Academic journal article Energy Law Journal

Appropriateness of Imposing Common Carrier Status on Interstate Natural Gas Pipelines*

Academic journal article Energy Law Journal

Appropriateness of Imposing Common Carrier Status on Interstate Natural Gas Pipelines*

Article excerpt

I. INTRODUCTION

For every problem there is a simple solution . . . which is usually wrong.

H. L. Mencken1

Natural gas, which has been called a perfect fuel,2 currently is too expensive,3 priced too low,4 in excess supply, but will be in demand in the future.6 Although natural gas has enjoyed a price advantage over alternative fuels,7 natural gas now is more expensive than fuel oil in many parts of the United States8 This has caused a significant problem for interstate natural gas pipelines which find that their markets are eroding at the same time when they must take or pay for large volumes of unmarketable natural gas pursuant to contractual obligations incurred in the middle and late 1970's during the period of natural gas curtailments.9

As a partial solution, some10 have argued that the existing approximately 269,000 mile natural gas pipeline transportation system11 is a barrier to the sale, transportation, and use of natural gas unless that system is converted to one of common, or at least, contract carriage.12 As a result, the Reagan Administration and several members of Congress recently introduced legislation to impose common carrier obligations on interstate natural gas pipelines.13 If this occurred, large end-users of natural gas, such as petrochemical companies,14 as well as local distribution companies, could purchase natural gas directly from producers in the field, compel transportation of the gas to their plants or distribution facilities, and pay, presumably, a lower price than paid presently to their interstate pipeline supplier.15

This Article discusses the various proposals intended to make interstate natural gas pipelines subject to the principles of common carriage. As background, an overview is given of the existing regulatory structure of the natural gas pipeline industry. Second, the history of common carriage and contract carriage is discussed. Third, this Article analyzes past legislative attempts to impose common and/or contract carrier status on interstate natural gas pipelines. The final sections examine current attempts to subject natural gas pipelines to common or contract carriage principles. It is concluded here that imposing common carrier obligations on interstate natural gas pipelines may be appropriate in alleviating certain price distortions but would not be a great benefit to all natural gas consumers because of the established structure of the natural gas industry.

II. THE NATURAL GAS INDUSTRY

Are you gonna get any better, or is this it?

Earl Weaver16

A. The Past

There are three major segments of the natural gas industry: production, transmission, and distribution. Essentially, interstate natural gas pipeline companies act as middlemen, buying natural gas from producers at the wellhead, transporting it, and reselling it directly to large end-users or to local distribution companies,17 which in turn resell it for a variety of end users.18 In addition, several interstate natural gas pipelines also have established their own production affiliates for the purpose of developing their own natural gas reserves19 Interstate pipelines also perform, on a limited basis, contract carriage service, for which they receive the cost of transportation plus a profit20

The federal government's first significant involvement with the natural gas industry was in 1938 with the passage of the Natural Gas Act (NGA)21 The NGA granted the Federal Power Commission and its successor, the Federal Energy Regulatory Commission (Commission)22 the authority to regulate the transportation and sale of natural gas for resale in interstate commerce. The NGA further provided that natural gas pipeline facilities cannot be constructed or abandoned without prior approval of the Commission.23 Further, no rates for natural gas transported and sold for resale in interstate commerce can be charged unless first approved by the Commission.24

Until 1954, the Federal Power Commission essentially regulated only the interstate natural gas companies that resold gas to local distribution companies, i.e., interstate pipelines. The NGA had left ambiguous the question of whether the sale of gas from a producer to the pipeline was a "sale for resale." In Phillips Petroleum Corp. v. Wisconsin,25 however, the United States Supreme Court concluded that the Commission had authority to regulate at the wellhead the sale for resale of natural gas by producers26 The Supreme Court's ruling created an administrative nightmare at the Commission, which subsequently adopted various ratemaking formulas by which it regulated the price of natural gas until 1978.27

What evolved from Phillips was a bifurcated natural gas market. The federal government regulated the price of natural gas destined for the interstate market, while the states left unregulated the intrastate market28 In the late 1960's, when natural gas first became less abundant and demand increased, its price rose. In the interstate market, however, regulation kept the price of natural gas artificially low29 As the price rose in the intrastate market, a two-tiered market resulted. Because natural gas received a significantly higher price in the intrastate market, a surplus developed in that market and shortages were experienced in the interstate market, which included all states in which little or no production took place.30 Thus, in the 1970's, natural gas, which traditionally had been in plentiful supply, was not available in sufficient volumes to satisfy fully the demands of markets served by interstate natural gas pipelines.

The natural gas shortages in the 1970's produced a debate in Congress that resulted in the Natural Gas Policy Act of 1978 (NGPA).31 The NGPA effected several changes to remedy the dual market phenomenon, while abetting the creation of new problems for the 1980's. The NGPA eliminated the preference enjoyed by the intrastate market by imposing the same wellhead price controls on the intrastate market as imposed on the interstate market32 and by imposing a scheme of gradual deregulation for some categories of gas and complete price deregulation for others.33 Essentially, the NGPA created three major categories of natural gas: "high-cost" natural gas34 "new gas"35 and "old gas."36

The NGPA brought significant and unanticipated changes for the natural gas industry. In general, the NGPA is perceived as having accomplished its goal of eliminating a dual market and increasing supplies. Nevertheless, many fault the NGPA for a number of new problems.37 The NGPA has been blamed for affecting adversely interstate pipeline purchasing practices, i.e., onerous take-orpay provisions and above market clearing prices. Prior to the NGPA, interstate pipelines faced lower risks in buying and reselling natural gas than encountered today. Under the NGPA, pipelines are exposed to significant fluctuations in field prices and a concomitant number of market decisions. Pipelines must choose carefully from the various categories of natural gas to achieve a cost-mix acceptable to its customers. Moreover, as the price of natural gas to consumers rises, demand for gas has become much more sensitive. These factors, combined with the recent warmer than normal winters and economic recession,38 have raised questions about the possible reordering of the structure of natural gas industry pipeline industry.

