The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
S. HRG. 98-180
ECONOMICS OF NATURAL GAS DEREGULATION
HEARINGS
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
NINETY-EIGHTH CONGRESS
FIRST SESSION
FEBRUARY 7 AND APRIL 15, 1983
Printed for the use of the Joint Economic Committee
S.
Hbg.
98-180
ECONOMICS OF NATURAL GAS DEREGULATION
HEARINGS
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
NINETY-EIGHTH CONGRESS
FIRST SESSION
FEBRUARY 7 AND APRIL 15, 1983
Printed for the use of the Joint Economic Committee
U.S. GOVERNMENT PRINTING OFFICE
21-496 O
WASHINGTON : 1983
JOINT ECONOMIC COMMITTEE
(Created pursuant to sec. 5(a) of Public Law 304, 79th Congress)
SENATE
ROGER W. JEPSEN, Iowa, Chairman
W ILLIAM V. ROTH, Jb., Delaware
JAMES ABDNOR, South Dakota
STEVEN D. SYMMS, Idaho
MACK MATTINGLY, Georgia
ALFONSE M. D’AMATO, New York
LLOYD BENTSEN, Texas
W ILLIAM PROXMIRE, Wisconsin
EDWARD M. KENNEDY, Massachusetts
PAUL S. SARBANES, Maryland
HOUSE OF REPRESENTATIVES
LEE H. HAMILTON, Indiana,
Vice Chairman
GILLIS W . LONG, Louisiana
PARREN J. MITCHELL, Maryland
AUGUSTUS F. HAWKINS, California
DAVID R. OBEY, Wisconsin
JAMES H. SCHEUER, New York
CHALMERS P. W YLIE, Ohio
MARJORIE S. HOLT, Maryand
DAN LUNGREN, California
OLYMPIA J. SNOWE, Maine
B r u ch R. B a r t l e t t , Executive Director
J a m e s K. G a l b r a i t h , Deputy Director
(H )
CONTENTS
WITNESSES AND STATEMENTS
M on d ay , F e b ru a ry
7, 1983
Jepsen, Hon. Roger W., chairman of the Joint Economic Committee: Opening statement-------------------------------------------------------------------------------Means, Robert C., Director, Office of Regulatory Analysis, Federal Energy
Regulatory Commission------------------------------------------------------------------Bush, Nicholas J., president, Natural Gas Supply Association (NGSA),
Davenport, Iowa_____________________________________ ____________
McGrath, Jerome J., president, Interstate Natural Gas Association of
America (INGAA)________________________________________________
Hansen, Christine A., commissioner, Iowa State Commerce Commission,
Davenport, Iowa-------------------------------------------------------------------------- Kleckner, Dean, on behalf of the Iowa Farm Bureau Federation, Daven
port, Iowa________________________________________________________
Daniel, John, vice president-operation, Iowa-Illinois Gas & Electric Co__
Blanchard, Linda, president, Iowa Citizens for Community Improvement,
Des Moines, Iowa-------------------------------------------------------------------------Dunn, Gordon, vice president, Citizens for Community Improvement, Cedar
Rapids, Iowa---------------------------------------------------------------------------------Berka, Constance J., spokesperson, United Neighbors, Inc., Davenport,
Iow a_____________________________________________________________
Morrow, Opal, member, United Neighbors, Inc., Davenport, Iowa________
F rid a y , A p r il
Page
1
3
21
75
101
153
164
165
167
168
170
15, 1983
Jepsen, Hon. Roger W., chairman of the Joint Economic Committee: Open
ing statement_____________________________________________________
Johnson. Hon. Man u e l H., Assistant Secretary of the Treasury for E co
nomic Policy------------------------- --------------------------------
MacAvoy, Paul W., Frederick William Beinecke Professor of Economics,
Yale University----------------------------------------------------------------------------Twilley, Joshua M., member, National Association of Regulatory Utility
Commissioners — :-----------------------------------------------------------------------Cooper, Mark, director of research, Consumer Energy Council of America—
207
208
227
243
261
SUBMISSIONS FOR THE RECORD
M on d ay , F e b ru a ry
7, 1983
Bush, Nicholas J .: Prepared statement, together with attachments______
Hansen, Christine A .: Prepared statement, together with appendixes, a re
port^ exhibits, and an attachment----------------------------------------------------Kleckner, Dean: Prepared statement on behalf of the Iowa Farm Bureau
Federation ---------------------------------------------------------------------- ------------McGrath, Jerome J .: Prepared statement---------------------------------------------Means, Robert C .: Prepared statement, together with an appendix----------Process Gas Consumers Group, the: Statement of---------------------------------(h i )
25
104
157
78
6
176
IV
F r id a y , A p r i l
15, 1983
Adelman, M. A., department of economics and energy laboratory, Massachu
setts Institute of Technology, Cambridge, Mass.: Paper entitled “Natural
Gas Policy: International Aspects” _________________________________
American Farm Bureau Federation, Washington, D.C.: Letter to Senator
Jepsen regarding natural gas legislation, dated April 15, 1983_________
American Meat Institute, Washington, D.C.: Letter to Senator Jepsen re
garding natural gas legislation, dated April 29, 1983, together with an
attachment_______________________________________________________
Cooper, Mark: Prepared statement, together with attachments__________
Johnson, Hon. Manuel H .: Prepared statement—---------------- -------- ---------MacAvoy, Paul W .: Prepared statement_______________________________
Twilley, Joshua M .: Prepared statement----------------------------------------------
Pase
480
486
490
265
213
232
246
ECONOMICS OF NATURAL GAS DEREGULATION
MONDAY, F E B R U A R Y 7, 1983
C ongress of t h e U nited S tates ,
J o in t E conomic C om m ittee ,
Washington,}D.C.
'
The committee met, pursuant to notice, at 9:30 a.m., at the New
Federal Court Room, Iowa Federal Bldg., Davenport, Iowa, Hon.
Roger W, Jepsen (chairman of the committee) presiding.
Present: Senator Jepsen.
Also present: John Conrad, legislative assistant, Senator Jepsen’s
staff; and Chris Frenze, professional staff member.
OPENING STATEMENT OP SENATOR JEPSEN, CHAIRMAN
Senator J epsen . I would like to welcome the witnesses here this
morning testifying on the state of the natural gas prices and markets.
This country and this State are facing a crisis. The rapid escalation
of natural gas prices over the last few years has imposed a terrible
hardship on the people in their homes and in their businesses. In some
cases, people have been faced with the choice of food or fuel. The
recent survey that was made by an association in the Linn CountyCedar Eapids area showed that, in fact, of some 20 choices, the reduc
tion of food and groceries in order to pay the fuel bills was always
one of the top three most often cited concerns of the people involved.
The pricing problem is a very grave concern of not only the people
of Iowa, but people throughout this country. We’ve been blessed with
a mild winter which we have enjoyed prior to this latest snowstorm
and the cold of today. But it has not in any way diminished the concern
that people have over the mounting and increased prices of natural gas
and the proposed and projected increases to come.
It’s my conviction that quick action by Congress is necessary to re
solve this crisis. In the last session of Congress I introduced legislation
to broaden the abuse standard in gas-marketing contracts. I have again
introduced similar legislation, and I urge Congress to speedily enact
it. I look to the grassroots for support for legislation to cope with the
natural gas pricing problem.
You know, the worst thing we can do, as some have called for, is to
freeze prices at the current record-high levels. That is a simplistic re
quest, and when you analyze it, it really doesn’t make much sense. The
unconscionable and disastrous level of gas prices today must not be
(1)
2
frozen into law. The objective should be to lower gas prices in order to
let the consumers keep more of their hard-earned dollars. With the
decline in oil prices, natural gas prices must be permitted to drop to a
market-clearing level. Something is clearly wrong when gas prices
skyrocket as excess supplies increase. In this hearing we will explore
the reasons for this tragic and illogical situation.
At present, the cost of very high priced foreign gas can legally be
passed through to the consumers. Long-term contracts obligate pipe
lines to pay for certain amounts of this and other expensive gas whether
they take it or not. Obviously, more flexibility in this market is needed
to allow adjustments to changing demand and supply conditions.
