Financing the Natural Gas Industry: The Role of Life Insurance Investment Policies 9780231882293

Table of contents :
PREFACE
CONTENTS
TABLES
CHARTS
Chapter 1. INTRODUCTION
Chapter 2. ECONOMIC TRENDS IN NATURAL GAS
Chapter 3. NATURAL GAS FINANCING IN THE PREWAR PERIOD
Chapter 4. LIFE INSURANCE INVESTMENTS IN NATURAL GAS BONDS DURING THE POSTWAR PERIOD
Chapter 5. PROMOTION AND FINANCING OF TEXAS EASTERN TRANSMISSION CORPORATION
Chapter 6. PROMOTION AND FINANCING OF TRANSCONTINENTAL GAS PIPE LINE CORPORATION
Chapter 7. CONCLUSION
NOTES
Appendix. Quality Ratings of Public Utility Bonds Purchased by New York Life Insurance Company, Phoenix Mutual Life Insurance Company, and Teachers Insurance and Annuity Association, 1947–56
BIBLIOGRAPHY
INDEX

Citation preview

Financing the Natural Gas Industry

Number 602 COLUMBIA STUDIES IN THE SOCIAL SCIENCES Edited by the Faculty of Political Science of Columbia University

Financing the Natural Gas Industry T H E ROLE OF LIFE INSURANCE INVESTMENT POLICIES

by Richard W. Hooley

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C O L U M B I A UNIVERSITY PRESS, N E W YORK, 1961

T h e Columbia Studies in the Social Sciences (formerly the Studies in History, Economics, and Public Law) is a series edited by the Faculty of Political Science of Columbia University and published by Columbia University Press for the purpose of making available scholarly studies produced within the Faculty.

Copyright © 1958 Columbia University Press, New York First published in book form 1961 Published in Great Britain, India, and Pakistan by the Oxford University Press London, Bombay, and Karachi Library of Congress Catalog Card Number 61-10548 Manufactured in the United States of America

For J. W . H. and Α. Β. H.

PREFACE

T H I S VOLUME is concerned with the methods used to finance the rapid expansion of the natural gas industry during the last quarter century. Much of the basic material was originally presented as a doctoral dissertation at Columbia University in 1958. T h e present volume is revised throughout, and a number of sections have been rewritten to clarify the nature and extent of the financial innovations adopted by the industry, as well as some implications of these changes for the functioning of the capital markets.

T o attempt to list my vast obligations in writing this book would serve no useful purpose. Yet I wish to acknowledge a debt of special gratitude to a number of persons: to Professor James C. Bonbright, who read the manuscript at several stages and contributed thoughtful suggestions and incisive comments; to Professor Arthur F. Burns, who read and commented in detail on a final draft of the manuscript; to Daniel Parson of the American Gas Association and Franklin Thomas of the National Association of Insurance Commissioners, who were kind enough to read portions of the manuscript dealing with their respective fields. In analyzing the significance of changes in institutional investment policies, I received invaluable assistance from numerous discussions with several of my former associates, especially Grant Martell of the New York Life Insurance Company, Lyndes Stone and Chan Ryder of the Phoenix Mutual Life Insurance Company, and Paul Medow of Rutgers University. T h e study was greatly facilitated by the cooperation of private concerns engaged in the insurance and natural gas industries, which supplied the author with an enormous amount of unpublished material including over two hundred conformed copies of loan agreements, bond indentures, contracts, etc. T h e final work however, is the sole responsibility of the author. RICHARD W .

HOOLEY

CONTENTS

1.

INTRODUCTION

1

2.

ECONOMIC TRENDS IN N A T U R A L GAS

5

3.

N A T U R A L G A S FINANCING IN THE P R E W A R PERIOD

4.

L I F E INSURANCE INVESTMENTS IN N A T U R A L G A S BONDS DURING THE POSTWAR PERIOD

5.

46

PROMOTION AND FINANCING OF T E X A S EASTERN TRANSMISSION CORPORATION

6.

85

P R O M O T I O N AND FINANCING OF T R A N S C O N T I N E N T A L GAS P I P E L I N E CORPORATION

7.

