Natural Gas Act Summary

  • Last updated on November 10, 2022

The Natural Gas Act mandated the Federal Power Commission to control gas prices in interstate commerce and to decide which pipelines could enter the interstate market.

Summary of Event

On June 21, 1938, Congress passed the Natural Gas Act (NGA), and seven days later, President Franklin D. Roosevelt signed it into law. The NGA provided the Federal Power Commission (FPC) much discretion in determining “just and reasonable” rates for the sale of natural gas in interstate commerce. The findings of the commission were to be “conclusive” so long as “supported by substantial evidence,” but these findings could be challenged in court. The regulation of prices was not to apply to local sales or to intrastate deliveries; the state public-service commissions would continue to regulate these services. The FPC was given additional powers to regulate interstate pipelines and to award certificates of public convenience and necessity, meaning that no new pipeline could enter the interstate market without FPC approval. The major purpose of the law was to protect consumers from excessive prices; public safety and conservation of a scarce resource were secondary considerations. [kw]Natural Gas Act (June 21, 1938) [kw]Gas Act, Natural (June 21, 1938) [kw]Act, Natural Gas (June 21, 1938) Natural Gas Act (1938) Federal Power Commission [g]United States;June 21, 1938: Natural Gas Act[09780] [c]Environmental issues;June 21, 1938: Natural Gas Act[09780] [c]Natural resources;June 21, 1938: Natural Gas Act[09780] [c]Laws, acts, and legal history;June 21, 1938: Natural Gas Act[09780] Lea, Clarence Frederick Rayburn, Sam Roosevelt, Franklin D.

Since the late nineteenth century, the federal government had been regulating interstate business that was monopolistic or “affected with a public interest.” Until the late 1920’s, however, natural gas was generally an intrastate business, and it had been regulated by the state public-service commissions since the beginning of the twentieth century. The business changed as improvements in metals and welding made it possible for long seamless pipelines to cross state borders between areas of production and large urban centers in the North, and by 1936, thirty-five states had access to supplies of natural gas. The U.S. Supreme Court, in Missouri v. Kansas Natural Gas (1924), Missouri v. Kansas Natural Gas (1924) interrupted the status quo by ruling that the states could no longer regulate the prices of natural gas transported from one state to another, because the Constitution gave Congress exclusive power to regulate interstate commerce.

After the Court’s decision, those suspicious of the large energy companies wanted the Congress to “fill in the gap” in the regulation of natural gas. In 1928, the Senate instructed the Federal Trade Commission Federal Trade Commission to investigate the matter, and the commission’s one-hundred-volume study recommended federal regulation of both electricity and natural gas. With the support of this study, the New Deal Congress passed the Federal Power Act of 1935, Federal Power Act (1935) which enlarged the scope of the FPC and authorized it to regulate electricity sold between states. The FPC had both quasi-legislative and quasi-judicial functions, so that it could formulate rules with the force of law and interpret these rules in specific cases, subject to appeals in the federal courts.

After the passage of the Federal Power Act, Congressman Sam Rayburn, one of the strongest proponents of New Deal regulations in the House of Representatives, instructed legislative drafters to take the law and use it as a model for similar legislation authorizing controls of natural gas sales. As Rayburn introduced the bill into the House, Burton Kendall Wheeler introduced the same bill into the Senate. Natural gas companies and state regulators, however, objected to some of the features of the Rayburn bill, and it failed to become law. The next year, Representative Clarence Frederick Lea, chairman of the appropriate commerce subcommittee, revised the bill with the assistance of Clyde Seavey, one of the members of the FPC. Lea introduced the new bill into the House that year, and although there was little opposition, there was not enough interest to get it to the floor for a vote.

