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Natural Gas Distribution

Distribution is the final step in delivering natural gas to customers. While some large industrial, commercial, and electric generation customers receive natural gas directly from high capacity interstate and intrastate pipelines (usually contracted through natural gas marketing companies), most other users receive natural gas from their local gas utility, also called a local distribution company (LDC). LDCs are regulated utilities involved in the delivery of natural gas to consumers within a specific geographic area. There are two basic types of natural gas utilities: those owned by investors, and public gas systems owned by local governments. Local distribution companies typically transport natural gas from delivery points located on interstate and intrastate pipelines to households and businesses through thousands of miles of small-diameter distribution pipe. The delivery point where the natural gas is transferred from a transmission pipeline to the local gas utility is often termed the 'citygate', and is an important market center for the pricing of natural gas in large urban areas. Typically, Utilities take ownership of the natural gas at the citygate, and deliver it to each individual customer's meter. This requires an extensive network of smalldiameter distribution pipe. The U.S. Department of Transportations Pipeline and Hazardous Materials Safety Administration reports that there are just over 2 million miles of distribution pipe in the U.S., including city mains and service pipelines that connect each meter to the main. Because of the transportation infrastructure required to move natural gas to many diverse customers across a reasonably wide geographic area, distribution costs typically make up about half of natural gas costs for households and small Installing Small Diameter volume customers. While large pipelines can reduce unit costs Distribution Pipe by transmitting large volumes of natural gas, distribution Source: Duke Energy Gas Transmission Canada companies must deliver relatively small volumes to many more different locations. According to the Energy Information Administration (EIA), transmission and distribution costs represented about half of a typical residential natural gas customers monthly gas utility bill in 2009, with costs of the physical natural gas commodity itself representing the other half. Delivery of Natural Gas

The delivery of natural gas to its point of end use by a distribution utility is much like the transportation of natural gas discussed in the transportation section. However, distribution involves moving smaller volumes of gas at much lower pressures over shorter distances to a great number of individual users. Smaller-diameter pipe also is used to transport natural gas from the citygate to individual consumers.

Components of Residential Natural Gas Prices

Source: Energy Information Administration-2008

The natural gas is periodically compressed to ensure pipeline flow, although local compressor stations are typically smaller than those used for interstate transportation. Because of the smaller volumes of natural gas to be moved, as well as the small-diameter pipe that is used, the pressure required to move natural gas through the distribution network is much lower than that found in the transmission pipelines. While natural gas traveling through interstate pipelines may be compressed to as much as 1,500 pounds per square inch (psi), natural gas traveling through the distribution network requires as little as 3 psi of pressurization and is as low as psi at the customers meter. The natural gas to be distributed is typically depressurize d at or near the citygate, as well as scrubbed and filtered (even though it has already been processed prior to distribution through interstate pipelines) to ensure low moisture and particulate content. In addition, mercaptan - the source of the familiar rotten egg smell in natural gas - is added by the utility prior to distribution. This is added because natural gas is odorless and colorless, and the familiar odor of mercaptan makes the detection of leaks much easier. Traditionally, rigid steel pipe was used to construct distribution networks. However, new technology is allowing the use of flexible plastic and corrugated stainless steel tubing in place of rigid steel pipe. These new types of tubing allow cost reduction, installation flexibility and easier repairs for both local distribution companies and natural gas consumers. Another innovation in the distribution of natural gas is the use of electronic meterreading systems. The natural gas that is Distribution Compressor Station consumed by any one customer is measured Source: Duke Energy Gas Transmission Canada by on-site meters, which essentially keep track of the volume of natural gas consumed at that location. Traditionally, in order to bill customers correctly, meter-reading personnel had to be dispatched to record these volumes. However, new electronic meter-reading systems are capable of transmitting this information directly to the utility. This results in cost savings for the utility, which are in turn passed along to customers.

The installation of natural gas distribution pipe requires the same process as for larger pipelines: the excavation of trenches into which the pipe is laid. However, new trenching techniques are allowing for the installation of distribution pipe with less impact on the above ground surroundings. Guided drilling systems are used to excavate an underground hole in which the pipe may be inserted, and can lead to significant excavation and restoration savings. This is particularly important in crowded urban settings and scenic rural environments, where the installation of natural gas distribution pipe can be a major inconvenience for residents and business owners. Supervisory control and data acquisition (SCADA) systems, similar to those used by large pipeline companies, are also used by local distribution Installing Residential Distribution companies. These systems can integrate gas flow Source: Duke Energy Gas Transmission Canada control and measurement with other accounting, billing, and contract systems to provide a comprehensive measurement and control system for the local gas utility. This allows accurate, timely information on the status of the distribution network to be used by the utility, to ensure efficient and effective service at all times. Regulation of Natural Gas Distribution Traditionally, local gas utilities have been awarded exclusive rights to distribute natural gas in a specified geographic area, as well as perform services like billing, safety inspection, and providing natural gas hookups for new customers. Like interstate pipelines, utilities have historically been viewed as natural monopolies. Because of the high cost of constructing the distribution infrastructure, it is uneconomic to lay multiple redundant distribution networks in any one area, resulting in only one utility offering distribution services. Because of their position as natural monopolies in a given geographic area, distribution companies have historically been regulated to ensure that monopoly power is not abused, and natural gas consumers do not fall victim to overly high distribution costs or inefficient delivery systems. State public utility commissions are charged with the oversight and regulation of investor owned local natural gas utilities. Those utilities owned by local governments are typically governed by local government agencies to ensure that the needs and preferences of customers are met in a cost effective manner. State regulation of local distribution companies has a variety of objectives, including ensuring adequate supply, dependable service, and reasonable prices for consumers, while also allowing for an adequate rate of return for investor owned Utilities. State regulators are also responsible for overseeing the construction of new distribution networks, including approving installation sites and proposed additions to the network. Regulatory orders and methods of oversight vary from state to state. To learn more about the regulation of natural gas distribution in your state, click here to visit the National Association of Regulatory Utility Commissioners (NARUC). Historically, local distribution companies offered only bundled services; that is, they combined the cost of transportation, distribution, and the natural gas itself into one price for consumers. However, beginning in the 1990s, residential customer choice programs began to be offered as part of a movement toward the retail unbundling of natural gas sales. Many states now offer programs in which customers may choose a supplier from whom to purchase the natural gas commodity separately, and use the gas utility simply for service and delivery of that gas. Customer choice programs are in place in more than 20 states and the District of Columbia. To learn more about the status of state distribution customer choice programs, visit EIA.

Although the majority of residential and small commercial customers still tend to purchase 'bundled' natural gas from utilities, the increasingly important role of natural gas marketers, as well as the innovation fueled by increasing competition in the marketplace, is leading to innovative ways of supplying natural gas to small volume users as well as new bundled service options, such as home security systems. Please visit our section to learn more about natural gas marketing in residential markets. Distribution and Safety Local distribution companies, like the larger interstate and intrastate pipelines, maintain the highest safety standards to ensure that preventable accidents are avoided, and problems with the distribution network are remedied in a timely fashion. Many of the safety programs maintained by utilities are quite similar to those of interstate pipeline companies. Safety measures at the local level include: Leak Detection Equipment Utilities have in place sophisticated leak detection equipment, designed to pick up on leaks of natural gas from the distribution network. Utilities also add odorants to the natural gas to make it easier to detect a leak. Safety Education Programs - Utilities typically run natural gas safety seminars in schools, community centers, and through other organizations to ensure customers are well versed in natural gas safety procedures and know what to do in the event of a leak or emergency. Technicians on Call - Utilities maintain fleets of technicians on call 24 hours a day, seven days a week to respond to customers' problems and concerns. Emergency Preparedness - Utilities participate in community and local emergency preparedness programs, educating and preparing for emergency events such as natural disasters. One Call Systems - Provides customers, contractors, and excavators with a single phone number to call before commencing excavation or construction, to ensure that the pipelines, and other buried facilities are not damaged. A national call-before-you-dig phone number of 811 was adopted in 2008 with the support of utilities, communities, emergency responders and government officials. These are but a few of the safety measures maintained by local distribution companies. Especially important for the safe distribution of natural gas, particularly in densely populated areas, is the education of customers. By teaching natural gas users the safe use of natural gas, what to do in an emergency, and how to detect leaks, distribution companies ensure that the distribution of natural gas will remain one of the safest forms of energy transmission. For more information on natural gas safety in your area, contact your natural gas utility. For information on natural gas pipelines including please visit the Department of Transportations Office of Pipeline

Community Emergency Response Team - Checking Gas Meters

Source: Federal Emergency Management Agency

Safety .