26

126

CONCLUSION

158

NOTES

171

APPENDIX

201

BIBLIOGRAPHY

213

INDEX

217

SYSTEM M A P : T E X A S EASTERN TRANSMISSION CORPORATION AND TRANSCONTINENTAL

GAS PIPE

LINE

CORPORATION

86-87

TABLES

1. Share of Four Leading Financial Intermediaries in Domestic Corporate Bonds Outstanding at Selected Dates, 1900-1952 2. Changes in United States Mineral Energy Production, 1946-57 3. Proved Natural Gas Reserves in the United States, 1925-58 4. Oil and Gas Wells Completed in the United States, 1947-58 5. Humble Oil and Refining Company: Average Cost of Well Completions in the United States, 1940-55 6. Type and Depth of Oil and Gas Well Completions in the United States, 1947-58 7. Sales by Producers of Natural Gas to Natural Gas Pipeline Companies, 1953 8. Marketed Production of Natural Gas in the United States, 1946—59 9. Comparative Consumption of Natural Gas in the United States, 1946 and 1956 10. Average Wellhead Price of Natural Gas in the United States, Listed by Region, 1946-59 11. Index of Retail Prices for Natural Gas and Fuel Oil, 1946-58 12. Gas Househeating Customers and Heating Saturations, Listed by Census Division, 1958 13. Cost of Residential Heating Fuels, Listed by City and Types of Fuel, December, 1959 14. Actual and Planned Construction Expenditures of the Natural Gas Industry, 1958-62 15. Natural Gas Pipeline Bond Investments of All Domestic Life Insurance Companies in Selected Years, 1945-55 16. Pacific Northwest Pipeline Corporation, Schedule of Aggregate Amounts of Bonds of the 1975 Series to Be Purchased by Life Insurance Companies, 1955-56

3 6 7 9 9 10 12 13 14 16 21 22 23 25 48

55

χ

TABLES

17. Quality of Utility Bonds Purchased by New York Life Insurance Company, Phoenix Mutual Life Insurance Company, and Teachers Insurance and Annuity Association, 1947-56 18. Institutions Purchasing Texas Eastern Transmission Corporation First Mortgage Bonds, 3.5 Per Cent Series Due 1962 19. Texas Eastern Transmission Corporation: Consolidated Net Income Available for Sinking Fund and Dividend Requirements, 1947-55 20. Texas Eastern Transmission Corporation: Bond Sinking Fund Coverage at Actual and Minimum Loads in 1948, 1952, 1955, and 1958 21. Texas Eastern Transmission Corporation: Consolidated Statement of Income, 1947-58 22. Texas Eastern Transmission Corporation: Consolidated Statement of Assets, Liabilities, and Capital, 1947-58 23. Institutions Purchasing Transcontinental Gas Pipe Line Corporation First Mortgage Bonds, 3i Per Cent Series Due 1968 24. Transcontinental Gas Pipe Line Corporation: Income Available for Sinking Fund and Dividend Requirements, 1951-55 25. Transcontinental Gas Pipe Line Corporation: Bond Sinking Fund Coverage at Actual and Minimum Loads, 1951, 1953, 1955, and 1958 26. Transcontinental Gas Pipe Line Corporation: Consolidated Statement of Income, 1951-58 27. Transcontinental Gas Pipe Line Corporation: Consolidated Statement of Assets, Liabilities, and Capital, 1951-58

78 92

112

122 123 124

133 143

154 155 156

CHARTS

1. Distribution of Utility Bond Purchases for Selected Life Insurance Companies, 1947-56 2. Effective Yields on Utility Bond Purchases of Selected Life Insurance Companies, 1947-58 3. Texas Eastern Transmission Corporation: Sources of Capital, 1948-58 4. Transcontinental Gas Pipe Line Corporation: Sources of Capital, 1951-58

50 53 120 152

Financing the Natural Gas Industry

Chapter

1.

INTRODUCTION

WHY have life insurance companies loaned billions of dollars to enterprises whose main business is to transport a wasting asset thousands of miles from the Southwest to the consuming regions of the United States? H o w have these traditionally conservative institutions attempted to protect their investments secured by wasting assets? W h a t has been the experience of life insurance companies with natural gas loans? W h a t impact has life insurance financing had on the

financial

structure of the natural gas industry? T o what extent have the life insurance companies protected themselves at the expense of stockholders? W h a t are the implications for the traditional lender-borrower relationship arising from this experience with institutional

financing?