Lea then turned to the natural gas companies for their views; after making some changes, he introduced the bill a second time in April, 1937. The companies had decided that regulation was in their interest. At this time, the companies’ major problem was that oversupplies were driving down prices, and they were now happy to accept regulation in exchange for a guaranteed profit margin. In spite of a consensus in favor of regulation, the Senate was slower than the House to vote in favor of the bill, and the differences between the two chambers were not worked out until June 21, 1938. Compared with many innovative laws of the New Deal, the NGA was considered rather unexceptional, and the press at the time almost ignored the issue.

The NGA was vague and ambiguous in several key areas, and thus the implications of the law would evolve with judicial challenges. The most uncertain portion of the NGA was the statement that FPC regulation would not extend to “the production and gathering of natural gas.” It was clear that the FPC would not have authority over the physical production of gas. Because the term “production and gathering” was not defined, however, it was unclear whether the FPC was authorized to regulate the sale of gas in the fields if the gas was destined for the interstate markets, or whether FPC regulations would apply only after the gas had been sold. This particular ambiguity would be the most controversial aspect of the history of the NGA. Over the years, interpreting this and similar provisions of the NGA would give employment to a large number of lawyers.

Significance

The first major court battle of the NGA had to do with the method that the FPC was to use in determining “just and reasonable” rates. When the act was passed, regulatory bodies generally were following the fair-value standard that a probusiness Supreme Court had articulated in its 1897 Smythe v. Ames decision. According to this standard, regulated businesses were entitled to a rate of return based on the value of their capital investment. Beginning in 1942, a more aggressive FPC changed its standard to one of production investment costs, which meant a lower rate of return for gas businesses. The issue was tested in court in the case Federal Power Commission v. Hope Natural Gas (1944), Federal Power Commission v. Hope Natural Gas (1944) in which the Supreme Court supported the FPC’s position and overruled the Smythe precedent. The Court enunciated the principle that government regulators were no longer required to use the investment-value standard, but they could use any reasonable method or formula.

A more long-standing controversy was whether the FPC was authorized to regulate the price charged for natural gas in the fields (at the wellheads). The issue was complex, because although large companies were involved in both the production and the transmission of natural gas, some four thousand independent producers were not involved in interstate transmission. At first, the FPC did not regulate any sales in the fields, but in 1942, the commission began to regulate the large companies that both produced gas and controlled pipelines. The FPC decided against the regulation of the independent producers, but in the surprising landmark case Phillips Petroleum Company v. Wisconsin (1954), Phillips Petroleum Company v. Wisconsin (1954) the Supreme Court ruled that the intent of Congress in 1938 had been to regulate the sale of natural gas in the fields when its destination was interstate commerce.

Because the Phillips decision required the FPC to regulate the sales of thousands of independents, the work of the FPC became much more extensive and complex. Lawyers and economists tended to view the Phillips decision as almost equal in importance to the NGA itself. Until 1960, the FPC made individual price determinations through a case-by-case approach. After a study pointed to the FPC as an example of the “breakdown of the administrative process,” the commission changed to the area rate method, which was a determination of the reasonable requirements within each of twenty-three geographic regions. In the 1970’s, the FPC changed to one standard rate to be used nationwide.

Until about 1968, large supplies of natural gas kept prices low, but by 1972, the FPC acknowledged that there actually were shortages in parts of the country. Because oil and gas are often substituted for each other, the increase in oil prices after the embargo of 1973 had a great impact on the market for natural gas. By about 1975, gas prices in the intrastate markets were about twice as high as those in the interstate market, and it was becoming apparent that price regulations were contributing to gas shortages in the interstate market. The situation became critical in the cold winter of 1976 and 1977, when a lack of supplies forced four thousand manufacturing plants to close and resulted in 1.2 million workers temporarily losing their jobs. Hundreds of schools had to close their doors in order to protect gas supplies for residential consumers.

