNG projects. In a broader sense, however, the Commis-
sion's disclaimer of jurisdiction over reformer facilities is not likely
to significantly affect the volume of SNG supply entering interstate markets
in view of the Commission's uncontroverted authority to deny or condition
the transportation of SNG (when mixed with natural gas) and its sale for
resale in interstate commerce.
In regard to feedstock, two of the five projects mentioned above
contemplate use of both foreign and domestic naphtha, one contemplates use
of only domestic naphtha at least initially, one is based on domestic
liquids (unspecified as to type) and the fifth would rely on imported LPG
from Canada. Those projects based on use of foreign naphtha require import
authorization from the Oil Import Administration which, to date, has
granted no licenses for the importation of naphtha for conversion to
synthetic gas. Use of domestic naphtha avoids this problem, but it is
-23-
-------
presently more expensive than foreign supplies and also is not generally
available today for uses other than the manufacture of gasoline and
military jet fuel. As to LPGs, any widespread use of domestic supplies
for gasification purposes would cause a considerable upward price effect
in various markets, including the petrochemical market which, in the United
States, largely depends on natural gas liquids for feedstock purposes.
Canadian LPGs are not subject to U.S. import quotas but are subject to
Canadian export restrictions. In short, the question of feedstocks for
SNG projects -- particularly those based on use of foreign liquids --
involves complex considerations which should be evaluated in the context
of overall energy policy objectives.
Finally, assuming the precedent established in regard to LNG
imports from El Paso Algeria, the FPC can be expected to require incre-
mental pricing for SNG supplies. This could cause marketing difficulties.
E. Other Regulatory Controls
1. Departments of State, Defense and Commerce
The Departments of State and Defense both have an important
voice in policy matters affecting the supply of petroleum in the United
States. In the past, the activities of the two Departments have been
directed largely to oil. However, in light of the probability of increasing
imports of gas (and/or liquids as feedstock for the manufacture of gas),
the degree of interfuel substitutability possible in many markets and the
need for a coordinated interfuel approach to current energy questions,
-24-
-------
both State and Defense seem likely to become increasingly involved in
formulation of policies affecting the supply of gas in the future.
To date, the State and Defense Departments have been consistently
asked by the FPC for their position concerning both pipeline imports from
Canada and, more recently, LNG imports from Algeria and Libya.— There has
been no opposition by the State Department to any announced gas import pro-
ject thus far. Nor has the Defense Department recommended denial of any
gas import project, although it has expressed concern in some instances
that individual pipelines and gas distribution companies not become overly
dependent on imported LNG.
Similarly, the Commerce Department has not played a significant
role in policies affecting gas supply in past years -- although, during
1972, it participated in trade negotiations with the Soviet Union involving,
among other things, the possibility of joint ventures to bring Soviet gas
in liquefied form to the U.S. by the end of this decade. The Secretary of
Commerce, however, recently advised that an early agreement concerning any
such venture was not imminent.
2. Office of Coal Research
The Office of Coal Research administers the Federal Government's
coal gasification program. This program was accelerated during the latter
half of 1971 following President Nixon's Clean Energy Message of June 4, 1971
I/ Under Executive Order No. 10485, the FPC is required to obtain the
~~ favorable recommendations of the Departments of State and Defense for
the construction and operation of border facilities for the exporta-
tion and importation of gas.
-25-
-------
calling for expedited development of coal gasification technology. Sub-
sequently, OCR signed an agreement with the American Gas Association pro-
viding for joint government-industry funding of expanded research efforts
to produce pipeline-quality synthetic gas from coal. The agreement con-
templates joint funding of $30 million annually over a four-year period,
two-thirds to be provided by the Federal Government and one-third by
industry.
The current OCR gasification program includes four ongoing pilot
plant projects. The pilot plant program is intended to aid the design of
a demonstration plant to be built, largely through industry financing,
within five or six years. It is hoped that operation of the demonstration
plant will provide, by the end of the decade, a sound commercial basis for
the construction and operation of large coal-based synthetic pipeline gas
plants. OCR's target date for coal gasification on a commercial scale is
1980.
3. Price Commission
The Price Commission, established under Executive Order No. 11627
of October 15, 1971, was directed to prescribe specific standards, criteria
and regulations to carry out the goals of the Cost of Living Council to
stabilize prices and rents.
Sales of gas subject to regulation -- including wellhead sales
under FPC jurisdiction -- are governed by Price Commission rules issued for
regulated public utilities. These rules have undergone several revisions
over the past year with respect to requirements for notifying the Price
-26-
-------
Commission of requested rate increases and those approved by regulatory
agencies, provisions for further review by the Price Commission of agency-
authorized increases, and guidelines applicable to utility increases.
Since its inception, however, the Price Commission has generally accepted
the rulings of state and federal commissions in regard to rate increases
for regulated companies. To date, no rate increase approved by the FPC
for either gas pipeline companies or gas producers has been blocked by
the Price Commission.