Overview of Natural Gas|Natural Gas - From the Wellhead...|Business Overview|N

The Transportation of Natural Gas

The efficient and effective movement of natural gas from producing regions to consumption regions requires an extensive and elaborate transportation system. In many instances, natural gas produced from a particular well will have to travel a great distance to reach its point of use. The transportation system for natural gas consists of a complex network of pipelines, designed to quickly and efficiently transport natural gas from its origin, to areas of high natural gas demand. Transportation of natural gas is closely linked to its storage: should the natural gas being transported not be immediately required, it can be put into storage facilities for when it is needed. There are three major types of pipelines along the transportation route: the gathering system, the interstate pipeline system, and the distribution system. The gathering system consists of low pressure, small diameter pipelines that transport raw natural gas from the wellhead to the Source: Duke Energy Gas Transmission processing plant. Should natural gas from a particular well Canada have high sulfur and carbon dioxide contents (sour gas), a specialized sour gas gathering pipe must be installed. Sour gas is corrosive, thus its transportation from the wellhead to the sweetening plant must be done carefully. Review the treatment and processing of natural gas. Pipelines can be characterized as interstate or intrastate. Interstate pipelines are similar to in the interstate highway system: they carry natural gas across state boundaries, in some cases clear across the country. Intrastate pipelines, on the other hand, transport natural gas within a particular state. This section will cover only the fundamentals of interstate natural gas pipelines, however the technical and operational details discussed are essentially the same for intrastate pipelines. Interstate Natural Gas Pipelines The interstate natural gas pipeline network transports processed natural gas from processing plants in producing regions to those areas with high natural gas requirements, particularly large, populated urban areas. As can be seen, the pipeline network extends across the entire country. Interstate pipelines are the 'highways' of natural gas transmission. Natural gas that is transported through interstate pipelines travels at high pressure in the pipeline, at pressures anywhere from 200 to 1500 pounds per square inch (psi). This reduces the volume of the natural gas being transported (by up to 600 times), as well as propelling natural gas through the pipeline.

Interstate Natural Gas Pipelines

Source: National Energy Technology Laboratory, DOE

This section will cover the components of the interstate pipeline system, the construction of

pipelines, and pipeline inspection and safety. For more information on interstate pipelines in general, click here to visit the website of the Interstate Natural Gas Association of America. Pipeline Components Interstate pipelines consist of a number of components that ensure the efficiency and reliability of a system that delivers such an important energy source year-round, twenty four hours a day, and includes a number of different components. Transmission Pipes Transmission pipes can measure anywhere from 6 to 48 inches in diameter, depending on their function. Certain component pipe sections can even consist of small diameter pipe, as small as 0.5 inches in diameter. However, this small diameter pipe is usually used only in gathering and distribution systems. Mainline transmission pipes, the principle pipeline in a given system, are usually between 16 and 48 inches in diameter. Lateral pipelines, which deliver natural gas to or from the mainline, are typically between 6 and 16 inches in diameter. Most major interstate pipelines are between 24 and 36 inches in diameter. The actual pipeline itself, commonly called 'line pipe', consists of a strong carbon steel material, engineered to meet standards set by the American Petroleum Pipes in Transit Institute (API). In contrast, some distribution pipe is Source: Duke Energy Gas Transmission Canada made of highly advanced plastic, because of the need for flexibility, versatility and the ease of replacement. Transmission pipelines are produced in steel mills, which are sometimes specialized to produce only pipeline. There are two different production techniques, one for small diameter pipes and one for large diameter pipes. For large diameter pipes, from 20 to 42 inches in diameter, the pipes are produced from sheets of metal which are folded into a tube shape, with the ends welded together to form a pipe section. Small diameter pipe, on the other hand, can be produced seamlessly. This involves heating a metal bar to very high temperatures, then punching a hole through the middle of the bar to produce a hollow tube. In either case, the pipe is tested before being shipped from the steel mill, to ensure that it can meet the pressure and strength standards for transporting natural gas. Line pipe is also covered with a specialized coating to ensure that it does not corrode once placed in the ground. The purpose of the coating is to protect the pipe from moisture, which causes corrosion and rusting. There are a number of different coating techniques. In the past, pipelines were coated with specialized coal tar enamel. Today, pipes are often protected with what is known as a fusion bond epoxy, which gives the pipe a noticeable light blue color. In addition, cathodic protection is often used; which is a technique of running an electric current through the pipe to ward off corrosion and rusting. Compressor Stations As mentioned, natural gas is highly pressurized as it travels through an interstate pipeline. To ensure that the natural gas flowing through any one pipeline remains pressurized, compression of this natural gas is required periodically along the pipe. This is accomplished by compressor

stations, usually placed at 40 to 100 mile intervals along the pipeline. The natural gas enters the compressor station, where it is compressed by either a turbine, motor, or engine. Turbine compressors gain their energy by using up a small proportion of the natural gas that they compress. The turbine itself serves to operate a centrifugal compressor, which contains a type of fan that compresses and pumps the natural gas through the pipeline. Some compressor stations are operated by using an electric motor to turn the same type of centrifugal compressor. This type of compression does not require the use of any A Compressor Station of the natural gas from the pipe, however it Source: Duke Energy Gas Transmission Canada does require a reliable source of electricity nearby. Reciprocating natural gas engines are also used to power some compressor stations. These engines resemble a very large automobile engine, and are powered by natural gas from the pipeline. The combustion of the natural gas powers pistons on the outside of the engine, which serves to compress the natural gas. In addition to compressing natural gas, compressor stations also usually contain some type of liquid separator, much like the ones used to dehydrate natural gas during its processing. Usually, these separators consist of scrubbers and filters that capture any liquids or other unwanted particles from the natural gas in the pipeline. Although natural gas in pipelines is considered 'dry' gas, it is not uncommon for a certain amount of water and hydrocarbons to condense out of the gas stream while in transit. The liquid separators at compressor stations ensure that the natural gas in the pipeline is as pure as possible, and usually filter the gas prior to compression. Metering Stations In addition to compressing natural gas to reduce its volume and push it through the pipe, metering stations are placed periodically along interstate natural gas pipelines. These stations allow pipeline companies to monitor the natural gas in their pipes. Essentially, these metering stations measure the flow of gas along the pipeline, and allow pipeline companies to 'track' natural gas as it flows along the pipeline. These metering stations employ specialized meters to measure the natural gas as it flows through the pipeline, without impeding its movement. Valves

A Ground Valve Interstate pipelines include a great number of valves Source: Duke Energy Gas Transmission Canada along their entire length. These valves work like gateways; they are usually open and allow natural gas to flow freely, or they can be used to stop gas flow along a certain section of pipe. There are many reasons why a pipeline may need to restrict gas flow in certain areas. For example, if a section of pipe requires replacement or maintenance, valves on either end of that section of pipe can be closed to allow engineers and work crews safe access. These large valves can be placed every 5 to 20 miles along the pipeline, and are subject to regulation by safety codes. Control Stations and SCADA Systems Natural gas pipeline companies have customers on both ends of the pipeline - the producers and processors that input gas into the pipeline, and the consumers and local gas utilities that take gas out of the pipeline. In order to manage the natural gas that enters the pipeline, and to ensure that all customers receive timely delivery of their portion of this gas, sophisticated control systems are required to monitor the gas as it travels through all sections of what could be a very lengthy pipeline network. To accomplish this task of monitoring and controlling the natural gas that is traveling through the pipeline, centralized gas control stations collect, assimilate, and manage data received from monitoring and compressor stations all along the pipe. Most of the data that is received by a control station is provided by Supervisory Control and Data Acquisition (SCADA) systems. These systems are essentially sophisticated communications systems that take measurements and collect data along the pipeline (usually in a metering or compressor stations and valves) and transmit it to the centralized control station. Flow rate through the pipeline, operational status, pressure, and temperature readings may all be used to assess the status of the pipeline at any one time. These systems also work in real time, meaning that there is little lag time between the measurements taken along the pipeline and their transmission to the control station. Pipeline Control Station The data is relayed to a centralized control Source: Duke Energy Gas Transmission Canada station, allowing pipeline engineers to know exactly what is happening along the pipeline at all times. This enables quick reactions to equipment malfunctions, leaks, or any other unusual activity along the pipeline. Some SCADA systems also incorporate the ability to remotely operate certain equipment along the pipeline, including compressor stations, allowing engineers in a centralized control center to immediately and easily adjust flow rates in the pipeline. Pipeline Construction As natural gas use increases, so does the need to have transportation infrastructure in place to supply the increased demand. This means that pipeline companies are constantly assessing the flow of natural gas across the U.S., and building pipelines to allow transportation of natural gas to those areas that are underserved.