B. Current Issues

The term "market disorder" has been used to describe distortions that have developed in the natural gas market39 After a decade of soaring oil prices and a lesser period of natural gas shortages, a natural gas surplus and declining oil prices are manifest in the early 1980's.40 Like past natural gas shortages which partly resulted from Commission regulation that kept interstate prices at an artificially low level, the present natural surplus also results from federal regulation or "deregulation" under the NGPA. The chief anomaly is that the price of natural gas has increased steadily despite a condition of oversupply. Also, pipeline suppliers seemingly have overlooked lower cost natural gas while acquiring more expensive supplies, including imported liquefied natural gas. All these factors have combined to create a serious and possibly irreversible consequence for the natural gas industry: markets permanently lost to alternate fuels and conservation. When the price of natural gas surpasses that of fuel oil, large industrial and commercial users of natural gas have the ability and incentive to switch to the cheaper fuel, thus exacerbating the current natural gas glut.41

The natural gas oversupply situation creates serious consequences for the industry. First, the diminished market for new gas has caused a sharp decline in natural gas exploration:42 second, smaller independent producers that borrowed heavily in contemplation of sales income that is not forthcoming now may default on these loans. Third, notwithstanding their current oversupply problems, natural gas transmission companies presently have contractual obligations to buy additional supplies which they cannot sell43 or store because they have reached or are close to reaching the capacity of their storage systems.44

At the center of the controversy are two legal issues. First, section 601(c) of the NGPA45 allows interstate pipelines to pass through automatically their cost of purchased gas. Consumer interests forced to pay the higher cost of deregulated gas claim that this passthrough guarantee partially has negated the pipelines' incentive to acquire the lowest cost natural gas. The second major legal issue concerns the contracts that pipelines negotiated with producers of natural gas following the shortages in the mid-1970's. In the sellers' market that followed those natural gas shortages, producers were able to negotiate contract provisions that called for the pipeline to either take natural gas or, even if not taken, pay for it.46 Fundamentally, pipelines may have overestimated their supply needs in light of their experience of having been caught short before. These "take-or-pay" clauses have been the object of much debate because of the oversupply situation.47

Recently, most of the Nation's large natural gas pipeline companies have taken significant efforts to alleviate their oversupply problem and to retain their eroding markets. Several have tried to lower gas purchase costs by modifying long-term contracts with natural gas producers in order to take without penalty natural gas below minimum contractual levels.48 This type of action has not been uniformly welcomed. For example, Tennessee Gas Pipeline Company's emergency gas purchase policy, under which the pipeline attempted to lower costs by reducing purchases to a percentage of contract volumes regardless of contractual terms, was immediately challenged by producers in state and federal courts.49 Other pipelines have undertaken experimental marketing programs in order to sell surplus natural gas.50 Transcontinental Gas Pipe Line Corporation (Transco), for example, has begun a six-month experimental Industrial Sales Program (ISP).51 By the terms of the ISP, Transco has arranged, as broker, to transport portions of surplus gas to eligible industrial customers that have contracted directly with producers for the surplus gas. Another object of the plan is to create a greater supply of lower priced natural gas available to industrial customers in order to keep such industrial users from switching their energy supply to oil.

The Commission has attempted to respond to these problems, but it is constrained by the current statutory framework. In less than eighteen months, the Commission issued policy statements on the "fraud and abuse" issue, the takeor-pay issue, and off-system sales.52 Such policies, however, do not have the effect of law.53 In addition, the Commission recently has issued final rules intended to encourage but not mandate transportation by interstate pipelines of natural gas owned by end-users.54 Therefore, without any Commission power inter alia to mandate common carriage for the natural gas industry, and if specific ad hoc proposals of pipelines are not adequate, congressional action is perceived as being required.

III. COMMON LAW HISTORY OF COMMON CARRIAGE

The knowledge of past times . . . is . . . ornament and nutriment to the human mind.

Leonardo Da Vinci55

A. A Short History of Common Carriage

The common carrier doctrine developed under English common law during the Middle Ages. Although the exact date is not known, the term "common carrier" was first used sometime after 1300. Among the first professions to have the term applied to it were printers and boatmen.56 An earlier reference to common carrier - "aliis communibus cariatoribus" - referred to "the old order of porters and creelmen."57

One of the most important contributions to the common carrier doctrine was made in the middle of the 17th Century by Sir Matthew Hale, Lord Chief Justice of the King's Bench58 In De Portibus Maris, he summarized the law of businesses "affected with a public interest," as follows:

If the king or subject have a publick wharf unto which all persons that come to that port must come and unlade or lade their goods, because they are the wharfs only licensed by the queen,... or because there is no other wharf in that port,... in that case there cannot be taken arbitrary and excessive duties or cranage, wharfage, pesage, and so forth, neither can they be enhanced to an immoderate rate, but the duties must be reasonable and moderate though settled by the king's license or charter. For now the wharf and crane and other conveniences are affected with a publick interest, and they cease to be Juris prirati only.

English courts distinguished between "common callings," or "public employments," and "private employments." These "common" occupations included innkeepers, surgeons, smiths, victualers, ferrymen, carriers, bargemasters, wharfingers, teamsters, taverners, and sheriffs.60 The most striking characteristic of a "common calling" was that it was a profession to serve the public needs. A "holding out" to the general public had to exist for a calling to be common.61 A "common" or "public" business had to observe special duties that other businesses did not.62

The distinction between the private callings-the rule-and the public callingsthe exception-is the most consequential division in the law governing our business relation. In private businesses, one may sell or not as one pleases, manufacture what qualities one chooses, demand any price that can be gotten and give any rebates that are advantageous. All this time in public business one must serve all that apply without exclusive conditions, provide adequate facilities to meet all the demands of the consumer, exact only reasonable changes for the services that are rendered, and between customers under similar circumstances make no discriminations.

