SIC 4924
NATURAL GAS DISTRIBUTION



This industry classification is comprised of establishments engaged in the distribution of natural gas to end users. Establishments involved in both the transmission and distribution of natural gas are classified in SIC 4923: Natural Gas Transmission and Distribution.

NAICS Code(s)

221210 (Natural Gas Distribution)

Industry Snapshot

From the years 2000 to 2015, natural gas consumption in the United States is expected to increase 25 to 30 percent (or about 2 percent annually, according to the U.S. Department of Energy). At the turn of the twenty-first century, 70 percent of new homes being built were piped to receive natural gas. The biggest gain in usage, however, is expected to come from electric utility companies that continue to shut down their nuclear energy or coal-burning facilities and convert to natural gas energy.

In 2003 there were over 1,200 local distributing companies (LDCs) in the United States, with control of over 833,000 miles of pipeline. Although many of these companies continue to operate a monopoly within their distribution area, deregulation has begun to take hold in some regions, offering consumers choices in their natural gas purchases by "unbundling" natural gas production, transportation, and distribution into separate activities. According to the Energy Information Administration, as of December 2002, 27 states had no unbundling programs in place, 6 states were completely unbundled, and the remaining states were in the initial phases of separating specific services.

Organization and Structure

Gas utility companies receive their supplies of gas from a transmission system at a transfer point called the "city gate." The utility then delivers the gas through mains and distribution lines to end users in a particular geographic area. There are four traditional classes of gas utility customers: individual residences, commercial establishments, industrial facilities, and electric utilities. There are two types of customers within these classes. "Core" customers require stable amounts of gas on demand because gas is their only source of fuel. "Noncore" gas customers can switch to other types of fuel when gas is unavailable or too expensive. Residential and commercial customers are typical core customers; industrial and electric-generating companies are examples of non-core customers.

LDCs are subject to regulation by state public utility commissions (PUCs). PUCs establish rates for different classes of customers. Prices per unit are typically lower for larger users. In setting rates, PUCs attempt to find an appropriate balance between the different interests of consumers, who want low rates, and company investors, who seek adequate returns on their investments.

In addition to state PUCs, federal regulations also influence the gas distribution industry. In 1992, the Federal Energy Regulatory Commission (FERC) issued its Order 636. Although Order 636 had its most direct impact on the gas transmission industry, it also affected local distribution companies. Its provisions necessitated changes in the way distribution companies arranged for gas purchases, transportation, and storage. FERC's order also permitted pipelines to pass transition costs on to distribution companies.

The natural gas distribution system continues to "unbundle" in a deregulated industry, giving end users more choices than ever over who delivers their gas supplies. Many local distribution companies (often referred to as LDCs or gas utilities companies) saw their largest and most profitable customers switching to alternate gas sources. In some cases, industrial users and electric utilities contracted with pipeline companies to construct direct access to transmission systems and bypass the LDC altogether. In other instances, the customer purchased the actual gas from independent suppliers but continued to buy transmission services from the LDC.

To cope with the changing industry environment, LDCs have begun far-reaching marketing efforts. They have offered services to large industrial users, such as natural gas storage, in attempts to keep profitable customers within the system. They have obtained new industrial customers by promoting fuel switching away from electricity and oil. LDCs have also expanded efforts aimed at increasing demand through the development of new technologies, including vehicular natural gas and natural gas fuel cells.

Background and Development

The nation's earliest gas distribution companies delivered synthetic gas, manufactured from coal, to cities for use in lighting. In the late 1800s, naphtha gas (derived from crude petroleum) replaced coal gas. By the time the first company to distribute natural gas, the Fredonia Gas Light and Water Works Company, was formed in New York, approximately 300 companies were already delivering manufactured gas. Other local distribution companies were formed in the closing years of the nineteenth century. Two examples are Brooklyn Union Gas Company, which was incorporated in 1895, and East Ohio Gas Company, founded in 1898 by the Standard Oil Company. Many early gas distribution companies were owned by holding companies involved in other segments of the natural gas industry. The Public Utility Holding Act of 1935 required large holding companies to divest themselves of their public utility companies.

In 1937, Texas became the first state to require the addition of an odorant in distributed natural gas. Ethyl mercaptan, originally introduced in Germany in 1880, aided in detecting natural gas leaks and provided an early warning system to help prevent disasters. The use of mercaptan and mercaptan blends gave natural gas, a compound that has no inherent smell, a distinctive odor.

During World War II, fuel oil and gasoline rationing led to an expansion of natural gas markets. Production during the war years increased by 55 percent. Natural gas was a key ingredient in more than 5,000 industrial processes and was used as an industrial fuel and in the manufacture of explosives. Natural gas usage continued to increase following the war and from 1945 to 1954 consumption doubled.