We are here today to hear from those directly affected by this prob
lem, the business and the home users. We look forward to hearing their
concerns and their ideas on how to solve this problem.
We have perhaps for the first time in discussing this issue in the
country put together here today representatives from every area that
is of concern in this problem of natural gas pricing. We have repre
sentatives here today from Government regulatory agencies, on both
the Federal and the State level. Robert Means is from the Federal
Energy Regulatory Commission in Washington, and Christine Hansen
is representing the Iowa Commerce Commission in Iowa. We have rep
resentatives from the producers, Nicholas Bush, from the Natural Gas
Supply Association. We have representatives of the pipeline and the
distributor folks with Jerome McGrath of the Interstate Natural Gas
Association of America. We have a representative of Iowa agriculture
here from the Farm Bureau Federation, Dean Kleckner—Iowa agri
culture being one of the major users of natural gas in the State. We
have a representative of the distribution companies, and that’s John
Daniel from Iowa-Illinois Gas and Electric. And then we have several
representatives of the residential consumers including Linda Blanch
ard from Cedar Rapids, representing the Citizens for Community Im
provement, and Constance Berka from the United Neighbors here in
Davenport. Ms. Morrow is also here from Davenport, and I understand
we have an additional witness, Gordon Dunn, with Ms. Blanchard from
Cedar Rapids.
Now, I would point out that, if one wanted to really pick the specks
out of the pepper, one could say, well, you have everybody represented
except industrial users, and to a degree, that’s true, we don’t have
someone specifically represented from the manufacturing industry,
but I can assure you that these people that we do have here will reflect
many of the concerns that industry may have with this problem.
At this time I would announce that at this hearing we will gather
facts and information, and we hope bring the white light of pub
licity to focus on this problem. At the risk of using a pun, we have had
some instances in the past where we have generated more heat than
light on this situation. This hearing today will be a factual gathering,
an exchange of ideas, focused so that those of us in Congress can move
with dispatch, can move on an informed basis. Frankly, by having a
3
hearing at the grassroots levels here where it’s all happening, I hope
that the attention will prompt citizens to report to their individual
representatives, and our report will be able to be distributed to those
working on this problem in Washington and in the Congress. This will
make for legislation that, when it is passed and acted on, will provide
a true resolution of this problem, and not just some bandaid approach
that may last just a few months, or some sort of a mask to cover up
the real problem.
I
now ask that we divide this hearing into two panels. The first
panel will include Robert C. Means of the Federal Energy Regula
tory Commission from Washington, D.C.; Nicholas Bush of the
Natural Gas Supply Association; and Jerome McGrath of the Inter
national Gas Association of America. I f those gentlemen would please
come and take their seats.
While the electronic media are setting up the tools of their trade, I
would point out again that this panel includes representatives of the
Federal Energy Regulatory Commission, the gas producers, and the
gas pipelines. There has not been any established order of procedure
here, and if I may, I would suggest that we hear first from Mr. Means
of the Federal Energy Regulatory Commission, better known in the
jargon of the bureaucracy and the Government as FERC. So, Mr.
Means, you may proceed.
STATEMENT OF ROBERT C. MEANS, DIRECTOR, OFFICE OF REGULA
TORY ANALYSIS, FEDERAL ENERGY REGULATORY COMMISSION
Mr. M ean s . Thank you, Mr. Chairman. I ’m very pleased to be here
this morning. I ’ve submitted a prepared statement, and with your
permission I would like simply to summarize the basic points in it.
Senator J epsen . Let the record show that the prepared statement
submitted by Robert Means will be entered into the record as if read.
You then may proceed in any way you so desire, and the Chair would
appreciate it if, in the interest of time and the desire that everyone does
have an opportunity to be heard, that you do indeed summarize and
proceed to consolidate your prepared statement.
Mr. M eans . Thank you, Mr. Chairman. I f this hearing had been
held a year ago, the gist of my testimony would have been that natural
gas was underpriced; that although it would cause short-term disloca
tion, it would have been preferable to deregulate natural gas, to pro
mote conservation and to ease the transition to a deregulated market.
The market conditions have changed markedly over the past year, how
ever. The points that I make today are quite different. The price of
natural gas is now too high. Not too high simply in reference to some
standard of fairness, but too high in comparison with the price that
would prevail in a rational deregulated market. This is true already
on a number of pipeline systems. Unless the rules that govern the pric
ing of natural gas are changed, it would be true on most pipeline sys
tems within a relatively short time.
4
The problem is not principally the high cost of deregulated gas, the
high cost of imported gas, although these aggravate the problem. The
problem has come to be the. price that pipelines are paying for their
basic supply of regulated gas. The problem arises from two sources.
The Natural Gas Policy Act of 1978 established price ceilings that
increase as a result of inflation automatically without action from this
Commission or any other body. Second, virtually all natural gas is
governed by contracts that guarantees the producer that maximum
lawful price. Together, the statute and the contracts have begun to
carry the price of natural gas above the market-clearing level as re
flected in the current surpluses to which you refer. There is in this
combination of rules, statutory and contractual, no provision for re
sponse to market conditions. It is an automatic escalator that has been
running now for several years without reference to market conditions.
Unless changed, it will continue to run without reference to market
conditions. Gas will become increasingly overpriced, surpluses will
continue to grow and, if as many expect, world oil prices decline, the
problem will simply become that much the greater.
In brief, the general nature of what is required is easy to describe.
Natural gas producers cannot continue to receive the maximum lawful
prices specified by the Natural Gas Policy Act. The difficulty is in
describing the path to that goal. The first point I would like to
emphasize is that the Federal Energy Regulatory Commission does
not have the statutory power to achieve that goal. The Natural Gas
Policy Act of 1978 has restricted our effective legal powers largely
due to the regulation of interstate pipelines.
There are only two respects in which we have jurisdiction over the
price charged to the pipelines by producers. One is in setting incentive
prices, which we have done primarily for what is called tight sands
gas. The other is in establishing new, just, and reasonable rates for old
flowing gas. The Commission staff is already actively considering
reducing the incentive price that we have established for tight sands
gas, but that gas comprises only about 2 percent of the total supply.
Reducing that ceiling price, that incentive price, in my measure is a
useful step, but its impact on consumers will be very small.
The Natural Gas Policy Act, on the other hand, forbids us to
reduce the just and reasonable price for old flowing gas. Our only
discretionary authority under the statute is to increase that ceiling.
We have no authority whatsoever to reduce it. A reduction in the
ceiling price for category of gas, tight sands, that amounts to perhaps
2 percent of the total, then would exhaust our direct statutory
authority to deal with wellhead price.
We are seeking indirectly to increase wellhead price by placing
greater risks of marketability on the interstate pipelines. We believe
that that kind of a shift of risk is a necessary step in moving toward
rational natural gas markets, but the limits on that administrative
strategy have to be recognized. The interstate pipelines simply do not
5
have the assets. They do not have the income to absorb large purchased
gas costs without passing them on to consumers. Totally eliminating
the profits of the interstate pipelines would buy us only some months
of relief from the increase in price of natural gas to consumers. The
strategy of shifting risks to the interstate pipelines will have an effect
on consumers if and only if they in turn are able to reduce the price
that they pay to natural gas producers. To some degree they can do
this unilaterally through invoking what are known as market-out
clauses, and most of the interstate pipelines have now taken that step,
but those clauses cover only a small part of the total supply.
To reduce the price on the larger part of their gas supply, they will
have to renegotiate their contracts with producers. And one of the
most deeply disturbing features of the current situation is, up to this
time, there has been no significant successful renegotiation of price
terms. Renegotiation of take-or-pay terms there has been, but of price
terms there has not. If this continues to be the case, then, of necessity,
the responsibility will have to pass to the Congress because it is the
only remaining form with the authority to revise the terms of those
contracts.
