I. Introduction

The American Gas Association ("AGA") appreciates the opportunity to present its views on the role of federal tax law in addressing the energy situation currently faced by the nation. AGA represents 185 local natural gas distribution companies, which deliver natural gas to approximately 60 million customers throughout the United States. AGA member companies serve more than 90 percent of America’s gas consumers, and AGA member companies are located in every one of the United States.

II. Executive Summary

Events of the last year have made clear the importance to consumers and the economy of adequate and reliable supplies of reasonably priced natural gas. Providing the natural gas that the American economy demands will require providing incentives to bring the plentiful reserves of North American natural gas to production and to deliver that gas to end-use consumers. To that end, AGA believes that federal tax legislation should:

• Provide incentives for the investment of $150 billion that will be necessary to ensure the infrastructure required to serve this natural gas market, including:

• Seven-year depreciation for new natural gas infrastructure
• Expensing of natural gas storage facilities
• Repeal of the tax on Contributions in Aid of Construction

• Provide incentives to produce the vast, untapped reserves of natural gas, particularly those reserves that might not otherwise be produced, that will be necessary to serve a market that will consume in excess of 30 Trillion cubic feet per year. AGA particularly endorses proposals to extend the tax credit provided under Section 29 of the Internal Revenue Code for certain "nontraditional" sources of natural gas.
• Provide incentives for new energy technologies such as distributed generation, combined heat and power, and natural gas cooling.

III. Tax Incentives Are Necessary to Ensure Required Gas Infrastructure

As AGA will explain in further detail below, events in energy markets over the last year have strongly underscored the need for a comprehensive national energy policy that will ensure that sufficient gas supplies are brought forth to meet the projected growing demand for this clean and readily available fuel. Producing gas from the ground is, however, only the beginning of providing the energy that consumers require. In most instances the gas must then be moved hundreds or thousands of miles through large-diameter, high-pressure transmission lines. It is often stored underground during the off-season to be delivered in the peak season. After delivery by the interstate pipeline company, the pressure of the gas is reduced, and it is transported through miles of local distribution lines. Often local distribution companies will own underground gas storage to meet the needs of their temperature-sensitive customers.

AGA’s members are engaged in the local distribution of natural gas. They have an interest, as will also be explained below, in making certain that adequate supplies of natural gas are available for consumers. But their most direct interest is in ensuring that adequate infrastructure is in the ground to serve their end-use customers. Secondarily, they have an interest in making sure that sufficient interstate pipeline infrastructure exists to transmit the requisite volumes of gas from the producing areas to the market areas.

Adequate natural gas is in the ground; it is simply necessary to assure that it is produced to meet the needs of our growing economy. Natural gas supply is, however, only half of the solution. Once natural gas is produced, it is necessary, as discussed previously, to have adequate infrastructure (typically in the ground) to deliver it to residential, commercial and industrial customers. Should overall natural gas demand in the years ahead reach the 30 to 35 Tcf level, significant capital investment will be required. The recent Fueling the Future study by the American Gas Foundation, as well as a study by the National Petroleum Council, project that $150 billion in natural gas infrastructure will have to be constructed to deliver those supplies of gas to consumers. Roughly $100 billion in infrastructure will be required for local distribution company service and $50 billion will be required for interstate pipeline companies. Without this investment in infrastructure the projected market demand for natural gas may not be served.

Tax incentives for infrastructure can provide natural gas pipelines and distributors with the additional incentive to place these necessary facilities in the ground. They can also provide the spur for investors to invest in the federal- and state-regulated utilities that provide the vast majority of natural gas service in the United States. These utilities are generally regulated as to the rates they can charge. As such they tend not to secure the types of entrepreneurial returns that readily attract capital. Yet it is clear that significant amounts of capital must be secured to serve the natural gas market that most forecasters expect to materialize.

To this end, AGA supports seven-year accelerated depreciation for new natural gas infrastructure. This would include gas transmission, gas storage, and gas distribution facilities. On average over the past 15 years, local gas distribution infrastructure investment has been $3 to $5 billion per year. This pace will simply be inadequate to provide the infrastructure that AGA believes will be necessary to support projected consumer demand for natural gas. More rapid tax depreciation for these needed new facilities will provide the necessary impetus for investment in this infrastructure.