Constructing natural gas pipelines requires a great deal of planning and preparation. In addition to actually building the pipeline, several permitting and regulatory processes must be completed. In many cases, prior to beginning the permitting and land access processes, natural gas pipeline companies prepare a feasibility analysis to ensure that an acceptable route for the pipeline exists that provides the least impact to the environment and public infrastructure already in place. Assuming a pipeline company obtains all the required permits and satisfies all of the regulatory requirements, construction of the pipe may begin. Extensive surveying of the intended route is completed, both aerial and land based, to ensure that no surprises pop up during actual assembly of the pipeline.

Surveying the Right-of-Way

Source: Duke Energy Gas Transmission Canada

Installing a pipeline is much like an assembly line process, with sections of the pipeline being completed in stages. First, the path of the pipeline is cleared of all removable impediments, including trees, boulders, brush, and anything else that may prohibit the construction. Once the pipeline's path has been cleared sufficiently to allow construction equipment to gain access, sections of pipes are laid out along the intended path, a process called 'stringing' the pipe. These pipe sections are commonly from 40 to 80 feet long, and are specific to their destination. That is, certain areas have different requirements for coating material and pipe thickness. Once the pipe is in place, trenches are dug alongside the laid out pipe. These trenches are typically five to six feet deep, as the regulations require the pipe to be at least 30 inches below the surface. In certain areas, however, including road crossings and bodies of water, the pipe is buried even deeper. Once the trenches are dug, the pipe is assembled and contoured. This includes welding the sections of pipe together into one continuous pipeline, and bending it slightly, if needed, to fit the contour of the pipelines path. Coating is applied to the ends of the pipes. The coating applied at a coating mill typically leaves the ends of the pipe clean, so as not to interfere with welding. Finally, the entire coating of the pipe is inspected to ensure that it is free from

'Stringing' the Pipe

Source: Duke Energy Gas Transmission Canada

defects. Once the pipe is welded, bent, coated, and inspected it can be lowered into the previously-dug trenches. This is done with specialized construction equipment acting to lift the pipe in a level manner and lower it into the trench. Once lowered into the ground, the trench is filled in carefully, to ensure that the pipe and its coating retain their integrity. The last step in pipeline construction is the hydrostatic test. This consists of running water, at pressures higher than will be needed for natural gas transportation, through the entire length of the pipe. This serves as a test to ensure that the pipeline is strong enough, and absent of any leaks of fissures, before natural gas is pumped through the pipeline.

Laying pipe across streams or rivers can be accomplished in one of two ways. Open cut crossing involves the digging of trenches on the floor of the river to house the pipe. When this is done, the pipe itself is usually fitted with a concrete casing, which both ensures that the pipe stays on the bottom of the river and adds an extra protective coating to prevent any natural gas leaks into the water. Alternatively, a form of directional drilling may be employed, in which a 'tunnel' is drilled under the river through which the pipe may be passed. The same techniques are used for Lowering Pipe road crossings - either an open trench is Source: Duke Energy Gas Transmission Canada excavated across the road and replaced once the pipe is installed, or a tunnel may be drilled underneath the road. Once the pipeline has been installed and covered, extensive efforts are taken to restore the pipeline's pathway to its original state, or to mitigate any environmental or other impacts that may have occurred during the construction process. These steps often include replacing topsoil, fences, irrigation canals, and anything else that may have been removed or upset during the construction process. For more information on natural gas pipeline construction, visit the website of the Interstate Natural Gas Association of America. Pipeline Inspection and Safety In order to ensure the efficient and safe operation of the extensive network of natural gas pipelines, pipeline companies routinely inspect their pipelines for corrosion and defects. This is done through the use of sophisticated pieces of equipment known as smart pigs. Smart pigs are intelligent robotic devices that are propelled down pipelines to evaluate the interior of the pipe. Smart pigs can test pipe thickness, and roundness, check for signs of corrosion, detect minute leaks, and any other defect along the interior of the pipeline that may either impede the flow of gas, or Pig - Pipeline Inspection Tool pose a potential safety risk to the Source: Duke Energy Gas Transmission Canada operation of the pipeline. Sending a smart pig down a pipeline is fittingly known as 'pigging' the pipeline. In addition to inspection with smart pigs, there are a number of safety precautions and procedures in place to minimize the risk of accidents. In fact, the transportation of natural gas is one of the safest ways of transporting energy, mostly due to the fact that the infrastructure is fixed, and buried underground. According to the Department of Transportation (DOT), pipelines are the safest method of transporting petroleum and natural gas. While there are in excess of 100 deaths per year associated with electric transmission lines, according to the DOT's Office of Pipeline Safety in 2009, there were 0 deaths associated with transmission pipelines, and 10 deaths associated with distribution systems. To learn more about pipeline safety, visit the DOT's Office of Pipeline Safety.

A few of the safety precautions associated with natural gas pipelines include: Aerial Patrols - Planes are used to ensure no construction activities are taking place too close to the route of the pipeline, particularly in residential areas. Unauthorized construction and digging is the primary threat to pipeline safety, according to INGAA Leak Detection - Natural gas detecting equipment is periodically used by pipeline personnel on the surface to check for leaks. This is especially important in areas where the natural gas is not odorized. Pipeline Markers - Signs on the surface above natural gas pipelines indicate the presence of underground pipelines to the public, to reduce the chance of any interference with the pipeline. Gas Sampling - Routine sampling of the natural gas in pipelines ensures its quality, and may also indicate corrosion of the interior of the pipeline, or the influx of contaminants. Preventative Maintenance - This involves the testing of valves and the removal of surface impediments to pipeline inspection. Emergency Response - Pipeline companies have extensive emergency response teams that train for the possibility of a wide range of potential accidents and emergencies. The One Call Program - All 50 states have instituted what is known as a 'one call' program, which provides excavators, construction crews, and anyone interested in digging into the ground around a pipeline with a single phone number that may be called when any excavation activity is planned. This call alerts the pipeline company, which may flag the area, or even send representatives to monitor the digging. The national 3-digit number for one call is 811.

While large interstate natural gas pipelines transport natural gas from the processing regions to the consuming regions and may serve large wholesale users such as industrial or power generation customers directly, it is the distribution system that actually delivers natural gas to most retail customers, including residential natural gas users.

Industry and Market Structure

The natural gas industry is an extremely important segment of the U.S. economy. In addition to providing one of the cleanest burning fuels available to all segments of the economy, the industry itself provides much valuable commerce to the U.S. economy. Below is a brief description of the structure of the natural gas industry and market, as well as links to information on the make-up of the various segments of the natural gas industry, and recent statistics regarding the supply of natural gas. To learn about the processes associated with the natural gas supply chain, click here. To jump ahead to specific topics in this section, click on the links below: Overview of Industry Structure - discusses how different market participants interact to bring supplies of natural gas to the market. Industry Makeup - discusses the composition of the industry. Source: NGSA Natural Gas Market Overview - discusses the natural gas market, and the forces that affect the interaction of supply and demand for natural gas . Market Activity -provides a snapshot of recent wholesale market activity as reported by

various indices and platforms. Overview of Industry Structure The structure of the natural gas industry has changed dramatically since the mid-1980's. In the past, the structure of the natural gas industry was simple, with limited flexibility and few options for natural gas delivery. Exploration and production companies explored and drilled for natural gas, selling their product at the wellhead to large transportation pipelines. These pipelines transported the natural gas, selling it to local distribution utilities, who in turn distributed and sold that gas to its customers. The prices for which producers could sell natural gas to transportation pipelines was federally regulated, as was the price at which pipelines could sell to local distribution companies. State regulation monitored the price at which local distribution companies could sell natural gas to their customers. Getting Natural Gas to Market - Prior to Deregulation and Pipeline Unbundling Thus, the structure of the natural gas industry prior to deregulation and pipeline unbundling was very straightforward. However, with regulation of wellhead prices, as well as assured monopolies for large transportation Source: NGSA pipelines and distribution companies, there was little competition in the marketplace, and incentives to improve service and innovate were few. Regulation of the industry also led to natural gas shortages in the 1970s, and surpluses in the 1980s. To review the history of natural gas regulation, click here. The natural gas industry today has changed dramatically, and is much more open to competition and choice. Wellhead prices are no longer regulated; meaning the price of natural gas is dependent on supply and demand interactions. Interstate pipelines no longer take ownership of the natural gas commodity; instead they offer only the transportation component, which is still under federal regulation. LDCs continue to offer bundled products to their customers, although retail unbundling taking place in many states allows the use of their distribution network for the transportation component alone. End users may purchase natural gas directly from producers or LDCs. One of the primary differences in the current structure of the market is the existence of natural gas marketers. Marketers serve to facilitate the movement of natural gas from the producer to the end user. Essentially, marketers can serve as a middle-man between any two parties, and can offer either bundled or unbundled service to its customers. Thus, in the structure mentioned above, marketers may be present between any two parties to facilitate the sale or purchase of natural gas, and can also contract for transportation and storage. Marketers may own the natural gas being transferred, or may simply facilitate its transportation and storage. Essentially, a myriad of different ownership pathways exist for natural gas to proceed from producer to end user. Simplified Structure of Industry after Pipeline Unbundling

The diagram shows a simplified representation of the structure of the natural gas industry after pipeline unbundling and wellhead price deregulation. It is important to note that the actual ownership pathway of the gas may be significantly more complicated, as the marketer or the LDC are not the final users. Either of these two entities may sell directly to the end user, or to other marketers or LDCs. The regulatory environment of the day has a dramatic effect on shaping the structure of the industry. To learn more about the current regulatory environment for the natural gas industry, click here.

