A RATIONAL NATURAL GAS PRICING POLICY WHICH MAXIMIZES CONSUMER

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85M00363R001002190006-7
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 17
• Document Creation Date: December 20, 2016
• Document Release Date: September 11, 2007
• Sequence Number: 6
• Publication Date: January 4, 1983
• Content Type: MEMO

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January 4, 1983
MEMORANDUM FOR THE CABINET COUNCIL ON NATURAL RESOURCES
FROM: DANNY J. BOGGS, CHAIRMAN
NATTTRAT. C;AS WORKING GROU `.
PUBLIC POLICY GOAL
A rational natural gas pricing policy which maximizes consumer
welfare by providing gas supplies adequate to satisfy demand in
both the short and the long run at reasonable market prices.
As our experience with oil controls and decontrol has shown, a
free market operating under decontrol generally leads to lower
prices and greater consumer benefits than would otherwise be the
case. Under natural gas control, consumer prices have been
rising rapidly, and production has been deterred, at least
relative to levels that could have been obtained. A continuation
of current policy threatens continued price increases without
incentives to increase supply from the most economic sources.
This discussion and proposal is presented with an eye to
increasing the overall benefits to the American economy and to
the ultimate benefit to all American consumers. Any price impact
of deregulation on low income Americans is mitigated by existing
low income energy assistance programs that provide an averasge
$180 per family participating.
ISSUE
Should the public policy goal continue to be sought through
partial or complete federal price controls, or should price and
demand controls be lifted in order to permit market forces to
allocate available gas supplies?
Natural gas commerce has been heavily regulated in the United
States from its inception, with explicit wellhead price controls
on all natural gas sold in the interstate market since 1954. The
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low level of prices under controls caused increasing distortions
in the late 1960s and early 1970s, a condition which rapidly
worsened as oil prices increased after 1973. Increased prices
allowed by the Federal Power Commission in 1976 offered some
relief, but natural gas exploration continued weak, and gas
production was increasingly diverted to the unregulated intra-
state market. These conditions led to predictable shortages and
consequent rationing of natural gas in the regulated interstate
market during the winter heating seasons of 1976 and 1977.
In 1977 and 1978, Congress and the President attempted to deal
with the distortions caused by the price control system then in
effect, but only succeeded in creating a new set of problems.
The Natural Gas Policy Act of 1978 (NGPA) is a system of partial
price controls which has the following major features:
o All gas in the country was brought into the new system,
as price controls were extended to the unregulated
intrastate market.
o Some increase in prices was allowed for categories of
"new" gas (drilled after 1977), and all prices were to
be adjusted for inflation.
o New gas was to be deregulated in January 1985, and
certain categories of gas ("deep gas") were totally
decontrolled in 1979.
o In all, more than 20 categories of gas were created,
depending on date of discovery, type of formation, size
of producer, and location of reservoir.
In theory, prices for new gas were to rise smoothly until in 1985
new gas prices would approximate a decontrolled price, and decon-
trol could occur smoothly. Under this partial decontrol scheme,
about 40-50 percent of the nation's gas would remain subject to
price controls in 1985. The percentage of price controlled gas
is expected to decline under NGPA to about 25 percent in 1990 as
reserves of that gas are exhausted. The hope of a smooth transi-
tion to decontrol was upset by the price increases following the
1979 Iranian revolution. Between the enactment of the NGPA in
late 1978 and late 1981, oil prices far exceeded prices permitted
for comparable energy from natural gas. Additionally, higher oil
prices greatly increased oil exploration relative to gas explora-
tion (oil drilling up 40 percent annually, gas up 10 percent),
and also encouraged conversions from oil to gas, even though
price increases for gas did continue to create incentives for
conservation.
Department of Energy analysis in late 1981 indicated that upon
deregulation of natural gas, either immediate or phased, the
average wellhead price of gas would rise significantly (about 70
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percent), although that price would be no higher than the price
after the currently planned partial immediate decontrol in early
1985. There would be substantial efficiency gains, as more gas
would be produced and substituted for expensive oil, and as
increased quantities of gas would be conserved.