In 1710, an English court proclaimed that "any man undertaking for hire to carry the goods of all persons indifferently, ... is, as to this privilege, a common carrier."64 Similarly, in Lane v. Cotton, it was observed:

If a man takes upon him a public employment, he is bound to serve the public as far as the employment extends; and for refusal an action lies, as against a farrier refusing to shoe a horse, against an innkeeper refusing a guest, when he has room, against a carrier refusing to carry goods when he has convenience, his waggon not being full.65

In sum, the essence of common carriage is the duty to serve all a reasonable rate66 and the strict liability for the care of goods entrusted to it.67

Toward the end of the eighteenth century many "common" callings in common law countries ceased to hold that status. The mercantilistic concepts of public interest and common carriage lost favor to laissez-faire economics. These economic principles elevated the institutions of private property and contract and advocated freedom from legal restraints.68

Despite the influence of laissez-faire principles on American economic development, the common carrier doctrine re-emerged in the United States after the Civil War.69 The expansion of the railroads across America led to competitive practices that were abusive to shippers. For example, railroads charged very low rates to eliminate competition. Once a monopoly was established, however, they would raise the rates.70 Consequently, Congress regulated the railroads, making them common carriers, by passing the Act to Regulate Commerce of 1887,7 now known as the Interstate Commerce Act. For the first time, a federal statute incorporated the common law obligations of common carriers.72

Several years before, in Munn v. Illinois,73 the United States Supreme Court upheld an Illinois statute that designated grain elevators as public warehouses. Munn represents the origin in this country of the principle that certain businesses are "affected with a public interest."74 In 1871, Munn arose when Illinois passed a law licensing warehouses and elevators and setting maximum rates for them. Two Chicago elevator owners refused to obtain a license and continued charging rates above the statutory maximum. The Supreme Court upheld the Illinois statute, citing in support Lord Chief justice Hale's work De Portibus Maris.75 The Supreme Court concluded in Munn:

[W]e find that when private property is affected with a public interest, it ceases to be juris privati only. This was said by Lord Chief justice Hale more than two hundred years ago, .. . and been accepted without objection as an essential element in the law of property ever since. Property does become clothed with a public interest when used in a manner to make it of public consequence, and affect the community at large. When therefore, one devotes his property to a use in which the public has an interest, he, in effect, grants to the public an interest in that use, and must submit to be controlled by the public for the common good, to the extent of the interest he has thus created. he may withdraw his grant by discontinuing the use; but so long as he maintains the use, he must submit to the control."

Today, principles of common carriage are found, inter alia, in such industries as rail, motor, air, water, pipeline carriers, and communications.77

B. Contract Carrier - A Form of Common Carnage

At common law the only two classes of carriage recognized were common and private. In Niagara v. Cordes the Supreme Court in 1858 stated:

A common carrier is one who undertakes for hire to transport the goods of those who may choose to employ him from place to place. he is, in general, bound to take the goods of all who offer, unless his complement for the trip is full, or the goods be of such a kind as to be liable to extraordinary danger, or such as he is unaccustomed to convey....

Although a common carrier cannot select its customers, it may limit its service by restricting the nature of the items it transports, as long as it holds itself out to serve that entire class without discrimination.79

In contrast, a private carrier has no duty to serve the public and may accept or reject offers even if it has available capacity to carry the goods.80 A contract carrier also differs from a common carrier in that it provides transportation services subject to contracts with one or a limited number of persons of its choosing.81 The concept of the contract carrier arose in the 1920's in the trucking industry, which was later regulated by the Motor Carrier Act of 1935.82 Certain truck operators, whose services did not fit neatly into either category of common or private carriage, were termed contract carriers because their services were "individual and specialized.83

Most fixed-rate interstate transport systems existing today have common carrier status, at least nominally, and are subject to government regulations. This common carrier status promotes two important goals. First, it ensures equal access to transportation facilities for industries in which production activity and end-use markets are far apart. Second, common carriage regulations prevent ruinous competition between carriers in industries with substantial fixed costs, such as the railroad industry, by granting quasi-franchises for specific routes.

Natural gas pipeline companies, despite characteristics quite similar to other common carriers, have avoided common carrier regulation. Although natural gas pipelines are heavily regulated, they operate as private and contract carriers because they taketitle to the gas that they transport and offer transportation under individualized contracts. The natural gas industry's problems, however, have presented the possibility of imposing common carrier status on natural gas pipelines.

IV. PRIOR LEGISLATIVE ATTEMPTS To IMPOSE COMMON CARRIAGE ON INTERSTATE NATURAL GAS PIPELINES

Power goes to the factor which is hardest to obtain or hardest to replace.

John Kenneth Galbraith84

A. Before the Natural Gas Act

Congress first considered the imposition of common carrier status on interstate natural gas pipelines when it chose in 1906 to regulate oil pipelines as common carriers under the Interstate Commerce Act.85 Although Congress chose not to include natural gas pipelines at that time,86 efforts to impose common carrier status on interstate natural gas pipelines were renewed. On November 3, 1913, the Senate, without debate, passed a bill, S. 3345,87 to amend the Act of 1887 to put companies transporting natural gas by means of pipelines under the control of the Interstate Commerce Commission. The bill's intent was to make these pipelines common carriers as had been done in 1906 with regard to oil pipeline companies. The bill's proponents were motivated by the desire to compel the then federally unregulated pipelines to deliver more gas to the Midwest during the winter.88

In 1914, the House Committee on Interstate and Foreign Commerce held hearings on S. 3345.89 At that time, the issue of common carriage fully was aired, and pipeline interests raised a storm of protest over the Senate's action. Representatives from the industry argued that natural gas pipelines were fundamentally different than oil pipelines because of the nature of natural gas.90 It was asserted that natural gas could not be stored like oil, had to be used contemporaneously with its transportation, and its usage was subject to seasonal peaks. Ultimately, the pipelines' position prevailed over the contention that the "world of gas available" could be brought to market at economical prices if pipelines were common carriers.91

B. Immediately Prior to the Passage of the Natural Gas Act

Although the Congress passed the Natural Gas Act (NGA) in 1938, the Act originated ten years earlier in Senate Resolution 83.92 That resolution authorized and directed the Federal Trade Commission (FTC) to investigate certain aspects of public utility corporations doing an interstate business in electricity or gas.93 The FTC made monthly reports to the Congress for over seven years, making recommendations as to possible legislation to "correct any abuses that may exist in the operation of such holding companies."94 This initial inquiry into the natural gas industry produced a recommendation that the Congress consider imposing common carrier obligations on interstate natural gas pipelines. In a portion of the report filed January 28, 1935, the FTC advised the Congress to:

give consideration to the enactment of legislation declaring all interstate gas pipelines to be common carriers or public utilities subject to Federal control and regulation as to construction, operation, financing, and matters affecting the purchase, shipment, sale, and distribution of natural gas.

