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Report to the Permanent Subcommittee on Investigations, Committee on 
Homeland Security and Governmental Affairs, U.S. Senate: 

United States Government Accountability Office: 

GAO: 

September 2006: 

Natural Gas: 

Roles of Federal and State Regulators in Overseeing Prices: 

Natural Gas: 

GAO-06-968: 

GAO Highlights: 

Highlights of GAO-06-968, a report to the Permanent Subcommittee on 
Investigations, Committee on Homeland Security and Governmental 
Affairs, U.S. Senate 

Why GAO Did This Study:

Following Hurricanes Katrina and Rita, natural gas prices spiked to 
over more than $15 per thousand cubic feet, nearly seven times higher 
than in the late 1990s. As a result, policymakers have increasingly 
focused on better understanding how prices are overseen. 

The prices that consumers pay for natural gas prices are composed of 
three componentsó (1) the commodity price, (2) the cost of interstate 
transportation, and (3) local distribution charges. --that together 
make up the price that consumers pay for natural gas. Oversight of 
these components belongs to the federal government, through the Federal 
Energy Regulatory Commission (FERC), and the states. In 1993, federal 
price controls over commodity prices were removed, but FERC is still 
charged with ensuring that prices are fair. Recently, the Energy Policy 
Act of 2005 (EPAct 2005) broadened FERCís authority. 

GAO agreed to (1) analyze FERCís role overseeing natural gas prices, 
(2) summarize FERCís progress in implementing EPAct 2005, and (3) 
examine statesí role in overseeing natural gas prices. In preparing 
this report, (can we say a few words her about scope and 
methodology?)GAO met with officials from 10 states that regulate gas in 
different ways and analyzed relevant laws and documentation. 

What GAO Found: 

Since natural gas commodity prices were deregulated in 1993, FERCís 
role in ensuring that commodity prices are determined competitively and 
are free from manipulation has been limited to (1) indirectly 
monitoring commodity markets to identify and punish market manipulation 
and (2) supporting competition in those markets. FERC faces challenges 
ensuring prices are fair, however, because staff cannot monitor all of 
the potentially millions of transactions and because it is difficult to 
determine whether identify markets are free from manipulation. FERCís 
oversight of commodity markets has risen in importance recently because 
the commodity price amounted to nearly 60 percent of the total consumer 
price in 2005 compared with about 30 percent in 1993. FERC also 
directly approves interstate transportation prices. 

FERC has completed action on four of the six new tasks identified by 
EPAct 2005 related to natural gas. FERC officials said that EPAct 2005 
is having has achieved tangible results. For example, following FERCís 
issuance of a policy statement on enforcement in October 2005, some 
industry members have self-reported instances of noncompliance with 
FERC-approved rules in an effort to gain consideration for a lesser 
penalty. 

States directly oversee prices for local distribution of natural gas 
and have a limited role approving commodity and interstate 
transportation prices. States directly approve utilitiesí charges for 
local delivery of natural gas, but this represented only about 30 
percent of the consumer price in 2005. While states can deny gas 
utilities from passing on the cost of the gas commodity to consumers, 
state officials told us this rarely occurs. State officials rely on 
FERC to ensure that commodity prices are fair, but some said they are 
unaware of FERCís oversight efforts. FERC officials agree that 
expanding the information they provide to stakeholders would improve 
stakeholdersí understanding of FERCís efforts and could help deter 
manipulation. 

Figure: Changes in Average natural Gas Prices Paid by Consumers, 1993 
to 2005 (in 2005 dollars): 

[See PDF for Image] 

Source: GAO analysis of Energy Information Administration data. 

Note: Prices shown represent an illustrative example of natural gas 
prices, in 2005 dollars, based on the average price paid by most 
utility consumers for 1,000 cubic feet of natural gas. 

[End of Figure] 

What GAO Recommends: 

To improve understanding of FERCís market oversight and to help deter 
market manipulation, FERC should better inform stakeholders about its 
market monitoring and investigations by FERC . 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-968]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Jim Wells at (202) 512-
3841 or wellsj@gao.gov. 

[End of Section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

FERC's Role in Influencing Prices That Consumers Pay for Natural Gas 
Has Been Limited: 

FERC Has Made Substantial Progress Implementing Additional EPAct 2005 
Authorities but Has Not Begun Imposing Fines or Penalties: 

States Directly Oversee Utilities' Prices for Local Distribution of 
Gas, but They Have a Limited Role in Natural Gas Commodity and 
Transportation Prices: 

Conclusions: 

Recommendation for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Method: 

Appendix II: Comments from the Federal Energy Regulatory Commission: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Table: 

Table 1: Status of FERC's Implementation of Additional Authorities 
Related to Natural Gas Provided under EPAct 2005: 

Figures: 

Figure 1: Natural Gas Production, Interstate Transportation, and Local 
Distribution: 

Figure 2: Breakdown of Most Consumers' Natural Gas Prices, by 
Component, 1993 through 2005: 

Abbreviations: 

CFTC: Commodities Futures Trading Commission: 

EIA: Energy Information Administration: 

EPAct 2005: Energy Policy Act of 2005: 

FERC: Federal Energy Regulatory Commission: 

LNG: liquefied natural gas: 

MOU: memorandum of understanding: 

NARUC: National Association of Regulatory Utility Commissioners: 

United States Government Accountability Office: 
Washington, DC 20548: 

September 8, 2006: 

The Honorable Norm Coleman: 
Chairman: 
The Honorable Carl Levin: 
Ranking Minority Member: 
Permanent Subcommittee on Investigations: 
Committee on Homeland Security and Governmental Affairs: 
United States Senate: 

High prices for natural gas have the attention of policymakers and the 
public. After years of being relatively low, natural gas prices have 
trended upward over the past 5 years. More recently, following 
Hurricanes Katrina and Rita in 2005, natural gas prices spiked to over 
$15 per thousand cubic feet, nearly seven times higher than they had 
been in the late 1990s. The high prices have created hardships for many 
consumers, particularly low-income residential consumers and energy- 
intensive industries such as fertilizer manufacturing. 

The price that most consumers pay for natural gas is composed of three 
major components. The first is the charges for the natural gas itself, 
referred to as the natural gas commodity. The second includes the 
charges for interstate transportation of the natural gas, generally 
through large pipelines from areas where it is produced to areas where 
it is consumed. The third includes the charges for local distribution 
by natural gas utilities--the private companies that deliver natural 
gas to consumers in homes and businesses. Utilities generally pass on 
to consumers the costs of the commodity and interstate transportation, 
adding these costs to the charges for local gas distribution. 