President Jimmy Carter and his administration concluded that the only answer was to move to the deregulation of natural gas at the wellheads, and the result was the Natural Gas Policy Act Natural Gas Policy Act (1978) (NGPA) of 1978. The NGPA was complex because it made distinctions among about twenty different categories of natural gas. The schedules provided that price controls for new gas and hard-to-get gas from deep wells would end by 1985, whereas the lifting of controls on old gas and gas in shallow wells would not end until 1987. President Ronald Reagan and his administration were committed to competitive markets, and they generally supported the principles of the NGPA of 1978. After the beginning of decontrols, prices did increase significantly by 1982, but adequate supplies ceased to be a problem. Thereafter, new discoveries of natural gas appeared to produce a satisfactory equilibrium and the public lost interest in the issue.

By the 1990’s, the controversies of the Natural Gas Act of 1938 were a memory. Most economists tended to conclude that the NGPA of 1982 was a positive step, and few people wanted to return to the field regulations that began with the Phillips decision. It was not clear whether the Natural Gas Act had actually operated in the interest of the consumer, because evidence indicated that the realities of supply and demand had always influenced prices more than had price regulations.

With the growing concern for the environment, there was a new complexity about the implications of the term “conservation” in regard to the natural gas industry. Since the passage of the NGA in 1938, the justification for conserving natural gas had been to place a limit on how much gas was consumed so that supplies would last longer. Natural gas, however, is a clean-burning, environmentally friendly fuel, and efforts to decrease its use result in the increased use of other forms of energy that do more ecological damage. The limits of the obtainable reserves of this wonderful resource are as yet unknown. Natural Gas Act (1938) Federal Power Commission

Further Reading
  • citation-type="booksimple"

    xlink:type="simple">Baum, Robert. The Federal Power Commission and State Utility Regulation. Washington, D.C.: American Council on Public Affairs, 1942. Presents a favorable interpretation of the early history of the FPC’s regulation of natural gas.
  • citation-type="booksimple"

    xlink:type="simple">Breyer, Stephen, and Paul W. MacAvoy. Energy Regulation by the Federal Power Commission. Washington, D.C.: Brookings Institution, 1974. Emphasizes the economics of regulation and argues that price regulation at the wellheads resulted in shortages.
  • citation-type="booksimple"

    xlink:type="simple">Castaneda, Christopher James. Invisible Fuel: Manufactured and Natural Gas in America, 1800-2000. Boston: Twayne, 1999. History of the use of gas as an energy source in the United States includes discussion of the Natural Gas Act of 1938. Features chronology, selected bibliography, and index.
  • citation-type="booksimple"

    xlink:type="simple">DeVane, Dozier. “Highlights of Legislative History of the Federal Power Act of 1935 and the Natural Gas Act of 1938.” George Washington Law Review 14 (December, 1945): 30-41. Very informative account of how the act was passed, emphasizing the roles of Congressmen Rayburn and Lea.
  • citation-type="booksimple"

    xlink:type="simple">Hawkins, Claud. The Field Price Regulation of Natural Gas. Tallahassee: Florida State University Press, 1969. Excellent, scholarly, and readable account of the passage of the act and of interpretations of the law by the courts.
  • citation-type="booksimple"

    xlink:type="simple">Kohlmeier, Louis, Jr. The Regulators: Watchdog Agencies and the Public Interest. New York: Harper & Row, 1969. Interesting journalistic account is critical of the regulatory process. Includes substantial coverage of the regulation of natural gas.
  • citation-type="booksimple"

    xlink:type="simple">MacAvoy, Paul W. The Natural Gas Market: Sixty Years of Regulation and Deregulation. New Haven, Conn.: Yale University Press, 2001. Argues that federal attempts to regulate natural gas have cost the United States billions of dollars and have encouraged intrusive involvement in the natural gas market on the part of regulatory agencies.
  • citation-type="booksimple"

    xlink:type="simple">Sanders, M. Elizabeth. The Regulation of Natural Gas: Policy and Politics, 1938-1978. Philadelphia: Temple University Press, 1981. Excellent, informative study considers various theories of regulation. Concludes that legislators in 1938 were primarily influenced by local interests and that capture of the industry did not take place.

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