In sum, other than adding another tier of regulation, Price
Commission controls have had little impact on the price of gas sold in
interstate commerce for resale. However, with respect to intrastate gas
sales which are not subject to FPC regulation, the Price Commission in
several instances has denied rate increases because they exceeded base
period prices or profit margins, or for failure to meet certain other
criteria. The result has been the diversion of considerable quantities
of intrastate gas, particularly in Louisiana and Texas, to interstate
sales under FPC emergency procedures. These procedures permit producers
to sell gas to interstate pipelines for short-term periods at prices
higher than the area ceilings; in many instances, the prices allowed for
these emergency sales exceed intrastate contract prices which are pro-
hibited from rising because of Price Commission restrictions.
-27-
-------
II. ALTERNATIVE REGULATORY STRATEGIES FOR INCREASING GAS SUPPLY
That the United States today faces a critical shortage of gas is
undisputed. Seven interstate pipelines in the past year have been compelled
to reduce deliveries to customers below firm contract levels, and 15 pipe-
lines have predicted the necessity to curtail customers in the current
winter season. Moreover, for most pipelines, there has been no supply
available to permit new or expanded service for some time. Carried through
to the retail level, gas distributors in many areas of the nation have been
forced either to refuse or sharply restrict the attachment of new and
increased loads. Industrial users of gas are being increasingly forced to
seek out alternative fuels which are generally available, if at all, only
at higher prices.
Another alarming indicator of supply is the steady decline in the
nation's gas reserve inventory picture. For example, as contrasted with a
92% overall increase in production over the 1958-1971 period, total proved
gas reserves in the Lower 48 States of the U.S. in 1971 were 2% below their
1958 level. More significantly, during the past four years when production
rose more than 13%, total proved reserves dropped by some 40 trillion cubic
feet (from 289.3 trillion cubic feet at the beginning of 1968 to 247.4 tril-
lion at the end of 1971), or nearly 15%. This drop reflects the fact that
reserve additions in the Lower 48 States averaged only about 50% of produc-
tion over the 1968-1971 period. The worsening supply trends also reflect
a steady decline in exploratory gas well drilling for more than a decade.
Still a further manifestation of the current gas shortage is the
proliferation of projects announced in the past few years for the importation
-28-
-------
of foreign LNG and development of synthetic gas supplies. In addition,
many U.S. pipelines and distributors are contributing large sums to gas
exploration efforts in frontier areas of Canada and Alaska as well as to
feasibility studies of pipeline projects to bring such gas to U.S. markets.
Increasing attention is also being given to coal gasification projects,
with one such proposal already filed with the FPC and others under active
consideration.- All of these supplemental supply sources are projected
to entail substantially higher unit costs of gas supply than domestic pro-
duction. But the anomaly is that the bulk of the projects are an outgrowth
of the decline in available domestic gas which, in turn, has been brought
about to a considerable degree by inadequate prices for wellhead production.
This study suggests several possible regulatory strategies for
increasing the supply of gas. Most of these strategies pertain to legis-
lative action or FPC action to stimulate domestic production which, despite
the publicity given to LNG, SNG and other such "glamor" sources of gas,
will continue to provide the bulk of the nation's supply through at least
this decade.- At the same time, current projections indicate that domestic
production will fall increasingly short of meeting demand in the years
ahead. Therefore, it is also necessary to formulate regulatory policies
I/ These projects are in addition to coal gasification research, jointly
funded by industry and the Federal Government, aimed at development of
a commercial process for converting coal to high-Btu pipeline quality
gas by 1980.
2/ According to FPC Staff projections, production in the Lower 48 States
will account for 941 of the estimated total U.S. gas supply (excluding
Alaska) in 1975, 821 in 1980 and 71% in 1985.
-29-
-------
at the earliest possible date to encourage development of supplemental gas
projects meeting national interest and economic feasibility criteria.
Even though gas imports and synthetic gas production will not be available
in any important degree to augment domestic sources until the latter part
of this decade or the early 1980's, the criteria and policies laid down in
the next year or so will be instrumental in influencing future development.
It should also be noted that none of the more likely means for
increasing gas supply will result in any substantial expansion of supply
overnight. With respect to domestic gas, the results of any significant
modifications of regulatory policy would take some time to perceive because
of the time lag between exploration for new reserves and the date production
commences to flow to markets. This lag is variously estimated at between
three to seven years depending upon the producing area and distance from
established market outlets. Nor, as indicated, do supplemental sources of
gas supply offer much hope of supply alleviation for the immediate future.
An exception could be the reforming of gas from naphtha and other light
hydrocarbon feedstocks since reforming plants can be built within a period
of two years or less. However, the bulk of naphtha feedstocks for such
plants would have to be imported, thus raising questions concerning inter-
fuel relationships and the direction of the nation's overall import policies
in the years ahead.
A. Sanctity of Contract Legislation
One means of encouraging increased domestic production would be
passage of legislation to assure contract sanctity, i.e., certainty of
-30-
-------
price and other contract terms. So-called "sanctity of contract" bills
were the subject of hearings before both House and Senate Committees in
the last session of Congress, but were never reported out of those com-
mittees. These bills are not aimed at decontrol of producer prices.