Over the past year, however, a significant change in circum-
stances has taken place. Against expectations, oil prices
declined substantially. The decline is dramatically illustrated
as the price for government purchases of oil for the SPR in early
1983 will be approximately 30 percent less than the price antici-
pated in early 1981. All sources now agree that a market
clearing price upon decontrol, immediate or phased, would be
considerably lower than anticipated in 1981. This means that the
pure efficiency advantages from a higher price will be lower than
anticipated earlier, but so will the consumer cost.
Some argue that the delivered cost of gas could even decline to
some extent under at least one decontrol option. Many consumers
groups, state public utility commissions, and gas distribution
utilities (who, anomalously perhaps, oppose decontrol) have
claimed in congressional testimony and before the Federal Energy
Regulatory Commission that substitute fuels have become cheaper
than gas, causing industrial customers to leave the gas market.
Although the statistical evidence for the contention is weak,
accepting the claims as true suggests that a properly structured
decontrol option would permit gas prices to decline so gas could
again compete with the substitute fuels.
Changed circumstances which have alleviated fears of dramatic
price increases in the event of decontrol are only one factor
arguing in favor of it. There are others. The present statute
spawns other inefficiencies than over-consumption and under-
supply caused by artificially low prices. It mandates unequal
access to certain categories of supply. Differentially priced
gas means that gas will continue to be allocated inefficiently,
while the various price categories induce the industry to produce
a mix of gas that is more costly than necessary. Pipelines have
different gas costs depending on how much cheap, price-controlled
gas they have under contract. That leads to anomalies such as
gas costing a dollar per thousand cubic feet less in western
Pennsylvania than eastern Pennsylvania (according to claims of
members of Pennsylvania's public service commission).
Long-term contracts, which are prevalent in this industry, lead
to other complications. As gas sales have declined due to
conservation, the recession, and fuel-switching, recent gas
purchase contracts have forced some pipelines to take and deliver
expensive gas while shutting in or delaying acceptance of some
amount of cheaper supplies. This has created the seemingly
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perverse effect of escalating prices in gas markets faced with a
declining demand. The existence of controls has compounded this
problem. By reducing the certainty of available supplies,
controls have served to increase the level of take or pay
commitments (described below) that were written into more recent
gas purchase contracts.
Furthermore, many analysts fear the effect of "indefinite price
escalator clauses," defined below. Upon scheduled partial
decontrol under the NGPA, gas under such contracts could rise to
110-130 percent of the price of No. 2 heating oil, which is about
twice the level of the presently estimated market-clearing price.
A major item of public discussion at this time is why, in,the
face of falling oil prices, gas prices continue to rise sharply.
It should be noted that these increases are not unexpected.
Overall, natural gas prices have been rising at about 20 percent
a year in the residential market for the last six or seven years,
and price increases have been fairly close to what was projected
at the time the Natural Gas Policy Act was passed. It is true
that in a free market prices will generally fall when supply
rises and demand falls. This is what has been happening in the
only free part of the natural gas market, the market for deep
gas.
When prices have been controlled at an artificially low level, it
is not surprising that they would continue to rise from that
artificially depressed level to at least market clearing levels,
even if the market clearing price is falling at the same time.
The cause is two-fold. First, the NGPA provides for inexorable
statutory price ceiling increases for categories of "newer" gas,
while older and much cheaper supplies are being exhausted.
Accordingly, the statutory decontrol schedule is allowing average
gas costs to come up to market levels. Simultaneously, contract
provisions which developed in a price-regulated regime permit
prices to rise with NGPA-allowed increases, but do not permit
them to fall in response to market pressure. As a consequence,
the NGPA's price ceilings often act as price floors.
Even though the NGPA now provides for the decontrol of about half
of all gas in 1985, there is no guarantee that this will actually
take place. There are a number of congressional efforts now
underway to freeze or roll back natural gas prices, and to delay
decontrol, raising the predictable spectre of consequent short-
ages and rationing such as experienced in 1976-77. In addition,
if decontrol is not already accomplished or deemed phased in (as
oil decontrol was), the political pressures to "save the con-
sumers" by renewed controls in the summer of 1984 may prove
irresistable, to the detriment of consumers.
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The Working Group unanimously agreed that a deregulation initia-
tive could be prepared which would be better for the country than
either a continuation of the present law, or increased controls.
The group also unanimously agreed that if there were some reason-
able prospect of success, the President should present a decon-
trol initiative to Congress.
