The Natural Gas Market: Sixty Years of Regulation and Deregulation

Published by EH.NET (July 2001)

Paul W. MacAvoy, The Natural Gas Market: Sixty Years of Regulation and

Deregulation. New Haven: Yale University Press, 2000. xv + 140 pp. $35

(hardback), ISBN: 0-300-08381-5.

Reviewed for EH.NET by Christopher Castaneda, Department of History,

California State University – Sacramento.

Paul W. MacAvoy has had a distinguished career as a scholar, dean, corporate

board member, and natural gas industry expert. Since 1991, he has been the

Williams Brothers Professor of Management Studies at Yale University.

(Williams is an energy and high-technology firm that currently transports

approximately 16 percent of the nation’s natural gas.) Much, but by no means

all, of MacAvoy’s distinguished career has involved natural gas issues.

In The Natural Gas Market, MacAvoy argues that government regulation of

the natural gas industry benefits no one. The author examines the major

federal regulatory acts imposed during the last sixty years, and he utilizes

econometric analysis to prove that in each case regulation has not provided

consistent benefits to either consumers or industry participants. The real

temporal focus of this treatise, however, is on events following the

nationwide natural gas shortages that appeared first in the late 1960s. Thus,

the book in some ways complements an earlier work MacAvoy, co-authored with

Stephen Breyer, Energy Regulation by the Federal Power Commission

(1974) that examined the regulatory causation of those shortages.

Although The Natural Gas Market is a brief book, it is the capstone of

a career-long studious investigation into U.S. natural gas industry economics.

MacAvoy notes that this book’s origins are found in his Yale doctoral

dissertation written during the late 1950s. Since then, MacAvoy has published

several books and testified before the Federal Energy Regulatory Commission

(FERC) on natural gas issues.

Federal gas industry regulation commenced in 1938 when Congress passed the

Natural Gas Act (NGA). This law authorized the Federal Power Commission (FPC)

to regulate interstate gas pipelines through controls on sales prices and

industry entry. The guiding principle of initial FPC regulation was to protect

consumers by ensuring “just and reasonable” prices and a “fair profit” for gas

companies. It is, in fact, coverage of early regulatory efforts that is the

least developed part of the book. MacAvoy delves neither into the causes nor

reasons for the NGA. The NGA is therefore not presented in historical context.

Rather, it represents here more of a starting point for understanding federal

regulatory administrative powers than highlighting a significant political or

social event. Also, unlike MacAvoy’s argument throughout the latter part of

the book, the very brief discussion of federal regulation from 1938 through

the mid-1950s is not supplemented with tables of historical statistics or

econometric models that estimate prices, production, and supply without

regulation.

The strength of MacAvoy’s book begins with his analysis of regulatory policy

in the 1950s. In 1954, the U.S. Supreme Court’s so-called Phillips Decision

case resulted in the FPC gaining new regulatory power. The FPC acquired

authority to regulate the prices at which producers sold natural gas to

interstate gas pipelines for resale. Previously, the FPC regulated the prices

at which interstate pipelines sold gas but not the price at which they

purchased that gas from producers. This augmentation of the FPC’s

price-setting powers is shown to be, in this work and many others, the single

most important cause of the natural gas shortages that first appeared in the

late 1960s. By further restricting the prices at which producers could sell

their gas to interstate pipelines for resale, the FPC inadvertently removed

the producers’ financial incentive to discover and produce additional gas

supplies. Thus, MacAvoy shows how the FPC’s attempt to restrict prices for the

consumers’ benefit resulted in a declining supply base, market imbalance, and

overall industry dysfunction that resulted in the 1970s shortages.

The shortages prompted government to modify natural gas regulatory policy in

order to stimulate production. A complex series of events led to congressional

passage of the Natural Gas Policy Act of 1978 (NGPA). Basically, the NGPA,

administered by the newly created Federal Energy Regulatory Commission (FERC)

of the Department of Energy, sought to phase out gas price ceilings and

stimulate production to eliminate shortages. The NGPA, as MacAvoy effectively

depicts, was effective in creating a natural gas supply “bubble.” This

oversupply situation created a new problem: pipelines committed to long-term

gas contracts found that these contracts required substantially higher prices

than those in the emerging “spot” market that developed in order to clear the

oversupply.

This new market scenario prompted yet another federal regulatory reaction. In

order to relieve gas pipelines of their long-term, high cost gas purchase

contracts with producers, FERC initiated a new process that ultimately

resulted in eliminating interstate pipelines’ merchant status and replacing it

with a transportation function. Thus, under FERC Order 636 (as well as other

orders leading up to this one), FERC transformed gas pipelines into virtual

common carriers. Industrial and large consumers now contracted directly with

producers for natural gas supply and pipelines for transportation services.

However, FERC has continued to regulate the gas pipelines’ transportation

function.

MacAvoy argues that while this partial deregulation of the natural gas

industry is a step in the right direction, it has not solved the gas

industry’s structural problems. By regulating transportation service prices,

FERC is ultimately restricting growth in overall pipeline capacity. He states

that “By preventing markets from fully using available capacity, FERC

regulation continues to impose rigidities in supply that were inherent in the

merchant contract system of the 1970s and 1980s” (p. 95). Later in the

conclusion, MacAvoy admits that “Gas production and transport is moving toward

long-term supply levels that are likely to be close to those realized if

markets were free of regulation.” (p. 120), but he calls for full deregulation

now in order to benefit from “prices today that are 20 percent less .” (p.

120).

MacAvoy also examines what has become the “missing person” in the deregulated

energy industry. The once highly touted prospect that residential consumers

nationwide would be able to chose their gas supplier in a way similar to that

of long-distance telephone companies has not come to fruition for many

customers. MacAvoy attributes this reality to both consumer indifference and

the fact that individual consumers probably would not realize a significant

benefit from such unbundled services.

MacAvoy’s concise book provides a strong argument buttressed by historical

statistics and econometric modeling that natural gas regulation has not

provided consistent benefits to any segment of the natural gas industry

including consumers. Ultimately, MacAvoy posits that over time an unregulated

gas market will function in the public interest more so than a regulated one.

His thesis is compelling, but it leaves unaddressed the issue of why

government imposed regulation in the first place. MacAvoy has shown that even

a well-intentioned regulatory regime is no match for an unregulated and truly

competitive market in maintaining supply-demand balance and reasonable prices.

Christopher Castaneda is an Associate Professor of History at California

State University, Sacramento and author of several books on the natural gas

industry including Invisible Fuel: Manufactured and Natural Gas in America,

1800-2000 (New York: Twayne Publishers, 1999).