Eleven months later, when the FTC submitted its final report including specific recommendations concerning the natural gas industry, no recommendation of a common carrier provision for natural gas pipelines was made.96

In the same year, 1935, Representative Sam Rayburn, Chairman of the House Committee on Interstate and Foreign Commerce, introduced H.R. 5423 for the control and elimination of public utility holding companies.97 Extensive hearings were held.98 Title III concerned the regulation of the natural gas industry, but this title was not reported out of committee. With significant amendments and alterations, however, this Title III ultimately became the NGA in 1938. Sections 303 and 304 of H.R. 5423 imposed a common carrier obligation on natural gas pipelines.99 They provided in pertinent part:

Section 303(a). It shall be the duty of every distributor to furnish natural gas to, exchange natural gas with, and transmit natural gas for any person upon reasonable request therefor; and to furnish and maintain such services and facilities as shall promote the safety, comfort and conveniences of all its customers, employees, and the public, and shall he in all respects adequate, efficient and reasonable.

Section 304. Whenever the Commission after notice and opportunity for hearing finds such action necessary or desirable in the public interest, it may by order direct a distributor to make additions, extensions, repairs, or improvements to or changes in its facilities, to establish physical connection with the facilities of one or more persons, to permit those of its facilities by one or more persons, or to utilize the facilities of, sell natural gas to, purchase natural gas from, transmit natural gas for, or exchange natural gas with one or more other persons. . . . [T]he Commission may prescribe the terms and conditions of the arrangement to be made between such persons, including the apportionment or reimbursement reasonably due to any of them.100

Thus, the original version of the NGA actually contained a comprehensive and extensive scheme to make pipelines common carriers.

During hearings held on H.R. 5423, several witnesses from the natural gas industry opposed the common carrier provision as being unrealistic and unworkable.01 Arguments against imposing a common carrier obligation upon interstate natural gas pipelines attempted to distinguish natural gas transportation from other common carrier enterprises, such as railroads, oil pipelines, and telephones. First, it was argued significant volumes of natural gas could not be stored economically as could oil or freight.102 Rather, natural gas had to be "used as fast as delivered and delivered as fast and only as fast as consumed."103 Second, natural gas transmission companies claimed that they did not hold themselves out to be common carriers, whereas railroads and oil pipelines did.104 Witnesses emphasized that the natural gas industry from wellhead to burnertip was integrated, not by ownership but physically and practically.105 Railroads and oil pipelines, in contrast, were concerned solely with transportation. They neither purchased nor distributed their product. In the early era of natural gas usage,106 however, a natural gas pipeline company usually secured supplies by producing gas itself, or by purchasing it from a production affiliate. It also was involved in the local distribution business. Distributors were sometimes completely dependent on one interstate gas pipeline. Moreover, the pipeline companies viewed the industry as an integrated whole since they designed a sale as a complete unit. Customers had to be assured an adequate supply of gas even on the coldest day. Because of this service obligation, pipeline companies were reluctant to assume solely a transportation function or to rely completely on independent producers for supplies of gas.107

Maintaining a balanced delivery system with adequate but not excess capacity was a difficult task.108 The pipeline companies did not want the added burden of balancing and accounting for volumes of gas that they were ordered to be transported. They feared such an obligation would thoroughly confuse and handicap the growing industry. One witness concluded:

to make natural gas pipe lines common purchasers and common carriers would disorganize the present satisfactory service to the public and increase the cost which in the end must be borne by the consumers.

A common carrier provisions again appeared in 1936 during hearings on H.R. 11662,110 which was introduced after H.R. 5423 died in committee.111 H.R. 11662 had no common carrier provision,112 but at least two witnesses at the hearings were asked to address specifically the issue of natural gas pipeline common carrier status.113 The subcommittee's first witness, the Solicitor of the Federal Power Commission, Dozier DeVane, confirmed at the outset that this bill contained "no provision . . . which gives the Commission the authority to make their [pipelines] take gas...."114 Mr. DeVane also noted that natural gas pipelines were different from railroads, electric utilities, and telephone utilities because the capacity of a pipeline is limited where the capacity of the others is not. He concluded:

if the service of the other community depending on that natural gas requires all the pipe line is able to transport, then, of course, you cannot give gas to a community that may deserve it.

Colonel William T. Chantland, a FTC attorney involved in an investigation of utilities, testified:

The reasons are perhaps not so much against the idea of making the obligation as they are factual, against the legal situation. The Supreme Court has said, of course, very definitely, that you cannot make a person a common carrier by declaring him to be one. The facts are the things which control. And in the natural-gas pipe-line industry the natural-gas pipe-line company carries to a large extent its own gas, whether it is produced by the company or purchased from others, so that a large number of them are outside the field of common carriers.

Although Congress initially considered the idea of treating natural gas pipelines as common carriers, strong advocacy by the pipeline industry dissuaded legislative action.117 Thus, by 1938, when the Natural Gas Act passed, Congress appeared convinced that imposing common carrier status upon interstate natural gas pipelines was not required.

C. Legislation after the Natural Gas Act Affecting Interstate Natural Gas Pipelines

Congressional action with respect to the natural gas industry did not end with the passage of the NGA. Since 1938, Congress, in enacting several statutes, debated the common carrier issue several times, but no current law imposes common carrier status on interstate gas pipelines.

Initially, Congress confronted a problem specifically because it did not make pipelines common carriers. In 1947, Congress amended the NGA to give interstate natural gas pipelines the right of eminent domain."8 The right of eminent domain provides that property may be taken for public use.119 In several states, however, the term "public use" was construed to be limited to local use and, thus, did not include endeavors solely in interstate commerce.120 If a pipeline crossed a state without distributing gas in that state, the pipeline was not allowed to condemn the land necessary to construct the pipeline. Some states expressly denied the right of eminent domain to natural gas companies even though the federal certificate of public convenience and necessity permitted the company to pass through a given area.121 Rail, water, and air carriers were required to be common carriers under federal law, and, as such, had been granted the right of eminent domain by Congress.122 Congress chose not to make interstate natural gas pipelines of common carriers. Instead, it expressly granted them the right of eminent domain.

