Increasing Competition

Market restructuring promotes growth in US natural gas distribution segment

About 70 million customers consuming 20 trillion cubic feet (tcf) of natural gas per annum in the US depend on the national distribution network for gas supplies. Gas currently accounts for about 22 per cent of the total energy consumed in the US per year, with a customer base of 92 per cent residential units, 7 per cent commercial businesses and 1 per cent large industrial and power generation customers.

About 60 per cent of the natural gas consumed by end-users in the US is delivered by local distribution companies (LDCs) and the remaining 40 per cent is supplied through mainline pipeline systems. Although LDCs still account for almost two-thirds of the total gas supplied to end-users, their share in the market has declined during the past decade due to market restructuring.

Smart Utilities presents an overview of the country’s local gas distribution business and examines the changing role of natural gas distributors in light of various regulatory and operational changes…

Impact of legislative and regulatory reforms on market structure

The role of natural gas distributors in the US has changed significantly over the past two decades as the country’s legislative and regulatory initiatives, along with market forces, have helped create a more competitive end-user market. This can be attributed to the restructuring of pipeline transmission operations in the 1990s and the growing competition between pipeline and local distribution segments for catering to large-volume customers.

A major factor in the reform of the natural gas industry was the notification of the Federal Energy Regulatory Commission (FERC) Order 636 (1992), which mandated the provision of open access transportation and restricted the sale and purchase of natural gas by interstate pipeline companies. This allowed large-volume gas users to buy supplies in an open and competitive market rather than from a single-source pipeline at the interstate level.

The switch to open access suppliers resulted in a reduction in the customer base of LDCs that typically provided bundled sales and delivery services. As part of an effort to minimise such “bypassing” of LDCs, a few states established their own open access programmes that allowed LDCs to formulate policies that facilitated open access.

Natural gas supplies decreased in all end-user sectors in the late 1990s and mid-2000s, except in the power generation sector. The decline in average consumption per user was particularly evident in the residential and commercial user segments, which are the core customers of LDCs and account for over 50 per cent of the natural gas supplies. Moreover, gas volumes delivered by LDCs declined by 16 per cent despite an increase of 8 million (14 per cent) in their user base during 2000-10.

The US natural gas market has transformed over the past decade. While earlier LDCs and pipeline companies operated as both buyers and sellers of natural gas, providing transportation as part of their bundled services, their business and operational environments changed significantly following market restructuring.

The FERC’s Order 636 mandated that the interstate pipeline business should be reorganised from a merchant (sales) business to a transportation-only operation (open access). Moreover, by allowing multiple buyers and sellers of natural gas to sign contracts directly with each other, the monopoly or monopsony position of pipeline operators in the country’s upstream and downstream markets was eliminated. The increasing number of market participants was expected to create a more competitive environment, thereby ensuring higher efficiency and offering lower average natural gas costs to consumers. Open access operations in the interstate market helped stabilise natural gas prices and resulted in streamlining the delivery mechanism.

Although the order is targeted at only the interstate pipeline industry, it has influenced the operations of some intra-state pipeline companies and LDCs. Following the order’s success, the state governments started adopting the open access model for local markets as well. Several states have realised the need for open access transportation that allows large-volume consumers such as industrial and electric power generators to sign contracts with the LDCs for transportation services only.

In addition, the FERC’s order addressed the needs of small-volume customers — residential, commercial and industrial users. “Customer choice” programmes were also implemented by several state regulators and legislatures, or in some cases, the LDCs themselves.

By 2007, at least 23 states had implemented these programmes. These states have mandated most of their LDCs to offer unbundled transportation-only service to residential and small-volume customers.

Market structure and composition

In the US, there are primarily nine types of companies that supply natural gas to one or more end-user groups. However, four types of companies predominate, either in terms of volume delivered or the number of customers served. These include investor-owned LDCs, municipal LDCs, intra-state pipeline companies and interstate pipeline companies.

Investor-owned LDCs

Of the 1,500 LDCs, 260 investor-owned LDCs are currently operational in the US. These companies cater to the majority of the end-users in the US (61 million in 2006). The residential customer segment forms the core market of investor-owned LDCs, accounting for about 35 per cent of their total natural gas deliveries per annum.

The two largest investor-owned LDCs in the country, Southern California Natural Gas Company (SoCal) and Pacific Gas and Electric Company (PG&E), are located in California, each accounting for about 4 per cent of the natural gas delivered to end-users. The Northern Illinois Gas Company  is the third largest, accounting for about 2 per cent of all natural gas supplies.

Several investor-owned LDCs also operate in the north-eastern and mid-western regions of the US. Keyspan Delivery Inc. mainly operates in the eastern parts of New York State, with subsidiaries in Massachusetts and New Hampshire as well. In the mid-west, the states of Indiana, Michigan and Ohio host several of the top 20 (in terms of volumes delivered) investor-owned LDCs such as the Dominion East Ohio Gas Company and the Northern Indiana Public Service Company.