Does the case of natural gas suggest how the operation of the capital market may be affected when funds are supplied by a relatively small number of

financial

intermediaries on the basis of "tailored" loan

agreements? T h e s e are the major questions to which this study is addressed. Institutional investments in natural gas are viewed on the following pages as the result of a process of financial innovation.

T h e de-

velopment of new and more flexible loan instruments along with some alteration in investment standards has made possible a large flow of institutional funds into this industry, which would have been impossible twenty years ago. T h e nature of the changes in loan instruments and the secondary or indirect effects on lender and borrower alike are matters that will receive close scrutiny. T h e significance of these developments in

financial

instruments

extends beyond the natural gas industry. W h e n the investment process is being analyzed on an abstract level, it is generally assumed that decisions to save and invest are made by individuals. In classical theory, for example, the capital market is considered in the same light as any

2

INTRODUCTION

other commodity market: a collection of numerous demanders (investors) and suppliers (savers) of capital, mutually determining the price (rate of interest) by their individual transactions in a homogeneous commodity. Keynes, although departing from classical investment theory in many respects, continued to view the investment process in a highly individualistic fashion. After discussing the consumption function in terms of the decision by an individual consumer as to what part of his current income will be devoted to consumption, he proceeded to assume that the saver would make his own decision to invest—or lend. T h a t is, the individual saver was pictured as exercising his own choice with respect to the purchase of one or more debt or equity instruments. 1 These assumptions are valid as long as individual investors predominate in the securities markets. But to an increasing extent the ownership of financial assets is passing from individual savers to financial intermediaries such as life insurance companies, pension funds, etc. Correspondingly, the decision to lend is often made not by the individual saver but by a fiduciary institution with whom individual savings have been deposited. While financial intermediaries have increased their share of ownership in national assets sharply in recent years, the trend is especially evident in private, fixed long-term intangibles—i.e., in bonds and mortgages. In 1900, institutions owned only 35 per cent of total domestic corporate bonds outstanding; but their share had climbed to 94 per cent by 1952.2 From T a b l e 1 it is instructive to note that the life insurance companies alone accounted for most of this increase. When we turn to the utility bond market the importance of the life insurance investors increases still further: by the end of 1951 life companies owned approximately 63 per cent of all utility bonds outstanding. 3 In the field of natural gas bonds, the dominance of the life company investors is even more evident. In 1950, approximately 78 per cent of these securities were owned by life insurance investors. 4 These considerations might suggest a number of interesting hypotheses with respect to how the flow of investment funds has been affected by the institutionalization of savings, along with indirect

INTRODUCTION

3

effects on other economic variables. I t is not the primary intention of this monograph, however, to speculate further on the matter. I t is felt that the more pressing need at the moment is for an empirical investigation of the investment policies of a particular financial intermediary in a given situation. Such an approach will add more to our knowledge of institutional investment policies than would a broader and more general inquiry. TABLE 1 SHARE OF FOUR LEADING FINANCIAL I N T E R M E D I A R I E S IN DOMESTIC C O R P O R A T E BONDS OUTSTANDING A T SELECTED DATES, 1900-1952 Percentage Financial

Intermediary

of Bonds

1900

1922

1939

1949

19} 2

7.9 8.7 9.8

9.2 14.9 13.9 0.2

24.7 20.9 10.2 1.6

54.6 10.2 8.0 5.6

58.0 9.9 6.7 8.9

* Detail not available. Source: Raymond W. Goldsmith, Financial Intermediaries in the Economy since 1900 (Princeton, Princeton University Press, 1958), p. 224.

American

Private life insurance companies Personal trusts Commercial banks Private pension funds (non-insured)

ft

A question may arise as to the reasons for choosing the natural gas industry for purposes of the study. T h e industry differs from many others in representing an unusually large capital investment, and in being subject to considerable government regulation. I t differs from other branches of the public utilities group in possessing a debt-heavy capital structure secured by a wasting asset. Its rate of growth since W o r l d W a r II has generally exceeded that of other utilities. It is, however, precisely these features that make investigation of the

financing

of this industry most rewarding. In natural gas we have a large, rapidly growing industry which has relied upon long-term institutional financing to a far greater degree than most other industries. W e are therefore in an excellent position to study the extent these investors were willing to meet the demands of this new industry for capital; the extent to which institutions purchased unseasoned natural gas bonds and under what conditions the financing was accomplished. T h a t is to say, it is possible to observe here the changes made in the instru-