Oversight of these components is shared by the federal government and 
the states. The Federal Energy Regulatory Commission (FERC) is the lead 
federal agency with authority over certain sales of the natural gas 
commodity for resale (for example, the sales by interstate natural gas 
pipelines or their affiliates to the natural gas utilities that, in 
turn, sell natural gas to consumers) and over the interstate 
transportation of natural gas. FERC is obligated to, among other 
things, ensure that natural gas prices under its jurisdiction are "just 
and reasonable." Prior to 1993, FERC regulated the commodity and 
interstate transportation prices subject to its jurisdiction by 
approving prices based on costs and other factors. While the regulated 
market ensured stable prices, it also caused severe gas supply 
shortages because, with artificially low prices, producers had no 
incentive to increase production and consumers had no reason to curtail 
their demand. The Natural Gas Wellhead Decontrol Act[Footnote 1] 
required that certain natural gas commodity prices--generally prices 
charged by natural gas producers--be deregulated by 1993 as part of an 
effort to address supply concerns and provide other benefits to 
consumers. Since that time, natural gas commodity prices have been 
largely determined in the market by supply and demand. Deregulation 
improved the availability of natural gas and initially lowered prices. 
The Energy Policy Act of 2005 (EPAct 2005) broadened FERC's authority 
over natural gas commodity markets to include, among other things, more 
authority to police natural gas markets, punish manipulation, and 
impose greater penalties for other types of violations.[Footnote 2] The 
act also identified six specific actions that FERC should take related 
to natural gas oversight, including issuing a report to Congress and 
promulgating regulations necessary to implement the new authorities. 

In the states, public utility commissions or their equivalents are 
responsible for overseeing the operations of natural gas utilities. As 
part of that oversight, the commissions are charged with approving 
utilities' investments into new local pipelines and utilities' charges 
to consumers for local distribution of the natural gas commodity. 

Given the high natural gas prices seen in recent months, policymakers 
have increased their attention to better understanding the oversight 
and regulation of the natural gas industry and how prices are 
determined. In this context, you asked us to provide information about 
federal and state oversight of natural gas prices. Specifically, you 
asked us to (1) analyze FERC's role overseeing natural gas prices, (2) 
summarize FERC's progress in implementing additional responsibilities 
and authorities under EPAct 2005, and (3) examine states' role 
overseeing natural gas prices. 

In preparing this report, we reviewed reports, legislation, 
regulations, and other documentation on the natural gas industry, 
markets, and federal and state oversight. We examined data on natural 
gas prices and consumption. In addition, we interviewed officials from 
FERC, trade associations, industry, and others. We also interviewed 
state regulators in 10 states--California, Colorado, Georgia, Iowa, 
Maryland, Pennsylvania, South Carolina, Texas, Vermont, and Wyoming-- 
about their activities and their perspectives on FERC oversight. We 
selected these states to ensure a broad representation of natural gas 
consumption levels, residential prices paid for natural gas, purchasing 
options available to consumers, and methods states use to approve 
natural gas rates. We conducted our work from February through August 
2006 in accordance with generally accepted government auditing 
standards. 

Results in Brief: 

Since natural gas commodity prices were deregulated in 1993, FERC has 
been limited to an indirect role overseeing the market that determines 
commodity prices while it has continued with its direct role approving 
interstate transportation prices. FERC's role since deregulation has 
shifted from approving natural gas commodity prices to a more limited 
role of monitoring the markets that now determine prices. In carrying 
out its responsibility and to understand the overall market, FERC staff 
in the Office of Enforcement review a wide range of data on natural gas 
commodity prices at key energy market trading centers nationwide and on 
other aspects of the market in order to identify price anomalies or 
potential market manipulation and undertake informal or formal 
investigations when needed. To promote competition in natural gas 
commodity markets, FERC has issued rules of conduct designed to prevent 
pipeline companies from giving undue preference to their energy 
affiliates and to open access of pipelines to other entities. More 
recently, FERC has updated the rules designed to prevent natural gas 
pipeline companies and public utilities from giving affiliates undue 
preference and developed standards designed to improve the robustness 
and availability of price information. While FERC's role overseeing 
natural gas commodity markets has been limited, recently it has become 
more important because the commodity price accounted for almost 60 
percent of the total consumer price in 2005, compared with about 30 
percent in 1993. FERC faces challenges in ensuring that commodity 
prices are competitive and free from manipulation. For example, 
although FERC officials said they now have the authority to examine 
virtually all transactions, they are still not able to actively monitor 
all of the potentially millions of transactions that occur in numerous 
physical and financial markets. While FERC has worked to improve the 
functioning of competitive markets and focused its oversight efforts on 
identifying and punishing market manipulation, staff acknowledged that 
is often difficult to determine whether markets are always competitive 
and free from manipulation. Regarding interstate transportation of 
natural gas, FERC retains a direct oversight role approving the 
transportation charges. However, this role has decreased in importance 
in determining prices consumers pay because transportation declined to 
about 10 percent of the total consumer price in 2005 from about 20 
percent in 1993. 

FERC has completed action on four of the six actions identified in the 
Energy Policy Act of 2005 related to its oversight of natural gas 
markets and it has expanded its market-monitoring activities in 
response to the new authorities provided by the act. In particular, in 
January 2006, FERC promulgated new rules regarding market manipulation. 
In addition, FERC has initiated action on the two remaining actions. 
For example, FERC has begun writing regulations regarding its role as 
the lead agency for coordinating environmental approvals of 
construction of new pipelines. In addition, FERC staff told us they 
have begun to use their broadened antimanipulation authority granted by 
EPAct 2005 to investigate entities previously outside FERC's regulatory 
reach. For example, they are analyzing data on the transactions between 
producers and traders that occur before the gas is shipped through 
interstate pipelines; prior to EPAct 2005, these transactions were 
outside FERC's jurisdiction. According to FERC officials, however, it 
has not yet used its new authorities to issue fines or penalties 
because none of the investigations FERC is conducting under the new 
authority have been completed. FERC officials said that EPAct 2005 is 
having tangible results. For example, following FERC's issuance of a 
policy statement on enforcement in October 2005, some industry members 
have self-reported instances of noncompliance with FERC-approved rules 
in an effort to gain consideration for a lesser penalty. 

States directly oversee prices for local distribution of natural gas 
and also have a limited role approving the federally overseen natural 
gas commodity and interstate transportation prices that gas utilities 
charge their customers. States directly approve utilities' charges for 
local delivery of natural gas from interstate pipelines to homes and 
businesses and for related services such as meter reading. These 
charges accounted for about 30 percent of the consumer price for 
natural gas in 2005, down from about 50 percent in 1993 when natural 
gas commodity prices were lower. In addition, states have a limited 
role approving the prices that gas utilities charge their customers for 
the commodity and transportation costs. In general, states allow gas 
utilities to recover these costs, but states can deny recovery under 
some circumstances. For example, state regulators can and do review 
utilities' gas purchases and, in certain instances, may deny recovery 
of the costs if the utility's purchase price was above prevailing 
market prices. In practice, however, according to regulators and 
experts, state regulators rarely deny utilities these charges because, 
for example, it is difficult to demonstrate that prices utilities paid 
are above prevailing market prices. State officials in only 4 of the 10 
states in our review said that they had denied recovery of a major 
natural gas commodity purchase in the past 3 years--and then in only a 
few instances. Because of their limited authority, state regulators 
told us they generally rely on FERC to ensure that the commodity and 
interstate transportation portions of natural gas prices are 
reasonable. FERC has conducted some outreach activities to keep state 
regulators informed about its gas market oversight activities. In 
addition, FERC publicly reports some enforcement information, such as 
the number of hotline calls it receives and statistics on closed 
investigations and audits in documents available through its Web site. 
Despite these actions on FERC's part, some stakeholders, including 
state regulators, other government officials, and the public do not 
fully understand what FERC does to oversee commodity markets, and some 
lack confidence that natural gas commodity prices in particular are 
free from manipulation. FERC officials noted they are prohibited by 
regulation from providing detailed or specific information to 
regulators or the public about ongoing enforcement efforts without 
approval by FERC's commissioners. However, they recognize that 
providing more information about ongoing and completed efforts, as long 
as it would not compromise ongoing investigations, would help 
stakeholders better understand FERC's oversight activities and deter 
illegal activity. 