Rather, their purpose would be to immunize new producer contracts -- after
a one-time review and approval by the FPC -- from subsequent regulatory
change. The FPC review would extend to the entire pricing structure
(initial price plus provisions for fixed escalations), the length of the
contract and other contract terms. In passing on the contracts, the
Commission would be prohibited from using the cost of service, public
utility rate base method and instead would look to supply and demand
factors, price levels deemed required to elicit adequate supplies for
the interstate market, and economic and cost trends.
A major benefit of the sanctity of contract legislation would be
the avoidance of the price confusion and risk which characterized FPC pro-
ducer regulation in the 1960's. In South Louisiana, for example, the FPC
rolled back price levels three times between 1960 and 1968. Such action
was hardly inducive to producers to commit new reserves to the interstate
market as opposed to the intrastate market where contract terms were
binding. Another principal benefit would be to free the FPC from the cost
of service ratemaking method. Although there are some (e.g. , the American
Public Gas Association and certain other consumer groups) who maintain
that the cost of service approach is the only means of protecting consumers
against unjust and unreasonable rates, it is our view that experience in
the area rate proceedings over the past decade has shown application of the
-31-
-------
cost method to producers on an area basis to present nearly as many
difficulties as its application on an individual company basis.
Significantly, in two recent area rate decisions, the FPC recognized
that cost calculations cannot be mathematically precise, but rather
reflect arbitrary judgments as to allocation procedures and a wide
margin of error as to both data and methods used. (FPC Opinion No. 595
issued May 6, 1971 in the Texas Gulf Coast Area Proceeding; FPC Opinion
No. 598 issued July 16, 1971 in the Southern Louisiana Area Rate
Proceeding.) Relieved from any precedents or pressures to attempt to
apply the cost method further for new gas supplies, the FPC could proceed
to develop more rational regulatory standards giving greater recognition
to market forces and the incentives necessary to elicit greater supply
additions.
Generally speaking, there is little opposition to the concept of
contract sanctity. However, various provisions of the proposed bills have
been criticized on the ground that they go far beyond what is necessary to
accomplish that goal. These criticisms reflect a fear of departing very
far from the past regulatory scheme. However, it is now generally acknow-
ledged that this past scheme was a factor which contributed in significant
degree to the development of the present gas shortage.
B. Decontrol Legislation
Another regulatory strategy requiring Congressional action is
decontrol of wellhead prices. This approach is urged by those who believe
that sanctity of contract legislation would not go far enough in restoring
the ability of gas prices in the field to react to market forces and hence
in stimulating the needed turnaround in domestic supply.
-32-
-------
Deregulation proposals take three general forms: decontrol of
all gas, decontrol of gas under new contracts only, and decontrol of new
gas contracts subject to certain safeguards.- Decontrol of producer
prices for new gas are known to be under active consideration by the
Administration at this time. Support for legislation of this nature has
been expressed by officials of the Interior, Commerce and State Departments;
the Director of the Office of Emergency Preparedness; and the President's
Council of Economic Advisers, among others. In addition, two current FPC
members -- Pinkney Walker and Rush Moody -- favor immediate decontrol of
domestic wellhead prices.
On the other hand, efforts to deregulate producers will probably
be opposed by consumer and other interests as well. FPC Chairman Nassikas,
for example, has come out against deregulation on the principal ground that
the results would be chaotic in a time of supply shortage. He and others
question whether producer markets are sufficiently competitive to permit
adjustment to realistic price levels and whether, once gas price ceilings
are removed, interfuel competition could provide any meaningful restraints
on increasing gas prices. Another major question is the extent to which
I/ In the last category, bills were introduced in the last two sessions of
Congress by Senator Tower and Rep. Price (both of Texas) to eliminate
FPC rate control over future contracts, provided that (a) the acreage
involved had not previously been dedicated to the interstate market,
(b) contract prices, including any escalations, are expressed in terms
of a definite charge per unit, with indefinite price escalations pro-
hibited, and (c) all other contractual provisions (such as quality,
rate of take, prepayment arrangements, and abandonment of service),
regardless of their effect upon contract prices, continue to be subject
to Commission approval and review.
-33-
-------
the price of gas would rise and the degree to which supply would respond
if FPC wellhead regulation were eliminated.
Further, the reaction of Congress to any decontrol proposals is
problematical at best.
Despite the uncertainties and reservations concerning the effects
of decontrol, legislation in this direction would assuredly spur greater
exploratory efforts and lead to increased gas supply additions. Should EPA
desire to support the decontrol route, probably the type of proposal most
likely of passage by Congress (and the one least disruptive to present con-
sumer markets) would be legislation along the lines proposed by Senator
Tower. In other words, deregulation would be limited to new gas contracts
only, with safeguards to preserve some measure of FPC control.
C. Legislation to Expand Federal Regulation
Another general approach advocated by some to meet the current
gas shortage is the expansion, not the reduction, of federal regulation.
This approach includes proposals to establish national end-use controls on
consumption of gas, together with extension of FPC jurisdiction over intra-
state and direct sales in order to prevent unregulated markets from siphoning
off new gas supplies for low priority uses.