AGA also supports proposals to permit expensing natural gas storage costs. Natural gas storage has been increasingly important over the last ten years in permitting local distribution companies to acquire gas during periods of low prices and deliver the gas to their customers during higher-priced periods. Such facilities are, during conditions such as those that have existed recently, even more important tools in dampening retail price volatility for consumers. Providing full expensing of natural gas storage facilities will give the critical impetus necessary to bring more such facilities online, with concomitant consumer benefits in the form of lower delivered gas prices overall. This approach is particularly important if competing fuels are accorded such tax treatment so that tax law does not artificially skew the choice among fuels.

Another area for tax reform that will benefit energy consumers is correcting the tax treatment of contributions in aid of construction (CIAC). At present a new customer (either residential or a residential developer) that seeks to connect to the natural gas system is often required to pay a hookup fee that the utility uses as an offset to the costs of making the connection. Under present law local distribution companies are taxed on these contributions. In fairness, they should be treated as contributions of capital to the natural gas system. This CIAC tax works as a disincentive to new gas connections. As a result it discourages additional gas usage, even though that fuel is the most environmentally benign fuel available, is usually the most economic fuel, and is almost always procured from North American sources.

AGA urges Congress to take constructive action to ensure that the needs of America’s gas consumers are met by providing tax incentives for needed new energy infrastructure.

IV. America’s Current Energy Situation

Ample, reliable energy supplies at affordable prices are critical to providing economic and national security for America and its citizens. Energy is consumed in every sector of our economy. There is virtually no business entity in the United States that does not rely upon energy in order to operate. Our economy cannot grow, and, indeed, cannot maintain its present vitality, without assurances of adequate, reliable, and reasonably priced supplies of energy. Continued economic stability and growth are inexorably tied to the nation’s energy supply. Economic stability and growth are, in turn, keys to continued full employment, growth in national wealth, and the important state and federal tax revenues that are so essential to funding important government social, public safety, and defense programs.

The intermittent California electric blackouts this year have dramatically raised public awareness of these issues. Additionally, energy costs in most areas of the country have risen significantly, including gasoline, electricity, and natural gas. These events have caused both businesses and consumers increasingly to realize that reliable and reasonably priced energy are required to support our economic vitality as well as the many comforts and necessities that Americans have come both to enjoy and to expect in the postwar era. Energy is more in the public mind now than it has been at any time in the last twenty years.

The Federal Government occupies a critical position in the current energy situation. By conceiving, enacting, and implementing a comprehensive national energy policy, the government presently has a unique opportunity to ensure that America will enjoy reliable and reasonably priced energy for many years to come. A sound energy policy will lead to continued prosperity and employment for America’s citizens. Although a comprehensive national energy policy will have many elements, a key component will be a prudent, measured tax policy. Sound tax policy will play a critical role in driving a national energy policy.

America has significant reserves of domestic energy. The events of the last year, however, make plain that we must do more to bring these ample energy supplies to production and to expand the infrastructure that is necessary to deliver that energy to the places that demand it. Not much more than a year ago the price of natural gas was approximately $2.50 per million British Thermal Units ("Btu") at Henry Hub in Louisiana. In the last several months the Henry Hub price has been about $5.00 per million Btus. At the height of the winter the price reached $10 per million Btus. This price movement indicates the tightness in the marketplace and it reflects the sensitivity to changes in production and consumption levels. As a result, most American natural gas consumers experienced significant, unwelcome increases in the natural gas bills over this past year.

The increase in natural gas prices resulted from supply, demand, and weather. Drilling for natural gas declined in 1998 and 1999 in response to extremely low prices. Demand for natural gas continued to grow with the robust condition of the economy as well as the public’s recognition of the economic and environmental benefits of natural gas. As a result, natural gas prices began to rise in the spring of 2000. In November and December of 2000 record cold weather hit many parts of the country. All of these factors together led to very high natural gas bills for most consumers in America.

V. The Future Energy Supply and Demand

The United States has enormous untapped reserves of natural gas. It is widely believed that in excess of 1200 Trillion Cubic Feet (Tcf) of natural gas—or a 60-year supply at current levels of production—are available in North America. Current proved reserves are approximately 170 Tcf. At present the United States consumes approximately 23 Tcf annually. Virtually all projections suggest that over the coming decades U.S. consumption will top 30 Tcf.