Legislation on natural gas may deal with a number of problems,
take or pay, our authority over pipelines, perhaps increased competi
tion in burner-tip markets, but the central concern has to be, I think,
the price that is paid to producers for the natural gas. There must be
in one way or another a revision of the contracts that guarantee pro
ducers the maximum lawful price established by the Natural Gas
Policy Act.
Mr. Chairman, thank you.
[The prepared statement of Mr. Means, together with an appendix,
follows:]
6
P repared S tatem en t
C h a i r m a n Jepsen,
of
R obert C . M eans
m y nam e is Ro b e r t C. Means.
I a m the
D i r e c t o r of the O f f i c e of R e g u l a t o r y A n a l y s i s at the F e d e r a l
E n e r g y R e g u l a t o r y Comm i s s i o n .
I a m p l e a s e d to a p p e a r before
y ou to d a y to d i s c u s s the c u r r e n t n a t u r a l g a s situat i o n .
B e c a u s e of its l e g i s l a t i v e m a n d a t e a n d a d m i n i s t r a t i v e
r e s p o n s i b i l i t i e s , the F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n is
n e c e s s a r i l y c o n c e r n e d a b o u t the recent i n c r eases in the p rice
of g as to c o nsumers.
T h i s t r e n d is e s p e c i a l l y p r o b l e m a t i c
b e c a u s e it has c o n t i n u e d in the face of a n a t i o n a l s u r p l u s in
n a t u r a l g as d e l i v e r a b i l i t y .
R i s i n g p r i c e s in a time of s u r p l u s
s t r o n g l y sugg e s t that there are f u n d a m e n t a l d e f e c t s in the w ay
by w h i c h n a t u r a l g a s p r i c e s are est a b l i s h e d .
The C o m m i s s i o n
has been a t t e m p i n g to i d e n t i f y these d e f e c t s and, w i t h i n the
terms of its au t h o r i t y ,
it has been e x p l o r i n g the m e a n s a v a i l
able to it for c o r r e c t i n g them.
One reason that I w e l c o m e the
o p p o r t u n i t y to d i s c u s s these issues is that this a u t h o r i t y is
inad e q u a t e for this purpose.
Let me begin by d e s c r i b i n g the r e a sons for the p r e s e n t
r o und of price increases, a n d th e i r p o l i c y impl i c a t i o n s .
I
shall then turn to the C o m m i s s i o n ' s e f f o r t to r e s p o n d to the
pr o b l e m , a n d to p o t e n t i a l legi s l a t i v e solutions.
7
The i n c reases in n a t u r a l gas prices over the past four ye a r s
are the r e sult of the inte r a c t i o n of two sets of legal rules:
one c o n t a i n e d in the N a t u r a l Gas P o l i c y Act of 1978, and the
o t h e r c o n t a i n e d in the c o n t r a c t s between na t u r a l gas p r o d u c e r s
and pipelines.
The N a t u r a l G a s P o l i c y Act
[NGPA] d i v i d e s
na t u r a l gas into a n u m b e r of d i f f e r e n t categories.
One c a t e
g o r y of n a t u r a l gas, c o m p r i s i n g a b o u t 5 per cent of the total
supply,
is n o w d e r e g u l a t e d , and its price is d e t e r m i n e d solely
by contract.
For the o t h e r catego r i e s , the N G P A e s t a b l i s h e s
price ceilings.
T h ese cei.lings increase a u t o m a t i c a l l y at least
at the rate of inflation, and for some c a t e g o r i e s of gas the
N G P A p r o v i d e s for a rate of increase faster than the rate of
inflation.
In addi t i o n ,
the rela t i v e i m portance of the d i f f e r e n t
ca t e g o r i e s of gas is c h anging w i t h time.
In ord e r to focus
in c e ntives where they w o u l d be like l y to p roduce the l a r gest
supp l y response,
the C o n g r e s s e s t a b l i s h e d h i g h e r p r ice ceili n g s
for n e w e r c a t e g o r i e s of gas a nd lower ones for gas b eing p r o d u c e d
from e x i s t i n g wells.
I n evitably,
the relative i m p o r t a n c e of
the n e w e r c a t e g o r i e s of gas in c r e a s e s wi t h time, whi l e the
supply of gas from the o l d e r w e l l s is g r a d u a l l y exhaus t e d .
As
a result, the m i x t u r e of gas in the total s u p p l y is g r a d u a l l y
s h i f t i n g towards the h i g h e r - p r i c e d categories.
The N G P A e s t a b l i s h e s o n l y price c e i l i n g s .
P i p e l i n e s and
p r o d u c e r s are l e gally free to e s t a b l i s h a n y price they choose
so long as it does not e x c e e d the ceiling.
In p r a c t i c e , h o w
ever, v i r t u a l l y all n a t u r a l gas is g o v e r n e d by c o n t r a c t s that
8
gu a r a n t e e the p r o d u c e r the m a x i m u m lawful p r ice a l l o w e d by the
NGPA.
The p r a c t i c a l e f f e c t of the N G P A therefore is to e s t a b l i s h
not just c e i l i n g s but the price that p i p e l i n e s a c t u a l l y pay p r o
d u c e r s for their gas.
A s a result of the e s c a l a t i o n ter m s built into the N G P A
a n d the incr e a s i n g i m p o r t a n c e of the h i g h e r - c o s t c a t e g o r i e s of
gas, the av e r a g e cost of gas to p i p e l i n e s has been i n c r e a s i n g
m u c h faster than the rate of inflation.
O v e r the past s everal
years, the rate of increase has a v e r a g e d a r o u n d 20 per cent per
year.
The forces b e h i n d this increase have v i r t u a l l y n o t h i n g
to d o w i t h m a r k e t cond i t i o n s ;
the price of the small a m o u n t
of d e r e g u l a t e d gas has te n d e d to re s p o n d to c h a nges in s u pply
a n d demand, but the price of m o s t gas i n creases at a rate that
is d e t e r m i n e d a l m o s t s o l e l y by the rate of inflation a n d the
c h a n g i n g i m portance of the indi v i d u a l c a t e g o r i e s of gas,
The
p rice increase thus c o n t i n u e s at a p p r o x i m a t e l y the same rate
in time of surp l u s as in time of shortage.
When the Iranian
c ris i s resu l t e d in a large increase in the price of oil, a nd
thus a l s o in the p rice of the a l t e r n a t i v e fu e l s w i t h w h i c h
n a t u r a l g a s competes, the rise in n a t u r a l g as p r i c e s did not
accelerate appreciably.
N o w today, when there is a large s u r
p l u s of n a t u r a l gas, the rise in n a t u r a l g a s p r i c e s has not
slowed.
A s a result, the pr i c e of n a t u r a l g as is n o w a b o v e the m a r k e t c l e a r i n g level on a n u m b e r of p i p e l i n e systems.
T he imba l a n c e
b e t w e e n s u p p l y a nd d e m a n d is li k e l y to g r o w wor s e o v e r the n e x t
9
year.
E c o n o m i c r e c o v e r y sh o u l d increase d e mand for na t u r a l
gas, but its e f f e c t is l i kely to be mo r e than of f s e t by that
of still h i g h e r gas pr i c e s and a decl i n e in w o r l d oil prices.
N a t u r a l gas p r i c e s are n o w too high, not just in c o m p a r i s o n wit h
some s t a n d a r d of f a i r n e s s but in comp a r i s o n wit h the p rice that
w o u l d p r e v a i l in a ra t i o n a l u n r e g u l a t e d market.
O u r goal sh o u l d be n a t u r a l gas p r i c e s that can fall as we l l as
rise; pr i c e s that can resp o n d f l e x i b i l y both to p e r i o d s of s urplus
and to pe r i o d s of shortage.
gas p u r c h a s e s will not do.
sive to m a r k e t forces.
For this goal, the c o n t r a c t s go v e r n i n g
Th e y si m p l y are not a d e q u a t e l y r e s p o n
T h e y can lead to e x c e s s i v e l y h i g h pr i c e s
even in strong n a t u r a l gas markets, and they are i n c apable of
re ducing p r i c e s in we a k ones.
They m u s t be reformed.
The C o m m i s s i o n lacks the po w e r to require this reformation.