Pressures for federal end-use controls over all gas markets
reflect growing concern respecting the potential consequences of gas supply
curtailments. If the present gas situation continues to deteriorate, some
sort of controls may be needed to avoid curtailment of service to existing
residential and commercial customers who have no feasible alternative to
-34-
-------
the use of gas. However, determination of priorities for other classes of
customers presents difficulties and especially so on a nationwide basis
because of the considerable variation in patterns of gas usage in different
regions of the country.-
Above all, proposals for end-use control and/or intrastate sales
regulation constitute measures for coping with the gas shortage, not for
relieving it. On the other hand, if wellhead prices were permitted to
rise to realistic market levels, purchasers of gas for interstate markets
should again be able to compete with intrastate purchasers, and the tendency
for newly available gas supplies to be committed to intrastate markets
should diminish.
D. Modification of Producer Regulation
Leaving aside remedial legislation, the FPC can itself take
regulatory actions designed to alleviate the gas shortage. In fact, it has
already adopted several measures towards this end. However, there is a
limit to how far the Commission can go within the present statutory scheme,
and its actions are always subject to appeal and the possibility of court
reversal.
A case in point is the FPC's recent adoption on August 3, 1972
of an optional procedure for certificating new gas sales, clearly its most
innovative supply-inducement step to date. The new procedure is intended
I/ Even so, the FPC has recently acted to establish eight end-use
priorities to be applied by all interstate pipelines in the nation
during periods when insufficient gas supply necessitates curtailment
of service fFPC Order No. 467, issued January 8, 1973). The FPC has
also advanced a proposal to adopt the same priorities regarding usage
of new gas supplies. (Docket No. R-467)
-35-
-------
to provide two incentives to domestic production: authorization of sales
of gas not prevously available to the interstate market at prices in
excess of area rates (specifically, at prices "shown to be in the public
interest"), and reduction of future rate uncertainty to the extent possible
within the FPC's present statutory powers. The optional procedure -- con-
trary to some press reports and other pronouncements --is not a decontrol
measure. Not only must all contracts be submitted for FPC review and
approval, but use of the procedure is also subject to several restrictions.
Moreover, while the FPC proclaimed the intent to provide certainty of rates
to the extent of its authority, it recognized that it cannot bind future
Commissions not to modify those rates prospectively in the future. Never-
theless, the measure has been vehemently challenged by at least 15 Senators
and 20 House members --as well as certain consumer interest groups -- as a
usurpation of the legislative function by seeking to effect, through
administrative action, both contract sanctity and deregulation of new gas
sales. A group of "Concerned Congressmen" and the American Public Gas
Association immediately appealed the FPC's action to the courts. A final
decision may be a year or more in the future.
The FPC apparently intends to rely to a considerable extent on
the new optional certificate procedure as a vehicle for allowing higher
prices. However, in the four months since its adoption, the optional pro-
cedure has not generated much response. To date, only four applications
have been filed. While one of these applications was certificated rela-
tively promptly, no protest was filed and the rate involved did not exceed
the level already approved for sales in an adjacent producing area. The
other three applications propose 45
-------
current area rate level -- for sales in South Louisiana. Various parties
have petitioned in opposition, so that more protracted processing will be
required.
Another course of action open to the FPC is to raise area rates
-- either for new gas sales, or for both new and existing sales --in order
to give greater recognition to market value factors, including prices
negotiated for intrastate sales, prices of competitive fuels, and cost and
economic trends. This might be done through a reopening of the area pro-
ceedings, consideration of petitions to amend the area ceilings, or possibly
through the establishment of some type of index permitting periodic price
adjustments in accordance with changes in specific economic or cost
indicators. However, adjustments within the present area pricing framework
are not without drawbacks, and the FPC recently indicated reluctance to
proceed in this direction.—
I/ In Opinion No. 639 issued December 12, 1972, the Commission denied an
unopposed petition to raise the new gas ceiling rate for Appalachian
Area sales in the view that neither perpetuation of the present system
of area pricing by contract vintage nor the initiation of a new round
of area proceedings offered much hope for alleviating the natural gas
shortage. Instead, the Commission urged wider use of the optional
certificate procedure. The FPC also commented as follows to criticisms
of the present area rate method on grounds of its failure to achieve
a workable relationship between supply and demand and its dependence
on the use of noncurrent cost data:
"We appreciate that a uniform national rate for gas sold in
interstate commerce, arrived at through rulemaking and tending
toward recognition of the commodity value of gas, would not be
subject to these infirmities, but before considering this course
of action, as an alternative to area rate proceedings, we await
the guidance of reviewing courts now hearing appeals of [three
area rate decisions]." (Opinion No. 639, Mimeo, ppll-12.)
-37-
-------
Given the present area rate system, an increase in rates for
existing sales deserves serious consideration since net revenues from
such sales provide an important source of cash for undertaking additional
exploration and development. Some have opposed any price increases for
presently flowing gas without assurance that the additional revenues will
actually be devoted to a search for new gas supplies and not diverted to
other types of investment. In certain recent decisions, the FPC has
responded to this position by providing for increases in flowing gas rates
only after specified commitments of new gas reserves to interstate pipe-
lines. Alternatively, in one case, it granted an increase subject to the
requirement that the resultant additional revenues be expended in an
exploratory program over and above the normal level of expenditures for
such activities.