4

INTRODUCTION

ments of corporate finance to surmount the special problems tutional investment in this field. T h e period of time covered extends from 1930 to the However, focus is on the last decade, since it is during the period that life insurance investments in natural gas occurred large volume.

of instipresent. postwar in truly

Chapter 2. ECONOMIC T R E N D S IN N A T U R A L GAS

commercial use of natural gas in the United States occurred in 1821, at Fredonia, New York, where it was used for illuminating homes in the village. A small but growing demand for natural gas as a fuel and illuminant continued in New York, Pennsylvania, Ohio, and West Virginia until 1878, when the first major gas well was discovered in Murrysville, Pennsylvania. Discovery of additional commercial wells in the Appalachian area was followed by a steady expansion in marketed production of natural gas.1 During the decade of the 1920's the rate of growth of production increased sharply with construction of major interstate pipelines. The Northern Natural, Panhandle Eastern, El Paso, and Cities Service gas pipeline systems, to mention only a few, were initiated during this period. Marketed production, which amounted to only about 800,000 m.m.c.f. in 1920, climbed to nearly 2,000,000 m.m.c.f. in 1930. By 1941 it was approaching 3,000,000 m.m.c.f.2 During the decade following World War II, the gas industry completed a vast network of long distance pipelines serving natural gas to practically all the important fuel consuming areas of the United States. Some of the more important effects of this expansion on the growth of the industry can be seen in Table 2. Measured in terms of energy content, production of natural gas has more than doubled since the war, and the rate of increase of output has exceeded that of oil by a wide margin. As a result, natural gas practically doubled its share of the mineral energy output of the United States. THE

FIRST

G A S RESERVES

Gas occurs in underground reservoirs, often in contact with oil. "Associated gas" is free natural gas in immediate contact with, but not

6

ECONOMIC TRENDS TABLE 2

CHANGES IN UNITED STATES MINERAL ENERGY PRODUCTION, 1946-57 Energy Content of Mineral Fuels Production Coal Year 1946 1957 change

15326 13,485 -2,041

Oil Gas (in trillions of Btu) * 10,057 15,190 +5,133

4,550 11,587 +7,037

Total 30,133 40,262 +10,129

Percentage of Mineral Energy Production from Natural Gas 15.1 28.8

+ 13.7

* Based on heat-unit values used by the Bureau of Mines: anthracite, 12,700 Btu per pound; bituminous coal and lignite, 13,100 Btu per pound; oil, 5,800,000 Btu per barrel; natural gas 1,075 Btu per cubic foot. Sources: U.S. Bureau of Mines, Minerals Yearbook: 1947 (Washington, D.C., U.S. Government Printing Office, 1948); U.S. Bureau of the Census, Statistical Abstract of the United States: 1958 (Washington, D.C., U.S. Government Printing Office, 1959).

dissolved in, crude oil. "Dissolved gas" is gas in solution with crude oil. "Non-associated gas" is free natural gas not in contact with, or dissolved in, crude oil. Gas which is produced as a by-product of oil production is called "casinghead gas," and accounts for about one third of annual domestic production of natural gas. 3 Estimates of natural gas reserves are usually of "proved" reserves. Each estimate involves some assumption with regard to the minimum size of reservoirs to be included. Primary emphasis is usually given to proved reserves which are economically recoverable, and this recovery factor is also a matter for the estimator's judgment. Estimates of proved reserves can be made by experienced geologists with a very high degree of accuracy. Sometimes estimates are made of "available" or "probably available" reserves. Such estimates usually include, in addition to proved reserves, reserves expected to become available from the extension of known fields. T h e bulk of natural gas reserves are located in the Southwest. In 1955 Texas alone accounted for 50 per cent of the total proved recoverable reserves in the United States. Four states—Texas, Kansas, Oklahoma, and Louisiana—accounted for 80 per cent of the nation's proved reserves. Proved reserves have continued to increase u p to the present.