B efo r e e n a c t m e n t of the N G P A , the C o m m i s s i o n had br o a d a u t h o r i t y
over w e l l h e a d prices, but u n d e r the N G P A we have bec o m e ag a i n
p r i n c i p a l l y a r e g u l a t o r of pipelines.
The cost of the p i p e l i n e s
t h e m s e l v e s have been i n c r e a s i n g rapidly, and C o m m i s s i o n staff
is a c t i v e l y s t u d y i n g the re a s o n s for this increase.
B u t the
p r i n c i p a l reason for the increase in c o n s u m e r gas pri c e s is the
i ncrease in the price paid by p i p e l i n e s to producers.
The NG P A
has left us d i s c r e t i o n a r y a u t h o r i t y to change this w e l l h e a d
p rice in o n l y two areas.
We have the p o w e r to set incentive
pric e s u n d e r S e c t i o n s 1 0 7(c)(5); and we have the p o w e r to set
10
new just a nd r e a s o n a b l e p r i c e s u n d e r S e c t i o n s 104, 106, and
109.
C o m m i s s i o n s taff is n o w stud y i n g a p r o p o s a l to reduce the
i n c e ntive pr i c e s that we have e s t a b l i s h e d un d e r Se c t i o n 107, but
the v o l u m e of gas g o v e r n e d by those i ncentive pr i c e s a m o u n t s to
on l y a b o u t 2 per cent of the total supply.
We cannot take any
c o m p a r a b l e action w i t h r e s p e c t to the m u c h larger volu m e of gas
g o v e r n e d by S e c t i o n s 104, 106, or 109, because those s e c t i o n s
e x p l i c i t l y limit us to r a i s i n g the e s t a b l i s h e d m a x i m u m lawf u l
price.
A r e d u ction in the incentive price e s t a b l i s h e d und e r
Se c t i o n 107 thus w o u l d e x h a u s t our d i r e c t a u t h o r i t y to lower
w e l l h e a d prices, a n d such a r eduction w o u l d have onl y a very
small e f f e c t on c o n s u m e r gas prices.
If we are to have a b r o a d e r e f f e c t on w e l l h e a d prices,
m u s t be indirectly, t h r o u g h o u r regu l a t i o n of pipelines.
it
The
C o m m i s s i o n has been s e e k i n g to place more of the risk of m a r k e t i n g
gas on the p i p elines,
r a ther than on the d i s t r i b u t i o n c o m p a n i e s
that sell to the e nd user.
In an a p p e n d i x to this t e s t i m o n y I
have b r i e f l y d e s c r i b e d a n u m b e r of C o m m i s s i o n a c t i o n s of this
kind.
It shou l d be e m p h a s i z e d , however,
that there are p r a c
tical limits on the e x t e n t to wh i c h p i p e l i n e s can be r e q u i r e d
to a b s o r b gas costs w i t h o u t being able to pass them on to their
customers.
C o m m i s s i o n a c t i o n s pl a c i n g more risk on the p i p e l i n e s
can on l y have a s i g n i f i c a n t impact on consumers' ga s p r i c e s if
the p i p e l i n e s can re s p o n d to these a c t i o n s by re d u c i n g the
pri c e that they pay to produc e r s .
P i p e l i n e s can in some cases
11
do this by invoking m a r k e t - o u t clauses, that is, c o n t r a c t clau s e s
that a l l o w t h e m u n i l a t e r a l l y to reduce the price of the gas if
they are u n able to resell it at the p r e v a i l i n g price.
Bu t such
c l a uses are not included in m o s t gas p u rchase contracts, and
where they are not, the p i p e l i n e ' s on l y a l t e r n a t i v e is to re
n e g o t i a t e its co n t r a c t s wi t h producers.
R e n e g o t i a t i o n requi r e s
the c o o p e r a t i o n of both p a r t i e s to the contract, however.
I
a m d e e p l y c o n c e r n e d that p i p e l i n e s a p p e a r so far to have been
unable to obtain price c o n c e s s i o n s from na t u r a l gas producers.
There has been some s u c c e s s f u l r e n e g o t i a t i o n of t a k e - o r - p a y
o b ligations, but as yet there a p p e a r s to have been no s i g n i f i c a n t
r e n e g o t i a t i o n of prices.
I hope that r e n e g o t i a t i o n succeeds.
If it does not, the
re s p o n s i b i l i t y n e c e s s a r i l y p a sses to the Congress.
In g e n eral
terms, I be l i e v e that v i e w that na t u r a l g as l e g i s l a t i o n s h ould
both remove the s t a t u t o r y price c e ilings that ke e p the price of
some gas b e l o w the m a r k e t - c l e a r i n g level a nd m o d i f y the o p e r a t i o n
of the n a t u r a l gas c o n t r a c t s to make them more r e s p o n s i v e to
c hanges in sup p l y and demand.
The first change is r e l a t i v e l y
s t r a i g h t f o r w a r d , a l t h o u g h there c l e arly is roo m for legitimate
de bate c o n c e r n i n g the time o v e r w h i c h the price c e i l i n g s should
be elimin a t e d .
The s e cond change is m u c h mor e complex.
There
is no e n t i r e l y s a t i s f a c t o r y w a y of a c h i e v i n g flexible pr i c e s
th r ough legislation.
L e g i s l a t i o n i mposes a single s o l u t i o n on
t h o u s a n d s of d i f f e r e n t c o n t r a c t s a nd e c o n o m i c r e l a t i o n s h i p s ,
12
and i n e v i t a b l y the l e g i s l a t i v e s o lution will be u n f a i r or
i n a p p r o p r i a t e in some cases.
If p i p e l i n e s an d p r o d u c e r s are
u n a b l e to r e n e g o t i a t e their c o ntracts, however,
l e g islation is
p r e f e r a b l e to a c o n t i n u e d s e n s e l e s s rise in n a t u r a l gas prices
in the face of large surpluses.
T here a p p e a r to be two g e n e r a l ways to a c h i e v e more m a r k e t r e s p o n s i v e p r i c e s th r o u g h legislation.
One is to give p i p e l i n e s
a broad m a r k e t - o u t clause in a ll of their gas purch a s e contracts.
S u c h a clause w o u l d en a b l e p i p e l i n e s u n i l a t e r a l l y to b r ing the
price of t heir gas down to the m a r k e t - c l e a r i n g level, and indeed
pe r h a p s the g r e a t e s t p o t e n t i a l s h o r t c o m i n g of such c l a u s e s is
that they may o f f e r little p r o t e c t i o n to prod u c e r s , e s p e c i a l l y
in a time of surp l u s supply.
lines'
T o p r o t e c t producers,
the p i p e
right to lower the p r ice t herefore sh o u l d be b a l a n c e d by
an o b l i g a t i o n to t r a n s p o r t the gas to a n o t h e r p u r c h a s e r if the
p r o d u c e r is u n w i l l i n g to a c c e p t the lower price.
The s e cond a l t e r n a t i v e is to s u b o r d i n a t e i n d e f i n i t e price
e s c a l a t o r cl a u s e s to a cap d e s i g n e d to a p p r o x i m a t e the m a r k e t cl e a r i n g price for gas.
The e v i d e n t p r o b l e m w i t h this a l t e r
na t i v e is to devise a formula that does r e s p o n d to n a t u r a l gas
m a r k e t s c onditions.
Some have p r o p o s e d l i n king the cap to oil
prices, for e x a m p l e se t t i n g it at some p e r c e n t a g e of the price
p a i d for oil by U n i t e d S t a t e s refiners; but the c o m p e t i t i v e
r e l a t i o n s h i p b e t ween oil a n d ga s pr i c e s m a y n o w be too u n c e r t a i n
a n d too v o l a t i l e for it to p r o v i d e an a d e q u a t e b a s i s for legis-
13
lation.
An a l t e r n a t i v e w o r t h e x p l o r i n g w o u l d be to link the
cap to the price c u r r e n t l y being n e g o t i a t e d by p i p e l i n e s for
n e w u n c o m m i t t e d s u p p l i e s of gas.