The experience of the past year makes plain that available natural gas production and current natural gas demand are closely matched. The behavior of natural gas prices over the last twelve months strongly suggests that very little incremental supply of gas is presently available in the market place. In other words, the "gas bubble" of the last ten or more years is a thing of the past.

Recent gas prices have spurred record new drilling for natural gas, and some of those supplies are already coming on line. Yet there is reason to be concerned whether there will be production of the volumes of natural gas that most commentators believe the market will require in the coming decade and beyond. Should natural gas production not keep up with growing demand, the result will be significant price volatility and generally higher prices. The trajectory of the last year in terms of prices and supplies could well accelerate if supplies do not keep pace.

A comprehensive national energy policy must ensure that adequate supplies of natural gas are produced and that adequate infrastructure is in place to deliver that gas to consumers. Federal tax law can perform an important function in ensuring that the energy needs of consumers and businesses are met in the years ahead.

VI. Reasonable Tax Incentives Are Necessary to Ensure Adequate Supplies of Gas

AGA member companies distribute natural gas to America’s residential, commercial, and industrial consumers. That natural gas is usually purchased from others, most often natural gas producers or energy marketers. AGA member companies do not make a profit on the sale of gas to consumers; rather they earn their revenues from distributing that gas to end users. Accordingly, AGA member companies do not have an economic stake in gas production or gas prices. Rather, their interest, like that of their customers, is in ensuring that ample supplies of gas are reliably available and at reasonable prices.

AGA believes strongly that the Federal Government, including the Congress, must take affirmative steps to assure adequate future gas supplies to meet consumer needs. AGA defers, however, to those most directly involved in this end of the business—natural gas producers. AGA traditionally has left it to that segment of the industry to make the specific legislative and regulatory proposals that are necessary to ensure adequate gas supplies. Notwithstanding this fact, AGA supports legislative initiatives to promote sufficient gas supplies.

AGA generally supports a number of proposals made by the producer community to spur increased gas production. For example, AGA supports those who urge that Section 29 of the Internal Revenue Code, providing incentives for "nontraditional" gas production, be extended. The history of Section 29 makes clear that it has brought forth major volumes of natural gas that would not, in all likelihood, have been produced otherwise. (It is interesting to speculate as to prices this past winter had Section 29 never been enacted.) Similarly, AGA endorses tax incentives for production from marginal wells. Such incentives will bring to market volumes of gas that might otherwise remain forever in the ground.

A very large volume of the United States gas consumption is produced by smaller independent gas producers. These producers do not enjoy access to New York, London, and Hong Kong capital markets. Rather, they are dependent for their activities upon convincing local and regional banks to extend them financing or, more likely, their own cash flow. Modest tax incentives for these types of producers can provide important benefits for the nation. For example, proposals to expense (rather than capitalize) geological and geophysical costs and shut-in royalty payments can provide producers with significantly increased cash flow. Similarly, proposals to permit ten-year carryback for percentage depletion can be of major assistance, particularly to small independent producers.

AGA generally supports reasonable and well considered tax incentives of this sort that will have a genuine impact in bringing to market more of America’s significant natural gas resources.

VII. Tax Incentives Are Necessary to Encourage New Energy Technologies

AGA also supports tax incentives for new energy technologies such as distributed generation, combined heat and power, and gas cooling. Distributed generation in particular warrants close Congressional attention. Onsite power generation has many benefits. It removes load from the electric transmission and distribution grid, averting congestion and additional construction of new transmission facilities. It also obviates the need to build new central station power plants. Moreover, it tends to draw on the natural gas transmission system at offpeak times, providing additional natural gas load without the need for additional gas facilities, thus leading to lower unit costs for all gas customers.

VIII. Conclusion

Natural gas is the right fuel at the right time to solve many of the nation’s energy problems. AGA believes that the federal government should take whatever steps it can to bring this fuel to America’s consumers right now. It can do so by encouraging the construction of the natural gas infrastructure that will be necessary to meet projected natural gas demand by consumers. It can do so by encouraging the production of natural gas, particularly from sources that might not otherwise be produced. It can do so by supporting new technologies that utilize natural gas in new and efficient means. Tax incentives should be adopted to promote all of these ends.