Natural Gas Supply Association

805 15th Street N.W., Suite 510, Washington, D.C. 20005

Electricity Restructuring and the Natural Gas Industry

The following questions and answers discuss some of the major issues that will be central to restructuring of the electric industry. They focus on the role of natural gas in electricity production.

Q. Who are the members of the Natural Gas Supply Association?

A. The Natural Gas Supply Association represents integrated and independent companies that produce and market natural gas in the U.S. Established in 1965, NGSA encourages expanded use of natural gas and a regulatory climate that fosters competitive markets.

Q. What stake do natural gas producers have in the restructuring of the electricity industry?

A. Currently, one fourth of all natural gas consumed in the U.S. is used to generate electricity. In the last few years, many analysts have predicted strong growth in gas-fired generation because it is efficient, low-cost, and environmentally preferred. More recently, however, some have warned that the ways in which electricity restructuring occurs could have significant negative consequences both for natural gas demand and for the environment.

Q. Why does the U.S. electricity industry need to be restructured?

A. There are several reasons:

Regional differences in electricity prices distort the marketplace by forcing similarly situated companies to pay widely differing electricity prices--differing costs that are then reflected in their product prices. These differences also create distortions in the international marketplace, impeding U.S. companies' competitiveness with non-U.S. firms.
Electricity subsidies create unreasonable and economically inefficient competition between electricity and competing fuels. Restructuring that includes unbundling of currently bundled services can expose these subsidies and help eliminate them.
Independent power producers (IPPs) have demonstrated that competition can dramatically reduce the price of electricity to end users. The current system, however, prevents many consumers from benefitting from the purchase of this more competitive power.
Restructuring of other regulated industries, such as natural gas, indicates potential major savings to consumers and an increase in industry reliability through increased competition.

Q. Who currently supports electricity restructuring.

A. Typical supporters include organizations in the following categories:

Corporate electricity users and their associations.
Environmental and corporate organizations that support use of renewable fuels.
Consumer groups.
Natural gas industry.
Many federal and state agencies.

Q. Who opposes electricity restructuring?

A. Typical opponents include organizations in the following categories:

The more inefficient electric utilities.
Segments of the electric utility industry that enjoy their current monopolistic position.
Groups that believe competition could increase prices.
Environmental groups that believe that conservation programs could be at risk and that some approaches to restructuring could significantly increase the amount of coal-fired generation, to the detriment of U.S. air quality.

Q. Why do natural gas producers support electricity restructuring?

A. Natural gas producers have traditionally supported increased competition in all areas of the energy industry to ensure that consumers (including themselves) pay rates set by market forces and to prevent energy from becoming a structure inside of which government officials can hide benefit programs that would not otherwise be supported by the public. Support for the restructuring of the electricity industry is a manifestation of this philosophy.

Despite the fact that restructuring is likely to slow the growth of gas-using cogeneration and IPPs, gas producers see long-term increased opportunities for gas generation in a more competitive, market-based electricity industry. Today, gas is the least-expensive form of electricity generation other than hydropower and as such, in a competitive market, is well positioned to gain the lion's share of the new electricity capacity likely to be needed as coal facilities age and as nuclear plants are decommissioned.

Q. Why isn't more gas used today for electricity generation?

A. Reasons include:

Fall-out from the Fuel Use Act remains. Some utilities are saddled with non-gas plants they were forced to build during the time the Fuel Use Act was in effect--a time when natural gas was incorrectly believed to be scarce and when prices were incorrectly believed to be likely to rise to high levels. Today, gas is widely accepted as a reliable resource. However, today's utility executives must in many cases live with the consequences of the long-lived capital investments made in previous eras.
A number of federal environmental laws favor coal-burning at utilities and penalize gas users.
Fall-out also remains from the time when federal regulators established wellhead prices that were higher than the market could bear. Some utility executives continue to believe that gas prices are "volatile," despite contracting practices that today promise gas deliveries at steady rates backed by established financial instruments and the strong reputations of natural gas companies.
Some coal-fired facilities are able to take advantage of special financial provisions available to industries more fully integrated than is the natural gas industry. For instance, mine-mouth coal-fired plants are able to capitalize mining equipment as part of the capitals costs of electricity generation, making them available for the guaranteed return on investment available to utilities. Equipment used to produce natural gas, on the other hand, is not available for such favorable financial treatment.
Most investor-owned electric utilities must pass fuel costs through to customers without making a profit on them; profits are earned primarily on invested capital. This leads utilities to favor coal's high-investment, low-fuel-cost generation, even though the total costs are higher. The same skewed financial structure also leads to current utility "dispatch rules," which favor electricity produced from high-capital-cost coal and nuclear facilities.