Source: NGSA

The actions of the federal government and its related agencies and departments can also have a significant impact on the structure and functioning of the natural gas industry. To learn more about how government actions can affect the natural gas industry, click here. Industry Makeup Now that the basic structure of the natural gas industry has been discussed, it is possible to examine the business characteristics and relevant statistics of each industry segment. An excellent source for statistics and information on the natural gas industry and its various sectors is the Energy Information Administration (EIA). The EIA was created in 1977 as the statistical arm of the Department of Energy, charged with developing energy data and analyses that help to enhance the understanding of the energy industry. Click here to view the EIA's homepage. For a good overview of relevant updated statistics related to the natural gas industry, view the EIA's summary statistics on natural gas here.

Source: NGSA

Below are some statistics (based on EIA data for the year 2007) on the makeup of the natural gas industry. Follow the links to view the most up to date information on each sector: Producers - There are over 6,300 producers of natural gas in the United States. These companies range from large integrated producers with worldwide operations and interests in all segments of the oil and gas industry, to small one or two person operations that may only have partial interest in a single well. The largest integrated production companies are termed 'Majors', of which there are 21 active in the United States. For more information on the production of natural gas in the United States, click here. Information on the production of natural gas is also available on EIA's website here. Processing - There are over 530 natural gas processing plants in the United States, which were responsible for processing almost 15 trillion cubic feet of natural gas and

extracting over 630 million barrels of natural gas liquids in 2006. For more information on natural gas processing, visit the Gas Processors Association here. For updated statistics on the processing of natural gas in the United States, click here. Pipelines - There are about 160 pipeline companies in the United States, operating over 300,000 miles of pipe. Of this, 180,000 miles consist of interstate pipelines. This pipeline capacity is capable of transporting over 148 Billion cubic feet (Bcf) of gas per day from producing regions to consuming regions. For more information on the natural gas pipeline infrastructure in the United States, click here. To see a list of major pipeline companies, including links to their websites, visit the Federal Energy Regulatory Commission's website here. Storage - There are about 123 natural gas storage operators in the United States, which control approximately 400 underground storage facilities. These facilities have a storage capacity of 4,059 Bcf of natural gas, and an average daily deliverability of 85 Bcf per day. The EIA maintains a weekly storage survey, monitoring the injection and withdrawal of stored natural gas. This survey gives a good indication of the status of the natural gas market, measuring the natural gas that is extracted or stored at any one time in response to the demand for natural gas. To learn more about this survey, visit the EIA here. To view more statistics and information related to natural gas storage in the United States, click here. Marketing - The status of the natural gas marketing segment of the industry is constantly changing, as companies enter and exit from the industry quite frequently. As of 2000, there were over 260 companies involved in the marketing of natural gas. In this same year, about 80 percent of all the natural gas supplied and consumed in North America passed through the hands of natural gas marketers. The volume of non-physical natural gas that passes through the hands of marketers is very large, and can be much greater than the actual physical volume consumed. This is an indication of vibrant, transparent commodity markets for natural gas. For instance, in 1998, it is estimated that for every thousand cubic feet of natural gas consumed, about 2.7 thousand cubic feet passed through natural gas marketers. For more information on natural gas and energy marketers, visit the National Energy Marketers Association here. Local Distribution Companies - There are about 1,200 natural gas distribution companies in the U.S., with ownership of over 1.2 million miles of distribution pipe. While many of these companies maintain monopoly status over their distribution region, many states are currently in the process of offering consumer choice options with respect to their natural gas distribution. To learn about the status of distribution restructuring across the United States visit the EIA here. To learn more about natural gas distribution companies and their regulatory structure, visit the National Association of Regulatory Utility Commissioners here. The American Gas Association is also an excellent source for information on LDCs.

Natural Gas Market Overview The nature of the natural gas market is similar to other competitive commodity markets: prices reflect the ability of supply to meet demand at any one time. The economics of producing natural gas are relatively straightforward. Like any other commodity, the price of natural gas is largely a function of demand and the supply of the product.

When demand for gas is rising, and prices rise accordingly, producers will respond by increasing their exploration and production capabilities. As a consequence, production will over time tend to increase to match the stronger demand. However, unlike many products, where production can be increased and sustained in a matter of hours or days, increases in natural gas production involve much longer lead times. It takes time to acquire leases, secure required Natural Gas Volatility and Price Levels at Henry Hub government permits, do exploratory Source: Energy Information Administration, Office of Oil and Gas; seismic work, drill wells and based on Natural Gas Monthly publications connect wells to pipelines; this can take as little as 6 months, and in some cases up to ten years. There is also uncertainty about the geologic productivity of existing wells and planned new wells. Existing wells will naturally decline at some point of their productive life and the production profile over time is not known with certainty. Thus, it takes time to adjust supplies in the face of increasing demand and rising prices. To learn more about factors that affect the supply of natural gas, click here. The supply response to prices was demonstrated emphatically following the winter of 2000-2001 as producers substantially increased production investments and activities in response to higher prices. Likewise higher prices (and the U.S. recession) also reduced demand for natural gas. The supply and demand responses led to a new equilibrium in 2002 between supply and demand at market clearing prices far below the 2000-2001 peak. In an environment of falling gas prices, the converse will be true. Producers will respond to lower natural gas prices over time by reducing their expenditures for new exploration and production. Production decline in existing wells will decrease productive capacity. At the same time, the lower prices will increase the demand for natural gas. This, in turn, will ultimately result in upward pressure on gas prices. This relationship between changes in the price of natural gas and variations in the supply of and demand for natural gas is sometimes referred to as the "natural gas market cycle." In the short term, and in relation to existing producing wells, the supply of natural gas is relatively inelastic in response to changes in the price of natural gas. Contrary to some views, producers do not routinely shut in wells when natural gas prices are low. There are several economic drivers that provide an incentive for producers to continue producing even in the face of lower prices.
Source: NGSA First, if production is halted from a natural gas well it may not be possible to restore the well's production due to reservoir and wellbore characteristics. Second, the net present value of recapturing production in the future may be negative relative to producing the gas today -- i.e., it may be better to produce gas today than to wait until the future to produce the gas. If a producer chooses not to operate a well, the lost production cannot be recovered the next month but is instead is deferred potentially

years in the future. There are no guarantees that the prices for gas in the future are going to be higher than prices today. Third, some gas is produced in association with oil, and in order to stop the flow of natural gas, the oil production must be stopped as well, which may not be economic. Finally, a producer may be financially or contractually bound to produce specific volumes of natural gas.

Producers and consumers react rationally to changes in prices. Fluctuations in gas prices and production levels are a normal response of the competitive and liquid North America gas market. While the price of the natural gas commodity fluctuates, it is this inherent volatility that provides the signals (and incentives) to both suppliers and consumers to ensure a constant move towards supply and demand equality. Because the natural gas market is so heavily dependent on the interaction of supply and demand, it is important to have knowledge of the factors that affect these two components. To learn more about the supply and demand of natural gas in the United States, click on the links below: Natural Gas Demand Natural Gas Supply

The History of Regulation

Regulation of the natural gas industry in the United States has historically been a tumultuous ride, resulting in dramatic changes in the industry over the past 30 or more years. This section will outline the major historical regulatory events related to the natural gas industry, and show how the current structure of the industry in the U.S. is the product of a long regulatory evolution. Today, competitive forces are being relied upon more heavily to determine market structure and operation. However, this has not always been the case. Almost all aspects of the natural gas industry were regulated at one point - a situation which led to tremendous difficulties in the industry, including the natural gas shortages experienced in the 1970s. To learn more about the current regulatory environment, click here.