Various other measures could be taken by the FPC to increase the
supply of funds available for exploration and development. For example, in
a few major cases in the past 18 months, the Commission has adopted a pro-
cedure under which refunds determined to be owing by producers to pipelines
for excess charges in the past can be worked off by dedicating additional
gas reserves to the interstate market. This procedure, or some other type
of refund relief conditioned on further exploration, could be applied by
the Commission in other cases as well. While waiver of refunds involves a
number of equitable considerations, refund monies nevertheless are a poten-
tial source of supplemental funds to be directed to exploratory ventures
holding promise for future supplies. Consumers could benefit far more by
application of the funds in question to a search for additional gas reserves
-38-
-------
than by receiving the refund monies either in cash or as a credit to their
gas bill.
Still additional funds for gas exploration could be made avail-
able by extension and expansion of the FPC's program which permits pipe-
lines to make advance payments to producers for development and production
activities and to recover such advances in their rates. This program is
presently scheduled to expire on December 31, 1972 but is now under review
by the FPC with a view toward its extension and enlargement to include
exploratory activities. Also, the Commission could provide encouragement
to gas distributors -- as it has to small producers and pipelines --to
search for gas. Several large distributors have established exploration
subsidiaries, and some have discovered reserves which they seek to have
transported by an interstate pipeline to their service area. One case
presenting this situation is now before the Commission.
E. Acceleration of Offshore Leasing
Clearly, one of the most obvious means for encouraging expansion
of natural gas supply is to accelerate, and regularize, the leasing of lands
on the Outer Continental Shelf. Offshore lands have been estimated by the
U.S. Geological Survey to contain about 40% of total U.S. potential gas
reserves (including Alaska), yet only about 1% of the federal offshore area
has been leased to date. The Interior Department has recognized the need
for accelerated leasing and is currently going forward with a plan to hold
two general lease sales annually over a five-year period in the Gulf of
Mexico. Some delay in this schedule has already occurred due to court
-39-
-------
litigation over the adequacy of Interior's environmental impact statement.
At a minimum, all possible efforts should be made to see that the 10 pro-
jected lease sales are conducted without further delay
Interior's current leasing plan has its principal focus in the
Gulf of Mexico, which is reasonable since potential gas reserves in DCS
lands off Louisiana and Texas are estimated together to comprise 152 tril-
lion cubic feet, or well over 601 of the total offshore potential (excluding
Alaska). Offshore Louisiana, in addition, is already a prolific producing
area. However, it is imperative that efforts also go forward to enable
leasing in the Atlantic and Pacific OCS areas, and in the Gulf of Alaska,
at the earliest possible time. The Atlantic OCS -- estimated by the
Potential Gas Committee to contain 36 trillion cubic feet of potential
gas reserves -- is a nearby and geologically promising source of increased
domestic supply for the East Coast, already heavily dependent on imports
of foreign oil and likely to become also dependent on imports of foreign
gas (LNG) in the future. Similarly, the Pacific OCS, with estimated
potential gas reserves of some 11 trillion cubic feet, represents an
obvious source of additional clean-burning fuel for West Coast states,
especially California. Yet, leasing of either the Atlantic OCS, or
further leasing of the Pacific OCS, can be expected to encounter sub-
stantial opposition on environmental grounds.
It is, of course, understood that OCS leasing should go forward
only under stringent environmental safeguards. The danger of oil spills
can never be entirely eliminated. However, regulations and enforcement
of standards to prevent oil spills are stronger today than ever before
-40-
-------
and also are under constant review to identify possible improvements.
The efforts being taken by the Interior Department to require and enforce
strict precautionary measures, and the fact that reasonably safe drilling
operations can be conducted on offshore lands, need repeated emphasis to
the public. The fact that the petroleum potential in the Atlantic DCS is
deemed to be at least 30 miles from shore should also be stressed.—
F. Encouragement of Supplemental Gas Supplies
The most likely sources of nonconventional gas on the horizon
at this time for increasing U.S. supply over at least the next decade are:
2/
(1) gas from Alaska, primarily the North Slope;— (2) gas imported by
I/ While there is some question under international law as to the outer
limit of the DCS area subject to U.S. jurisdiction, the 1958 Geneva
Convention on the Continental Shelf clearly grants the U.S. sovereign
rights to explore and exploit the natural resources of the Continental
Shelf to a depth of 200 meters (about 656 feet). The width of the OCS
at this depth varies widely in different offshore regions of the
United States.
With respect to the Atlantic OCS, the U.S. Geological Survey has
described the continental shelf as a submerged platform extending
from mean low tide to the break marking the beginning of the
continental rise -- with a width varying from less than three miles
off southern Florida to about 285 miles off Newfoundland, and some-
what less than 600 feet in depth at most places. (Geological Survey
Professional Paper No. 659, "Geologic Framework and Petroleum
Potential of the Atlantic Coastal Plain and Continental Shelf,"
1971.)