There are oth e r m a t t e r s that should or m i g h t be d e a l t with
in n a t u r a l gas legislation.
The NGPA ' s i n c r emental pr i c i n g p r o
v i sions a p p e a r to have o u t l i v e d their usefulness;
the same is
true of the Fuel Use Act ' s r e s t r i c t i o n s on the use of gas.
L e g i s l a t i o n m i g h t a l s o give the Commis s i o n broa d e r p o w e r s to
e n c o u r a g e p i p e l i n e s to m i n i m i z e the long-run cost of gas to
consumers.
Some have s u g g e s t e d that l egislation m i g h t a l s o
a t t e m p t to create g r e a t e r f l e x i b i l i t y a nd co m p e t i t i o n in b u rnertip markets,
These o t h e r issues are important.
However, they sh o u l d not
be a l l o w e d to ob s c u r e the ce n t r a l issue of price.
The m e c h a n i s m
that d e t e r m i n e s the price that p i p e l i n e s pay for gas m u s t be
changed, and the change m u s t come e i t h e r from the c o o p e r a t i v e
ac t i o n of p i p e l i n e s and p r o d u c e r s or from the Congress.
And if
p i p e l i n e s a n d p r o d u c e r s are u n able to rene g o t i a t e their contracts,
the p r i n c i p a l r e s p o n s i b i l i t y mu s t rest on the Congress.
2 1 - 1+96 0
83 - 2
14
APPENDIX
C o m m i s s i o n A c t i o n s A f f e c t i n g the Risk of M a r k e t a b i l i t y
The Co m m i s s i o n is s e e k i n g to p r o v i d e in c e n t i v e s for the
r e f o r m a t i o n of n a t u r a l gas pu r c h a s e contracts.
m u s t be pl a c e d on the pipelines.
The in c e n t i v e s
D i s t r i b u t o r s are not in a
p o s i t i o n to p a r t i c i p a t e d i r e c t l y in the r e f o r m a t i o n process;
p r o d u c e r s fall la r g e l y outs i d e the C o m m i s s i o n ' s jurisdiction,
The C o m m i s s i o n ' s role thus m u s t be ca r r i e d out t h r ough its
re g u l a t i o n of inters t a t e pipelines.
The limits a n d im p l i c a t i o n of this role are still being
explored.
S o m e t h i n g of its p o s s i b i l i t i e s m a y be s u g g e s t e d by
a bri e f e x a m i n a t i o n of some recent a c t i o n s by the C o m m i s s i o n
a nd issues n o w being p r e s e n t e d to it.
A.
Rate De s i g n to D i s c o u r a g e Load Loss
One e x a mple of the C o m m i s s i o n ' s a t t e m p t to give p i p e l i n e s
e x p l i c i t ince n t i v e s to insure the m a r k e t a b i l i t y of the i r gas is
its d e c i s i o n in T e n n e s s e e Gas P i p e l i n e C o . , 21 FERC 1161,004
(Oct.
1, 1982) a nd seve r a l c a s e s w h i c h f o l l o w e d that d e c i s i o n ' s
approach.
In T e n n e s s e e , the C o m m i s s i o n g r a n t e d the p i p e l i n e ' s
r e q u e s t e d p u r c h a s e d gas adju s t m e n t ,
but n o t e d that p i p e l i n e s
p e r h a p s s h ould be r e s p o n s i b l e for load loss due to fuel s w i t c h i n g
induced by hi g h gas costs.
The C o m m i s s i o n st a t e d that it could,
in a s ection 4 or 5 rate p r o c e e d i n g , c o n s i d e r rate d e s i g n p r o
15
p o sals w h i c h w o u l d prov i d e i n c entives to the pi p e l i n e to m i n i
mize gas costs.
For exam p l e ,
the Commis s i o n said that rate design
m i g h t make full r e c o v e r y of the p i p e l i n e ' s fixed costs c o n t i n g e n t
on its a v o i d i n g or limiting load loss.
B.
Di s c o u n t Rates
The same concern wit h incent i v e s for r e t a ining load thro u g h
m i n i m i z i n g gas c o sts is r e f l e c t e d in the C o m m i s s i o n ' s recent
orders a l l o w i n g three p i p e l i n e s to charge s p ecial d i s c o u n t
rates to certain indust r i a l cust o m e r s
CP83-14, C P 8 2 - 4 8 5),
(Docket Nos. CP82-542,
The d i s c o u n t s were intended to pr e v e n t
the loss of load to c o m p e t i n g fuels.
The p i p e l i n e s p r o p o s i n g
th e m a r g u e d that all c u s t o m e r s w o u l d b enefit from the special
rates since c u s t o m e r s q u a l i f y i n g for the d i s c o u n t s w o u l d o t h e r
wise leave the s y s t e m and wo u l d n o longer make an y c o n t r i b u t i o n
to fixed costs.
The d i s c o u n t rates raised two p o l i c y concerns.
The first
was that the rates in fact b e n e f i t n o n d i s c o u n t c u s t o m e r s in
the short term.
The C o m m i s s i o n therefore re q u i r e d that the
rates e x c e e d the costs that the pipe l i n e w o u l d a v o i d if it did
not mak e the d i s c o u n t sales.
If that st a n d a r d was not met,
the
n o n d i s c o u n t c u s t o m e r s w o u l d be b e tter off if the pi p e l i n e lost
the load than if it re t a i n e d it thro u g h the d i s c o u n t rate, and
the C o m m i s s i o n t herefore w o u l d not appr o v e the s p e cial rate,
8/
8/
A pipel i n e is c o n s i d e r e d to have two a l t e r n a t i v e s :
it can
m a k e the d i s c o u n t sale and r e c eive the d i s c o u n t price; or it
can not m a k e the sale a nd a v o i d c ertain costs.
The d i s c o u n t
rate b e n e f i t s n o n d i s c o u n t c u s t o m e r s in the short t e r m onl y if
it e x c e e d s those a v o i d e d costs.
16
The s e cond c o n cern was that the special d i s c o u n t rates
m i g h t serve as an a l t e r n a t i v e to r e n e g o t i a t i n g g as p u r c h a s e c o n
tr a c t s to reduce gas c osts for all customers.
A pipeline's
a v o i d e d gas c osts could prove to be quite low. 9/
For exam p l e ,
p r o b l e m s such as drain a g e m i g h t force a pipe l i n e to take gas
and store it if it could n ot make the d i s c o u n t sale; the
cost a v o i d e d by n ot m a k i n g the sale then could be ev e n lower
than its av e r a g e cost of gas.
A d i s c o u n t rate in e x c e s s of
this low a v o i d e d cost still m i g h t bene f i t n o n d i s c o u n t c u s t o m e r s
in the short term, but if it tended to insulate the pi p e l i n e
f r o m m a r k e t p r e s s u r e to r e n e g o t i a t e its contracts,
not be n e f i t them in the longer term.
it wou l d
The C o m m i s s i o n ther e f o r e
i mposed a second c o n d i t i o n on the p r o p o s e d d i s c o u n t rates:
the d i s c o u n t rate m u s t a l s o e x c e e d the p i p e l i n e ' s w e i g h t e d
a v e r a g e cost of gas.
C.
M i n i m u m Bill Cases
The p r o b l e m of a l l o c a t i n g the risk of gas m a r k e t a b i l i t y
al s o has been raised in a n o t h e r context.
In s e v eral c a ses n o w
9/
If a pi p e l i n e is a t t a c h i n g n e w reserves, its a v o i d e d cost
in g e n e r a l wil l at least e q u a l the price of the m o s t costly
n e w r e s e r v e s that it is c u r r e n t l y a t t a ching, but p i p e l i n e s
that seek s pecial d i s c o u n t rates m a y a l s o have t e m p o r a r i l y
s u s p e n d e d the a t t a c h m e n t of n e w reserves.
If so, their a v o i d e d
g as c osts w o u l d be the a m o u n t that they w o u l d save by re d u c i n g
sales from e x i s t i n g reserves.