To increase stakeholders' understanding about FERC's oversight of 
natural gas commodity markets and to deter market manipulation, we are 
recommending that FERC better inform stakeholders, including state 
regulators, other government officials, and the public, about the 
monitoring and investigation activities that FERC undertakes to help 
ensure that prices are free from manipulation. 

Background: 

Natural gas is a vital energy source used in a large variety of 
applications, providing about one-fourth of the energy consumed in the 
United States. Natural gas is a colorless, odorless fossil fuel found 
underground that is composed mainly of methane and generated through 
the slow decomposition of ancient organic matter. Most natural gas 
consumed in this country is produced in North America, but an 
increasing portion is shipped from overseas in the form of liquefied 
natural gas (LNG). Natural gas is used in about 60 million homes and 5 
million businesses in a variety of ways, such as for heating, fueling 
industrial processes in manufacturing operations, fueling electricity 
generation, and fueling some cars and buses. Most natural gas consumers 
are residential users, but they use only about 24 percent of the gas 
consumed in the United States. Other natural gas consumers include 
industrial consumers, electricity generators, and transportation users. 

The natural gas industry performs three separate functions to deliver 
natural gas to consumers: (1) production of the natural gas commodity, 
(2) transportation of the commodity between states, and (3) local 
distribution within states. These major functions are illustrated in 
figure 1. 

Figure 1: Natural Gas Production, Interstate Transportation, and Local 
Distribution: 

[See PDF for image] 

Source: GAO analysis of Energy Information Administration and Natural 
Gas Supply Association data. 

Note: Although we display natural gas pipelines aboveground, pipelines 
for both interstate transportation and local distribution are generally 
belowground. We have also chosen to display interstate pipelines to 
illustrate that they are regulated federally; pipelines that do not 
cross state borders are regulated by the states. Some gas is produced, 
transported, and consumed in the same state and therefore does not 
enter an interstate pipeline. 

[End of figure] 

To produce the natural gas commodity, producers drill wells to reach 
pockets of natural gas, either at sea (such as in the Gulf of Mexico) 
or on land (such as in the Powder River Basin of the Rocky Mountain 
states). Once the gas well has been drilled, the drilling rig is 
removed and the natural gas flows to the surface, where it is combined 
with gas from other nearby wells and moved locally through a network of 
progressively larger local pipelines to processing plants. There, the 
raw gas is processed to remove water vapor, hydrogen sulfide, and other 
compounds so that it can be transported, bought, and sold nationally. 
Producers may choose to sell the natural gas commodity to a variety of 
customers, including marketers, traders, and a variety of consumers. 
Furthermore, the various players in the market may, in turn, sell gas 
back and forth several times before it is actually delivered. 

Eventually, the natural gas is transported via a network of larger 
interstate pipelines that connect various supply regions, such as the 
Gulf of Mexico, to areas where natural gas is consumed, such as large 
cities on the East Coast. Interstate pipelines converge at several 
pipeline network interconnections, which link gas consumers across the 
United States to several different production regions. As a result of 
this interconnected network, prices of natural gas at different trading 
locations vary somewhat, but they generally move together as the 
overall supply and demand balance changes. Some interstate pipeline 
intersections have become important locations for trading natural gas, 
such as the "Henry Hub" pipeline interconnection in Louisiana. 

Most consumers, particularly residential and small commercial 
consumers, receive natural gas from local natural gas utilities. 
Utilities generally operate as monopolies within service areas defined 
by states and, as such, are the only entity delivering natural gas to 
most consumers. In most cases, local gas utilities also purchase the 
natural gas commodity for their customers. Local gas utilities receive 
natural gas from interstate pipelines and route it into local delivery 
pipelines to homes and businesses, where it is consumed. A smaller 
number of consumers--such as operators of electric power plants or 
operators of industrial or manufacturing plants--may completely bypass 
the local gas utility. Because these consumers use large amounts of 
natural gas, they may purchase gas directly from suppliers and receive 
natural gas directly from interstate pipelines. 

The federal government has authority to regulate certain sales of 
natural gas and its interstate transportation and does so through two 
agencies. FERC has primary responsibility for natural gas oversight. 
FERC is led by five commissioners appointed by the President and 
approved by the Senate. The Commodities Futures Trading Commission 
(CFTC) also plays a role in federal oversight related to natural gas 
prices. It is responsible for ensuring that fraud, manipulation, and 
abusive practices do not occur in federally regulated financial 
markets, where some natural gas transactions are conducted. 

States directly regulate the local gas utilities that fall under their 
jurisdiction. Because only one utility generally provides gas to a 
specific service area, utilities lack competition and could take 
advantage of their monopoly by artificially raising natural gas prices 
for consumers or by taking other actions. To regulate investor-owned 
utilities, which distribute over 90 percent of the gas delivered by 
utilities,[Footnote 3] states created agencies called public utility 
commissions. States generally do not allow utilities to profit from the 
natural gas that they resell, although they allow utilities to recover 
the costs of purchasing the natural gas commodity by passing those 
costs on to customers. Traditionally, utilities sold natural gas at a 
single price per unit of gas--such as per thousand cubic feet--approved 
by a commission. However, as consumer prices have become more variable, 
states have generally started to allow utilities to use a "gas cost 
adjustment" system, where utilities independently adjust the rates they 
charge consumers, as long as utilities are not profiting from the gas 
sales.[Footnote 4] 

FERC's Role in Influencing Prices That Consumers Pay for Natural Gas 
Has Been Limited: 

Since natural gas commodity prices were deregulated in 1993, FERC's 
role ensuring that the price consumers pay for natural gas is fair has 
been twofold and limited. First, FERC has an indirect role overseeing 
the market that determines commodity prices, with activities generally 
limited to monitoring the market to identify and punish market 
manipulation while supporting the development of competition. Recently, 
this oversight role has become more important because the commodity 
portion of the price that consumers pay for natural gas has increased 
from about 30 percent in 1993 to almost 60 percent in 2005. FERC faces 
challenges in carrying out its oversight of the commodity markets, 
including difficulties ensuring that markets are competitive and 
completely free from manipulation. Second, FERC directly approves rates 
that determine interstate transportation prices. While FERC retains a 
direct role in approving the rates for interstate transportation, this 
role has decreased in importance because the interstate transportation 
portion of the price that consumers pay has decreased from about 20 
percent in 1993 to about 10 percent in 2005. 