I. Major Proposals
The types of initiatives suggested fall into three broad
categories, although a number of subsidiary issues, some with
sub-options, are presented later as well. The three major
proposals are referred to here as immediate total decontrol,
modified immediate decontrol, and phased decontrol.
A. The immediate total decontrol option essentially takes
the position that the current average wellhead price is
relatively close to the price that would prevail under
decontrol; that the individual aspects of the current
system are so complex and confounded that a gradual
unravelling will not be effective and that the benefits
of decontrol are sufficiently compelling that they
should be obtained as soon as possible. Under this
option, all gas is decontrolled immediately or in a very
short period, with provisions that simultaneously free
purchasers and sellers from existing contract obliga-
tions at the wellhead on contract terms such as price
escalators or required contract takes. This proposal
argues that giving producers immediately the price
freedom they have sought, especially on gas already
produced and contracted for, will be much more politi-
cally saleable if balanced by freeing purchasers from
obligations which they assumed, frequently in reliance
on the existence of controls or conditions created by
the system of controls.
B. The modified immediate decontrol option would also
decontrol all gas prices immediately, but would adopt
one of the more moderate contract solutions discussed
below. As in option A, immediate decontrol is preferred
because of the anticipated political pressures arising
in 1984 from phased decontrol and because of further
possible efficiency losses arising from a known delay in
full decontrol. Supporters of this view believe that
average wellhead prices are currently near the market
clearing level and that immediate decontrol limits the
possibility of "overshooting" of gas prices that could
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occur under phased decontrol. Supporters of this
modified option, however, also believe that some
contract "adjustment" is needed. It might, for example,
place a moratorium on indefinite price escalators for a
definite period of time to allow for renegotiation. In
addition, a temporary limit on take-or-pay obligations
might also be appropriate.
C. The phased decontrol option basically seeks to assemble
a consensus for a gas decontrol bill by a package of
specific changes to the current structure. It seeks to
phase out all price controls on natural gas by 1985,
while making some modifications to the contract regime
which grew up as a result of the various systems of
price controls. Supporters of this view believe that
the incremental approach can garner support that would
be put off by the seeming abruptness and risk of the two
alternatives discussed above.
D. The Working Group evaluated a fourth proposal of only
addressing the contracts problem. This idea was
rejected because it ignores the inefficiencies that
would be caused by continued price controls.
QUANTITATIVE ANALYSIS
The Department of Energy has continued its modeling work in
attempting to forecast the effects of alternative natural gas
systems, including immediate decontrol, current policy, and
continuing price controls. As was done last year, the DOE
modeling assumes that the 1985 fly-up of prices resulting from
indefinite price escalators does not materialize under NGPA,
immediate or phased decontrol. These options assume either that
the marketplace will force quick renegotiation of unreasonable
contract terms or that any decontrol scenario will be accompanied
by a legislative contract solution. Refiner acquisition costs
for imported oil are assumed to decline slightly in real terms
through 1984 and go up at 1 percent annually thereafter.
Current DOE analysis for immediate decontrol shows only a very
small price increase (10 percent at the wellhead, 5 percent for
residential users) as compared to 100 percent and 50 percent
respectively in last year's analysis. Efficiency benefits and
wealth transfers are correspondingly much smaller. This radical
difference in analysis is primarily due to lower oil prices,
improved supply prospects, and significant reduction in demand.
For the longer run, DOE analysis suggests that the market for gas
will tighten as the economy improves, and therefore projects real
average wellhead price incr(, ses of more than 10 percent per year
for several years with or without decontrol (about 5 percent in
residential prices). Some members of the group found this
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analysis somewhat extreme, expecting instead somewhat larger
price increases immediately under decontrol, but with little real
price increase thereafter. DOE notes that their current analysis
projects crude oil and residual oil prices 15-25 percent lower
than those assumed last year for the period 1983-1985.
Because of the relatively small difference in price between
current policy and full decontrol, phased decontrol tends to
differ little from either of the other two options. Phased
decontrol has almost the same effect whether one phases to a
60 percent or 70 percent crude oil target because it was assumed
that the new maximum lawful prices would not act as floors, and
that prices would be dictated by market conditions, not con-
tracts. Under immediate decontrol, market-clearing levels in
1985 are approximately at 60 percent of crude; therefore, the two
options appear the same.
DOE analysis continues to show substantial adverse effects from
extended price controls versus allowing NGPA to run its course.