As a result of t a k e - o r - p a y
o b l i g a t i o n s or, as in the e x a m p l e in the text, an e s s e n t i a l l y
a b s o l u t e o b l i g a t i o n to take the gas, the a v o i d e d g a s co s t s m ay
be less than the w e l l h e a d p rice of the gas.
17
before the C o m m i s s i o n
(U n i t e d G as P i p e l i n e , Do c k e t Nos. RP 8 2 - 1 6
and RP81-81, P a n h a n d l e Pi p e l i n e RP82- 1 0 5 and RP82-88, T r u n k l i n e
Gas C o r p . , D o c k e t No. R P 8 1 -1Q3, Colum b i a Gas T r a n s m i s s i o n ,
R P 8 3 - 8 ), d i s t r i b u t i o n c o m p a n i e s and,
in at least one case,
C o m m i s s i o n staff, have c h a l l e n g e d the " m inimum bill" o b l i g a t i o n
w h ich p i p e l i n e s have inclu d e d or are s e eking to include in their
tariffs.
A m i n i m u m bill r e q u i r e m e n t is like a t a k e - o r - p a y
o bligation; u n d e r both the p u r c h a s e r m u s t pay for gas w h e t h e r
it is taken or not.
W h e r e the co n t r a c t is between p r o d u c e r
and pipe l i n e , the o b l i g a t i o n is g e n e r a l l y refe r r e d to as a
t a k e - o r - p a y obli g a t i o n ; w here it is betw e e n p i p e l i n e s or between
a pipel i n e and a d i s t r i b u t o r it is g e n e r a l l y re f e r r e d to as a
m i n i m u m bill obligation.
Unlike take-or-pay, m i n i m u m bill p a y
m e n t s t y p i c a l l y are not c r e d i t e d toward future purchases,
In the U n i t e d case, the p r i m a r y issue is s i m p l y w h e t h e r its
prop o s e d level of m i n i m u m bill (two-t h i r d s of m a x i m u m c o n t r a c t
quantities)
is just an d reasonable.
The c o m p a n y has taken
the posi t i o n that the m i n i m u m bill is n e c e s s a r y to c o v e r
t a k e - o r - p a y o b l i g a t i o n s to s u p p l i e r s an d to a v o i d load loss.
FERC staff has taken the p o s i t i o n that, at the v e r y least,
the level of the m i n i m u m bill has to be based on the p i p e l i n e ' s
fixed costs.
Staff has not y et a d d r e s s e d the q u e s t i o n w h e t h e r
t a k e - o r - p a y o b l i g a t i o n s s h o u l d be t reated as fixed c osts for
this purpose.
18
The o t h e r three cas e s involve c h a l l e n g e s to e x i s t i n g m i n i
m u m bills.
In the P a n h a n d l e and T r u n k l i n e cases, the c u s t o m e r s
c h a l l e n g i n g the m i n i m u m bill have ra i s e d an a n t i t r u s t issue
in a d d i t i o n to the g e n e r a l just a nd r e a s onable issue.
P a r tial
r e q u i r e m e n t s c u s t o m e r s in these cases argue that the m i n i m u m
bill, w h i c h a p p l i e s on l y to the p a r t i a l r e q u i r e m e n t s rate
s c h e dule^ has been e s t a b l i s h e d at a level w h i c h is in t e n d e d
to d i s c o u r a g e c u s t o m e r s from se e k i n g a l t e r n a t i v e gas suppliers.
Th e y ar g u e that the m i n i m u m bill,
in c o m b i n a t i o n w i t h the rate
st ructure, e s s e n t i a l l y forc e s them to become full r e q u i r e m e n t s
customers.
The Colum b i a m a t t e r g rows out of that c o m p a n y ’s a t t e m p t to
a b r o g a t e its e x i s t i n g m i n i m u m bill w i t h its pipe l i n e suppliers.
The s u p p l i e r s p e t i t i o n e d the C o m m i s s i o n for e n f o r c e m e n t of
the tariff an d P a n h a n d l e sued in state c ourt in O h i o for
damages.
C o l u m b i a ' s de f e n s e is bas e d on the t h e o r y that the
e c o n o m i c r e c e ssion n o w p l a g u i n g the na t i o n and,
in partic u l a r ,
its s e rvice area, a m o u n t s to a force m a j e u r e .
D.
D i r e c t C h a l l e n g e s to Pipelines'
Finally,
Purchasing Practices
there are s e v eral C o m m i s s i o n p r o c e e d i n g s in
w h i c h pipe l i n e p u r c h a s e s t h e m s e l v e s are being d i r e c t l y s c r u t i
n i z e d u n d e r sect i o n s 4 a nd 5 of the N G A and u n d e r sect i o n 601(c)
of the NGPA.
The leading C o m m i s s i o n opin i o n in poi n t is T e n n e s s e e Gas
P i p e l i n e C o . , r e f e r r e d to above.
In that case the C o m m i s s i o n
19
indicated that the pa y m e n t of impr u d e n t pr i c e s for g a s was
not w i t h i n the "fraud, abuse, and s i m i l a r p r a c t i c e s " st a n d a r d
for d e n y i n g p a s s t h r o u g h u n d e r section 601(c) of the NGPA.
The
Co m m i s s i o n did hold, however, that the p r udence of a p i p e l i n e ' s
purc h a s e p r a c t i c e s cou l d be c h a l l e n g e d und e r se c t i o n s 4 a n d 5
of the NGA, i.e.,
in a g e n e r a l rate proceeding.
This m a t t e r
is n o w in hearings, as are oth e r p r o c e e d i n g s i n v o l v i n g si m i l a r
issues.
Tak e n as a whole, the T e n n e s s e e d e cision thus l a r g e l y closed
one door a nd o p e n e d another.
It largely f o r e closed C o m m i s s i o n
r e v i e w of indivi d u a l gas p u r c h a s e c o n t r a c t s for prudence.
This
rejection of a c o n t r a c t - b y - c o n t r a c t c o n s i d e r a t i o n of p u r c h a s e d
gas costs rested in part on a legal inter p r e t a t i o n of N G P A
section 601(c) an d in part on the a d m i n i s t r a t i v e i m p r a c t i c a b i
lity of a b road a p p l i c a t i o n of the c o n t r a c t - b y - c o n t r a c t approach.
But at the same time, as n o t e d above, T e n n e s s e e a l s o s t r o n g l y
sugg e s t e d that the C o m m i s s i o n w o u l d c o n s i d e r the c r e a t i o n of
g e n e r a l inc e n t i v e s d i r e c t e d at the same e n d of m i n i m i z i n g gas
costs.
The T e n n e s s e e case is n o w in hearings, as are o t h e r
cases r a i s i n g the same issues.
C o l u m b i a G as T r a n s m i s s i o n , Do c k e t Nos. T A 8 1 - 1 - 2 1 , T A 8 1 - 2 - 2 1
(Initial D ecision, D e c e m b e r 30, 1982)
is the only a d m i n i s t r a t i v e
d eci s i o n since T e n n e s s e e Gas Pi p e l i n e wh i c h de a l s w i t h the p r o
p r iety of pu r c h a s e gas co s t s u n d e r e i t h e r NGP A s e c tion 601(c)
or N G A sections 4 and 5,
In that d e c ision, w h i c h s till is
20
s u b j e c t to C o m m i s s i o n review, A d m i n i s t r a t i v e L a w J u d g e Le v a n t
d e n i e d p a s s t h r o u g h of g a s c o sts in P G A rates to the e x t e n t
they " e x c e e d e d the c ost s C o l u m b i a w o u l d have i n curred if it
had ma d e cutb a c k s in o r d e r of cost."
Further, u n d e r section
5 of the NGPA, J udge L e v a n t o r d e r e d C o l u m b i a to d e s i s t from
v a r i o u s p u r c h a s i n g p r a c t i c e s wh i c h a f f e c t e d C o l u m b i a ' s rates,
incl u d i n g inter alia "e n g a g i n g in gas a c q u i s i t i o n p r a c t i c e s
w h i c h fail to take c o n s i d e r a t i o n of the m a r k e t a b i l i t y of its
g a s in the m a r k e t s of all its c ustomers."