2/ Substantial gas potential is also believed to exist in the southern
~~ part of Alaska, primarily the Kenai Peninsula, where proved reserves
were estimated at slightly more than 5 trillion cubic feet at the end
of 1971. Gas from this area is now being liquefied and shipped to
Japan. At least one West Coast distributor is considering the possi-
bility of a project to bring LNG from the Kenai Peninsula to California.
-41-
-------
pipeline from Canadian frontier areas;-' (3) LNG imported by tanker from
overseas nations; (4) synthetic gas reformed from liquid hydrocarbons;
and (5) synthetic gas from domestic coal. Other possibilities have also
been mentioned -- such as nuclear fracturing of tight gas-bearing forma-
tions, oil shale gasification and tar sand gasification -- but these
appear speculative for some years to come for technological reasons,
among others.
Unlike wellhead production of domestic gas, the nonconventional
supplemental sources involve a number of different facets of national
policy. These considerations include national security questions con-
cerning sources of supply, balance of payments problems, and oil import
restrictions. In addition, nonconventional supply projects promise to be
very costly to consumers -- certainly far more so than the cost of domestic
gas now and probably still more so for the most part even with an increase
in domestic gas rates to market clearing price levels. In short, the
regulatory encouragement to be given to supplemental supply sources --
which ones, to what degree, and when -- requires a careful evaluation of
a mix of interrelated factors.
From the standpoint of national security, coal gasification
and Alaskan gas are the most advantageous. Assuming transportation of
I/ Assuming continuation of present export policies of the Canadian
- National Energy Board (which requires retention of sufficient proved
reserves in Canada to meet Canadian market requirements for approxi-
mately 30 years in the future before permitting exportation of gas),
as exemplified by its recent denial of all pending export licenses
for lack of exportable surplus, there seems little likelihood of any
substantial increase in imports from Canada until sufficient reserves
are developed in frontier regions to support new gas export projects.
-42-
-------
Alaskan gas via Canada, various Canadian controls would be exercised,
but, once gas was flowing, the danger of interruption of supply seems
remote. The same observation pertains with respect to Canadian gas trans-
ported from such frontier areas as the Mackenzie Delta in the Northwest
Territories, the Arctic Islands and eastern Canada offshore. As to
importation of LNG from overseas, the bulk of the world's estimated gas
reserves -- exclusive of North America -- are located in the Soviet Union,
the Middle East and North Africa. Each of these area sources could be
interrupted in the event of international political or military problems.
While the consequences of such interruptions could be mitigated over time
by achieving a maximum diversity of LNG sources, nevertheless, a cutoff of
supply for any significant period could cause severe problems for particular
pipelines or distributors which became heavily dependent on imported LNG.
Coal gasification presents little or no balance of payments prob-
lems , nor does Alaskan gas if transported by pipeline in Alaska and by tanker
to the West Coast (assuming tanker construction in domestic shipyards). Some
balance of payments considerations would be involved in the pipelining
of Alaskan gas through Canada. Projects based on importation of gas (or
LNG) or liquids for purposes of manufacturing gas raise greater problems
in this regard. However, in the case of gas imports, these problems would
be diminished to the extent that underlying foreign facilities utilized
equipment and materials purchased in the United States.
Considered from a capital requirements standpoint, reformer gas
projects based on naphtha feedstocks would appear to be the least costly
-43-
-------
of the various alternatives at this time.- For example, the Gas Arctic-
Northwest Project under study to transport North Slope gas to the Manitoba-
Minnesota border is currently estimated to cost $5 billion for a capacity
of 3.5 billion cubic feet per day --or more than $1.40 per cubic foot per
day. The El Paso Algeria project to import 1 billion cubic feet per day
is estimated to involve a total capital investment of over $1.6 billion
(including facilities in Algeria, LNG tankers, and related regasification,
storage and pipeline facilities in the U.S.) -- or about $1.60 per cubic
foot per day. A coal gasification project recently submitted by El Paso
to the FPC contemplates an even higher capital cost -- approximately $1.70
per cubic foot per day of capacity. By contrast, various gas reformer
plant proposals filed with the FPC to date indicate a capital investment
ranging between about 15
-------
cheaper source of gas to consumers in terms of cost per unit of supply.
On the basis of the year-round projects announced to date, the estimated
costs per unit of output range from 77
-------
rather than discouragement, of domestic refining capacity; (2) procure-
ment of two needed fuels rather than only one, with concomitant benefits
of interfuel competition; and (3) the ability to use high sulfur crude
oil as the basic refinery input.
The above discussion is intended to illustrate the myriad of
policy issues which bear on supplemental supply projects. These issues
must be resolved within a national policy context and cannot be viewed
from the standpoint of gas supply maximization alone.