Such controls would cost the American economy an extra $21
billion (NPV in 1980 dollars), a loss of 6.7 trillion cubic feet
of gas production and an increase of over 1.5 billion barrels in
additional oil imports through 1995.
Impact on Low Income Families
Low income households have been receiving federal cash
assistance for energy bills since FY80 at an annual rate of
about $1.8 billion, or an average of $180 per participating
household. While this program was enacted by Congress in
1979 to offset a portion of the increase in home heating oil
costs resulting from the doubling of oil prices in 1979,
this program applies to households using natural gas for
heating as well. The real increase in residential natural
gas prices in 1983 of approximately 5 percent expected under
full decontrol (about $30 per low income household) does not
justify a new low income energy assistance program or an
add-on to the existing program. Nor does the small increase
justify not proceeding with decontrol.
III. ELEMENTS OF MAJOR PROPOSALS
The specific issues addressed under these options are:
timing and scope of decontrol; demand restraints; problems
of escalator clauses in contracts; problems of take-or-pay
clauses in contracts; associated tax or expenditure
proposals.
A. Timing and Scope of Decontrol
Under both the immediate total decontrol and modified
immediate decontrol options, all natural gas would be
decontrolled either immediately upon enactment, or on
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some date certain within perhaps a year of enactment.
One variation would allow decontrol upon renegotiation
of contracts. At the end of a fixed period, a so-called
market-out clause would be imposed by statute, which
would allow buyers to abrogate contracts which had not
been renegotiated.
The phased decontrol option would follow the
recommendation made by the Cabinet Council.last year,
with the price of each category of gas allowed to
escalate from its current level to a target level of 70
percent of the refiner acquisition cost of crude oil by
January 1, 1985.
For this discussion, the 70 percent price level has been
maintained, although some DOE analysis argues that the
likely market clearing price is as low as 60 percent.
This was done for two reasons. First, there is some
significant skepticism that the current market is
sufficiently soft that the 60 percent figure is
accurate. Second, a price "under-shoot" could raise
once again the spectre of a price "spike" in early 1985
and.stimulate cries at that time for continued control.
A similar "overshoot" would simply mean that the market
clearing price would be reached prior to the decontrol
date, and that price increases would then level off, if
the gas market operates in a competitive fashion.
B. Demand Restraints
Under the theory behind the NGPA, natural gas use should
be restricted to "high priority" uses, such as
residential and commercial use, so other uses should be
specifically discouraged (Fuel Use Act) or should pay
very high prices (incremental pricing). As predicted by
opponents at the time of passage, this has led to an
artificial diminution in industrial use, which is now
increasing oil demand, and raising the amount of fixed
cost that the residential sector must bear as industrial
load leaves the system. Under all' options, the
incremental pricing provisions of the NGPA and all
provisions of the Fuel Use Act which impact natural gas
prices would be repealed upon enactment.
C. Problems of Escalator Clauses in Contracts
The basic problem addressed here is that most contracts,
both in the interstate and intrastate market, contain
provisions specifying prices that can be charged at
specified times in the future, or upon decontrol. The
most popular type of these clauses are as follows:
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o "Definite price escalator" -- These include such
figures as a 1 percent increase every five
years, or a specified dollar price upon
deregulation.
o "Oil parity clauses" -- set a price by specific
reference to other oil (or gas) product prices,
such as the equivalent of 130 percent of the
distillate price in New York Harbor, the average
of all decontrolled gas, etc.
o "Favored nations clauses" -- set the price for
gas equal to.some high gas or average gas price
within a specified area, such as a county,
state, or producing field.
o "Area rate clauses" -- These were originally
clauses which specified that the producer could
receive the highest rate permitted in his area
by the FPC. Some controversy has arisen as to
how these would be interpreted upon decontrol,
when there was no ceiling price set by any
regulatory authority.
o "Indefinite price escalators" generally applies
to all escalator clauses other than "definite
escalators."
The problem generally addressed in discussions of
these clauses is that upon decontrol at least some
contracts would escalate to "oil parity" prices and
producers would receive these new higher prices.
Then, "favored nations" clauses would be
"triggered" throughout the areas in which the oil
parity clauses operate. The evidence seems to be
that there are sufficient oil parity clauses, and
the areas specified in favored nations clauses are
sufficiently widespread that a "cascading" effect
would ensure that a very large proportion of all gas
in the country would have at least the theoretical
right to a price which would be substantially above
what the market would support.