ECONOMIC T R E N D S

7

Prior to 1946 there was no systematic reporting of reserves for the natural gas industry. Various individuals did, however, estimate gas reserves although such estimates were not strictly comparable. Shown below are estimates of gas reserves from 1925 to the present. TABLE 3 PROVED N A T U R A L GAS RESERVES IN T H E UNITED STATES, 1925-58 (In trillions of cubic feet)

Year

Reserves at Beginning of Year·

1925

23.0

1930

46.0

Additions

Withdrawals

Net Additions to Reserves

Reserves at End of Year

Year's Supply Based on Withdrawals

b

1934

62.0

1938

70.0

3.0

1942

85.0

4.5

1946

147.8

17.7

4.9

12.8

160.6

1947

160.6

10.9

5.6

5.3

-165.9

29.5

1948

165.9

14.0

6.0

8.0

173.9

28.9 29.1

25.0 18.9 32.5

1949

173.9

12.8

6.2

6.6

180.4

1950

180.4

12.1

6.9

5.2

185.6

26.9

1951

185.6

16.2

8.0

8.2

193.8

24.2

1952

193.8

14.5

8.6

5.9

199.7

23.2

1953

199.7

20.9

9.2

11.7

211.4

23.0

1954

211.4

9.6

9.4

0.2

211.7

22.5

1955

211.7

22.0

10.1

11.9

223.7

22.1

1956

223.7

24.9

10.8

14.1

237.8

22.0

1957

237.8

20.1

11.4

8.7

246.5

21.6

1958

246.5

19.0

11.4

7.6

254.1

22.3

From 1 9 4 6 - 5 8 volumes of reserves are calculated at 14.65 psia (pounds per square inch) and at a temperature of 60 degrees Fahrenheit. Data prior to 1946 are estimates of various geologists, and differ with regard to pressure base and the size of gas fields. T h e 1938 and 1942 estimates do not include dissolved gas, which is included in the estimates from 1946 on. " . . . = detail not available. Source: Historical Statistics of the Gas Industry (New York, American Gas Association, 1956), pp. 20-21; see also Gas Facts: 1959 (New York, American Gas Association, 1959). a

These data indicate that while reserves have continued to increase rapidly, withdrawals have also been increasing steadily, and at a more rapid rate than additions. T h e result has been a steady decline in the ratio of reserves to annual withdrawals from 1946 to 1957, with an interruption in the downward trend appearing in 1958. As pointed

8

ECONOMIC TRENDS

out by the Federal Power Commission, the true significance of such a ratio lies not in the absolute number of years supply of gas available, but the direction of the trend. So long as the trend is either upward or stable, the reserve situation is in a healthy condition. . . . A leveling off of this index, or its downward trend, would suggest the need for reappraisal of this natural resource in relation to the consumer requirements to be met, and a closer surveillance of proposed extensions of pipe-line facilities.4

Over the past decade gas pipelines expanded their deliveries at a more rapid rate than additions were made to reserves. This was made possible by the presence of substantial amounts of uncommitted gas at the end of World War II. Since then, however, pipelines have negotiated long-term contracts for gas at a rate to keep pace with their increased throughput. As a result, the available (or uncommitted) gas supply has become much tighter despite annual increases in proved reserves. Thus the rate of increase in use of gas in the future will probably be more closely related to changes in supply than in the recent past.8 In view of this tightening of gas supplies, it is well to review the prospects for future additions to the supply of gas, particularly with respect to the scope and success of drilling activity. Measured in terms of well completions, exploratory activity has increased by approximately 75 per cent during the last decade, as shown by the data presented in Table 4. The steady rise in well completions was broken in 1957 and 1958, due primarily to enlarged oil stocks and soft prices in the petroleum markets. However, while oil well completions declined by about 17 per cent between 1956 and 1958, gas well completions declined only 11 per cent. Wildcat wells, which accounted for only 16.5 per cent of total completions in 1947, accounted for 22.4 per cent in 1956 and 19.5 per cent in 1958. This trend is of special significance in analyzing prospects for additions to gas supplies. E. L. De Golyer once stated that "several things have contributed to the notable increase in natural gas reserves, but the most important has been the tremendous amount of wildcatting that has gone on in the search for oil." β Although the extent of exploratory efforts in the search for gas and oil in this country is impressive, we must also investigate trends

ECONOMIC T R E N D S

9 TABLE 4

OIL AND GAS WELLS COMPLETED IN T H E U N I T E D STATES, 1947-58

Year

Total Well Completions

1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958

33,122 39,778 39,038 43,279 44,516 45,821 49,279 53,930 56,682 58,160 53,838 49,111