Since Deregulation, FERC Has Had a Limited, Indirect Role Overseeing 
Natural Gas Commodity Prices: 

In carrying out its responsibilities to help ensure that natural gas 
commodity prices in deregulated markets are competitive and free from 
manipulation, FERC's Office of Enforcement polices wholesale natural 
gas commodity markets for manipulation. Relying on a wide range of 
energy data sources in FERC's Market Monitoring Center, energy market 
analysts in the Office of Enforcement monitor prices and volumes of 
natural gas commodity transactions at many key energy market trading 
centers nationwide to identify price anomalies or other unusual market 
activity that might indicate market manipulation. FERC officials 
explained that because natural gas prices at different locations 
generally move together, FERC's monitoring of prices at key energy 
market trading centers allows them to understand the overall natural 
gas market. In addition, they monitor other factors that may affect the 
market, such as storage levels, imports and exports, weather, supply 
and demand for other fuels, and electricity transmission constraints 
and outages. The Office of Enforcement also operates an enforcement 
hotline, through which anyone can anonymously offer information about 
suspicious market activities, such as bidding anomalies or improper 
transactions between a company and an affiliate. When Office of 
Enforcement staff identify unexpected or unexplained deviations in 
price behavior or other anomalies, they examine the anomaly and 
undertake informal or formal investigations when needed. In response to 
unusual circumstances resulting in short-term market changes, the 
office has increased its monitoring and enforcement efforts. For 
example, in response to persistent high energy prices and Hurricane 
Katrina, which substantially disrupted domestic natural gas supplies 
during the fall and winter of 2005, the office initiated a daily review 
of market activity and intensified its investigation of unusual trading 
activity, according to office officials. 

In addition, the staff conduct a variety of random and targeted audits 
of individual companies to determine whether companies are following 
rules and regulations regarding trading activities. For example, in 
2004, FERC completed 27 financial audits to determine compliance with 
its accounting regulations and an additional 12 audits to determine 
compliance with FERC standards of conduct and other requirements. Among 
other things, these audits resulted in over 100 recommendations to 
remedy deficiencies and uncovered $10 million in pipeline costs that 
were improperly capitalized. 

To further help ensure that natural gas commodity prices are 
competitive and free from manipulation, FERC also supports the 
development of competitive markets. It has done this primarily by 
promulgating rules that prevent pipeline companies from giving undue 
preference to their energy affiliates by requiring that pipeline 
companies completely separate (or "unbundle") their transportation, 
storage, and sales services and open access of their pipeline to other 
entities. Recently, it has supported the development of competitive 
markets by fine-tuning existing policies rather than making major 
changes: 

* In 2003, for example, FERC Order Number 2004 updated rules of conduct 
designed to prevent natural gas pipelines and public utilities from 
giving undue preference to their affiliates. 

* Also in 2003, FERC developed standards and issued orders designed to 
improve the information about natural gas markets published in price 
indices--a key source of market information that market participants 
use to make informed decisions about buying and selling natural 
gas.[Footnote 5] 

While FERC's role overseeing natural gas commodity markets has been 
limited, it has become more important in recent years because the 
commodity portion of prices that consumers pay for natural gas has 
increased more than the other components. As shown in figure 2, real 
natural gas commodity prices accounted for almost 60 percent of the 
total consumer price in 2005, compared with about 30 percent in 1993. 
Specifically, real natural gas commodity prices increased from $2.59 in 
1993 to $7.51 in 2005--an increase of about 190 percent. Over the same 
period, real interstate transportation prices and other charges 
decreased from $1.48 to $1.13 and local distribution charges increased 
slightly from $3.75 to $4.17. 

Figure 2: Breakdown of Most Consumers' Natural Gas Prices, by 
Component, 1993 through 2005: 

[See PDF for image] 

Source: GAO analysis of Energy Information Association data. 

Notes: Percentages may not add to 100 due to rounding. 

[A] Gas commodity price represents the price of the natural gas itself. 

[B] Interstate transportation and other charges represent the cost of 
transporting natural gas from natural gas wells to local utilities, as 
well as other related charges such as storage costs. 

[C] Local distribution charges are charges by utilities that deliver 
natural gas to more than 90 percent of all consumers in the United 
States. 

[End of figure] 

FERC continues to face challenges ensuring that the gas commodity 
market is competitive and free from manipulation. EPAct 2005 allows 
FERC to gain access to information about virtually any natural gas 
transaction. However, senior Office of Enforcement officials told us 
that while they have increased the number and types of data sources 
they actively monitor, they do not actively monitor all natural gas 
trades that occur through established markets. The officials said that, 
even after increasing the number of staff working in the Office of 
Enforcement dedicated to market monitoring, they are still not able to 
examine all of the potentially millions of transactions that occur in 
numerous physical and financial markets. Since the passage of EPAct 
2005, FERC also has authority to police all markets that could affect 
natural gas for manipulation, including sales that do not involve 
pipeline companies or their affiliates. However, FERC officials have 
acknowledged that it is often difficult to determine whether markets 
are competitive and completely free from manipulation because, for 
example, it is difficult to determine what prices should be under 
completely competitive conditions. 

FERC Directly Approves Interstate Transportation Charges: 

In addition to its efforts regarding competitive natural gas commodity 
markets, FERC continues to approve the prices that pipeline companies 
charge for the interstate transportation of natural gas. The Natural 
Gas Act of 1938, as amended, mandates that FERC regulate the rates that 
natural gas pipeline companies under its jurisdiction can charge for 
interstate transportation of natural gas to ensure that rates are just 
and reasonable.[Footnote 6] Specifically, FERC requires that every 
natural gas company file schedules with FERC showing all rates, 
contracts, and charges for interstate transportation of natural gas 
subject to FERC. FERC staff analyze the information provided by these 
companies to ensure that proposed rates are just and reasonable. 
However, in practice, FERC officials told us that typically, the 
proposed rate for each unit of service is calculated by dividing a 
pipeline's overall cost of service--that is, the company's total 
revenue required to cover the pipeline's operations plus a just and 
reasonable return on its investment in facilities--by the projected 
amount of gas its customers will use. A just and reasonable return is 
typically determined by evaluating the range of returns generally 
experienced in the industry, and adjusted to reflect the specific 
investment risks of the pipeline company as compared with the industry. 
Ultimately, the return on investment must be sufficient to attract 
capital and compensate the pipeline's investors for the risks of their 
investment, but not higher. 

FERC's role in regulating the rates charged for the interstate 
transportation component of the price that consumers pay for natural 
gas has become less prominent in recent years because the rates that 
pipeline companies charge for transportation of natural gas along 
interstate pipelines have declined relative to the other components of 
the price consumers pay. As a result, the interstate transportation 
portion of the consumer price for natural gas accounted for less than 
10 percent in 2005, compared with about 20 percent in 1993, as shown in 
figure 2. 