To meet demand, local distribution companies purchased gas from an available pipeline that reached their area. The pipeline typically sold the gas at a single price that represented an average of all the categories of gas handled by the pipeline and included charges for transportation and storage. Changes in federal regulations during the 1980s and 1990s required pipelines to "unbundle" their services and offer gas utilities access to gas transmission services separately from gas purchases. As a result, local distribution companies were permitted to buy gas from a variety of sources.

As the gas distribution industry entered the 1990s, residential use accounted for about one-fourth of the nation's natural gas consumption. Because residential use fluctuated according to weather patterns, weather was an important issue. The industry judged "normal weather" as the mean of temperatures experienced over a 30-year period and adjusted its norms every ten years. A "degree day" was defined as a measurement comparing the daily mean temperature to a guide of 65 degrees Fahrenheit. Although the decade began amid a series of years with warmer than average temperatures and a slowed economy, demand for natural gas grew.

Environmental and conservation efforts contributed to increased demand for natural gas. In some instances, state regulatory agencies required electric utilities to use more natural gas and to encourage their customers to switch from using electricity during peak demand periods. Often the preferred replacement fuel was natural gas.

Wisconsin and Vermont required electric utilities to help retail customers shift from electricity as their primary source of energy in instances where switching to fuels would be cost effective. Under the ruling, residential customers with electric heat were offered assistance in converting to other fuels.

Maximizing use of their system's capacity by providing gas to a variety of users is a vital concern to local distribution companies. Gas utilities hoped that improvements in natural gas cooling technologies for uses such as refrigeration and air conditioning would help balance winter and summer demand.

Another concern facing local distribution companies was "bypass." Bypass referred to a process under which natural gas suppliers provided direct sales and service to large users, circumventing the local gas utility. According to bypass proponents, the practice provided an opportunity for customers to shop around for the best gas prices. According to critics, bypass provisions unfairly affected small users, such as residential customers, because the distribution companies lost substantial loads resulting in higher fixed costs being passed on to the remaining customers.

For the nation as a whole, deregulation meant that industries that used a lot of natural gas became more competitive internationally, while consumers paid more of the real cost of the gas they used. Analysts saw the trend toward unbundling as being in the consumer's best interest; an increasing number of companies began to offer unbundled delivery at the residential level as well as at the level of larger customers. In spite of deregulation and other changes, profits among natural gas distributors continued to soar.

As of August 1999, residential end users in 23 states and the District of Columbia were able to purchase natural gas from one of several suppliers but have their local utility company deliver it. These options accommodated roughly 22 million (or 40 percent) of the 55 million households with natural gas service. Between 1996 and 1999, four million residential customers actually switched to a non-utility supplier. According to a December 1998 report published by the U.S. General Accounting Office (GAO), residential customer choice programs resulted in individual savings of 1 to 15 percent on the total gas bill. New York State was a leader in offering customer choice to residential customers, and Ohio made customer choice a state policy. As of 1999, Georgia had the largest number of residents exercising purchase options. The state's largest natural gas utility, Atlanta Gas Light, continued to offer delivery services of natural gas, irrespective of the residential user's purchase source. In 1997, 88 percent of all gas consumed by electric utilities companies was purchased under this option, as was 33 percent in commercial/industrial facilities.

In the early 2000s, the American Gas Association (AGA) estimated that overall natural gas consumption would increase 40 percent by the year 2015. By 2010, the United States was expected to use 30 trillion cubic feet (tcf) annually. In order to accommodate these needs, industry analysts estimated new pipeline costs to be as much as $32 billion, plus another few billion to provide for storage. New England states were anticipated to be the first to require more pipeline construction, as nuclear and coal energy facilities continued to shut down and/or convert to natural gas. The Southeast was also a priority.

According to Pipe Line & Gas Industry 's 1999 interview with Dick Terry, chairman of AGA, residential natural gas customers paid 14 percent less for natural gas in 1997 than they did in 1987. Much of this savings was attributable to "unbundling" and gas utilities' reduction in operating and maintenance costs, down by nearly 2 percent annually between 1990 and 1995. The price drop was more dramatic for the larger users, electric utilities and industrial customers, who paid 17 to 18 percent less.