Producing ·

Oil

Gas

20,302 24,855 23,424 25,679 24,833 24,948 27,024 30,785 32,327 32,207 29,225 26,615

3,305 2,897 2,887 2,843 3,030 3,255 3,806 3,977 3,613 4,115 3,912 3,674

Nonproducing (dry)

Wildcat Wells Completed

9,519 12,026 12,727 14,757 16,653 17,618 18,449 19,168 20,742 21,838 20,701 18,822

5,461 6,877 7,294 8,554 10,302 10,552 11,062 11,280 12,271 13,034 11,739 9,588

Percentage of Wildcat Wells among Total Completions 16.5 17.3 18.7 19.8 23.1 23.0 22.4 20.9 21.6 22.4 21.8 19.5

* Total completions equals producing plus nonproducing wells. Source: The Oil and Gas Journal, annual review issues.

in the cost of finding these minerals. Table 5 presents drilling costs for one of the major domestic producers. According to these statistics, the money cost of drilling a producing well has increased approximately TABLE 5 HUMBLE OIL AND REFINING COMPANY: AVERAGE COST OF W E L L · COMPLETIONS IN T H E U N I T E D STATES, 1940-55

Year 1940-14 (average) 1945-49 (average) 1950-54 (average) 1951 1952 1953 1954 1955

Total Producing Wells Wells Completed Completed 434 679 985 1,133 1,102 898 374 857

347 521 766 893 808 660 798 665

Total Drilling Drilling Expenditures Expenditures per Completed (in thousands Well" of dollars) (in dollars) 19,482 63,917 100323 105,576 118,317 100,751 108,569 109,659

44,889 94,134 102,053 93,183 107,366 112,194 111,467 127,956

Drilling Expenditures per Completed Producing Well' (in dollars) 56,144 122,681 131,231 118,226 146,431 152,653 136,051 164,900

• Includes oil, gas, and dry wells. * Total drilling expenditures divided by total wells completed. c Total drilling expenditures divided by number of producing wells completed. Source: Humble Oil and Refining Company, Annual Report (1955), pp. 11-14.

ECONOMIC TRENDS

10

threefold in the past fifteen years. The rate of increase in costs was extremely sharp during the war, becoming more moderate during the postwar period. The chief reasons for the increased drilling costs include rising prices for equipment and labor used in the drilling operation, more time spent in testing and other service operations, more dry holes relative to producing completions and deeper drilling. The change in the real costs of drilling a producing well is difficult to measure with precision. There is no reliable index of prices of drilling inputs with which to deflate data on money costs of drilling. However, statistics on two important components of real costs are presented in Table 6. T h e implication of these data is that the real cost TABLE 6 TYPE AND DEPTH OF OIL AND GAS WELL COMPLETIONS IN THE UNITED STATES, 1947-58

Year 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958

Average Depth of Wells Completed (in feet) 3,445 3,454 3338 3,680 3,871 4,085 4,035 4,061 3,992 4,022 4,122 4,019

Percentage of Dry 1 among Total Completions ' 28.7 30.2 32.6 34.1 37.4 38.4 STA 35.5 36.6 37.5 38.5 38.3

• Number of dry wells completed divided by total of wells completed. Source: Oil and Gas Journal, January 26, 1959, and Table 4.

of well completions is rising owing to the fact that these minerals are becoming increasingly difficult to find. The average depth of well completions rose from 3,445 feet in 1947 to 4,019 feet in 1958. Actually, the increase in depth of drillings is considerably greater than these figures suggest since the deepest drillings are occurring in some of the most productive fields.7 Since 1952 the average depth of completions has shown no tendency to increase. Similarly, dry holes as a percentage of total completions reached a peak of 38.4 per cent in 1952. T h e inference suggested by