In one analysis, this situation could not be main
tained for long, and private renegotiation of
contracts would eliminate the problems by providing
the same resolution as would have been reached in a
market without these clauses. There is, conse-
quently, some argument for making no reference to
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this contract escalator problem. However, the fear
of the effects of such clauses is sufficiently great
that a bill which made no reference to these
problems would be even more difficult than usual to
In the immediate total decontrol proposal, this
problem is solved by allowing the purchaser simply
to opt out of any contract containing such clauses
if it cannot be renegotiated. At the same time,
because a pipeline in many cases has monopsony power
over a producer that is connected only to that
pipeline, a pipeline that opted out would be
required to transport gas to a new purchaser, in
return for a transportation charge specified by
FERC.
The modified immediate decontrol and phased
decontrol solutions, on the other hand, would
essentially "decouple" or "insulate" indefinite
price escalator clauses from other contracts or
events happening prior to decontrol. No clause or
contract or event entered into or occuring before
the date of decontrol could be used to trigger any
indefinite price escalator. Thus, if one producer
were receiving $10 per mcf under a contract entered
into in 1978, this could not be used to escalate
prices under a contract at the time of decontrol.
On the other hand, if new contracts were entered
into after decontrol at whatever price, then
contracts could operate according to their terms.
Supporters of this option argue that a decoupling
initiative represents minimum interference with
respect to contract integrity, yet at the same time
attacks the primary source of a possible cascading
price effect.
An alternative option would specifically limit
prices under escalator clauses to a numerical price
cap such as, e.g., 70 percent of the refiner
acquisition cost of crude oil or the average price
of new gas contracted for during any period after
decontrol. The Working Group believed that the
latter option would in effect be a new form of price
control, requiring FERC action to formulate the new
pricing levels. For this reason, the working Group
rejected this proposal, although it would have two
attractions: (i) it would provide absolute assurance
that some set of circumstances could not drive
escalator clause contracts above the general average
level of contracts after decontrol; and (ii) it
would also attack oil-parity contracts themselves.
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Some in the Working Group believed that those who
signed oil parity contracts knew very well what they
were doing, and thus do not deserve the special
relief provided by this option. Furthermore, a
granting of relief in this case could contradict
earlier Administration policy against such contract
bailouts and would lead to renewed pressures for
contract relief in other industries. Others believe
that the relative equity of oil parity contracts is
irrelevant because (i) not granting relief on oil
parity contracts represents a glitch in the
otherwise smooth functioning of the deregulation
-initiative; and (ii) it could be divisive to
development of a consensus because of the
predictably strong negative reaction of pipelines,
distribution companies and consumers. Also, a cap
based on a rolling average of prices does not give a
federal agency broad discretion as to where prices
should be set. Instead, it implies only a data
collection and distribution function.
In addition to oil parity issues, other contentious
issues seem sure to arise. If, for instance, an
interventionist contracts option is chosen, there is a
choice as to whether to include contracts for already
deregulated Section 107 gas. Such interference will be
popular politically but represents blatant recontrol of
gas prices to the detriment of investors in these
high-cost projects.
D. Problems of Take-or-Pay Clauses in Contracts
The production of natural gas is a highly capital
intensive activity. To minimize capital costs, it often
is not efficient for several pipelines to serve a single
locality. Therefore, a potential producer will usually
demand a long-term contract to protect himself from the
potential future bargaining power of the contracting
pipeline. On the other hand, before a pipeline may be
constructed, the pipeline company must show its
regulators and creditors that the proposed pipeline has
sufficient assured supply. The pipeline, thus, also has
an important interest in signing a long-term contract.
Take-or-pay clauses are important integral components of
these long-term contract arrangements. By requiring
specified payments, regardless of the buyer's momentary
needs, those clauses ensure that pipelines cannot
arbitrarily walk away from a contract to buy gas.
Under price controls, purchasers are forbidden to
compete for new supplies by offering a higher price.
Therefore, purchasers under controls competed by
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increasing their take-or-pay commitments to very high
percentages (80-100 percent). In a time of lessened
demand, as in the present, a pipeline may find that it
has over-extended and obligated itself to take a lot of
high priced gas, and is correspondingly forced to cut
back some of its other potential supplies, even if they
could sell at a lower price.