Congress handled differently the status of natural gas pipelines operating on federal lands. Section 28 of the Mineral Leasing Act of 1920 provided that rights-of-way through public lands would be granted to natural gas pipelines by the Secretary of Interior only "upon the express condition that such pipelines shall be constructed, operated and maintained as common carriers."123 In 1935, Congress expanded the provision by requiring that such pipelines "shall accept, convey, transport, or purchase without discrimination, oil or natural gas produced from Government lands in the vicinity of the pipe-line in such proportionate amounts as the Secretary . . . determine[s] to be reasonable."124 Thus, if a natural gas pipeline company desired to operate on federal lands, it had to agree to assume the burdens of a common carrier and of a common purchaser. The Act did not provide, however, for the regulation of rates charged by such pipelines.

The absence of rate regulation in the Mineral Leasing Act was not challenged until 1941 when a dispute arose between Montana-Dakota Utilities Company, an interstate pipeline operating on federal lands pursuant to the Act, and one of its customers.1 5 That customer, Mondakota Development Company, complained that rates charged by the pipeline for transportation were excessive and discriminatory, and that fair rates should be set by the Commission. In response, the pipeline maintained that its common carriage was not subject to Commission rate regulation. The Commission rejected the pipeline's argument, pointing out that without an obligation to publish and maintain reasonable and nondiscriminatory rates, "the statutory obligation to transport natural gas as a common carrier would be useless."126 The Eighth Circuit upheld the Commission's view, finding that the pipeline was subject to the rate regulation of the Commission.127 The court of appeals further held that the regulatory power of the Commission did not end at the boundary of the public land traversed by the pipeline but extended "over every part of the interconnected pipe line system."128

Later, a different interstate natural gas pipeline argued that the passage of the Natural Gas Act impliedly repealed section 28 of the Mineral Leasing Act. The D.C. Circuit disagreed, finding both statutes to be "fully compatible."129 The court did refuse, however, to allow the Secretary of Interior, after thirty-one years of passive regulation, to attach extensive regulations, including rate regulation, to the pipeline's application for right-of-way in the form of a stipulation.130 The Secretary's authority to regulate pertained only to "the physical aspects of the right-of-way and not to the operation of the pipe line.131 Thus, the court upheld the provisions but significantly constricted the Secretary of Interior's authority to regulate pipelines operating on federal lands as common carriers.132

In 1953, the Congress resolved the uncertain status of natural gas pipelines operating on federal lands by specifically exempting them from section 28 of the Mineral Leasing Act.133 The legislative history of the amendment documented the apparent incompatibility between the characteristics of a natural gas pipeline and its operation as a common carrier.134 Sponsors of the amendment believed that section 28 restricted the capacity of pipelines to serve public needs and, thus, explained that the object of the amendment was to "relieve" those pipelines from the common carrier obligation.135 In 1973 Congress further revised section 28 of the Mineral Leasing Act but left intact the qualified exemption for natural gas pipelines in the Trans-Alaska Pipeline Authorization Act.136

In 1953, Congress also enacted the Outer Continental Shelf Lands Act (OCS Lands Act),137 which gave rights-of-way to oil and natural gas pipelines operating on the Outer Continental Shelf. Section 5 of the OCS Lands Act did not expressly require natural gas pipelines operating in the outer continental shelf to be operated as common carriers, but only created the specific duty to transport or purchase natural gas without discrimination.138 This provision cannot be characterized, however, as a common carrier provision. Congress did not grant the Commission jurisdiction to regulate rates charged by natural gas pipelines operating on the Outer Continental Shelf.139 Section 5 was further amended by the Outer Continental Lands Acts Amendments of 1978.140 The 1978 amendments primarily were with environmental and safety aspects of offshore pipelines.141 Congress did provide specifically, however, that natural gas pipelines granted rights-of-way on or across the Outer Continental Shelf "must provide open and nondiscriminatory access to both owner and nonowner shippers."142 In addition, the 1978 amendments granted the FERC the authority to order a pipeline to expand its facilities to increase its throughput capacity.143

When Congress enacted the Alaska Natural Gas Transportation Act of 1976 (ANGTA),144 it left open the question of whether such a pipeline would be a common carrier. Section 13(a) of ANGTA145 provided only for the equal access by both owners and non-owners to pipeline facilities. The purpose of the section was "to assume that any tariffs applied to the transportation of gas through the system would be equal for owners and non-owners alike."146 Although section 13(a) of ANGTA made no mention of common carrier status, the Commission interpreted it "to mean that Congress wants the Alaskan gas transportation system operated as a common carrier."147 Nevertheless, upon further study of the legislative history of ANGTA, the Commission reversed its original interpretation.148 At issue was whether an Alaskan natural gas pipeline would be burdened with the full panoply of common carrier obligations. The Commission answered in the negative and concluded that capacity could be allocated on a first come, first served basis so long as nonowners were not discriminated against in terms of access and tariffs.149

V. CURRENT PROPOSALS TO CHANGE THE STATUS OF INTERSTATE NATURAL GAS PIPELINES TO COMMON CARRIERS

[A] month of experience will be worth a year of hearings.

Harold Leventhal150

A. Major Federal Legislative Proposals

On February 26, 1983, President Reagan announced that his Administration would seek to decontrol the price of natural gas.151 The next week Secretary of Energy, Donald P. Hodel, unveiled a comprehensive legislative proposal aimed at correcting several problems in the natural gas industry.152 On February 28, 1983, Senator McClure introduced the Administration's bill, the "Natural Gas Consumer Regulatory Reform Amendments of 1983" and it was designated S. 615.153 The bill was referred to the Senate Committee on Energy and Natural Resources, in which extensive hearings followed.154 The identical House version of the Administration's bill, H.R. 1760, was referred to the House Subcommittee on Fossil and Synthetic Fuels for hearings.155

Title IV of S. 615, entitled "Removal of Impediments to Interstate Movements of Gas," would amend the NGPA to facilitate the transportation of natural gas. An important component of Title IV would give the Federal Energy Regulatory Commission the authority to order any interstate pipeline to transport natural gas on behalf of a producer or a purchaser on a contract basis. Section 403 of S. 615 would add the following new section 317 to the NGPA:

SEC. 317. CONTRACT CARRIER AUTHORIZATION.

(a) IN GENERAL - Upon application by a producer of natural gas or by a purchaser of natural gas from a producer, the Commission shall order any interstate pipeline to carry gas under contract between producer and purchaser upon such terms and subject to such conditions as it considers just and reasonable if the Commisison finds that such pipeline has available capacity, that no undue burden will be placed upon such pipeline, that no construction of new facilities would be required, and that such order would not impair the ability of such pipeline to render adequate service to its existing customers. The Commission may implement his section by rule or order.