ECONOMIC TRENDS

11

these statistics is that the search for oil and gas has met with increased difficulties during the last decade. But it also appears that since 1952 the principle of diminishing returns may have been offset by advances in the technology of drilling for oil and gas. The volume of ultimately recoverable gas supplies located in the continental United States is probably very large. Perhaps the best known estimate is that of Terry and Winger. They maintain that 1,200 trillion feet of gas, including reserves already proved, may remain as economically recoverable to be produced in the future. 8 It is generally felt that additions to proved reserves will be found in the deeper regions of producing fields, in extensions of known fields and in new areas. It may be concluded that natural gas reserves in the United States are of a truly large volume, and annual additions to proved reserves are growing, although at a rate less rapid than the growth in annual withdrawals. Moreover, if present trends continue, the cost of exploration and development of new gas reserves may increase substantially. CONTROL OF NATURAL G A S RESERVES

The nation's natural gas reserves are largely owned by four groups of producers—major oil companies, independent producers, natural gas pipelines, and carbon black interests. While comprehensive statistics on the distribution of ownership of gas reserves are unavailable, an analysis made by the Federal Power Commission indicates considerable concentration. Based on 1952-54 data, the Commission concluded that approximately 91 trillion cubic feet, or 43 per cent of the country's proved reserves in 1953, were owned by 19 producers.® Concentration in ownership of gas reserves leads to concentration in natural gas sales. Data presented in Table 7 show that natural gas pipelines purchase a large part of their requirements from a relatively small group of producers. T o an increasing extent pipelines are relying on purchased gas to meet throughput requirements. In 1946, natural gas utilities (including pipelines and distributors) produced 36 per cent of their total gas requirements, while in 1955 this figure had dropped to 13 per cent. 10 The chief factors accounting for increased reliance of the pipelines

12

ECONOMIC TRENDS TABLE 7 SALES BY PRODUCERS • O F NATURAL GAS T O NATURAL GAS PIPELINE COMPANIES, 1953 First 4 8 16 30 119

producers producers producers producers producers

Cumulative Sales (in millions of cubic feet)

Cumulative Per Cent

1,103 1,667 2224 2,919 4,080

27 41 55 72 100

* Includes producers whose annual sales were 5 billion cubic feet or more in 1953. Source: U.S. Federal Power Commission data, in Hearings, Amendments to the Natural Gas Act, 84th Cong. 1st Sess. (Washington, D.C., U.S. Government Printing Office, 1955), pp. 1244-46.

on purchased gas have been the rapid expansion of gas sales and the valuation policy of the Federal Power Commission with respect to pipeline-owned gas reserves. T h e postwar expansion of gas sales has been accompanied by the organization of new pipelines which necessarily have relied heavily on purchased gas. Nor has there been much incentive for pipelines to acquire gas production properties. For more than a decade after enactment of the Natural Gas Act, the Commission included pipelines' gas producing properties in the rate base on an original cost basis, and in this treatment the Commission was sustained by the courts. 11 But it eventually became clear that this valuation policy encourages dependence of pipelines on purchases at arm's length for their entire gas supply. The Commission, convinced that this policy is in the interest of neither the pipeline or the public, adopted a policy of allowing pipelines to receive for the gas they produce a price reflecting the "weighted average arm's length payments for identical natural gas in the fields. . . ." 1 2 Recently, however, this policy of the Federal Power Commission has been reversed by the courts. The United States Court of Appeals maintained that while the Commission has a right to consider field prices in determining the value of gas in the ground, it is also necessary to consider original cost, at least "as a basis of comparison." 13 It might have been expected that extension of Federal Power Commission jurisdiction to independent producers by the Phillips decision 14 would have solved the diffi-

13

ECONOMIC TRENDS

culty. Why this has not been the case will be covered at a later point in this chapter. G R O W T H O F INTERSTATE TRANSMISSION

In recent years the volume of gas marketed has grown rapidly, due in large part to the expansion of transmission facilities. Table 8 presents statistics on the volume of gas shipped interstate. While marketed production nearly tripled during the last thirteen years, interstate shipments rose six-fold, accounting for 60 per cent of marketed production by 1959. However, after 1954 the rate of growth of interstate shipments slackened somewhat. Indeed, the only decline in interstate shipments as a per cent of marketed production occurred from 1955 to 1956.15 TABLE 8

Year 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959

MARKETED PRODUCTION OF NATURAL GAS IN THE UNITED STATES, 1946-59 Interstate shipments Interstate Marketed as a Percentage of Shipments » Production Marketed Production (in billions of cubic feet) 4,031 1,146 28.4 1,402 30.6 4382 5,148 34.1 1,757 5,420 2,008 37.0 2344 6,282 403 3,243 7,457 433 8,013 47.4 3,795 8,397 4,201 50.0 8,743 4,662 53.3 9,340 5,115 54.7 5350 10,275 54.0 6,048 10,680 56.6 11,030 6,440 58.4 6,840 11,400 60.0

* Includes imports and exports from the United States. Sources: U.S. Bureau of Mines, Minerals Yearbook (Washington, D.C., U.S. Government Printing Office, 1954-59), and World Oil, February 15, 1960.

