When Barriers to Markets Fail: Pipeline Deregulation, Spot Markets, and the Topology of the Natural Gas Market

Until 184, Federal regulation sanctioned monopoly as the primary mechanism for distributing natural gas. Pipelines were granted protected markets and permitted to acquire and distribute gas only through long-term contracts. To buy or sell gas, users and producers had to deal with the pipeline, they could not deal directly. Gas markets failed to exit. In 1985, pipelines were given the option to become "open access" pipelines who transported gas. This change dissolved the barriers to markets and, for the first time in more than fifty years, authorized competition. In this paper, we observe and evaluate the emergence, evolution and performance of natural gas spot markets in this new environment. We discover that spot markets flourished in the absence of regulatory barriers to their existence; more than fifty spot markets came into existence and quickly replaced long-term contracts and pipelines as sources gas. The spot price evidence reveals that open access changed the topology of the pipeline network: the balkanized and disconnected network of gas markets created by regulation became more strongly connected and spot prices converged and became more correlated throughout the network. By the end of our sample period, gas markets had become liquid and informationally efficient -- demand or supply shocks are strongly damped across the network, and the price at any point contains all the information in the network. The spatially separated spot markets are now so strongly connected that they form a single national market for natural gas.