FERC Has Made Substantial Progress Implementing Additional EPAct 2005 
Authorities but Has Not Begun Imposing Fines or Penalties: 

FERC has made substantial progress implementing the additional 
authorities related to natural gas provided to it in EPAct 2005 but has 
not yet used its new authority to impose fines or penalties authorized 
by the act. EPAct 2005 identified six actions for FERC related to 
natural gas or natural gas markets. As of June 2006, FERC has met all 
deadlines thus far for implementing additional EPAct 2005 requirements, 
completing or initiating work on five of the six actions identified in 
EPAct 2005. FERC has not yet imposed any penalties for violations of 
rules and regulations related to its new penalty authority since the 
enactment of EPAct 2005, according to Office of Enforcement 
officials,[Footnote 7] because investigations of violations that have 
occurred since the passage of EPAct 2005 are still under way. Office of 
Enforcement officials told us that some investigations will be 
completed soon, and FERC will use its authority if the investigations 
warrant. Table 1 shows the status of the additional authorities related 
to natural gas provided by EPAct 2005. 

Table 1: Status of FERC's Implementation of Additional Authorities 
Related to Natural Gas Provided under EPAct 2005: 

Completed actions: 
1; FERC shall submit to Congress a report on progress made in licensing 
and constructing the Alaskan natural gas pipeline within 180 days of 
enactment of EPAct 2005, and every 180 days thereafter. FERC submitted 
reports to Congress on February 1, 2006, before the February deadline, 
and July 10, 2006, before the August deadline. 

Completed actions: 
2; FERC shall conclude a memorandum of understanding (MOU) with CFTC to 
facilitate transparency in electric and gas markets by ensuring that 
agencies may request information in possession of the other agency (for 
example, FERC may request information regarding futures and options 
trading data, and CFTC may request information on energy markets) 
within 180 days of enactment of EPAct 2005. FERC entered into an MOU 
with CFTC beginning October 12, 2005, before February deadline. 

Completed actions: 
3; FERC "may prescribe such rules as it determines necessary and 
appropriate" under the electric and gas market manipulation provisions, 
which make unlawful any manipulative device or contrivance (no deadline 
specified by the act). FERC issued a statement of enforcement on 
October 20, 2005, to clarify FERC's enforcement policy and issued 
antimanipulation rules on January 19, 2006, broadening FERC's scope in 
overseeing natural gas sales. 

Completed actions: 
4; FERC may authorize natural gas companies to provide storage and 
storage-related services at market-based rates for new storage capacity 
(placed into service after the date of enactment of the act) even 
though the company can't demonstrate it lacks market power (no deadline 
specified by the act). FERC issued a final rule on June 19, 2006, to 
amend its regulations to establish criteria for obtaining market-based 
rates for storage services even when a company cannot or chooses not to 
demonstrate that it lacks market power. 

Initiated actions: 5; FERC shall act as the lead agency for 
coordinating all applicable federal authorizations related to 
jurisdictional natural gas facilities, and for purposes of complying 
with the National Environmental Policy Act (no deadline specified by 
the act). FERC issued a policy statement shortly after EPAct 2005 was 
enacted to implement its provisions regarding the coordination of the 
environmental processing and consolidation of various agency records 
related to approving new pipeline construction. On May 18, 2006, FERC 
issued a notice of proposed rulemaking to codify that policy statement, 
and will likely issue a final rule in the fall of 2006. 

Actions FERC plans to initiate soon: 6; FERC may issue rules to 
increase transparency in electric and gas markets (no deadline 
specified by the act). FERC plans to hold a conference in October 2006 
to discuss ideas to improve transparency in electric and natural gas 
prices. 

Source: FERC. 

[End of table] 

In addition, the Office of Enforcement has begun to use the authority 
under EPAct 2005 to expand its monitoring and investigation of those 
who violate its new antimanipulation rules. Following the enactment of 
EPAct 2005, FERC issued antimanipulation regulations implementing its 
new authority to monitor, investigate, and impose fines and penalties 
on any person under its jurisdiction that manipulated natural gas 
commodity prices (action No. 3 in table 1).[Footnote 8] Previously, 
FERC could only penalize behavior that manipulated natural gas 
commodity prices for a limited number of transactions, such as those by 
owners of interstate pipeline companies and other entities transporting 
natural gas on an interstate pipeline. Under the new regulations that 
implement EPAct 2005, FERC's prohibition against market manipulation 
applies to transactions by producers, financial companies, local 
utilities, and natural gas traders, most of which were not previously 
regulated by FERC. According to Office of Enforcement officials, to 
implement the authority, the Office of Enforcement has dedicated more 
time and staff efforts analyzing transactions and other market behavior 
in venues previously outside FERC's jurisdiction. For example, Office 
of Enforcement officials told us they are now able to examine whether 
financial market transactions, which are not generally under FERC 
jurisdiction, affect the physical natural gas markets over which FERC 
has authority.[Footnote 9] 

However, FERC has not yet imposed any penalties for violations of rules 
and regulations related to its new penalty authority since the 
enactment of EPAct 2005, according to Office of Enforcement officials. 
With regard to antimanipulation rules, according to Office of 
Enforcement staff, proving market manipulation is harder than it was 
before EPAct 2005. Instead of proving that the market behavior had a 
"foreseeable" effect on market prices, conditions, and rules, FERC must 
now prove that the conduct that resulted in manipulated prices is 
intentional or reckless, which office staff told us is a more difficult 
standard. Although the Office of Enforcement has begun investigating 
possible violations that have occurred since passage of EPAct 2005--and 
that may be subject to the new penalty authority--the investigations 
are still under way. As a result, no penalties have been levied under 
the new authority, but FERC staff told us they will use its authority 
if warranted. Nevertheless, according to Office of Enforcement 
officials, their efforts to implement the new authorities granted by 
EPAct 2005 are already having tangible results outside of FERC's 
antimanipulation activities. Specifically, Office of Enforcement 
officials noted that following the issuance of FERC's Policy Statement 
on Enforcement in October 2005, which explained the new market 
manipulation rules and higher penalties, some industry members have 
self reported instances of noncompliance with FERC-approved rules in an 
effort to gain FERC's consideration for a lesser penalty. 

States Directly Oversee Utilities' Prices for Local Distribution of 
Gas, but They Have a Limited Role in Natural Gas Commodity and 
Transportation Prices: 

States directly oversee the prices utilities charge for local 
distribution of natural gas but have only a limited role approving 
natural gas commodity and interstate transportation prices. States 
review and approve the local delivery prices that utilities charge, and 
they review and approve the charges utilities pass on to consumers to 
recover the cost of purchasing and transporting the natural gas 
commodity. However, states generally allow utilities to pass on 
commodity prices to local consumers, according to state officials we 
interviewed. States rely on FERC to oversee commodity and interstate 
transportation prices, and stakeholders told us they lacked knowledge 
about FERC's oversight of natural gas commodity prices. Some 
stakeholders said they had little confidence that natural gas commodity 
markets were free from manipulation. FERC officials acknowledged that 
providing some additional information would increase stakeholders' 
understanding of FERC's oversight of natural gas and help deter market 
manipulation. 

