Economics Update (July-September 1997)

Deregulation to Provide Challenges and Opportunites for Natural Gas Companies
The natural gas industry, one of the few remaining monopolies, is in the process of deregulation. David R. Jones, deputy chairman of the Board of Directors of the Federal Reserve Bank of Atlanta, is president and chief executive officer of AGL Resources Inc., the holding company for Atlanta Gas Light Company. In this question-and-answer session, he shares his insight into the far-reaching changes that will affect the industry during deregulation.

What impact will deregulation have on the natural gas industry?

There will be significant changes for consumers and for the industry. Consumers, particularly small businesses and residential customers, will have the potential for lower prices. Consumers also will have greater choices in selecting a company to sell them gas (natural gas marketers). Natural gas marketers should provide more service offerings and other value-added services, like fees that don't change regardless of the weather, and, more generally, facilitate better customer service. The industry will experience energy convergence — one-stop energy providers for commodities and services. There will be competition in all industry business areas, including ancillary services such as billing and meter reading. As a result, the industry will become even more customer oriented, and companies will have to develop more competitive and profit-minded employees.

David R. Jones

David R. Jones,
president and CEO of
AGL Resources Inc.
How has the industry prepared for deregulation?

The industry has implemented many cost-cutting measures in preparing for deregulation. At Atlanta Gas Light, for instance, we reduced the size of our workforce from 3,600 employees in 1994 to 2,900 employees today. At the same time, many companies also reorganized their operation to be more competitive. Additionally, in some parts of the country, pilot programs were implemented to introduce marketing competition for gas service.

To help usher in deregulation, the industry also has worked with legislators to help craft legislation. In Georgia, we worked with legislators on Senate Bill 215, which was signed into law as the Natural Gas Competition and Deregulation Act earlier this year. This law changes the framework for natural gas delivery in Georgia.

What did the experience of the pilot programs suggest about the price consumers pay for natural gas?

In pilot programs, marketers in some states in the Northeast have reported 5 to 10 percent savings on commodity costs for residential customers and 10 to 15 percent savings for small commercial and industrial customers. I believe prices will decrease because competition among marketers will drive down average gas commodity prices.

When do you expect to operate as a deregulated industry in Georgia?

We expect the industry in Georgia to begin deregulating during the fall of 1998, when certain criteria in the Natural Gas Competition and Deregulation Act are met. Deregulation begins when Atlanta Gas Light Company elects to open its system to competition. Initially, the price of the gas commodity is deregulated when there are at least five competitors selling gas to customers. Ultimately Atlanta Gas Light will stop selling gas to customers. That will occur when 33 percent of the peak day requirements for firm distribution service is served through five or more marketers within predefined geographic areas on our distribution system. Nonaffiliated marketers must serve no less than 18 percent of this peak day requirement. After notifying consumers and giving them an opportunity to select a marketer, the rest of the market will then be allocated by random selection. Of course, in the early years this process will have to be managed carefully to be sure all markets have the ability to deal with extreme weather conditions.

What effect will deregulation have on Atlanta Gas Light as the largest natural gas distribution company in the Southeast?

Atlanta Gas Light will stop selling gas to consumers and become a pure gas pipeline delivery company. We will move to straight fixed-variable rates and to performance-based regulation compared with the traditional approach to rates, which is based on the cost of providing services.

Like other industries in transition to competition, the company also must provide for the recovery of stranded costs. Doing that will help enhance our ability to be a more efficient and stronger competitor. Stranded cost recovery represents costs that were incurred to provide regulated services that are no longer cost competitive. For example, we have developed a billing system for our regulated business that is not flexible enough to bill customers in a competitive environment. We need to address ways to make that system more efficient. At the same time we are creating a competitive landscape for all of our services, and we also are helping to establish a Universal Service Fund, which is critical because it will be used to ensure that natural gas marketers provide gas service to everyone.

How will the Universal Service Fund work?

The Universal Service Fund will be created from several revenue sources, including a surcharge on bills if necessary. The fund will have two uses. First, it will reimburse marketers of natural gas for their uncollectible accounts. Second, the fund will help promote economic development by contributing to delivery system expansion activities to offset costs associated with building new infrastructure.

Do you believe there will be a fallout of some industry competitors because they will be unable to compete?

Yes, industry experts estimate that in the next 10 years there will be 10 to 12 national energy providers — that is including combined gas and electricity providers — because of consolidation. Today there are almost 200 natural gas companies and municipal gas systems and perhaps an equal number of electrical companies. These providers are going to pursue a more global presence. The rationale is straightforward. There are substantial economies of scale — number of customers, multiple products and units of output — and economics of scope in the provision of energy-related services.

As the electric industry begins to consider deregulation issues, what are some similar challenges firms in that industry should expect to encounter?

I believe some similar challenges include state versus federal mandates for deregulation as well as legislative versus regulatory mandates for deregulation. Electric companies also have very significant stranded cost recovery issues to consider, much more sizable than the natural gas industry, because some power plants are much more efficient energy providers than others. As a result, electric plants with high capital cost — for example, those with nuclear facilities — will have difficulty competing in an open market. Like the natural gas industry, the electric industry will also have to train its employees to have competitive mindsets. Competition will also mean that electric companies, like natural gas companies, will encounter the challenges of mergers, acquisitions and diversification for competitors to achieve critical mass and grow earnings. I think that it is a challenging but exciting time for everyone.

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