Q. Is there enough gas for use in electricity generation?

A. Gas supplies are robust. North America has 100 years'-worth of gas that can be produced by conventional technologies. In addition, gas resources are now being discovered under the salt cap in the Gulf of Mexico and surrounding regions, promising still more conventionally available gas. Thousands of years'-worth of gas is available in North America through higher-cost, developing technologies. And worldwide supplies of gas--currently available in the U.S. as liquified natural gas--are estimated to be considerably larger than worldwide oil supplies.

This is not to say, however, that gas should or could replace coal as the primary fuel for electricity generation in the U.S. Currently, the U.S. natural gas market is approximately 20 trillion cubic feet (tcf) per year; were gas to replace coal in the electricity market, an additional 70 tcf annually would be needed--an upswing that would require huge financial investments unlikely to be in the best interests of the U.S. economy.

That said, however, gas supplies are certainly strong enough to increase significantly the amount of gas used in electricity generation and in fueling technologies such as reburn that help reduce emissions from coal.

Q. What are the states doing to restructure the electricity marketplace?

A. In 1994, California became one of the first states to consider restructuring and developed a blueprint for deregulation; since then, they have moved toward a compromise plan that enjoys widespread support.

Many other states have followed suit. Almost half of all states now have formal considerations of electricity restructuring underway, and most are expected to begin the process within two years. An increasing number of states have launched pilot programs in retail wheeling.

Q. What is the Federal Energy Regulatory Commission doing?

A. The FERC has jurisdiction over wholesale electricity rates. Its Order 888 creates non-discriminatory open access to transmission for wholesale purposes, and its Order 889 creates a structure for electronic information exchange within the industry.

A accompanying FERC Environmental Impact Statement demonstrated that Eastern air quality is expected to decline as a result of restructuring's providing an outlet for currently unused Midwestern coal-fired capacity. FERC reasoned that its actions on the wholesale level would not increase this potential and might, in fact, decrease it, depending on the relative prices of gas and coal. Commissioners have been adamant in stating their belief that environmental problems resulting from general, largely state-controlled electricity restructuring should be handled by the Environmental Protection Agency.

Q. Does NGSA support Order 888?

A. NGSA has serious concerns about the method FERC set up for handling stranded costs, exit fees, which could:

Act as a disincentive to customers to change electricity suppliers, thus rewarding high-cost, inefficient utilities and permitting them to prosper.
Erode the viability of IPPs before the establishment of a fully competitive electricity industry, thus reducing the number of potential competitors.
Give large, politically powerful customers--but rarely smaller ones--the opportunity to negotiate lower rates with utilities--a situation that could parallel the natural gas industry's Special Marketing Programs.

With specific reference to the intersection of natural gas and electricity, exit fees could:

Reduce opportunities for current, lower-cost gas-fired generators to seek new customers in areas with high electricity rates.
Slow or halt the growth of cogeneration.
Undermine the ability of current cogenerators to make efficiency improvements or change operations.
Reduce the potential that gas producers will be able to retain current gas-fired generation customers as their current contracts expire.
Make, in a worst-case scenario, some current gas-using cogenerators susceptible to offers of coal-fired electricity from over-capacity local utilities seeking to renegotiate cogenerators' current PURPA-related contracts.

Q. What federal legislation is being considered?

A. The current Congress has addressed:

Permitting the Department of Defense (DoD) and, by implication, other federal agencies, to procure electricity from sources other than the local utility and to generate electricity at larger sites. Legislation ordered a study of this issue, which has been submitted to Congress.
Removal of the mandate for electric utilities to purchase power from independent power producers (IPPs) as contained in the Public Utility Regulatory Policies Act (PURPA). NGSA led the fight to defeat this as a stand-alone issue and instead ensure that it is addressed only as part of comprehensive electricity legislation.
Comprehensive restructuring. Hearings have been held and some preliminary bills introduced on behalf of various interest groups, including the Electricity Consumers Resource Council (ELCON) and the National Independent Energy Producers (NIEP). Rep. Dan Schaefer's bill is expected this spring.

Q.Should the Public Utility Regulatory Policies Act (PURPA) be retained?