States Directly Approve Utilities' Charges for Distributing Natural Gas 
to Retail Consumers: 

States directly oversee utilities' charges for local distribution of 
natural gas. In most states, utilities file proposals to set or change 
natural gas distribution charges with state public utility commissions-
-state regulators--that specify the rates utilities may charge 
consumers. These rate proposals outline the utilities' costs to 
distribute natural gas. In general, states allow utilities to earn a 
regulated rate of return, or profit, and the profits allow utilities to 
realize a return on their investment and enable the utilities to make 
improvements. Utilities file rate proposals at different intervals. 
Some follow a regular schedule, such as filing monthly or annually, 
while others file only when they believe a price change is needed. 
State regulators review these proposals and may either accept them-- 
enabling the utility to charge those prices to consumers--or deny them, 
requiring the utility to charge a different rate. 

Although state regulators directly approve local distribution charges, 
the regulators cannot substantially lower utilities' local distribution 
charges without affecting service quality or long-term financial 
health, according to state officials. Like any business, utilities must 
cover their cost of service, which can include charges for the cost of 
expanding or maintaining the gas pipelines, the cost of storage paid by 
the utility, or the cost of utility employees to read consumers' meters 
or provide other services. Unless utilities cover these costs, they may 
eventually face financial problems or go out of business. 

Since deregulation, local distribution charges have risen slightly in 
real terms, but they have decreased significantly as a share of the 
total consumer price. Local distribution prices increased from $3.75 in 
1993 to $4.17 in 2005 (in constant 2005 dollars), but the share of the 
price consumers paid for utilities to distribute natural gas decreased, 
dropping from about 50 percent of the total price in 1993 to about 30 
percent in 2005. As a result, state regulators' ability to affect total 
natural gas prices paid by consumers has decreased. This occurred 
primarily because of the increase in natural gas commodity prices, 
which almost tripled in price over the same period. 

States Have a Limited Role Approving Commodity and Interstate 
Transportation Prices and Take Actions to Stabilize Consumer Prices: 

States exercise limited oversight of the gas commodity and 
transportation components of consumer prices by reviewing the costs 
utilities pass on to their consumers. States can deny utilities from 
recovering the costs of these purchases from consumers if the costs of 
the gas purchases do not reflect fair market prices; however, 
regulators in states we reviewed told us this rarely occurs. Officials 
in only 4 of the 10 states we reviewed said they had denied utilities' 
recovery of gas purchases since 2002. Of these 4 states, the state 
officials recalled that they had done so infrequently--generally in 
only one or two cases, out of the dozens of rate changes utilities have 
proposed since 2002. State regulators cited several reasons why states 
rarely denied utilities from recovering their costs--for example, they 
told us it is difficult to prove these costs were above a fair market 
price. Also, some state regulators we talked to expressed a desire to 
avoid being overly directive regarding utilities' purchases because the 
regulators said that utilities have greater expertise in making 
purchasing decisions. 

Because state regulators have limited oversight of consumer prices but 
are concerned about recent high and volatile prices, they generally 
provide for two types of actions to help stabilize consumer prices-- 
they influence how utilities purchase the commodity, and they sometimes 
implement "customer choice" programs. First, most states encourage 
utilities to engage in "hedging," which reduces the need for utilities 
to buy from volatile short-term spot markets. Hedging includes such 
techniques as buying gas at fixed prices in long-term contracts or 
storing gas purchased when prices are relatively low, to be used during 
times when prices are high. Utilities in these states often engage in 
some form of hedging to insulate consumers from "rate shocks," where 
prices greatly increase from one month to another. While hedging does 
not guarantee the lowest price, it tends to smooth prices, giving 
consumers greater price stability. 

Second, some states offer "customer choice" programs that allow 
residential consumers to choose to purchase gas from natural gas 
suppliers other than the utility provider. Customer choice programs may 
encourage more stable natural gas prices because nonutility suppliers 
have an incentive to hedge their gas purchases to minimize the risk of 
high prices--unlike utilities, which fully recover their gas purchase 
costs from the consumer. Therefore, nonutility suppliers may be more 
likely to offer gas service to consumers at a set price for a period of 
months or years. However, regulators in the states we reviewed told us 
that customer choice did not necessarily lead to lower prices, because 
nonutility gas marketers still purchase gas from the same natural gas 
commodity markets from which utilities purchase. Moreover, high and 
variable natural gas commodity prices have decreased participation in 
customer choice programs. According to the Energy Information 
Administration, participation in customer choice programs declined from 
4.1 million households in 2002 to about 3.9 million households in 2005-
-representing about 6 percent of all gas users in the United States-- 
and mostly concentrated in two states, Georgia and Ohio. 

States Rely on FERC to Oversee Natural Gas Commodity Prices, but Some 
State Regulators Lack Knowledge of FERC's Oversight Activities: 

States rely on FERC to oversee the market and investigate market 
manipulation. U.S. Supreme Court decisions and other legal 
interpretations have established that the federal government has 
exclusive responsibility for overseeing natural gas commodity prices. 
As a result, according to the state regulators and other experts we 
interviewed, the states must rely on FERC to monitor commodity markets 
and ensure prices are fair. FERC officials acknowledge that it is 
important to inform stakeholders about their oversight activities. In 
that regard, in recent performance reports FERC listed actions it has 
taken to provide information on its oversight, such as providing copies 
of its market surveillance reports to state public utility commissions. 
Officials in the Office of Enforcement told us they discuss their 
market-monitoring and oversight activities during twice-yearly meetings 
with the National Association of Regulatory Utility Commissioners 
(NARUC), a national organization of state regulators. In addition, upon 
request, Office of Enforcement officials have met with state regulators 
to discuss their market oversight activities. FERC compiles data on the 
numbers and subject areas of the informal and formal investigations it 
undertakes, and it reports some of those data for completed 
investigations. For example, FERC publicly reports the number of 
hotline calls it receives and some statistics on closed investigations 
and audits through documents available on its Web site, such as press 
releases, FERC staff reports, the agency's annual report to Congress, 
and its State of the Markets Report, which summarizes information about 
energy market conditions and identifying emerging trends. 

However, FERC staff are prohibited from disclosing details about 
ongoing investigations except by order from the FERC commissioners. In 
that regard, FERC's practice has been to release information about the 
numbers and subject areas of ongoing investigations only rarely because 
it has been its view that providing overly detailed information could 
risk undermining FERC's market-monitoring efforts. FERC officials 
recognize that publicly disclosing some additional information about 
its oversight activities, as long as it would not compromise ongoing 
investigations, could serve to increase stakeholder understanding and, 
potentially, deter market manipulation. In this regard, FERC has 
occasionally disclosed information about ongoing oversight efforts at 
the commissioner's discretion, as it did in 2002 during the Enron 
investigation in an effort to increase public understanding of FERC's 
oversight activities and raise public confidence in energy markets. 
FERC officials also told us that they are developing a Web page to 
better inform the public about its oversight activities in response to 
questions they received from the public. 