(b) CONSIDERATION - The consideration for any transportation provided under this section shall be $.05 per million Btu's plus the cost of such transportation, as established by the Commission, unless the Commission has established, by rule, a different rate as just compensation for such transportation. No amount of such consideration shall be required to be credited and flowed back to the customers of such pipeline.156

The contract carrier provision is not unique to the Administration's proposal. The concept has been included in numerous legislative proposals, including several Senate bills.157 The Senate Energy and Natural Resources Committee, after extensive discussion and several mark-up sessions, substituted the contract carrier provisions of one of those bills for those of S. 615 - the "Bradley Amendment."158 The Committee included this amendment in its comprehensive bill referred to the Senate in July 1983.159

The "Bradley Amendment" would empower the Commission and state agencies to order natural gas pipelines to use their excess capacity to transport gas as a contract carrier. The Bradley Amendment is designed to encourage voluntary contract carriage. First, it creates a rebuttable presumption that a pipeline has excess capacity available for contract carriage. If the pipeline voluntarily transports the natural gas, it may receive up to $0.05 per MMBtu over the cost of such transportation. If an interstate pipeline refuses to perform requested transportation service, it must protest to the Commission. Second, if the pipeline protests and the Commission determines that its protest was unreasonable, it may order the pipeline to perform the transportation service at a rate of less than $0.05 per MMBtu. The Bradley Amendment would apply to both interstate and intrastate natural gas pipelines, but it defers to state regulatory jurisdiction over intrastate pipelines if such authority exists. Another distinct feature of the Bradley Amendment makes it difficult for industrial users to disconnect from local distribution companies that have historically served their plants should the industrial user with to connect directly to the pipeline through a contract carriage arrangement.160 The Bradley Amendment also authorizes the Commission to order construction of minor pipeline facilities, but provides that the party requesting such construction shall pay for the facilities and their operation.161

Many other bills addressing the common or contract carriage issue have been introduced in the House of Representatives.162 Several of the proposals limit the impact of such a change by restricting the natural gas available for transportation to volumes freed by a marker-out clause under an existing contract.163 Of significance is section 3 of the "Natural Gas Equal Access Amendments of 1983," H.R. 2182, introduced by Representative Schroeder. It would adopt the concept of contract carriage for natural gets transporters,164 but would create a mandatory transportation obligation for intrastate, as well as interstate, pipelines based on available capacity and upon demonstration of need.165 H.R. 2182's most dramatic innovation is that it would give the Commission authority to require pipelines to add compression and looping facilities to increase capacity.1 6

Despite the variety and scope of hills introduced in the House, the House Subcommittee on Synthetic and Fossil Fuels of the Energy and Commerce Committee considered a new bill for purposes of mark-up.167 The contract carrier provisions of this proposal are less extensive than that proposed by other bills. Only volumes of natural gas freed from contractual commitments would be available for contract carriage.168 If an interstate or an intrastate pipeline declines an offer to purchase natural gas released from an existing contract pursuant to its right of first refusal, such a pipeline must transport those volumes. Thus, if the producer of the natural gas finds a new buyer, the pipeline would be obligated to transport those volumes on a best-efforts basis. Under this proposal, the Commission could order the termination of a transportation arrangement if it determines that the transportation would disrupt existing transmission and distribution systems or would be contrary to the public interest.169 The rate charged for transportation by an interstate pipeline under this section would be either a rate agreed to by the parties or a just and reasonable rate set by the Commission.17

B. State Legislative Proposals

Several states also have addressed the common carriage issue. Foremost has been West Virginia's enactment of a comprehensive utility regulatory reform bill.171 That law significantly alters the way in which local distribution companies and intrastate natural gas pipelines purchase and sell natural gas supplies in the state.172 It includes the following common carrier provision:

The [Public Service Commission of West Virginia] may by rule or order, authorize and require the transportation of natural gas in intrastate commerce by intrastate pipelines, by interstate pipelines with unused or excess capacity not needed to meet interstate commerce demands or by local distribution companies for any person for one or more uses, as defined, by rule, by the commission in the case of:

(1) Natural gas sold by a producer, pipeline or other seller to such person; or

(2) Natural gas produced by such person.

Kansas has considered bills that would make all natural gas pipelines operating within the state common carriers up to their excess capacity if the pipeline had been operating at less than seventy-five percent of its design capacity in excess of two consecutive years.174 The New York legislature passed a bill that would have imposed common carrier status on natural gas utility systems within the state, but the governor vetoed the legislation in August 1983.175 The Illinois Commerce Commission also has proposed a comprehensive "Consumer Access Plan" to Congress calling for an immediate change in the status of natural gas pipelines to common carriers.176

VI. ISSUES AND POLICY CONCERNS

It's lovely to be silly at the right moment. . . .

Horace177

A. Problems and Proposals Revisited: An Analysis

As already observed, natural gas pipelines are both transporters and buyersellers of natural gas. As transporters, interstate natural gas pipelines operate as contract carriers serving natural gas owners, typically industrial users.178 As resellers of the natural gas that they purchase and transport, pipelines are the link between producers and end-users. In this role, pipelines essentially function as brokers17 because they effectively match demand with available supplies.

The NGPA added new complexities and risks to the brokerage function of interstate natural gas pipelines. Prior to passage of the NGPA, the brokerage function entailed relatively few risks. Interstate natural gas pipelines had access to supplies of natural gas at artificially low prices. Consumers seldom balked at the price of natural gas because it was low in comparison to the cost of alternative fuels.

Partial deregulation of the wellhead price of natural gas under the NGPA, however, has increased the number of risks involved in natural gas marketing. As natural gas prices rise and surpass alternative fuel prices, natural gas consumers with fuel-switching capability will attempt to abandon natural gas as an energy source.180 This customer loss creates excess deliverability, and forces pipelines to spread fixed costs among even fewer consumers in the form of higher rates. Natural gas consumers faced with rising prices and producers faced with a market of oversupply have questioned whether pipelines have adequately performed their brokerage function, and support legislation that would allow them to move directly into the market themselves.