Source: ChevronTexaco Corporation

This section provides a timeline of important regulatory events regarding the natural gas industry. Click on the links below to skip ahead to later sections: The Early Days of Regulation The Beginnings of Federal Regulatory Involvement The Natural Gas Act of 1938 The Phillips Decision - Wellhead Price Regulation The Effects of Wellhead Price Control - 1958-1978 The Natural Gas Policy Act of 1978 The Move towards Deregulation FERC Order No. 436

The Natural Gas Wellhead Decontrol Act of 1989 FERC Order No. 636

Click here to view a condensed timeline of important regulatory developments. The Early Days of Regulation The regulation of natural gas dates back to the very beginnings of the industry. In the early days of the industry (mid-1800s) natural gas was predominantly manufactured from coal, to be delivered locally, generally within the same municipality in which it was produced. Local governments, seeing the natural monopoly characteristics of the natural gas market at the time, deemed natural gas distribution a business that affected the public interest to a sufficient extent to merit regulation. Because of the distribution network that was needed to deliver natural gas to customers, it was decided that one company with a single distribution network could deliver natural gas more cheaply than two companies with overlying distribution networks and markets. However, economic theory dictates that a company in a monopoly position, with total control over its market and the absence of any competition will typically take advantage of its position, and has incentives to charge overly-high prices. The solution, from the point of view of the local governments, was to regulate the rates these natural monopolies charged, and set down regulations that prevented them from abusing their market power. As the natural gas industry developed, so did the complexity of maintaining regulation. In the early 1900s, natural gas began to be shipped between municipalities. Thus natural gas markets were no longer segmented by municipal boundaries. The first intrastate pipelines began carrying gas from city to city. This new mobility of natural gas meant that local governments could no longer oversee the entire natural gas distribution chain. There was, in essence, a regulatory gap between municipalities. In response to this, state level governments intervened to regulate the new 'intrastate' natural gas market, and determine rates that could be charged by gas distributors. This was done by creating public utility commissions and public service commissions to oversee the regulation of natural gas distribution. The first states to do so were New York and Wisconsin, which instituted commissions as early as 1907. The Beginnings of Federal Regulatory Involvement With the advent of technology that allowed the long distance transportation of natural gas via interstate pipelines, new regulatory hurdles arose. In the same sense that municipal governments were unable to regulate natural gas distribution that extended beyond their areas of jurisdiction, the state governments were unable to regulate interstate natural gas pipelines. Between 1911 and 1928, several states attempted to assert regulatory oversight of these interstate pipelines. However, in a series of decisions, the U.S. Supreme Court held that such state oversight of interstate pipelines violated the interstate commerce clause of the U.S. Constitution. These cases, known as the 'Supreme Court Commerce Clause' cases, essentially stated that interstate pipeline companies were beyond the regulatory power of state-level government. Without any federal legislation dealing with interstate pipelines, these decisions essentially left interstate pipelines completely unregulated; the second regulatory gap. However, due to concern regarding the monopoly power of interstate pipelines, as well as conglomeration of the Interstate Pipelines Spurred Federal Regulation
Source: Duke Energy Gas Transmission Canada

industry, the federal government saw fit to step in to fill the regulatory gap created by interstate pipelines. In 1935, the Federal Trade Commission issued a report outlining its concern over the market power that may be exerted by merged electric and gas utilities. By this time, over a quarter of the interstate natural gas pipeline network was owned by only 11 holding companies; companies that also controlled a significant portion of gas production, distribution, and electricity generation. In response to this report, in 1935 Congress passed the Public Utility Holding Company Act to limit the ability of holding companies to gain undue influence over a public utility market. However, the law did not cover the regulation of interstate gas sales. Click here to view the Public Utility Holding Company Act as it exists today. The Natural Gas Act of 1938 In 1938, the federal government became involved directly in the regulation of interstate natural gas with the passage of the Natural Gas Act (NGA). This act constitutes the first real involvement of the federal government in the rates charged by interstate gas transmission companies. Essentially, the NGA gave the Federal Power Commission (the FPC, which had been created in 1920 with the passage of the Federal Water Power Act) jurisdiction over regulation of interstate natural gas sales. The FPC was charged with regulating the rates that were charged for interstate natural gas delivery, as well as limited certification powers. The NGA specified that no new interstate pipeline could be built to deliver natural gas into a market already served by another pipeline. In 1942, these certification powers were extended to cover any new interstate pipelines. This meant that, in order to build an interstate pipeline, companies must first receive the approval of the FPC. The rationale for the passage of the NGA was the concern over the heavy concentration of the natural gas industry, and the monopolistic tendencies of interstate pipelines to charge higher than competitive prices due to their market power. While the NGA required that 'just and reasonable' rates for pipeline services be enforced, it did not specify any particular regulation of prices of natural gas at the wellhead. To learn more about the Natural Gas Act, click here. The Phillips Decision - Wellhead Price Regulation As mentioned, the NGA instituted no specific regulatory oversight of sales of natural gas from producers to the pipelines: wellhead prices were unregulated. However, in Supreme Court cases during the early 1940s, it was determined that wellhead prices were subject to federal oversight if the selling producer and the purchasing pipeline were affiliated companies. However, the FPC contended that if the natural gas producer and pipeline were unaffiliated, natural market forces existed that would keep wellhead prices competitive.

Phillips - Wellhead Price Regulation

Source: NGSA

In 1954, however, this all changed with the Supreme Court's decision in Phillips Petroleum Co. v. Wisconsin (347 U.S. 672 (1954)). In this decision, the Supreme Court ruled that natural gas producers that sold natural gas into interstate pipelines fell under the classification of 'natural gas companies' in the NGA, and were subject to regulatory oversight by the FPC. This meant that wellhead prices - that is, the rate at which producers sold natural gas into the interstate market - would be regulated much the same as natural gas that was sold by interstate pipelines to local distribution utilities.

The Phillips decision had a complicated and far-reaching effect on the natural gas industry. In regulating wellhead prices, the FPC instituted a traditional 'cost-of-service' rate making determination. This system of setting rates relied on the cost of providing the service, rather than the market value of that service. This meant that prices were set to allow companies to charge prices high enough to cover the actual costs of producing natural gas, plus a 'fair' profit. Where regulating pipelines had been possible with this method due to the relatively small number of interstate pipeline companies, the large number of different natural gas producers meant that regulating producers was an extreme administrative burden for the FPC. Three eras of producer regulation ensued each with its own difficulties, until finally wellhead price control culminated in the natural gas shortages of the 1970s. From 1954 to 1960, the FPC attempted to deal with producers and their rates on an individual basis. Each producer was treated as an individual public utility, and rates were set based on each producer's cost of service. However, this turned out to be administratively unfeasible, as there were so many different producers and rate cases that a tremendous backlog developed at the FPC. For example, in 1959, there were 1,265 separate applications for rate increases or reviews, the FPC was only able to act on 240 cases. Due to this enormous backlog, the FPC in 1960 decided to set rates based on geographic areas. The U.S. was divided into five separate producing regions, and the FPC set rates for all wells in a particular region. The FPC set interim ceiling prices based on the average natural gas contract prices paid during 1959-1960 for a particular area. The FPC intended on using these interim ceiling prices until it could determine a 'just and reasonable' rate that it could apply to all natural gas sales from a particular region. However, the process for determining area wide rates took much longer and was much more difficult than anticipated, and by 1970 rates had been set for only two of the five producing areas. To make matters worse, for most of the areas, prices were essentially frozen at 1959 levels. The problem with determining rates for a particular area based on cost-of-service methodologies was that there existed many wells in each area, with vastly different production costs. By 1974, the FPC had determined that area wide pricing was unfeasible. In an effort to find a system of wellhead price regulation that worked, the FPC adopted national price ceilings for the sale of natural gas into interstate pipelines. Realizing that the prior price ceilings, based on the cost-of-service approach, were much lower than the market value of interstate natural gas, the FPC set a national price ceiling of $0.42 per million cubic feet (mcf) of natural gas. Although this price ceiling doubled the prices that had been set during the 60s, it was still significantly less than the market value of the natural gas being sold. This system of price controls was in place until the passage of the Natural Gas Policy Act (NGPA) in 1978. The Effects of Wellhead Price Controls 1954-1978