A. Short-term, yes. PURPA created the independent power sector, which is now poised to form the nucleus of electricity competition in a restructured market. Changing PURPA without broad competition in electricity could significantly damage the independent sector of the electricity industry and jeopardize the potential for additional low-cost energy that can result from restructuring. Longer-term, however, producers would likely support PURPA repeal once significantly increased competitive opportunities are in place.

Q. What is the difference between retail and wholesale competition? Is it appropriate to direct legislation and/or regulation to the wholesale market only?

A. Wholesale competition involves the sale of electricity among utilities and other wholesale-eligible customers such as municipalities. Retail competition involves the right of all consumers to procure electricity competitively.

Because of the structure of the U.S. electricity market, wholesale and retail competition will, of necessity, be addressed separately--wholesale at FERC, which has issued Order 888, and retail at the state level. Many analysts believe that, long-term, this division is unworkable if the aim is to create full interstate retail competition that brings maximum benefit to consumers. If 50 separate systems are permitted to exist, the benefits of increased competition are likely to be significantly eroded by the costs of altering business procedures as electricity crosses state lines.

Q. Would conservation programs suffer in a restructured electricity industry.

A. Cost-effective, economically sound conservation programs are likely to remain in place. In addition, in theory, at least, states would retain the power to subsidize inefficient energy conservation programs in which costs exceed benefits. However, competition and unbundling are likely to expose these programs, allowing state officials, consumers, and industrial users to better evaluate the desirability of continuing these programs.

Q. Is federal legislation appropriate given the strong state role in electricity regulation?

A. State jurisdictional issues are important and cannot be ignored. However, reality is that electricity is a commodity that travels in the interstate market and that affects industrial competitiveness throughout the United States. Therefore, some uniformity in rules and regulations needs to be adopted to ensure electricity reliability and non-monopolistic practices. Smaller details within a larger general framework could appropriately be delegated to the states.

Q. How do we increase competition at the retail level.

A. Approaches could include:

Separation of electricity generation, transmission, and distribution.
Competition among utilities for new and existing customers, thus getting rid of the "franchise" concept currently prevalent in the industry.
Competition that includes utilities, independent power producers (IPPs) and others to move electricity to any end user freely and openly across all interstate and intrastate transmission grids.
Competition that permits all consumers to choose their electricity provider.

Q. What are the potential environmental consequences of electricity restructuring?

A. For many years, analysts have seen increased use of natural gas in power generation based on gas's efficiency and low-emissions profiles. In theory, a more competitive electricity industry could speed up the use of new gas technologies.

Within the current regulatory environment, however, it appears that the grandfathering that protects utilities from many emissions limitations will, if unchanged, promote increased coal-burning and decreased gas-burning for electricity generation. The reason is that the Midwest currently has significant amounts of unused coal capacity that has no outlet within specific states. Once the transmission grid is fully open to interstate electricity competition, and as new transmission technologies are put into place that increase the grid's ability to transmit power over longer distances, these overcapacity facilities will be able to sell additional power for little more than the marginal price of coal. In addition, there is speculation that some utilities might bring back on line or sell to private investors a number of currently "mothballed" coal facilities that are not currently counted in general assessments of electricity capacity. Again, these facilities could increase coal use and replace gas use farther east, with negative effects on air quality that move from the Midwest eastward.

Q. What are stranded costs and how should they be dealt with?

A. Stranded costs are investments that cannot be recouped as a consequence of the move to a more competitive industry. These costs can include write-downs of inefficient or unneeded plants, equipment and contracts. While early estimates of these costs in electricity restructuring sometimes exceeded $600 billion, a more realistic estimate has now emerged, so that most analysts now predict stranded costs in the range of $200 billion.

In other industry restructurings, costs have been divided between the affected companies and ratepayers. In the gas industry, estimates are that pipeline stockholders paid about 20 percent of stranded costs, while customers paid 80 percent. The costs to be paid by stockholders and customers in electricity is an issue that is likely to generate considerable public policy debate.

NGSA advocates recovery of stranded costs that were prudently incurred, legitimate, and verifiable. Producers have strong reservations about recovering the costs through exit fees, however.

Q. How could stranded costs affect additional gas use in electricity generation?

A. Stranded costs are likely to slow the movement toward competition because they are such a complex issue to discuss and because so many competing interests are at stake. In addition, they are likely to hide the complete benefits of restructuring from consumers by inflating bills during the recovery period. In an effort to keep consumer costs as low as possible, electricity generators might delay construction of more-efficient gas facilities until the costs of current inefficient facilities are completely amortized. This could retard the speed of growth of gas-generated electricity.