The ulti m a t e d i s p o s i t i o n of the C o l u m b i a Gas case is u n
k nown at this time.
It m a y be wo r t h noting, however,
that
J u d g e L e v a n t ' s d e c i s i o n m a r k s an interm e d i a t e course betw e e n
the c a s e - b y - c a s e a p p r o a c h r e j e c t e d in T e n n e s s e e and the gene r a l
i n centive a p p r o a c h s u p p o r t e d there,
C o lumbia Gas de a l s d i r e c t l y
w i t h the p a s s t h r o u g h of p u r c h a s e d gas costs, but its r e fusal
to a l l o w p a s s t h r o u g h in some inst a n c e s is b ased p r i n c i p a l l y
on the p i p e l i n e ' s g e n e r a l p u r c h a s i n g p r a c t i c e s a nd n o t on the
p r u d e n c e of indivi d u a l contracts.
21
Senator J epsen . Thank you. Rather than going directly to questions,
I think I would ask that each one of the panel members make their
initial opening statement. Again, at a hearing it’s almost impossible
to keep to the 10-minute parameter that we have, so I would like to
summarize what I think I heard you say, and that is that the Federal
Energy Regulatory Commission has very little authority by statute to
address the problems that we’ve been experiencing. The statute, or the
Natural Gas Policy Act of 1978, was generated by the fact that at that
time it was felt that we were going to have a continued shortage of
natural gas in this country.
However, the combination of finding new sources of natural gas and
the conservation, on the other hand, brought us to this point today
where we now have a 1978 act that in some ways did a good job, but in
other ways presented problems. The Natural Gas Policy Act of 1978
does not seem to permit the entire industry, distribution, production,
so on, to adjust to changing market conditions. Now we’ve got to see
how true or rigid that statement is, which is one of the things we hope
to unravel here this morning.
Shall we start with the people who produce it ? That’s where the gas
comes from. Right out of the ground, so Mr. Bush, representing the
Natural Gas Supply Association, you may proceed.
STATEMENT OF NICHOLAS J. BUSH, PRESIDENT, NATURAL GAS
SUPPLY ASSOCIATION (NGSA), DAVENPORT, IOWA
Mr. B u s h . Good morning, Senator. My name is Nicholas J. Bush,
and I am president of the Natural Gas Supply Association, an orga
nization o f producers who market about 90 percent of the Nation’s nat
ural gas. We have large, integrated companies as members.
Senator J epsen . May I interrupt you? In the interest of getting
your remarks all on the record, and because of the location of the
microphones, would you please change places ?
Mr. B u s h . Oh, sure.
Senator J epsen . We want to make sure we have a complete record
so when we get done we have the knee bone connected to the thigh bone
and the thigh bone connected to the hip bone, and we indeed get a com
plete picture of this issue.
Mr. B u s h . Senator, as I was about to say, our organization repre
sents large integrated gas companies as well as small independent pro
ducers. Rather than read my full testimony, I also would ask you, Mr.
Chairman, if it could be submitted in its entirety for the record, and
I will summarize my remarks.
Senator J epsen . The record will show that the prepared statement
of Nicholas J. Bush will be printed in the record as if read, and you
may now proceed in any manner you so desire.
Mr. B u s h . Senator, I want to first associate myself with your open
ing remarks. I think they represent a very candid and very correct
assessment of the current situation.
Last week, Mr. Chairman, CBS News did a short piece on the even
ing news about the anger felt by Iowans about rising natural gas
prices. Rising prices, which once again Dan Rather, smiling into the
22
camera, said had begun with the beginning of decontrol in 1978. The
CBS reporter that was covering it here locally in Iowa felt com
pelled, I thought, to slip back into the debilitating commentary of the
1970’s and charged that consumers angry over these higher prices were
targeting their rage at big oil and gas. I hope, Mr. Chairman, that
many consumers this time won’t be falling for the media hype that
occurred in the 1970’s, and the charges by those who would like to
turn the argument into some form of class war.
I believe that there is a chance that that may occur, because I think
we can best illustrate it by taking a look at two headlines, and I brought
these along for issue sake. One, the headline in the Washington Post
that says: “ Natural Gas Surpluses Lead to 20 Percent Price Rise,”
and another one, a recent one in USA Today similar to many running
around the country these days: “ United States Gasoline Prices Prom
ise Some Break on Dollar Market.” There is only one difference, one
significant difference. Both of these are energy commodities where
there is less demand and more supplies. Natural gas is price con
trolled, oil is decontrolled. And as a result, oil reflects the price that
a consumer is willing to pay for it. That’s the one significant difference,
Senator, between those two commodities.
Now, the same people, Mr. Chairman, many of the same groups who
are now predicting disaster with natural gas decontrol are the same
ones who told us that oil decontrol would result in $100 a barrel oil
and $5 prices at the pump. They were wrong then and they are wrong
now. The only way a product can experience the kind of a situation
we have with natural gas when there is more than enough available
supply for delivery and purchase and the prices keeps going up is
when it’s a regulated commodity. Mr. Chairman, if there was one
myth that I could dispel before leaving this hearing room this morn
ing it would be that rising natural gas prices are the result of a deci
sion to decontrol. That’s just pure and outright baloney.
The Natural Gas Policy Act in 1978 extended controls into markets
that were formerly competitive and free. It set up more than 28 pric
ing categories for natural gas that is otherwise indistinguishable in
other aspects, and on January 1,1985, it does not, as many people still
erroneously believe, decontrol all natural gas; rather it decontrols
perhaps what will then be 40 to 50 percent of the gas flowing and
keeps the remainder forever regulated.
What has resulted from the Natural Gas Policy Act is a crazy quilt
of distortions and inequities that falls the heaviest on the consumer.
By immediately decontrolling that natural gas which is discovered
in reservoirs falling below 15,000 feet, so-called deep gas, the law
irrationally placed the greatest incentive for producers to explore for
and develop the most difficult and most expensive gas first. It’s not
altogether unlike telling a farmer to hire a helicopter and start pick
ing his apples from the top of the tree.
While this gas is only 4 or 5 percent o f the total now produced, it
represents a disproportionate share of the cost of many of the pipe
line systems. The reason for this is because a Natural Gas Policy Act
maintains most domestic gas under tight controls, encouraging the
purchase of new supplies by pipelines at prices higher than what the
23
market would otherwise bear. To the extent that a pipeline has a large
inventory of low-priced, forever-regulated gas, it can then buy un
economic, high-cost supplies such as deep gas, LNG, liquified natural
gas, the famous trunkline synthetic gas, imported gas, rolling in
these high-cost gas supplies with low-cost regulated supplies. As a
result, pipelines have paid up to $10 for some deep gas, $7.16 for
Algerian gas without any associated transportation costs on the land,
$5.01 for Mexican gas, and currently $4.94 for Canadian gas, while
the domestic price for natural gas on the average in September was
$2.53.
A matter of particular concern to Iowans and the Midwest in
general, we believe, is the increasing number and amount of imports
of Canadian gas into this region. Despite a decline in the first three
quarters of 1982 of 27 percent in domestic gas consumption here, Ca
nadian gas imports actually increased. It may interest you that in the
Midwestern region there were 140 billion cubic feet of gas from Ca
nada in 1941, and it’s projected by the American Gas Association that
it will be 252 billion cubic feet in 1983.
I think, Mr. Chairman, in relationship to that Canadian gas, if I
can just say a couple things. Northern Gas Co., which is the major
pipeline supplier in Iowa—provides over a third o f the State’s
natural gas requirements—is particularly going to be experiencing
rising gas costs attributable in a large degree to its Canadian gas pur
chases, and you will note some variation of this in the attachments to
my testimony. In purchased gas adjustments filed over a 12-month
period, December 31, 1981, to December 31, 1982, Northern Natural
showed a planned increase of 64 percent for their Canadian gas costs.
The latest PGA filing for prospective gas costs indicates that Ca
nadian gas will account for over 30 percent of Northern’s total gas
costs. I f one adds projects now pending approval, Iowa may be im
porting up to 100 percent more Canadian gas by the end of 1984
than in 1981.