All three of these systems of price control discussed above had disastrous effects on the natural gas market in the United States. The artificially low price ceilings that had been set since 1954 had a number of outcomes in the market, coming to bear in the late 60s and 70s. Because the set rates for natural gas were below the market value of that gas, demand surged. The low prices of natural gas, as set by the FPC, meant that consumers were receiving good value for their money. This combined with the oil price surges experienced during the OPEC crisis in the 70s made natural gas an even more attractive fuel. However, at the same time, there was little incentive for natural gas producers to devote the money required to explore for and produce new natural gas reserves. The selling price for natural gas was so low, it simply wasn't worth it for the producers. Producers also saw little incentive to search for new reserves. While the price at which they could sell interstate gas was fixed, the finding and development costs for establishing new reserves was as variable and unpredictable as ever. Producers saw little reason to engage in the exploration of new reserves that would cost more to find than they could be sold for under FPC wellhead price control. However, the FPC only regulated producer wellhead prices for natural gas destined for the interstate market, leaving natural gas sales within the intrastate market relatively free of regulation. So while demand was surging nationwide, economic incentives did not exist for producers to ship their gas across state lines. They could sell it at a much higher price to intrastate bidders. In 1965, a third of the nations proved reserves were earmarked for intrastate consumers; by 1975, almost half of the proved reserves were committed to intrastate consumers. This resulted in natural gas reaching consumers in the producing states, while the consuming states were experiencing natural gas supply shortages. In fact, in 1976 and 1977, many schools and factories in the Midwest were forced to close, due to a shortage of natural gas to run their facilities. Meanwhile, in the producing states, virtually no shortage was felt, due to the thriving intrastate market satisfying natural gas demand in these states. This led to certain 'curtailment' policies, advocated by the FPC and state utility regulators. These policies essentially set a schedule of priority, directing distributors and transporters to curtail supplies to certain customers who were deemed 'low priority'. However, these policies resulted in numerous litigation suits and FPC proceedings that turned out to be extremely complicated and time consuming. Realizing that something must be done at the federal level to reduce the strain of these supply shortages and demand surges, Congress enacted the Natural Gas Policy Act in 1978. The Natural Gas Policy Act of 1978 In November of 1978, at the peak of the natural gas supply shortages, Congress enacted legislation known as the Natural Gas Policy Act (NGPA), as part of broader legislation known as the National Energy Act (NEA). Realizing that those price controls that had been put in place to protect consumers from potential monopoly pricing had now come full circle to hurt consumers in the form of natural gas shortages, the federal government sought through the NGPA to revise the federal regulation of the sale of natural gas. Essentially, this act had three main goals: Creating a single national natural gas market Equalizing supply with demand Allowing market forces to establish the wellhead price of natural gas

This act attempted to accomplish these goals by statutorily setting 'maximum lawful prices' for the wellhead sale of natural gas, as well as breaking down barriers between intrastate and interstate natural gas markets. The FPC, the federal body with regulatory oversight of the natural gas market, was abolished and replaced with another body, the Federal Energy Regulatory Commission (FERC), under the Department of Energy Organization Act of 1977. Under the NGPA, FERC was given jurisdiction over the same areas as the FPC, with the exception of the

import and export of natural gas, which was the jurisdiction of the new Department of Energy. The ceiling prices for wellhead gas set by the NGPA differed from the system put in place under the NGA. Under the NGPA, increased price ceilings were set, intended to provide economic incentives for producers to search for and produce new natural gas. These ceilings and the mechanisms for increasing rates were set out in the statute, rather than relying on an independent body to determine these rates. Under the NGPA, some of the price ceilings that were set, specifically those affecting wellhead sales of new production, were designed to be phased out over a series of years, with the goal of complete deregulation of wellhead prices by 1985. However, the NGPA also dictated that gas brought into production before the passage of the Act would forever be subject to pre-NGPA regulations and price limits. In addition to this new system for rate-setting, and the goal of deregulation of wellhead prices in seven years, the NGPA also served to break down the barriers between interstate and intrastate natural gas. Under the NGPA, FERC was authorized to approve the transportation of natural gas by an interstate pipeline on behalf of intrastate pipelines and local distribution companies avoiding some of the regulatory hurdles that had created such a schism between interstate and intrastate markets. The NGPA was a fundamental first step in deconstructing the regulatory problems that had been created by the NGA. The market response to the provisions of the NGPA included: Pipelines, accustomed to gas shortages in the past years, signed up for many long-term natural gas contracts Producers expanded exploration and production, drilling new wells and using the longterm sales contracts with pipelines to recover their investment Average wellhead prices rose dramatically in the years following the NGPA Prices for end-users increased, but were mitigated by the pipelines, which blended the cost of gas under new contracts with regulated gas under old contracts when selling their bundled product to their customers Price increases led to decreased demand

Thus the NGPA allowed for more competitive prices at the wellhead. However, many members of the industry were unprepared for the corresponding drop in demand. The pipelines, used to the era of curtailment, were quick to sign up for long-term 'take-or-pay' contracts. These contracts required the pipelines to pay for a certain amount of the contracted gas, whether or not they can take the full contracted amount. While the NGPA did spur investment in the discovery of new natural gas reserves, the increasing wellhead price, mixed with the eagerness of pipelines to deliver as much natural gas as possible, led to a situation of oversupply. Where it was necessary to curtail natural gas deliveries in the 60s and 70s due to high demand and low supply, the situation reversed in the period from 1980-85. Rising natural gas prices resulted in the dropping off of some of the demand that had built up when the price for natural gas was held below its market value. The resulting 'oversupply' scenario had a number of effects, including requiring the pipelines to make 'take-or-pay' payments to their suppliers despite no longer needing the amount of natural gas that had previously been contracted. Customers of the pipelines, purchasing a 'bundled' product - including the natural gas itself and the transportation of that gas - lobbied for reduced natural gas prices. In addition, pipeline customers sought the right to purchase their own gas from producers and transport it over the interstate pipelines, instead of purchasing the bundled product directly from the pipelines. To learn more about the Natural Gas Policy Act, click here. The Move towards Deregulation

The Natural Gas Policy Act took the first steps towards deregulating the natural gas market, by instituting a scheme for the gradual removal of price ceilings at the wellhead. However, there still existed significant regulations regarding the sale of gas from an interstate pipeline to local utilities and local distribution companies (LDCs). Under the NGA and the NGPA, pipelines purchased natural gas from producers, transported it to its customers (mostly LDCs), and sold the bundled product for a regulated price. Instead of being able to purchase the natural gas as one product, and the transportation as a separate service, pipeline customers were offered no option to purchase the natural gas and arrange for its transportation separately. Several events led up to the 'unbundling' of the pipelines' product. In the early 1980s, noticing that a significant number of industrial customers were switching from using natural gas to other forms of energy (for example, electric generators switching from natural gas to coal), several pipelines instituted what they called Special Marketing Programs (SMPs). Essentially, these programs, which were approved by FERC, allowed industrial customers with the capability to switch fuels the right to purchase gas directly from producers, and transport this gas via the pipelines. However, SMPs were found discriminatory by the District of Columbia Circuit Court of Appeals in several 1985 cases. The court ruled that SMPs were discriminatory in that no other customer of the pipelines had the ability to purchase their own natural gas and transport it via pipeline. As a result of this, SMPs were eliminated on October 31, 1985. However, the practice of allowing customers to purchase their own gas, and use pipelines only as transporters rather than merchants, was not abandoned. In fact, it became part of FERC policy to encourage this separation by way of Order No. 436. FERC Order No. 436 In 1985, FERC issued Order No. 436, which changed how interstate pipelines were regulated. This order established a voluntary framework under which interstate pipelines could act solely as transporters of natural gas, rather than filling the role of a natural gas merchant. This order provided for all customers the same possibilities that the SMPs of the early 1980s had afforded industrial fuel-switching customers, thus avoiding the discrimination problems of the earlier SMPs. Essentially, FERC allowed pipelines, on a voluntary basis, to offer transportation services to customers who requested them on a first come, first served basis. The interstate pipelines were barred from discriminating against transportation requests based on protecting their own merchant services. Transportation rate minimums and maximums were set, but within those boundaries the pipelines were free to offer competitive rates to their customers. Although the framework established by Order 436 was voluntary, all of the major pipeline systems eventually took part. FERC Order No. 436 had a number of immediate effects, including: Pipelines began offering transportation service to all customers Pipeline customers realized cost savings, in that the spot market prices of natural gas were much lower than the prices offered for natural gas by the pipelines (due to the long term 'take-or-pay' contracts that the pipelines were bound under) The payments necessary under these 'take-or-pay' contracts increased for pipelines, as few customers were willing to purchase higher priced gas from the pipelines Pipelines and producers were often forced into litigation to resolve issues surrounding 'take-or-pay' contracts

FERC Order No. 436 also had a number of longer term effects, including: The transportation function became the primary function of pipelines, as opposed to offering the bundled merchant service A wide variety of natural gas purchasing and transportation patterns and practices

emerged due to the availability of choices to the end user New pricing patterns emerged, known as 'netback' pricing, in which a reasonable price was set at the point of consumption, and that minus the cost of distribution, minus the cost of transportation, gave the 'netback' price to the producer at the wellhead