The postwar development of the natural gas industry can be viewed as a transportation revolution. Interstate pipelines transport natural

14

ECONOMIC TRENDS

gas from the producing regions in the Southwest to the large consuming regions located largely in the East, North Central, and Middle Atlantic States. In 1953, 78 per cent of interstate shipments of natural gas originated in the West South Central States of Texas, Louisiana, Oklahoma and Arkansas. In the same year, 51 per cent of all natural gas shipped interstate was consumed by twelve states located in the Middle Atlantic and North Central regions of the United States. 16 T h e expansion of interstate transmission has resulted in some major shifts in the end-uses of natural gas, as is clear from T a b l e 9. TABLE 9 COMPARATIVE CONSUMPTION OF NATURAL GAS IN THE UNITED STATES, 1946 AND 1956

Residential Commercial Industrial field use carbon black petroleum refineries portland cement plants electric utility plants other industrial Total consumption

1956 1946 (in billions of cubic feet) 661 2,425 241 743 3,110 6,880 898 1,605 478 225 332 663 58 130 307 1,150 1,037 3,107 10,048 4,012

Change + + + + + + + + +

1,764 502 3,770 707 253 331 72 843 2,070 6,036

Source: World Oil, February 15, 1957, p. 190.

Residential and commercial consumption has increased more rapidly than industrial consumption, so that while industry accounted for approximately 78 per cent of total consumption in 1946, it accounted for only about 69 per cent in 1956. Again, within the industrial classification there exists a shift away from low-value uses such as carbon black in favor of "other industrial" which includes uses in manufacturing. 17 If wellhead prices continue to rise these trends can be expected to persist.

P I P E L I N E CONTRACTS FOR PURCHASE AND S A L E OF G A S

Pipelines purchase most of their gas on the basis of long-term contracts. T h e common term is for 20 years; however, contracts are also made for shorter terms, such as 5 or 10 years. Quantities of gas to be

ECONOMIC TRENDS

15

delivered by the seller under these contracts are sometimes fixed. T h a t is, the pipeline may agree to purchase and the producer agree to sell a specified quantity of gas on a daily basis. 18 A more common arrangement is that whereby the contract specifies a minimum quantity which the buyer must be ready to buy if required by the purchaser. 19 Contracts are also found where a minimum take-or-pay-for quantity is based upon dedicated reserves and a maximum upon the most efficient rates of flow of the wells. Purchase contracts covering small fields are also found where no minimum take is specified and under which the daily quantities of gas to be taken are at the pipeline's discretion. 20 Long-term purchase contracts have been negotiated with a fixed price over the entire term. Although the fixed price provision was common prior to World W a r II, few of the important purchase contracts negotiated since the war have been of this nature. Most purchase contracts made during the last decade contain some type of price escalation. T h i s may take the form of automatic increases in the prices to be paid for gas at designated intervals. At the present time contracts with this type of escalation generally provide for an increase of 1 cent per m.c.f. during each five-year interval. 21 Another common type of escalation is based on renegotiation. A price is determined for the first interval, and prices for gas during subsequent intervals are determined by renegotiation. 22 Sometimes contracts provide for automatic escalation during the first two or three intervals, making the price during the latter years of the contract subject to negotiation, with provision for arbitration if negotiations between the two parties fail. 23 Gas purchase contracts often contain "favored-nation" clauses. Basically a favored-nation clause provides for increasing the price of gas under contract in the event that gas in the comparable cost area is sold at a higher price. Under the two-party favored-nation clause, which is most common, the buyer agrees that if during the term of the contract he purchases gas from new sources of supply within the comparable cost area (as defined in the contract), then the seller has the right to request the buyer to pay the difference between the price in the existing agreement and the price paid to the new source of supply. If the buyer refuses to pay the higher price, the seller has the right to cancel the contract. 24

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