Other factors have contributed to the steady but consistent growth of the industry. New technology has increased the development of polyethylene piping that can withstand higher pressures, from 100 to 125 psi. Other developments include new devices for detection of natural gas leaks. Overall, the industry spent $4 billion in 1999 for safety, with reportable incidents dropping from 290 in 1988 to 206 in 1998. Finally, in 1999, the Gas Research Institute announced a joint venture with Germany's Karl Weiss GmbH & Company to bring to North America the new "trenchless" technologies for pipeline maintenance (requiring only two digging holes) and to install the curedin-place (CIP) liners to service lines and mains.

Current Conditions

Continuing deregulation remains the most influential factor in the distribution of natural gas within the United States. Prices are no longer regulated; therefore, supply and demand determine the cost of natural gas. Interstate pipeline no longer owns the gas transmitted but serves only as the transportation component of the process of moving natural gas from supply to the end user.

However, LDCs that focus on distribution alone have not taken over local markets as quickly or as successfully as was expected following deregulation. One problem for LDCs is liability for consumers who do not pay their bills. As the last in line from production to transportation to distribution, LDCs are the ones left holding the bill, namely the unpaid bill. Also natural gas distribution makes up just one-third of the energy industry, all of which underwent deregulation. Faced with the challenges of deregulating the entire industry, local areas tended to bypass issues that would successfully implement the separation of transmission from distribution. As a result, most LDCs continued to perform both transmission and distribution functions related to their businesses.

During the early 2000s the energy industry as a whole was significantly disrupted. During 2000 California experienced energy shortages and outages, which were later blamed on poor decisions and greedy policies among several energy providers who stood accused of creating an artificial crisis—or at least negatively contributing to the problem by withholding supply. When Houston-based Enron imploded under allegations of shady accounting practices in 2001, the bottom dropped out of the energy industry. As a result, credit ratings plummeted and investors disappeared, making it difficult for new distributors to enter existing markets, leaving established LDCs with very little influx of new competition.

Industry Leaders

Southern California Gas Co., a subsidiary of Sempra Energy (one of the largest natural gas transmission and distribution holding companies), was the leading LDC, with five million customers. Southern reported 2002 operating revenues of $3 billion. Next was Pacific Gas & Electric Co. (PG&E), which reported four million gas customers in 2002. Although PG&E was considered the largest utility holding company in the United States in 1998, with 4.6 million electric customers in addition to its gas customers, the company suffered significant losses during the California energy crisis and filed for Chapter 11 bankruptcy in 2001. In 2002 PG&E reported a net loss of $874 million on revenues of $12.5 billion, down from a net income of $719 on nearly $20 billion in sales in 1998.

One of the fastest-growing LDCs was Southwest Gas Corporation, exemplary of the unbundled industry's opportunities. Southwest obtains its gas from approximately 70 suppliers then forwards it to 1.4 million end users through its 22,000 miles of transmission and distribution pipeline. Southwest reported 2002 sales of $1.3 billion, resulting in a net income of $44 million.

Other industry leaders were Public Service Electric & Gas, with 1.7 million customers and 2002 revenues of $1.6 billion; Columbia Gas Distribution Company, with 1.4 million customers and 2002 revenues of $1.8 billion; and Nicor, with 1.9 million customers and 2002 revenues of $1.9 billion.

Further Reading

"Association News." Pipeline & Gas Journal, October 1999.

Dukart, James R. "Industry Restructuring: What Happened to Merger Mania?" Transmission & Distribution World, 1 January 2003.

Energy Information Administration. Natural Gas Residential Choice Programs, December 2002, 2002. Available from http://www.eia.doe.gov .

Freedenthal, Carol. "2002 Ends with Questions on Deregulation: A Close-Up Look at the Natural Gas Business." Pipeline & Gas Journal, February 2003, 68.

——. "Energy Deregulation Drives New Changes." Pipeline & Gas Journal, April 2002, 112.

Griffin, Jeff. "Pipeline Growth Potential Viewed With Cautious Optimism." Underground Construction, November 1999.

"Interview with American Gas Association Chairman Dick Terry." Pipe Line & Gas Industry, April 1999.

McDowell, Bruce. "Natural Gas Utilities Deliver Natural Gas—and Broader Choices—to Residential Customers." Pipeline & Gas Journal, November 1999.

Tubb, Jeff, et al. "PG&J's 19th Annual 500 Report." Pipeline & Gas Journal, November 1999.

U.S. Department of Labor, Bureau of Labor Statistics. 2001 National Industry-Specific Occupational Employment and Wage Estimates. 2001. Available from http://www.bls.gov .

U.S. Department of Transportation, BTS. Transportation Statistics Annual Report 1999. Washington, DC: 1999.

Wilkinson, Paul. "From the Ground Up: America's Natural Gas Supply Challenge." National Association of Regulatory Utility Commissioners, February 2003. Available from http://www.naruc.org .



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