One alarming note in the discussion of stranded costs has been sounded by those who see stranded costs as a way to change the economies of inefficient facilities--obsolete coal facilities, nuclear plants saddled with cost overruns. If these facilities are allowed to recoup the costs of inefficiency by declaring them to be "stranded costs" but at the same time permitted to keep on generating electricity, they would form a competitive structure that could undercut all industry participants--including the largely gas-based independent power production industry--that must recoup costs from ongoing business transactions.

A second alarming note is the potential for stranded cost collection via exit fees to discourage current utility customers from seeking competitive electricity.

Q. How is gas currently used to generate electricity?

A. Gas consumption differs markedly at electric utilities and independent power producers (IPPs). Following are some statistics, based on data from the Energy Information Administration and Edison Electric Institute:

Gas Consumed to Produce Electricity in 1993:

25 percent of gas consumed in the U.S. was used for electricity generation, up from 20 percent in 1988.
Natural gas contributed 13.5 percent of the total U.S. electricity generated.
Natural gas was used to generate 432.2 million megawatt-hours, up from 322.7 million megawatt-hours in 1988.
Natural gas generating capacity was 159,908 megawatts (21 percent of total generating capacity), up from 128,872 megawatts (18 percent of total generating capacity) in 1988.

IPPs in 1993:

Used 1.72 trillion cubic feet of natural gas.
Used gas for 53 percent of total generation.
Generated a total of 327 million megawatt hours.
Had natural gas generating capacity of 27,413 megawatts.

IPPs between 1988 and 1993:

Increased gas consumption by 1,028 billion cubic feet (148 percent).
Increased their share of total U.S. natural gas used for electric generation from 22 percent to 40 percent.
Increased gas-fired capacity from 37 percent to 47 percent.
Increased gas-fired capacity utilization from 64 percent to 72 percent.
Installed gas-fired capacity for 61 percent of total capacity increases, thus increasing total gas-fired capacity by 120 percent.

Utilities in 1993:

Used 2.68 trillion cubic feet of natural gas.
Used gas-fired generation for 9 percent of total utility generation.
Decreased gas-fired capacity utilization from 25 percent to 22 percent.
Generated a total of 2,883 million megawatt hours.
Had natural gas generating capacity of 132,495 megawatts, or 19 percent of their total generating capacity.

Utilities between 1988 and 1993:

Increased gas consumption by 46 billion cubic feet (1.7 percent).
Decreased their share of total U.S. gas consumption from 16.1 percent to 14.5 percent.

Q. What advantages does gas present as a fuel for generating electricity?

A. Gas use for generating electricity contributes to:

A cleaner environment
Electric generators in many regions are under heavy pressure to reduce emissions as a clean-air measure. Large electric plants emit over 90 percent of the nitrogen oxides (NOx) from stationary sources in the Northeast, for instance, complicating the region's compliance with federal ground-level ozone standards (to which NOx is a precursor). Dependence of electric utilities on coal also results in acid rain, air toxic emissions, and particulate problems that are a continuing focus of new federal and state environmental regulations.

In contrast, natural gas combined-cycle facilities produce only a fraction of coal's emissions--typically, less than one percent of the sulfur dioxide and particulates, and 20 percent of the nitrogen oxides.

Efficient energy use
Gas combined-cycle electric generation is 45-50 percent efficient, while coal-generation efficiency levels hover around 30-35 percent. Additionally, coal plants are one-third to twice as capital-intensive as gas plants, primarily because of higher construction and maintenance costs. Thus, even with the higher BTU input price of gas, combined-cycle generators can often produce electricity at a fraction of the cost of coal facilities.

Helping the nation find a satisfactory replacement for nuclear energy
Nuclear energy currently fuels 21 percent of the nation's electric generation, but licenses for 46 of the nation's 109 operating nuclear units will expire by 2015. Chances appear good that gas can replace much of this expiring capacity for reasons that include: 1) public opposition to nuclear power; 2) the unsolved issue of how to dispose of nuclear waste; 3) construction costs: gas-fueled generation construction costs about one-sixth the amount for nuclear construction; 4) profitability: in well-documented case studies, some utilities have found that converting nuclear facilities to gas-burning can turn major money-losers into profitable operations.

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This page was last updated August 31, 1997.