Despite FERC's past efforts, some stakeholders still do not have a full 
understanding of FERC's oversight activities and lack confidence in the 
fairness of natural gas commodity prices. Some state regulators we 
interviewed told us they lacked assurance that natural gas prices are 
free from manipulation. For example, regulators from one state sent a 
letter to FERC expressing concern about high gas prices and that FERC's 
oversight may not prevent market manipulation. In response, Office of 
Enforcement officials invited the state regulators to their offices in 
Washington, D.C., for discussions and to tour FERC's Market Monitoring 
Center to observe firsthand how FERC monitors the market. Between 
October 2005 and February 2006, FERC received similar letters from two 
other states and one municipal government requesting information about 
rising natural gas prices and possible market manipulation. Other state 
regulators we interviewed told us they would benefit from greater 
coordination with FERC regarding natural gas prices. Moreover, 
according to one state commissioner on the NARUC gas committee, state 
commissioners vary in their knowledge of what FERC staff do to monitor 
natural gas commodity markets--and many members have limited knowledge. 
In addition, a NARUC gas committee official elaborated that FERC 
outreach to the states would help both FERC and the states better 
fulfill their respective regulatory duties. Citing their concern over 
rising natural gas prices and concerns over monitoring of commodity 
markets, attorneys general from four Midwestern states commissioned a 
report to investigate whether natural gas prices were artificially high 
as a result of market manipulation.[Footnote 10] 

Conclusions: 

Oversight of natural gas markets has evolved substantially from the 
days when the federal government set prices based on costs for natural 
gas produced at wells and controlled, together with the states, nearly 
all of the rest of the costs of delivering it to consumers. However, 
aside from FERC's efforts to prevent market manipulation, neither the 
federal government nor the states have much influence on the natural 
gas commodity price that now accounts for the largest portion of the 
price that consumers pay. As a result, the natural gas prices consumers 
pay will remain highly affected by what happens in the commodity 
markets. 

Nevertheless, federal oversight of the commodity markets remains a work 
in progress. Stakeholders, including state regulators, other government 
officials, and the public, are highly affected by the commodity markets 
that FERC is charged with overseeing, but some of these stakeholders 
remain largely unaware of FERC's oversight processes and activities. 
Because of regulatory limitations, FERC staff do not publicly disclose 
information about informal and formal investigations unless the 
investigations have been completed and have resulted in a formal 
penalty, despite the advantages such information could have in 
increasing stakeholder understanding of FERC's oversight activities 
and, potentially, deterring market manipulation. However, under current 
regulations, FERC commissioners have it within their authority to 
disclose this information. Furthermore, because the commodity component 
of the price that consumers ultimately pay for their natural gas has 
taken on such prominence and because states rely on FERC to oversee the 
commodity market, it is increasingly important for stakeholders to 
understand what FERC is doing to police this market. In this regard, 
FERC recognizes the need to provide more information to stakeholders 
about its oversight efforts and has multiple ways to do so, such as 
through its Web site. In providing even more information to 
stakeholders on its oversight efforts, including information, as 
appropriate, about ongoing monitoring and investigation activities, 
FERC could both increase stakeholders' understanding about FERC's 
efforts to ensure the fairness of natural gas prices and better deter 
market manipulation. 

Recommendation for Executive Action: 

Given the potential benefits of providing more information on its 
oversight activities, we recommend that the Chairman of FERC provide 
more information to stakeholders, including state regulators, other 
government officials, and the public, about actions taken by FERC to 
ensure that natural gas prices are fair. This effort should be 
undertaken within existing law and regulation, build upon the efforts 
that FERC already has under way, and use the information FERC already 
compiles on its monitoring and investigations. We agree that disclosure 
of information that is specific or detailed could provide would-be 
market manipulators with information about FERC's sources and methods 
of operation. Therefore, we believe it prudent that the Chairman have 
initial discretion on how best to do this. The information we recommend 
that the Chairman consider providing to stakeholders, including state 
regulators and, where possible, the public, includes the following: 

* information on how the Office of Enforcement staff analyze natural 
gas markets and how the staff go about identifying market anomalies or 
unusual market behavior; 

* information on the types of unusual market behavior that warrant 
further investigation by the Office of Enforcement; and, 

* more timely information on the informal and formal investigations 
under way, such as the numbers and subject areas but not the identities 
of those under investigation. 

Agency Comments and Our Evaluation: 

We provided the Federal Energy Regulatory Commission with a draft copy 
of this report for review and comment. 

FERC generally agreed with the report's findings, conclusions, and 
recommendation and offered minor technical comments, which we have 
incorporated, as appropriate. FERC's written comments are reproduced in 
appendix II. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, will send copies to the Chairman of 
FERC and other interested parties. We also will make copies available 
to others upon request. In addition, the report will be available at no 
charge on the GAO Web site at http://www.gao.gov. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-3841 or wellsj@gao.gov. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. Key contributors to this report are 
listed in appendix III. 

Signed by: 

Jim Wells: 
Director, Natural Resources and Environment: 

[End of section] 

Appendix I: Scope and Method: 

To obtain information about efforts the Federal Energy Regulatory 
Commission (FERC) has taken to oversee natural gas prices, we reviewed 
legislation, regulations, reports, and other documentation on natural 
gas prices, markets, and federal oversight of natural gas prices. In 
particular, we reviewed laws and regulations pertaining to FERC's 
monitoring, investigation, and enforcement of the wholesale natural gas 
commodity market, including FERC's recent Order Number 670, which 
prohibits energy market manipulation. We also reviewed documentation of 
FERC's efforts to oversee and report on the natural gas market, 
including its State of the Markets Report, Performance and 
Accountability Report, Market Oversight Report, Market Snapshot Report, 
and documents describing FERC efforts to support competitive markets, 
including efforts following Hurricane Katrina and Rita. In addition, we 
toured FERC's Market Monitoring Center and interviewed senior officials 
at FERC's Office of Enforcement, including its director, about FERC's 
efforts to analyze market information for anomalies in market behavior, 
and a senior official at FERC's Office of Energy Markets and 
Reliability about FERC efforts to support competitive markets. We also 
interviewed representatives of industry trade associations, including 
the American Gas Association, which represents the investor-owned gas 
utilities that distribute over 90 percent of the natural gas delivered 
by utilities; the American Public Gas Association, representing 
publicly owned municipal utilities; the National Association of 
Regulatory Utility Commissioners (NARUC), representing state regulators 
of investor-owned utilities; the National Regulatory Research 
Institute, the research arm of NARUC; and other academic experts in the 
field to obtain their perspective on FERC's oversight efforts. In 
addition to our document review and interviews, we obtained and 
analyzed natural gas wholesale gas prices, city gate prices,[Footnote 
11] and end-user price data supplied by the Energy Information 
Administration (EIA) from 1993, when natural gas prices were 
deregulated, through 2005. We assessed the reliability of the EIA's 
natural gas price data by (1) performing electronic testing of required 
data elements for obvious errors in accuracy and completeness, (2) 
reviewing existing information about the data and the system that 
produced them, and (3) interviewing an agency official knowledgeable 
about the data. We determined that the data were sufficiently reliable 
for the purposes of this report. 