Still another issue has recently come into prominence with the
FPC's decision last June approving the importation of 1 billion cubic feet
per day of Algerian LNG by three major interstate pipelines serving the
East Coast. This issue -- which affects not only imported LNG but also
all other high-cost nonconventional supply supplements (and conceivably
new high-cost domestic production as well) -- is whether such supplements
should be sold at incremental prices (i.e., at the full cost of the
incremental supply) or at rolled-in rates (i.e., at the average cost of
all supplies).— Traditionally, pipelines in the U.S. have followed the
practice of rolled-in pricing. Over the years, this has resulted in
efficient use of capacity, avoided complex problems of allocating particular
supplies to particular customers and also avoided abrupt changes in prices
I/ Actually, two levels of sales are involved. First are sales to custo-
mers -- distributors and direct industrial customers --of pipeline
companies proposing to import LNG or obtain other high-cost increments
of supply. Second are sales by distributors to their customers, i.e.,
ultimate consumers. For the moment at least, the controversy has
narrowed to the method of pricing by pipeline companies to distributor
and direct customers.
-46-
-------
for new supply acquisitions at higher costs. Continuation of this system,
however, has now been placed in doubt by the FPC's decision requiring that
the three pipeline importers of the Algerian LNG sell this supply only at
incremental rates.
The basic rationale in favor of incremental pricing is that a
new supply which cannot be sold at its full economic cost is economically
infeasible. While this argument has appeal from a theoretical standpoint,
it presents serious difficulties when considered in light of pipeline
market realities today. Specifically, a consistent application of incre-
mental pricing principles to all new gas supply sources costing in excess
of the rolled-in average cost of a pipeline's existing systemwide supplies
would create a host of administrative problems but, even more important,
could limit and reduce the amount of new gas supplies for U.S. markets.
This is because there are only limited markets at this time prepared to
incur the risk of contracting for and then selling supplemental gas sup-
plies at a multiple of historically prevailing gas prices. Thus, incre-
mental pricing threatens the overall marketability of nonconventional
gas supplements and thereby could be detrimental to EPA's pursuit of an
enhanced supply of gas.
It might be argued that incremental pricing of new supplies
would be justified under certain conditions and in certain situations in
the future. However, the issue is complex and requires a thorough
evaluation by the FPC of the nature of individual pipeline markets,
whether supplemental gas is sought to maintain deliveries to existing
markets or expand deliveries, alternative sources of supply, and load
-47-
-------
balancing means.-
G. Means of Influencing Regulatory Policy
Various options are open to EPA and other interested groups to
seek to influence regulatory policy affecting gas supply. These include:
(1) Submission of statements to Congress on pending legislation
pertaining to the regulation of gas and other fuels, as well as to energy
research and other measures aimed at developing supplemental sources of
gas and other fuels. For example, assuming the sanctity of contract bill
which died in the last session of Congress is reactivated and legislation
to deregulate wellhead prices in part or entirely is introduced, both
measures would be obvious candidates for expression of views by groups
concerned with gas supply.
(2) Statements of position to federal agencies (within the Executive
Branch) considering certain actions. For example, statements might be
made to the Interior Department regarding plans for further sales of off-
shore oil and gas leases; to the Oil Policy Committee on imports of both
LNG and liquid petroleum feedstocks for SNG manufacture (a matter on which
the OPC invited comments in December 1971); or to the Maritime Administra-
tion on various factors bearing on the grant of subsidies for construction
of LNG tankers in U.S. shipyards.
(3) Statements of position to the Federal Power Commission on rule-
making proposals affecting the gas industry. In rulemaking proceedings,
I/ No such evaluation was attempted in the one case where the incremental
~ principle was adopted. In fact, no evidence was even submitted on the
subject in that case.
-48-
-------
formal intervention is not required. Any interested party may submit
written comments (and comments orally, if a hearing is held).
(4) Intervention in Federal Power Commission adjudicatory proceed-
ings having a significant impact on gas supply. (In independent regula-
tory agency proceedings of an adjudicatory as opposed to a rulemaking
nature, formal intervention is generally required as a condition of
participation.) For example, early cases dealing with applications for
new gas sales under the optional certificate procedure will undoubtedly
establish precedents regarding use of that procedure and thereby affect
its efficacy in stimulating exploration and development of additional gas
supplies. Other cases directed toward increasing area rates, use of
refund monies owed by producers on exploration for additional gas supplies,
or major new supplemental gas supply projects, might also warrant inter-
vention. Such intervention, at a minimum, would permit statements of
position setting forth reasons for or against the proposal in question.
It would also permit presentation and cross-examination of evidence, if
desired. This course might be particularly considered by a group with
expertise bearing on some aspect of a proposal under consideration (such
as, for example, the environmental consequences of coal gasification pro-
jects and related strip mining).
(5) Participation in state and local proceedings regarding leasing
of offshore oil and gas lands, zoning changes to permit construction of
LNG and SNG facilities, and other issues of this nature which have become
increasingly prominent in recent years.
-49-
-------
BIBLIOGRAPHIC DATA
SHEET
1. Report No.
APTD-1458
3. Recipient's Accession No.
I. Title and Subtitle
An Analysis of the Regulatory Aspects of Natural Gas Supply
(Abridged Report)
5. Report Date
March 1973
6.
7. Author(s)
M. W. Rockefeller
8* Performing Organization Rept.
No.