These LDCs operate in service territories that cover large portions of a state. In California, for instance, SoCal serves the entire southern region of the state while PG&E, caters to the northern region. Such dominant players are also present in states such as Texas, Virginia, North Carolina, South Carolina and Arizona, amongst others.

According to latest estimates, the top 20 investor-owned LDCs delivered 5.5 tcf of natural gas to end-users, equivalent to the total gas volumes collectively supplied by the remaining 237 investor-owned LDCs.

On an average, these players supplied about 53 per cent of their deliveries on an unbundled transportation-only basis while the remaining provided 44 per cent. This is due to the fact that 14 of the top 20 investor-owned LDCs operate in states that have implemented customer choice programmes. Investor-owned LDCs adapted quickly to the demands of their customers for more open access transportation service and less single-source sales.

Municipal LDCs

The majority of the local natural gas enterprises operating in the US are government owned. Many of these utilities were formed by small to medium-sized communities that were unable to arrange private investments for developing the local infrastructure required to support their natural gas demand. At present, more than 930 municipal LDCs operate throughout the country.

The four largest municipal LDCs in the country are Philadelphia Gas Works (Pennsylvania), San Antonio Public Service Board’s CPS Energy (Texas), the Memphis Light Gas & Water Company and Citizens Gas (Indiana). The highest number of municipal LDCs is found in the south-eastern and south-western regions of the country. Texas and Louisiana account for about 20 per cent, with 83 and 85 municipal LDCs respectively, followed by Georgia, Tennessee and Alabama that have over 65 municipal LDCs each. Collectively, the 15 states in these two regions account for over 60 per cent of all the municipal LDCs in the US.

Municipal LDCs mainly deliver gas through bundled services rather than transportation-only programmes. The 20 largest municipal LDCs have been delivering only about 25 per cent of their supplies through transportation-only programmes and only 11 per cent of the remaining municipal LDCs use this route to supply gas to end-users.

Although the vast majority of their customer base comprises residential users, this category accounts for only 32 per cent of all municipal LDC deliveries as compared to the industrial sector which accounts for 33 per cent. Several of the top 20 municipal LDCs deliver a significant portion of their supplies to electric power generation companies as well as industrial clients.

Pipeline companies

Mainline interstate and intra-state gas pipeline companies supply 38 per cent of the natural gas distributed to end-users, the majority of which is provided to large-volume users. In several areas, these large gas mainline pipeline systems are the primary suppliers of gas to electric power generation plants. Interstate gas pipelines carried about 35 per cent of the total volumes delivered to these companies during the past 10 years, while intra-state natural gas pipelines, which operate exclusively within a state’s borders, delivered about 30 per cent.

Natural gas pipeline companies account for an increasing share of the total natural gas delivered to gas-fired electric power plants each year, which currently stands at over 40 per cent. The largest US market for natural gas deliveries to power generation facilities is in Florida. Since 2000, the amount of gas supplied to this consumer segment has doubled, which has been made possible by adding pipeline capacity such as the Gulf stream system in 2002. The two largest natural gas pipeline companies in the state are the Florida Gas Transmission Company and the Gulfstream Natural Gas System.

In western US, the El Paso Natural Gas Pipeline Company and the Kern River Transmission Company are the major natural gas suppliers to electric power generation facilities. Nevada is one of the fastest growing state markets which recorded an increase of 36 per cent in consumption levels during 2000-10. Two interstate pipeline companies – the Kern River Transmission Company and the Tuscarora Pipeline Company – overtook the state’s two largest investor-owned LDCs – the Sierra Pacific Company and the Southwest Gas Corporation, in terms of gas deliveries to large-volume customers.

Intra-state pipeline systems also significantly increased their share in the large-volume natural gas market in the region. In California, for instance, the Calpine Corporation’s intra-state CPN Pipeline subsidiary more than doubled its supplies to power generation companies, from 36 billion cubic feet (bcf) in 2000 to 76 bcf in 2010.

In the southwest region, five of the largest intra-state pipeline companies in the US operate in Texas. Kinder Morgan Tejas and Kinder Morgan Texas are the leading companies, accounting for over 22 per cent of the total intra-state pipeline supplies. These two companies mainly cater to large industrial or electric power generation customers.

Conclusion

The US natural gas industry has witnessed significant changes since the early 1990s, triggered by an interstate restructuring of pipeline transmission operations under the FERC Order 636. The order helped promote competition between the pipeline and local distribution segments catering to large-volume customers.

Overall, natural gas deliveries by LDCs have decreased by 15 per cent since 2000 and some of their large-volume customers have switched to mainline pipeline systems. However, LDCs still form the backbone of the natural gas distribution network in the US.

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