To obtain information about FERC's progress in implementing additional 
authorities provided to it by the Energy Policy Act (EPAct 2005), we 
reviewed EPAct 2005 and relevant FERC regulations and information 
documenting FERC's progress, such as its Policy Statement on 
Enforcement, memorandum of understanding with the Commodities Futures 
Trading Commission, and FERC's Status of Energy Policy Act Activities. 
In addition, we interviewed senior officials in FERC's Office of 
Enforcement, including its director, about FERC's progress in 
implementing EPAct 2005's additional requirements and authorities. 

To understand efforts states take to oversee natural gas markets, we 
interviewed state officials responsible for oversight of investor-owned 
utilities in 10 states--California, Colorado, Georgia, Iowa, Maryland, 
Pennsylvania, South Carolina, Texas, Vermont, and Wyoming. We selected 
these states to ensure a broad representation of natural gas 
consumption levels, residential prices paid for natural gas, consumer 
choice purchasing options available to consumers, and gas rate approval 
models. We reviewed documents, regulations, legislation, and rate 
filings when relevant to our questions. We asked these states' 
officials general questions about the same topics, including the 
states' coordination with FERC; their regulatory efforts, including 
monitoring the market for manipulation; how often the states had denied 
gas utilities from recovering their cost of purchasing the natural gas 
commodity; and their anticipated challenges in regulating natural gas 
providers in their state. Because our sample of states was nonrandom 
and small, we did not attempt to extrapolate our results in order to 
offer conclusions about all 50 states. 

We conducted our work from February through August 2006 in accordance 
with generally accepted government auditing standards. 

[End of section] 

Appendix II: Comments from the Federal Energy Regulatory Commission: 

Federal Energy Regulatory Commission: 
Washington, DC 20426: 

Office Of The Chairman: 

August 16, 2006: 

Mr. Jim Wells: 
Director, Natural Resources and Environment: 
United States Government Accountability Office: 
Room 2T23: 
441 G Street, NW: 
Washington, DC 20548: 

Dear Mr. Wells: 

Thank you for the opportunity to comment on your report entitled 
Natural Gas: Roles of Federal and State Regulators in Overseeing 
Prices. As you have noted, the Federal Energy Regulatory Commission 
(Commission) has taken many steps to improve the understanding of the 
Commission's role in overseeing the market and deterring market 
manipulation. These efforts have included action taken by the 
Commission to address four of the six new tasks identified by the 
Energy Policy Act of 2005, along with the Commission's issuance of a 
policy statement on enforcement in October 2005. I believe these 
efforts have enhanced the Commission's oversight of the natural gas 
markets and contributed to an increased focus on understanding how 
natural gas prices are determined. 

In general, I agree with the conclusions and findings of the report. 
The report recommends improving the Commission's market oversight and 
deterring market manipulation by better informing stakeholders, 
particularly state regulators, about the Commission's market monitoring 
and investigations. The report noted that the Commission indirectly 
monitored commodity markets in order to identify and punish market 
manipulation and support competition in those markets. The Commission 
continues to work toward instilling greater overall confidence in the 
natural gas market by developing vigilant market oversight to ensure 
that commodity prices are competitive and free from manipulation. The 
report's recommendations of how to meet the challenges that lay ahead 
are consistent with our current direction of attempting to ensure the 
availability of adequate price information for market participants and 
improve the understanding of the Commission's role in ensuring the 
fair, competitive determination of prices on the natural gas market. 

Thank you for your insight and recommendations on how we can improve 
our role in efforts to regulate and oversee natural gas prices. I 
appreciate the diligence you and your staff put into this report and 
hope it will enable us to better utilize the new authority the 
Commission has been given to facilitate price transparency in wholesale 
energy markets following the enactment of the Energy Policy Act of 
2005. Thank you again for the opportunity to comment on the report. 

Sincerely, 

Signed by: 

Joseph T. Kelliher: 
Chairman: 

Enclosure: 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Jim Wells, (202) 512-3841 or wellsj@gao.gov: 

Staff Acknowledgments: 

In addition to the contact named above, Karla Springer (Assistant 
Director), Lee Carroll, James Cooksey, John Forrester, Jon Ludwigson, 
Kristen Massey, Alison O'Neill, Frank Rusco, Barbara Timmerman, and 
John Wanska made key contributions to this report. Others who made 
important contributions include Casey Brown, Michael Derr, Glenn 
Fischer, and Kim Raheb. 

FOOTNOTES 

[1] Pub. L. No. 101-60. In 1989, Congress passed and the President 
signed the Natural Gas Wellhead Decontrol Act of 1989, which 
deregulated natural gas commodity prices. The act restructured the 
natural gas industry from a regulated environment to one that places 
greater reliance on competition and mandated that federal controls over 
natural gas commodity prices end by 1993, allowing the price to be set 
freely in the marketplace. Prior to 1993, FERC regulated prices 
directly by approving prices primarily based on costs. 

[2] Pub. L. No. 109-58. 

[3] The remaining 10 percent is distributed by approximately 1,000 
publicly owned municipal utilities, which are regulated by consumer 
representatives in the municipalities they are located in. 

[4] According to experts, states vary in how often they allow gas cost 
adjustments--ranging from monthly to annually, or less frequently. In 
many cases, the prices a utility charges its customers change less 
frequently than the prices it pays to purchase natural gas on 
customers' behalf. As a result, states often allow utilities to hold 
some of the excess revenue collected when consumer prices are higher 
than purchased gas costs to offset periods when consumer prices are 
lower than purchased gas costs. 

[5] In December 2005, we reported that FERC's efforts to improve the 
availability and accuracy of natural gas price indices had increased 
industry confidence in short-term price data. See GAO, Natural Gas and 
Electricity Markets: Federal Government Actions to Improve Private 
Price Indices and Stakeholder Reaction, GAO-06-275 (Washington, D.C.: 
Dec. 15, 2005). 

[6] Pub. L. No. 75-688, 52 Stat. 821 (1938), as amended. 

[7] Expanded penalty authority provided to FERC after EPAct 2005 
applies to violations of any FERC rule, as well as market manipulation. 

[8] Prohibition of Energy Market Manipulation, FERC Order No. 670, 18 
C.F.R. ß 1c (2006). 

[9] CFTC is generally responsible for oversight of financial 
transactions, such as natural gas futures and options traded over 
exchanges, such as the New York Mercantile Exchange, but has limited 
oversight of off-exchange and over-the-counter markets, where certain 
antifraud and antimanipulation provisions of the Commodity Exchange Act 
apply. For more information on CFTC responsibilities, see GAO, Futures 
Markets: Approach for Examining Oversight of Energy Futures, GAO-06-
742T (Washington, D.C.: May 4, 2006). 

[10] Mark N. Cooper, The Role of Supply, Demand and Financial Commodity 
Markets in the Natural Gas Price Spiral (report prepared for Midwest 
Attorneys General Natural Gas Working Group, March 2006). 

[11] City gate prices include the wellhead price, pipeline 
transportation cost to the city gate, and marketer fees. 

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