9. Performing Organization Name and Address
Foster Associates, Inc.
1101 Seventeeth Street, N.W.
Washington, D.C. 20036
10. Projeci/Task/Wotk Unit No.
11. Contract/Gram No.
68-02-0640
12. Sponsoring Organization Name and Address
EPA, Office of Air Quality Planning and Standards
Strategies and Air Standards Division
Research Triangle Park, North Carolina 27711
13. Type of Report & Period
Covered
Final Report
14.
15. Supplementary Notes
16. Abstracts
A study was conducted to review the current regulatory picture affecting the supply and|
distribution of natural gas and low sulfur fuel oil, to analyze possible changes in tlii
regulatory pic.ture, and to appraise alternate regulatory strategies which could bring
about increased supplies of these clean-burning fuels. The results of the study are
contained in two separate reports, one report for natural gas and the other for fuel
oil. Also, abridged copies of the two comprehensive reports are provided.
17. Key Words and Document Analysis. 17o. Descriptors
Government
Law
17b. Idcntifiers/Opcn-Endcd Terms
Air pollution
Natural gas
17e. COSATI Field/Group
5D
18. Availability Statement
Unlimited
19. Security Class (This
Report)
UNCLASSIFIED
LASS1F1ED
Class (Thi
20. Security Class (This
Page
UNCLASSIFIED
21. No. of Pages
49
22. Price
FORM NTIS-35 (REV. 3-72)
USCOMM-OC M932-P72
-------
INSTRUCTIONS FOR COMPLETING FORM NTIS-35 (10-70) (Bibliographic Data Sheet based on COSATI
Guidelines to Format Standards for Scientific and Technical Reports Prepared by or for the Federal Government,
PB-180 600).
1. Report rjumber. Each individually bound report shall carry a unique alphanumeric designation selected by the performing
organization or provided by the sponsoring organization. Use uppercase letters and Arabic numerals only. Examples
FASEB-NS-67 and FAA-RD-68-09.
2. Leave blank.
i Recipient's Accession Number. Reserved (or use by each report recipient.
4- Title and Subtitle. Title should indicate clearly and briefly the subject coverage of the report, and be displayed promi-
nently. Set subtitle, if used, in smaller type or otherwise subordinate it to main title. When a report is prepared in more
than one volume, repeat the primary title, add volume number and include subtitle for the specific volume.
5. Report Dote. I1 :ich report shall carry a date indicating at least month and year. Indicate the basis on which it was selected
(e.g., date ol issue, date of approval, date of preparation.
6. Performing Organization Code. Leave blank.
7. Authors). Give name(s) in conventional order (e.g., John R. Hoc, or J.Robert Doc). List author's affiliation if it differs
from the performing organization.
8. Performing Organization Report Number. Insert if performing organisation wishes to assign [his number.
9- Performing Orgoni lotion Name and Address. Give name, street, city, state, and zip code. List no more than two levels of
an orgjnizaiion.il hierarchy. Display the name of the organization exactly as it should appear in Government indexes such
as USGROR-I
10. Project/Task/Work Unit Number. Use the project, task and work unit numbers under which the report was prepared.
11. Contract/Grant Number. Insert contract or grant number under which report was prepared.
12. Sponsoring Agency Nome and Address. Include zip code.
13. Type of Report and Period Covered. Indicate interim, final, etc., and, if applicable, dates covered.
14. Sponsoring Agency Code. Leave blank.
15. Supplementary Notes. Mnter information not included elsewhere but useful, such ns: Prepared in cooperation with . . .
Translation of ... Presented at conference of ... To be published in ... Supersedes . . . Supplements . . .
16. Abstract. Include a brief (200 words or less) (actual summary of the most significant information contained in the report.
If the report contains a significant bibliography or literature survey, mention it here.
17. Key Words and Document Analysis, (a). Descriptors. Select from the Thesaurus of Engineering and Scientific Terms the
proper authorized terms that identify the major concept ol the research and are sufficiently specific and precise to be used
as index entries for cataloging.
(b) identifiers and Open-Ended Terms. Use identifiers for project names, code names, equipment designators, etc. Use
open-ended terms written in descriptor form for those subjects for which no descriptor exists.
(c). COSATI Field/Group. Field and Group assignments are to be taken from the 1965 COSATI Subject Category List.
Since the majority o( documents are multidisciplinary in nature, the primary Field/Group assignmcnt(s) will be the speci(ic
discipline, area of human endeavor, or type of physical object. The applies!ion(s) will be cross-referenced with secondary
Field/Group assignments that will follow the primary posting(s).
IS- Distribution Statement. Denote releasahility in the public or limitation for reasons other than security for example "Re-
lease unlimited", fitc any availability to the public, with address and price.
19 & 20. Security Clossification. Do not submit classified reports to the National Technical
21. Number of Pages. Insert the total number of pages, including this one and unnumbered pages, but excluding distribution
list, if any.
22. Price. Insert the price set by the National Technical Information Service or the Government Printing Office, if known.
FORM NTIS-35 IREV. 3-721 USCOMM-OC 140S2-P72
------- |