Current legislative proposals could resolve these problems in part by making pipelines mandatory "contract carriers" or common carriers.181 Contract carrier proposals would require a pipeline to use its available capacity to transport natural gas owned by others on a pro rata basis at a reasonable rate. Proposed legislation, however, does not contemplate that contract carriage gas would preempt capacity necessary to meet the requirements of the pipeline's customers which purchase natural gas under the contract carriage proposals. Furthermore, the legislative proposals would give the regulatory authority discretion to establish rates for each transportation arrangement.182

Each legislative proposal to alter the present status of natural gas pipelines focuses explicitly or implicitly on the brokerage function. In theory, any party could act as a broker by providing an information exchange, presenting data on potential and available supplies, demand, price, and transportation availability. Currently, as the institutional broker, pipelines execute this function as part of their overall service. There is, however, a cost associated with this brokerage function. Certain economies of scale favor the pipeline broker who, in making hundreds of separate purchases and sales in a year, has accumulated knowledge that lowers the cost of additional brokerage transactions.183 Pn addition, because large interstate pipelines deal with such large volumes of natural gas, they have flexibility to create both sale and purchase packages to meet a natural gas purchaser's needs even though these needs do not match identically with a particular producer's supply. If others were to perform the brokerage function, they would necessarily encounter costs that would be passed on to the end-user. The legislative proposals to establish common carriage for interstate pipelines, therefore, raise the issue of whether a new brokerage system would cost more or less than the present system.

Proponents of common carriage claim that such systems would create freer access to the marketplace, and promote competition that would benefit everyone.184 They contend that because producers and end-users would receive market signals directly, the market would function more effectively. Producers and some pipelines also contend that certain producing areas should not become the exclusive supply preserve of one or two pipelines. Although monopsony power of pipelines over producers does not now appear to be a widespread problem,18 common carriage could assure that one interstate pipeline would not dominate a production area.

Large industrial users of natural gas generally favor common carriage proposals,186 believing they would be able to secure a constant supply of natural gas at lower prices.187 Although large end-users may purchase relatively inexpensive natural gas in the current surplus market, they are unable to have the gas transported to their plants because their pipeline-suppliers would rather sell their own supplies of more expensive gas. For example, a large ammonia plant, which attributes 85% of its operating costs to natural gas, predicts that it could ensure profitability by acquiring low-cost gas directly from the producer and compelling transportation under a common carriage structure.188 Distribution companies also contend that they could lower the cost of natural gas to their consumers under a common or contract carriage system.189 In contrast, greater access to producers for distribution companies and other end-users will put pipelines at risk of losing significant sales.190 Common carriage is likely to increase competition and reduce wellhead supplies and demand at the pipeline's points of resale.

Proponents of common carriage must be aware, however, that certain costs and risks will attend their entry into the marketplace. First, there is an undefined cost of brokerage. Most natural gas consumers are not suited to find, assess, and purchase adequate supplies of natural gas. They will be at a further disadvantage when the current natural gas surplus no longer exists. second, those most skilled at locating and contracting for low-cost gas may command a premium in the marketplace because the supply of lower priced natural gas is limited. One class of consumers, such as large well-financed industrial users, may then develop significantly better resources than another class, such as local distribution companies, and new inequities may develop. For example, residential consumers who are served by local distribution companies may be forced to pay even higher prices than are currently charged.191 Third, there will be the additional costs for transportation. Fourth, and perhaps most importantly, an end-user may find it impossible to acquire production and reserves that match its particular requirements. For example, a gas well's production generally cannot be tailored to meet precisely the operations of an industrial plant's usage, which fluctuates according to production schedule-time of day and days of week.

In summary, legislatively mandated contract carrier status could provide assistance in resolving the current market disorder. This alone, however, will not solve or even address all the problems in the natural gas industry. Mandated contract carriage or common carriage will remove artificial barriers to competition in the marketplace. Greater access to supplies and competition, however, will not guarantee a significant reduction in natural gas prices.

B. Specific Legislative Issues

In addition to the general policy question of whether to impose common carrier obligations on natural gas pipelines, Congress must consider important issues raised by different proposals. First, it must consider the administrative aspects of mandating contract carriage for natural gas pipelines. A second concern is a determination of fair compensation for pipelines compelled to transport natural gas. Third, Congress must decide what authority the Commisson will have over intrastate pipelines. Finally, Congress must consider the effect that the imposition of common or contract carrier status will have on local distribution companies.

1. The process of obtaining mandated contract carriage

Mandatory contract carriage proposals generally vest the Commission with the authority and discretion to order interstate pipelines to transport natural gas as a contract carrier. The administration's proposal (S. 615) provides that upon petition to the FERC, the Commisson could order transportation only if it found that: (1) the pipeline had available capacity; (2) "no undue burden" would be placed on the pipeline; (3) no construction of new facilities would be required; and (4) the transportation would not impair the ability of the pipeline to render adequate service to its existing customers.192

Under the Administration's proposal, the party requesting transportation service must persuade the Commission that all four factors are met. Other bills have placed the burden of demonstrating lack of capacity on the pipeline.193 During mark-up of S. 615, the Senate Energy and Natural Resources Committee substituted the Bradley Amendment for S. 615's common carriage proposal, placing the burden of demonstrating lack of capacity on the pipeline, and modified S. 615's four-factor test.194 The Bradley Amendment created a presumption that a pipeline had excess capacity and an explicit requirement that parties negotiate in good faith for use of that capacity before coming to the FERC. Thus, the Bradley Amendment encourages voluntary contract carriage, reducing the administrative burden on the Commission, Rather than mandating a full hearing, the Bradley Amendment establishes a pipeline protest procedure in which the pipeline can demonstrate that if it rendered the requested service, the pipelines' other customers would not be adequately served or that the seller or purchaser did not negotiate in good faith with the pipeline. Finally, the Bradley Amendment mandates expeditious treatment of the protest within ninety days.19

A related issue is mandatory construction of new facilities, which some new transportation agreements might necessitate. For example, the Administration's proposal precludes the transaction if it requires construction while other bills give FERC authority to order extensive construction of facilities.196 The Bradley Amendment provides that the Commission may order construction of only minor facilities not involving substantial costs that are necessary for contract carriage transportation if the person requesting the transportation and subsequent construction pays for its cost and operation.197