The movement towards allowing pipeline customers the choice in the purchase of their natural gas and their transportation arrangements became known 'open access'. Order No. 436 thus became generally known as the Open Access Order. While the general thrust of Order 436 was upheld in Court, several problems arose regarding the 'take-or-pay' contracts under which the pipelines were still obliged. Given these problems, and under remand from the D.C. Circuit Court of Appeals, FERC issued Order No. 500 in 1987. This order essentially encouraged interstate pipelines to buy out the costly take-or-pay contracts, and allowed them to pass a portion of the cost of doing so through to their sales customers. The LDCs to which these costs were passed through were allowed by state regulatory bodies to further pass them on to retail customers. However, the open access provisions of Order No. 436 remained intact. Open access to pipelines also spurred the first appearances of natural gas marketers. To learn more about natural gas marketing, click here. The Natural Gas Wellhead Decontrol Act of 1989 As mentioned, under the NGPA, the deregulation of natural gas producers sale prices at the wellhead had begun. However, it wasn't until Congress passed the Natural Gas Wellhead Decontrol Act (NGWDA) in 1989 that complete deregulation of wellhead prices was carried forth. Under the NGWDA, the NGPA was amended and all remaining regulated prices on wellhead sales were repealed. As of January 1, 1993, all remaining NGPA price regulations were to be eliminated, allowing the market to completely determine the price of natural gas at the wellhead. The NGWDA stated that 'first sales' of natural gas were to be free of any federal price regulations. The Act defined 'first sales' as the sale of gas: To a pipeline To a local distribution company To an end user Preceding the sale to any of the above Determined by FERC to be a first sale

Excluded from falling under the definition of a first sale were any sales of gas by pipelines and local distribution companies, including interstate pipelines. FERC Order No. 636 While FERC Order No. 436 made the unbundling of pipeline services possible, the establishment of transportation only services by a pipeline continued to be only voluntary. FERC Order No. 636 completed the final steps towards unbundling by making pipeline unbundling a requirement. Issued in 1992, the Order states that pipelines must separate their transportation and sales services, so that all pipeline customers have a choice in selecting their gas sales, transportation, and storage services from any provider, in any quantity. Order 636 is often referred to as the Final Restructuring Rule, as it was seen as the culmination of all of the unbundling and deregulation that had taken place in the past 20 years. Essentially, this Order meant that pipelines could no longer engage in merchant gas sales, or sell any product as a bundled service. This Order

required the restructuring of the interstate pipeline industry; the production and marketing arms of interstate pipeline companies were required to be restructured as arms-length affiliates. These affiliates, under Order 636, could in no way have an advantage (in terms of price, volume, or timing of gas transportation) over any other potential user of the pipeline. FERC Order No. 636 is the culmination of deregulating the interstate natural gas industry. Distilled to its main purpose, the Order gives all natural gas sellers equal footing in moving natural gas from the wellhead to the end-user or LDC. It allows the complete unbundling of transportation, storage, and marketing; the customer now chooses the most efficient method of obtaining its gas. Order 636 also requires that interstate pipelines offer services that allow for the efficient and reliable delivery of natural gas to end users. These services include the institution of 'no-notice' transportation service, access to storage facilities, increased flexibility in receipt and delivery points, and 'capacity release' programs. No-notice transportation services allow LDCs and utilities to receive natural gas from pipelines on demand to meet peak service needs for its customers, without incurring any penalties. These services were provided based on LDC and utility concerns that the restructuring of the industry may decrease the reliability needed to meet their own customers' needs. The capacity release programs allow the resale of unwanted pipeline capacity between pipeline customers. Order 636 requires interstate pipelines to set up electronic bulletin boards, accessible by all customers on an equal basis, which show the available and released capacity on any particular pipeline. A customer requiring pipeline transportation can refer to these bulletin boards, and find out if there is any available capacity on the pipeline, or if there is any released capacity available for purchase or lease from one who has already purchased capacity but does not need it. To learn more about FERC Order No. 636, click here. To learn more about the structure of regulation as it exists today, and the effect that this regulation has on industry, click here.

The Market Under Regulation

The current regulatory environment in which the natural gas industry operates is much less stringent and relies more heavily upon competitive forces than in the past. The last twenty years have seen dramatic changes throughout the industry, spurred by its everchanging regulatory environment. However, despite the restructuring and deregulation of some portions of the natural gas supply chain, there still exist significant regulatory oversight of the industry in the transportation and distribution of natural gas. This oversight is necessary to ensure that those market participants that possess monopoly power in the industry do not abuse this power or distort the smooth and efficient functioning of the natural gas markets. To jump ahead in this section, click on the links below:
Source: ChevronTexaco Corporation

Overview of Current Regulation Regulation of Distribution FERC - Regulation of Interstate Pipelines FERC Processes Some Important FERC Regulations and Orders

Overview of Current Regulation Under the current regulatory environment, only pipelines and local distribution companies (LDCs) are directly regulated with respect to the services they provide. Natural gas producers and marketers are not directly regulated. This is not to say that there are no rules governing their conduct, but instead there is no government agency charged with the direct oversight of their day to day business. Production and marketing companies must still operate within the confines of the law; for instance, producers are required to obtain the proper authorization and permitting before beginning to drill, particularly on federally-owned land. However the prices they charged are a function of competitive markets, and are no longer regulated by the government. Interstate pipeline companies, on the other hand, are regulated in the rates they charge, the access they offer to their pipelines, and the siting and construction of new pipelines. Similarly, local distribution companies are regulated by state utility commissions, which oversee their rates, construction issues, and ensure proper procedure exists for maintaining adequate supply to their customers. The current regulation of transportation pipelines by the Federal Energy Regulatory Commission (FERC) has designated that interstate pipelines can serve only as transporters of natural gas. In the past, interstate pipelines acted as both a transporter of natural gas, as well as a seller of the commodity, both of which were rolled up into a bundled product and sold for one Source: NGSA price. However, since FERC Order 636, interstate pipelines are no longer permitted to act as merchants and sell bundled products. Instead, they can only sell the transportation component, and never take ownership of the natural gas themselves. Pipelines must also now offer access to their transportation infrastructure to all other market players equally, referred to as 'open access' to the pipelines. This allows marketers, producers, LDCs, and even end users themselves to contract for transportation of their natural gas via interstate pipeline, on an equal and unbiased basis. The current regulatory environment is the product of many years of regulatory evolution. To review the history of natural gas regulation in the United States, click here. This section will focus on the regulation of the natural gas industry by the Federal Energy Regulatory Commission (FERC). FERC has jurisdiction over the regulation of interstate pipelines and is concerned with overseeing the implementation and operation of the natural gas transportation infrastructure. FERC obtains its authority and directives in the regulation of the natural gas industry from a number of laws; namely the Natural Gas Act of 1938, the Natural Gas Policy Act of 1978, the Outer Continental Shelf Lands Act, the Natural Gas Wellhead Decontrol Act of 1989, and the Energy Policy Act of 1992. Because FERC obtains its direction and authority from legislation, it is important to get an overview of important congressional committees and government departments that have jurisdiction over areas affecting the natural gas industry, as well as power to direct the future regulation of the industry. To view links to these committees, departments, and agencies charged with oversight of varying aspects of the natural gas industry, click here. Regulation of Distribution The regulation of local distribution companies has much the same objective as regulation of