An important policy issue is whether the federal
government should step in and abrogate these high
percentage take-or-pay contracts. In so doing, however,
the government would be rewarding those few pipelines
that exercised rather bad business judgment to the
detriment of those pipelines that refused to agree to
extreme contract terms and consequently had to go
without the additional gas supplies.
Under the immediate total decontrol option, the take-or-
pay clauses could be included in a statutory market-out
clause which would permit the purchaser to abrogate his
contract.
Supporters of the modified immediate decontrol option
generally believe that abrogation of take-or-pay clauses
should be avoided. As discussed in the case of oil
parity clauses, abrogation of take-or-pay clauses could
contradict existing Administration policy against
industry bailouts and could lead to a Pandora's box of
outcries for similar relief.
Under the phased decontrol option there are two possible
proposals: (i) a simple cap of limited duration, e.g.,
75 percent for three years; (ii) a comprehensive control
system requiring pipelines wishing to escape their take-
or-pay obligations to do so commencing with their most
expensive gas and gas produced by themselves or
affiliates. The latter option would require an
elaborate FERC enforcement apparatus with implications
for time lags in enforcement.
The percentage to which take-or-pay obligations could be
reduced could, of course, be varied. Congressman Brown
(R-Ohio) has submitted a bill which would allow reduc-
tion as far as 50 percent. This would be a rather
severe disappointment of the obligations and expecta-
tions of the producer at the time of contract.
One other consideration merits mention. Some gas is
produced in association with oil production. Contracts
for the sale of such "associated" gas often call for
very high percentages of take because the alternative is
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shutting in oil production when the purchaser refuses to
take gas or maintaining oil production, but wasting the
gas through venting or flaring. Accordingly, even a
restrictive take-or-pay solution should deal separately
with the peculiar problems of associated gas production.
A final consideration is applicable to the discussion of
,both indefinite price escalators and take-or-pay. If a
cap is placed on each of these provisions for some
period of time, a market-out could be provided upon
termination of that period and applied only to contracts
of specified types which have not been renegotiated.
There is some evidence that such a provision would
receive broad support. It would mitigate the problem of
intransigence in renegotiation, while advantaging
neither the pipelines nor producers unduly.
E. Duration of Legislated Contract Changes
The purpose of the various possible changes in the
contracts is to provide a transitional mechanism to move
from almost thirty years of price regulation (with its
attendant impact on contract terms) to a freer market
for natural gas sales. Thus the contract changes would
be expected to have a two to three year duration during
which time the parties to the contracts could
renegotiate the offending terms. The effect of these
terms would be suspended for the two or three year
period. If the parties did not renegotiate the take-or-
pay provision during such period, it would be
reinstated. however, the offending indefinite price
escalators, if not renegotiated, could (a) remain
suspended and subject to the transition pricing mode, or
(b) be subject to a market-out provision, or (c) be
reinstated.
F. Associated Tax or Expenditure Proposals
Many members of Congress have stated that a natural gas
decontrol proposal can be adopted only if there is some
type of tax on the "windfall" arising therefrom, either
as a means of helping consumers or punishing the
producer. The Working Group unanimously agreed that any
such tax would increase consumer costs and reduce gas
exploration and production, and was, therefore, totally
unjustified from a policy point of view. Under present
economic conditions, the revenues theoretically
generated would not be worth the increased consumer
costs and decreased exploration activity.
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G. Imported Gas
Five percent of U.S. gas is imported from Canada,
Mexico, and Algeria, with Canada representing about 90%
of this volume. Under the terms of an understanding
reached between the U.S. and Canadian Governments in
March 1980, there is a uniform border price (currently
$4.94 per million BTU) for all gas imported from Canada.
A similar understanding accorded Mexican gas the same
pricing treatment. While the U.S. views the uniform
border price as a ceiling, Canada and Mexico view it as
a floor. Therefore, although the U.S. does not now
preclude importeres from renegotiating lower prices with
Canadian and Mexican suppliers, such changes would be
subject to Canadian and Mexican Government approval.