2. Compensation

If Congress compels natural gas pipelines to render transportation service, Congress must ensure fair compensation for this service. Compensation should be sufficient to furnish an incentive for pipelines to provide the service. Some proposals have suggested a fixed rate plus the cost of transportation,198 while other bills allow for only a "just and reasonable" rate. " The Bradley Amendment merges the two approaches. The Bradley Amendment would entitle pipelines that voluntarily agree to transport contract carriage volumes to "an incentive allowance of up to $0.05 per million Btu's (in excess of the just and reasonable rate for such transportation as established by the Commission)" unless the Commission determined that another amount is reasonable.200 If the pipeline is performing the transportation upon the Commission's order, the Commission will determine the just and reasonable rate for transportation, not to exceed $0.05 MMBtu. The nickel per MMBtu should provide adequate incentive for pipelines to accept contract carriage voluntarily, even in a situation in which more than one pipeline is involved in the transportation and the nickel is divided.201

3. Commission jurisdiction over intrastate pipelines

The Commission presently has no jurisdiction over intrastate natural gas pipelines,202 even though they are an important component of the nation's natural gas transmission system. Only a portion of the total number of natural gas wells are connected directly to interstate natural gas pipelines, so in a mandatory contract carriage arrangement, an intrastate pipeline might be required to complete the transaction. A comprehensive common carriage bill, therefore, should grant a governmental body authority to order an intrastate natural gas pipeline to provide common carrier service.

Commission jurisdiction over intrastate pipelines, however, may create a conflict with state regulatory agencies. Some bills do not encompass intrastate natural gas pipelines, and other bills have treated both classes of pipelines identically.20 The Bradley Amendment provides that an application for intrastate pipeline contract carriage must first be filed with the appropriate state agency.204 Only if the state agency does not act within a "time certain" could the Commission order the intrastate pipeline to haul the subject natural gas. The Commission also has limited jurisdiction over intrastate pipelines for the purpose of establishing an equitable transportation rate for common carriage transactions.205

4. Local distribution company load loss

Local distribution companies sell and deliver gas directly to end users that are not connected to interstate pipelines. State or municipal public service commissions generally regulate distributors as public utilities and apportion fixed costs among their various customers, which include both large commercial and industrial users and residential customers. If a large user of natural gas leaves a distributor's system, the remaining customers must absorb that portion of the distributor's fixed costs of operation through increased rates.

The Senate Energy and Natural Resources Committee has proposed adopting the concept of historical service to prevent load loss problems for distribution companies.206 The Committee concluded that an industrial user has been "historically served" if it received natural gas from a local distribution company after January 1, 1980. If a pipeline has been historically served, it must acquire contract carriage volumes through its local distribution company, unless: (1) the facility's volume of gas to be transported exceeds its average annual deliveries within four years prior to the date of enactment; (2) the facility was not in existence prior to date of enactment; (3) the facility has a direct purchase contract with an interstate pipeline; or (4) the facility attempts unsuccessfully for three years following the date of enactment to have the local distribution company transport its contract carriage volumes.207

Another issue involved in the load loss amendment is the potential conflict between the jurisdiction of state public service commissions and FERC. The Committee's proposal authorizes FERC to order a local distribution company to perform contract carriage transportation only if the state commission has no jurisdiction over the local distribution company under state law and fails to act within a "time certain." If, however, the state commission's final action results in no transportation service, the FERC finds that the action was arbitrary, capricious, or an abuse of discretion, FERC may then order the requested transportation.208

Large industrial users of natural gas that decide to depart for a limited time from the local distribution company's system still face two significant hurdles. First, the transaction must receive a certificate of public convenience and necessity from FERC.209 Second, industrial customers do not have the right of eminent domain to facilitate a direct connection to a pipeline.210 These legal obstacles, their expense, and the expense of constructing a new line reduce the likelihood that industrial customers historically served by distribution companies will wish to leave that system.

CONCLUSION

[T] he final enemy is not chaos, but organization ....

Trevanian211

The issue of mandatory contract or common carriage status for interstate natural gas pipelines is not new. Recent legislative proposals echo earlier proposals that were never enacted. Rejection of those earlier legislative proposals, however, does not mean that the present ones are inappropriate. The appropriateness of imposing contract or common carriage on natural gas pipelines at this time must be assessed by determining how effective a new status for interstate pipelines will be in achieving significantly lower prices for consumers.

The reduction of natural gas prices as a result of congressionally imposed common carrier obligations on interstate natural gas pipelines is unlikely because of institutional factors in the natural gas industry. These factors include the history of dealings between producers and interstate pipelines, the personal relationships between sellers and buyers, the proximity of pipelines and gathering systems to production, and the ability of pipelines to buy large volumes of natural gas over a sustained period from several different production areas. In contrast, consumers, such as large petrochemical companies or distribution companies, generally have none of these advantages or the in-house ability to assess independently such questions as the deliverability rates, reserve life, or quality of the natural gas offered for sale. In addition, gas may not be available in the right location, and transportation costs paid to a network of interstate pipeline companies may eliminate any price advantage that the consumer might have gained from a direct purchase from a producer.

On balance, common carrier obligations, if imposed on all interstate and intrastate pipeline companies, should be mandated by Congress because it would give large consumers decisionmaking flexibility and an alternative to being captive of a single supplier for its fuel or raw material. Thus, common carriage would introduce new elements of competition into the natural gas industry. Common carriage contains certain risks and costs for the end-user of natural gas which seeks to establish contract carriage service, but it may yield favorable results. In practice, a common carriage requirement for natural gas pipelines may result in lower rates for certain consumers because pipelines may be compelled to reduce rates in order to deter customers from buying gas directly from producers.

[Author Affiliation]

William A. Mogel** John P. Gregg***

[Author Affiliation]

** B.A., cum laude Hobart College 1963; L.L.B. University of Pennsylvania 1966; Member of the District of Columbia and Maryland Bars; Partner, Ross, Marsh & Foster, Washington, D.C.; Adjunct Lecturer, The Washington College of Law, American University; and Editor-in-Chief, Energy Law Journal.

*** B.A. Hobart College 1979; J.D., The Washington College of Law, American University 1982; Member of the District of Columbia Bar; Associate, Ross, Marsh & Foster, Washington, D.C. The authors acknowledge the contribution by Marilyn Anderson, a student at George Washington University Law School.

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