intestate pipelines, including avoiding the exercise of market power, protecting customers who rely on their supply of natural gas from a single source (captive customers), and ensuring that the rates and prices set by an LDC are fair and equitable. State regulatory utility commissions have oversight of issues related to the siting, construction, and expansion of local distribution systems. Although these general objectives generally hold across states, there are different processes and regulations in place across the country. For more information on the regulation of natural gas distribution, visit the National Association of Regulatory Utility Commissioners here. Regulation of distribution is currently undergoing a process of change, with the adoption by many states of programs aimed at exploring and instituting retail choice programs. These programs allow natural gas consumers more flexibility in arranging the delivery of their gas, including allowing many customers the option of purchasing their own natural gas, and using the distribution network of their LDC simply to transport that gas. For more information on the status of retail choice programs and unbundling of LDC services across the country, visit the Energy Information Administration here. FERC - Regulation of Interstate Pipelines The Federal Energy Regulatory Commission is an independent regulatory agency charged with the regulation of certain aspects of the energy industry in the United States, including the regulation of natural gas transportation. It was created in 1977 under the Department of Energy Organization Act. Although a government agency, FERC is designed to be independent from any undue political party influence or affiliation, as well as independent from any influence from the executive or legislative branches of government, and industry participants, including the energy companies over which it has oversight. FERC is composed of five commissioners, who are nominated by the President of the United States, and confirmed into office by the U.S. Senate. Each commissioner serves a five year term, and one commissioner's term is up every year. The President also designates one of these commissioners to act as FERC Chariman, who has the responsibility for setting a biweekly commission agenda. FERC operates by majority rule, which means that any Order must be approved by at least three of the five commissioners. FERC also has a significant staff, which is responsible for administrative functions, as well as conducting research and advising the commissioners on important matters. There are approximately 1,150 FERC staff, of which 400 focus on electric industry issues, 325 focus on hydro power issues, and 425 concentrate on oil and natural gas issues. FERC oversees those industries in which member companies have significant market power over their sectors; for example natural gas pipelines are considered 'natural monopolies' due to the fact that in many areas, a single pipeline infrastructure has control over all of the transportation of natural gas to that area. FERC is charged with regulating to ensure that companies do not abuse these monopoly positions; and its regulatory objectives include: Preventing discriminatory or preferential service Preventing inefficient investment and unfair pricing Ensuring high quality service Preventing wasteful duplication of facilities Acting as a surrogate for competition where competition does not or cannot exist Promoting a secure, high-quality, environmentally sound energy infrastructure through the use of consistent policies Where possible, promoting the introduction of well functioning competitive markets in place of traditional regulation Protecting customers and market participants through oversight of changing energy markets, including mitigating market power and ensuring fair and just market outcomes for

all participants In the natural gas industry, FERC regulates the rates and services offered by interstate pipeline companies, as well as certifying and permitting new pipeline construction and some closely related environmental issues. In order to build new pipelines, or expand existing infrastructures, pipeline companies must show to FERC how the new or expanded pipeline will serve the public interest, that it is economically feasible, and that it does not have significant environmental impacts. The certification of new pipeline developments is required under Section 7 of the Natural Gas Act. To learn more about the certification process, visit the FERCs website here. FERC Processes There are essentially two types of issues faced by FERC: making company specific decisions, and making industry-wide decisions. Company specific issues can include applications for rate changes for one company's transmission services, applications for changes in terms or conditions of transportation contracts, and complaints filed by another industry member, including utilities, project sponsors, trade associations, or any other interested party. The process for dealing with a company specific issue is relatively straightforward. An application or complaint is filed (whether it is an application to expand a pipeline, construct a new one, or a complaint concerning unfair rates) to FERC. This filing is publicly posted, so that interested parties may have time to research and develop comments or viewpoints that they believe may help (or serve their purposes) in the decision making process. FERC staff members typically perform an analysis of the matter, and issue recommendations to the Commission. After FERC staff has reviewed the issue, it is time for the Commission to take action. FERC has fairly wide discretion with how it may decide to resolve issues; it may just make a decision without any further procedures, it may hold a trial-type hearing before an Administrative Law judge, or hold a technical conference or 'paper' hearing. Alternate dispute resolution, like mediation and arbitration, may also be used. For minor matters, the power to make a decision may be delegated to a FERC staff member (usually an Office Director). However, whatever the process Source: NGSA used, the Commission has the final say; although FERC decisions may be appealed in the Federal Court of Appeals. Industry wide issues and decisions may be much more complicated than company specific issues. Because issues and regulations that affect the entire industry are being contemplated, the number of interested parties can be very high, and countless opposing viewpoints may exist. It is the job of FERC to consider all different points of view, and issue a decision based on what it believes is the best course of action for the industry in general. FERC first addresses industry wide matters by issuing a Notice of Inquiry (NOI), or a Notice of Proposed Rulemaking (NOPR). Notices of Inquiry are generally intended to indicate that FERC is collecting information, ideas, and opinions regarding a certain matter. Notices of Proposed Rulemaking are generally intended to indicate the proposition of new regulations or policy changes. After issuing a NOI or NOPR, FERC then seeks comments from interested parties; essentially giving industry members, the public, trade associations, and any other interested parties the chance to explain their position to FERC. FERC then reviews and considers these comments before making a final decision. The final outcome of this process could be to issue an NOPR (after issues have been clarified under a NOI) to propose new regulations or policy changes, or to issue new regulations or policy changes (that were earlier proposed under a NOPR), usually in the form of a FERC Order, policy statement, or rulemaking. FERC also has the

option of abandoning the initiative altogether. Important FERC Regulations and Orders There are several important regulations which serve to shape the current regulation of interstate pipelines. Below is a brief description of a few FERC Orders that impacted the way in which interstate pipelines conduct business. This is by no means a comprehensive list of major FERC policy statements and Orders, but instead provide a brief overview of a couple of important Orders. To learn more about recent FERC actions in relation to the natural gas industry, visit FERCs website here. FERC Order 636 - 1992 FERC Order 636 involves the restructuring of interstate pipeline services. The main objectives of this order include: Requiring interstate pipelines to 'unbundle' their service, essentially separating the sale of natural gas from the transportation. Under FERC Order 436, pipeline unbundling was voluntary; Order 636 made it mandatory Allows FERC to issue blanket certificates which allow pipelines to offer unbundled services for firm or interruptible service at market-based rates Allows for abandonment options for interruptible and short term firm transportation, and in certain instances longer term firm transportation services Sets a generic capacity brokering program for pipelines to release excess capacity (which includes setting rate ceilings for the sale of released capacity)

For more information on FERC Order 636, visit the FERC website here. FERC Order 637 - 2000 FERC Order 637 involves the regulation of short term pipeline services, and the regulation of interstate pipelines. Essentially, this order served to address some of the issues that had arisen after six years of operating under Order 636, and revise the regulatory structure in response to increased competition in the natural gas industry, and in the transportation of natural gas. Some important aspects of this order include: Suspended price ceilings for the sale of short term (less than one year) released capacity until September 30, 2002 (to respond to the formation of a significant 'gray market' in the sale of bundled capacity during peak periods by marketers and LDCs that essentially circumvented the ceilings set by Order 636) Changes the regulations regarding scheduling procedures, capacity segmentation, and the penalties imposed on pipelines in order to improve competition and efficiency in the interstate transportation of natural gas Removes economic biases associated with the right of first refusal for pipeline services, while at the same time protecting the ability of captive customers (with no other options for meeting their natural gas supply needs) to resubscribe to long-term transportation capacity Improves the reporting requirements, allowing for more transparency in market pricing and allow for more effective monitoring of the industry

For more information on FERC Order 637, visit the FERC website here. FERC Order 639 - 1999

This order involved the regulation of the movement of natural gas in the Outer Continental Shelf (OCS) of the United States, under the Outer Continental Shelf Lands Act. This order was intended to ensure that the transportation of natural gas from facilities located on the OCS was offered on a non-discriminatory, open access basis. Some important issues in this Order include: The establishment of a regulatory regime for the Outer Continental Shelf that provides for greater market transparency similar to the regulation of interstate pipelines, requiring all Dictates that all gas service suppliers on the OCS are subjected to the same regulatory environment, whether they fall under the jurisdiction of the Natural Gas Act (interstate pipelines) or not Sets reporting requirements for OCS gas service providers, requiring that the provider disclose information regarding the facilities it operates, its affiliates, existing customer contracts or information on its conditions of service and rates charged, although there is currently legal dispute as to whether FERC has the power to demand the reporting of certain sensitive information This allows FERC to ensure that service is non-discriminatory, particularly with respect to affiliates of gas service providers in the OCS region

For more information on FERC Order 639, visit the FERC website here. NOPR - Standards of Conduct for Transmission Providers An important issue currently facing FERC is the regulation of the interaction of transmission providers and their affiliated companies. FERC initiated discussion about the standards of conduct for transmission providers by issuing a Notice of Proposed Rulemaking in September of 2001. This proposed rulemaking deals primarily with standards for transmission providers (including interstate pipelines) dealing with affiliated companies, and the possibility that pipeline affiliated companies may receive preferential treatment, or allow pipeline companies to 'circumvent' certain regulations. Thus FERC intends to develop a clear set of regulations and rules regarding the conduct of transmission providers, particularly in their dealings with affiliated companies. The process for setting standards of conduct for transmission providers gives a good indication of the number and range of interested parties who are concerned with FERC regulation. To learn more about this NOPR, and view the comments that have been submitted by various parties, visit the FERC website here. The regulatory environment in which the natural gas industry operates is constantly changing, with small modifications and company specific issues being dealt with, as well as the institution and modification of broader, far reaching policy objectives and major rulemakings. In order to understand the regulatory forces that affect the natural gas industry, a constant eye must be kept on the status of regulation. To get the most up to date information on current issues facing FERC with respect to natural gas, visit FERC's website here.