Effects on existing contracts: Under full decontrol and
a possible contracts "fix" scenario, there is a question
whether new legislation would apply to existing
contracts with foreign producers. There may be pressure
from Congress to include these existing contracts in any,
new legislation. Because of the government-to-govern-
ment understandings and the likely need for imported gas
during the life of existing contracts. The State
Department believes it would be preferable to use
diplomatic means, rather than unilateral and extra-
territorial legislative action, to bring about
renegotiation of existing contracts.
Effects on new contracts: Under full decontrol, there
would be no need for regulatory authorities to review
the price aspects of proposed gas imports from Canada
and Mexico (in addition, imports of Algerian LNG would
probably no longer be necessary). Following notifi-
cation to the Canadian and Mexican Governments that the
U.S. would no longer consider previous understandings as
valid for new contracts, the market would determine what
price importers pay for future foreign supplies and gas
imports would no longer receive special pricing treat-
ment. As a general principle, legislation affecting
other aspects of domestic contracts (take-or-pay,
escalator clauses) would also be applied to new inter-
national contracts in a non-discriminatory fashion.
Effects on international energy security and trade: An
Administration initiative on decontrol could increase
U.S. gas production and reduce oil imports. The SIG-IEP
has identified decontrol as a key domestic measure to
enhance U.S. energy security. Full decontrol would also
eliminate a source of trade friction with both the
Europeans and Japanese, who have complained that U.S.
price controls serve to subsidize U.S. petrochemical
exports.
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SUMMARY OF OPTIONS
A. (Immediate Total Decontrol)
Immediate decontrol, purchasers can opt out of
contracts.
Advantages
o Provides greatest efficiency benefits by allowing all
gas to reach a market-clearing price immediately.
o Permits greatest flexibility in prices, both up and
down.
o Permits legislators to disclaim responsibility for any
particular "target" price.
o Provides greatest flexibility for new market
arrangements.
o Provides earliest dismantling of regulatory apparatus.
o The most-unsettling aspect of decontrol would be
concluded before the highly charged 1984 election
season.
Disadvantages
o Violates legitimate contracts and expectations of large
numbers of businesses.
o Provides no protection against fears of unlimited price
increases.
o Could be politically difficult to sell.
o Requires effective restructuring of natural gas industry
under very short time deadline.
o Could be argued to jeopardize security of supply
necessary for service of long-term public utility
obligations.
o Creates renewed claims by other industries (e.g.,
timber) for contract "adjustments."
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B. (Modified Immediate Decontrol)
Uses a more "moderate" contracts approach.
Advantages
o Almost the same as in Option A.
o Does not interfere as much with legitimate contracts
entered into by private parties.
o Minimizes the overshooting or undershooting of prices
that could occur from phase decontrol.
Disadvantages
o The modified contracts approach may be difficult to
implement and contemplates government intervention.
o Would also be politically difficult to sell.
C. (Phased Option): Phase decontrol through 1985, with
moderate amendments to ease contractual problems.
Advantages
o Makes incremental moves from current situation to general
decontrol.
o Works in policy framework with which Congress is
familiar.
o Provides a predictable framework for future developments
in natural gas industry, both production and consumption.
o Should cause relatively minor price impact beyond that
which would occur anyway.
Disadvantages
o More likely to become mired in congressional changes and
horse trading.
o Still creates some additional government intervention by
modification of existing contracts in violation of
expectations.
o Sufficiently complex that true adjustment will not begin
in the natural gas industry until after 1985.
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D. (Continue NGPA)
Advantages
o Avoids an immediate political fight on our initiative.
0. Current situation is perceived as not too bad, as price
gap between oil and gas has diminished.
o Avoids the possibility of Administration initiatives
leading to an ultimate bill worse than the present
situation, which the President would have to decide
whether to veto.
Disadvantages
o Hurts consumers by leading to increased prices and
decreased supply over the long run.
o Leaves initiative in hands of proponents of controls, who
will continue to press for further restrictions on gas
prices.
o Prevents most effective and efficient production and use
___of_natural_gas,_thus exacerbating energy problems.
o Could hurt consumers by maintaining artificially high
prices over the short to mid term.
o Practically guarantees a fight over reimposition of
extension of controls in the 1984 political season.
o Will further discourage exploration and conservation
efforts as natural gas situation remains unsettled.
o Leaves energy and economic situation subject to the
vicissitudes of the world oil market. In the event of a
price increase, gas controls would become even more
entrenched and damaging.
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