Introduction to the Natural Gas Industry: My how you’ve changed

The natural gas industry has undergone a significant number of changes over the last twenty-five years in order to work its way into its current state. A large percentage of Mines students have not been around long enough to appreciate the impact these changes have had on the industry as a whole. Mines alumni and twenty-five year veteran of the natural gas industry, Jim Krebs, spent some time at Mines explaining the significance of these shifts in the business practices and priorities for companies that are involved and invested in natural gas.

Krebs began by segmenting the industry’s components into upstream, midstream, downstream, and marketing. He defined upstream components as those in charge of exploration, extraction, production, and treating the gas at the wellhead. Midstream covers the parts of the industry which handle gathering, compressing, processing, and treating the gas at sites other than the wellhead. Downstream encompasses intrastate and interstate pipelines and the facilities which store and distribute natural gas. Marketing pertains to selling the gas.

The most noticeable changes to the upstream portion of the gas industry came about when the federal government increased its regulation of the business. Prior to 1954, gas companies were free to charge whatever prices they wished and wellheads were not regulated. However, the Phillips Decision in 1954 gave the Federal Power Commission (FPC) control over wellhead prices and interstate commerce. The FPC was unable to handle the number of natural gas companies already in existence and as a result, they set the prices low enough that the high demand for gas overcame the low supply in interstate commerce. This created curtailments on the pipelines. Intrastate pipelines were not subject to such regulations and hence, did not suffer such problems. When the federal government realized the seriousness of the situation, it passed the Natural Gas Policy Act in 1978, which created new ceiling prices for the industry, a schedule for the deregulation of the price of wellheads, and broke down barriers between interstate and intrastate markets. It also caused pipeline companies to sign new contracts for business, which in turn encouraged other companies to start drilling natural gas reserves, restoring the supply of gas that the public demanded and raised the prices for gas. The other main change which the upstream members of the industry dealt with and benefited from is the increased technology at its disposal. Advances in the areas of seismic surveys, horizontal drilling, and hydraulic fracturing have improved the industry’s ability to drill effectively in varying locations and conditions.

Those operating in the midstream segment of the business have been affected by many factors as well. A large part of this section of the industry involves separating the gas from the natural gas liquids, and as prices over the last quarter century for both of these components has shifted greatly, the companies involved have had to do a great deal of speculation as they tried to figure out how profitable involvement with each component was. Another force of change on this part of the natural gas process was “open access.” Pipeline companies, at one point, were in charge of selling the gas in their pipes to the local distribution companies, but open access “broke up the sales function of the pipelines” and “gave the midstream companies access to potentially more markets for their gas” by connecting them to several different pipelines, according to Krebs. Open access also undid much of the vertical integration of the gas industry which the pipeline companies held prior to these changes, this shifted the force of ownership in the industry.

Downstream companies were more affected by a process known as unbundling that was started by Federal Energy Regulatory Commission (FERC), the successor of the FPC. Unbundling helped break up the vertical integration by removing pipelines from the marketing section of the industry and instead had the companies function more as a transportation service for the gas. The FERC issued two orders separated by a span of several years. The first, Order 436, offered an incentive for interstate companies to voluntarily implement unbundling, while the second, Order 636 mandated the unbundling of the interstate. Unbundling also had the effect of turning the rate structure for prices into a demand-based structure, as costs became heavily dependent on the use of the pipe. Intrastate pipelines became unbundled or remained as they were based on pressures from individual states, as these orders did not apply to them. This new arrangement of the pipeline companies introduced customer choice programs, which allow customers to choose who they buy their gas from.

The marketing segment experienced its greatest changes and growth as a result of unbundling, since the process gave companies an opportunity to buy capacity on the pipelines. Another major change occurred as a result of the failure of Enron, a company that facilitated a platform for buying and selling gas. Many other companies took inspiration from this platform and created similar methods for trading gas. After the failure of Enron, trading gas became more difficult to get involved in, as the failure created a sudden need for relatively difficult-to-obtain credit for such transactions.

The completion of this historical overview brought Krebs to explain the current state of the natural gas business. As he pointed out, prices for natural gas today are fairly low, especially when compared to prices earlier in the industry’s history. Much of the drilling done today with relation to natural gas is motivated more by oil or natural gas liquids than the actual gas itself. However, Krebs remains hopeful for the future of the industry. “Commodities are cyclical,” he said. “Natural gas will be back.” He ended the presentation with an optimistic perspective on the price fluxes of the industry, noting that “the cure for low gas prices is low gas prices.”