Consumers have every right to question the wisdom of trading off
relatively cheaper domestic gas for higher priced imports, and, Sena
tor, we would just call that to your attention.
There is quite a bit else in my testimony, Senator, that I think will
be of interest to you, and the Iowans, and to Midwesterners, but I will
at this point try to break off. Let me just say that I would welcome
an opportunity in the question-and-answer period on what we could
do to solve the problem. It rests in the belief that the consumer ought
to be determining what the price of natural gas is, not a regulatory
body, and we are willing very specifically to address the contract
issues.
Producers have been sneaking for over a year and a half about how
those questions can be addressed with equity and concern for everyone,
and let me finally close by saying that there is some misunderstanding
that producers are not concerned with consumers’ ability to pay for
gas bills. That, I would also say, is pure nonsense. The reason that a
producer and a producer representative can sit here and talk to you
about wanting to stabilize long-term prices instead of portraying
themselves as wanting higher and higher prices is that we make money
based on being able to sell gas, and it does not help us when indus
24
trial consumption in this area falls 40 percent and we can’t sell gas.
It doesn’t help us when Ms. Morrow or anyone else in this room can’t
afford to. We sell it and we want very much for those people to have
the best possible price. But if they don’t, they will go and find an
alternative source of supply, so we are very much afraid of the fact
that low-income and elderly and people on fixed incomes may very well
find alternatives.
So this is not the time to cut low energy assistance to people for
energy needs. We don’t know what the right level is, but there has
been some suggestion within the administration that this may be the
time to cut that assistance. We don’t think that’s appropriate, nor is it
timely to do so. Thank you.
[The prepared statement of Mr. Bush, together with attachments,
follows:]
25
P repared S tatem en t
of
N icholas J. B u sh
M y n a m e is N i c h o l a s J, Bush.
Natural Gas Supply Association
I am President of the
(NGS A ) , an o r g a n i z a t i o n
of p r o d u c e r s w h o m a r k e t a b o u t 90 p e r c e n t o f the n a t i o n ’
s
n a t u r a l gas.
The A s s o c i a t i o n t h a n k s t h e C h a i r m a n and h i s sta f f
for a f f o r d i n g u s the o p p o r t u n i t y to p a r t i c i p a t e in t o d a y ' s
h e a r i n g s , w h i c h w i l l e x p l o r e the s t ate of c u r r e n t ga s
m a r k e t s , the o p e r a t i o n of the N a t u r a l G a s P o l i c y A c t
( N G P A)y
t h e e f f e c t of c e r t a i n g a s c o n t r a c t p r o v i s i o n s , a n d the g as
price and supply outlook under several policy options.
a r e e s p e c i a l l y p l e a s e d to d i s c u s s t h e s e m a t t e r s w i t h y o u
in Iowa, w h e r e w e k n o w t h e s u b j e c t o f c u r r e n t g a s p o l i c y
h a s b e e n a f o c u s o f s p e c i a l e m p h a s i s a n d conce r n .
NGSA Position
To b e g i n , t h e N G S A a d v o c a t e s d e r e g u l a t i o n o f a l l
n a t u r a l g a s p r i c e s at t h e w e l l h e a d b y a d a t e c e r t a i n ,
n o t l a t e r t h a n t h e J a n u a r y 1, 1 9 8 5 d a t e for p a r t i a l
d e r e g u l a t i o n c o n t a i n e d in t h e N a t u r a l G a s P o l i c y Act .
We believe that a free natural gas wellhead m arket will
most efficiently ma t c h future gas supplies with demand
a t r e a s o n a b l e p r i c e s to c o n s u m e r s .
A comprehensive
solution will doubtless address other aspects of the
g a s issue, b u t t o t a l w e l l h e a d p r i c e d e r e g u l a t i o n m u s t
be ach i e v e d at the earliest possible date to pr e v e n t
We
26
regulation-induced distortions, which adversely affect
b o t h c o n s u m e r s a n d p r o d u c e r s of n a t u r a l gas.
Current Gas Policy
S i n c e 1978 n a t u r a l g a s p r i c i n g p o l i c y h a s b e e n
set b y t h e N a t u r a l G a s P o l i c y Act, p a r t o f t h e C a r t e r
A d m i n i s t r a t i o n ' s N a t i o n a l E n e r g y Act.
NGPA provides
for t he d e r e g u l a t i o n of r o u g h l y 50% of the n a t i o n ' s
n a t u r a l g a s s u p p l y on J a n u a r y 1, 1985, c o n t i n u e s
forever price controls on "old”natural gas previously
r e g u l a t e d u n d e r the N a t u r a l G a s Act, a n d a l l o w s
i n c e n t i v e p r i c i n g t r e a t m e n t for c e r t a i n h i g h - c o s t
n a t u r a l g a s s u p p lies, s u b j e c t t o F e d e r a l E n e r g y
Regulatory Commission
(FERC) d i s c r e t i o n .
NGPA contains
m o r e t h a n 28 p r i c i n g c a t e g o r i e s f o r n a t u r a l g a s
o t h e r w i s e i n d i s t i n g u i s h a b l e in q u a l i t y or a n y o t h e r
aspect.
S u p p o r t e r s of N G P A b e l i e v e d that, in s p ite of
its o b v i o u s c o m p l e x i t y , s u c h a " f i n e - t u n i n g " o f g a s
p r i c e s c o u l d s t i m u l a t e n e w g a s s u p p l i e s at l e s s c o s t
t h a n a m a r k e t - b a s e d p r i c i n g system.
E x p e r i e n c e u n d e r N G P A d e m o n s t r a t e s t h a t it is
no t w o r k i n g .
P ricing significant quantities of old
natural gas bel ow market has discouraged further
investment from previously-discovered reservoirs, from
w h ic h more qas w ould be produced at relatively reasonable
c o s t s to consumers.
Equally important, b el ow market p r i c i n g
27
of old gas has e ncouraged the purchase of additional
s u p p l i e s o f n a t u r a l g a s a t a b o v e m a r k e t - c l e a r i n g l e vels.
N G P A E n c o u r a g e s t he P u r c h a s e of Expensive. G a s
R e g u l a t i o n o f the d o m e s t i c n a t u r a l g a s m a r k e t c r e a t e s
irrational economic incentives.
Pricing significant quantities
of n a t u r a l g a s b e l o w m a r k e t e n c o u r a g e s the p u r c h a s e of n e w
s u p p l i e s at p r i c e s h i g h e r t h a n m a r k e t c l e a r i n g l e v e l s «
To
the e x t e n t t h a t a p i p e l i n e h a s a l a r g e i n v e n t o r y o f l o w
priced regulated gas
(e.g., a l a r g e g a s c u s h i o n ) , a p i p e l i n e
ca n p u r c h a s e u n e c o n o m i c h i g h c o s t s u p p l y i n c r e m e n t s s uch as
LNG, s y n t h e t i c gas, i m p o r t e d g a s a n d h i g h - p r i c e d d e c o n t r o l l e d
g a s b e c a u s e p r i c e r e g u l a t i o n u n d e r t he N G P A a f f o r d s a n
incentive to roll-in high cost gas supplies with low cost
r e g u l a t e d supp l i e s .
E v e n in a w i d e l y r e c o g n i z e d a t m o s p h e r e
of e x c e s s g a s d e l i v e r ability., a n d the a v a i l a b i l i t y o f l o w e r
c o s t d o m e s t i c sup p l i e s , some p i p e l i n e s w i t h a l a r g e c u s h i o n
c o n t i n u e to p u r c h a s e a b o v e m a r k e t f o r e i g n g a s r e f l e c t i n g
t he f a c t t h a t the N G P A c o n t i n u e s to p r o v i d e s u c h p i p e l i n e s
w i t h e r roneous signals wh i c h distort market realities.
C o n s u m e r s do n o t b e n e f i t w h e n n a t u r a l g a s p r i c e s a r e k e p t
artificially low by the N G P A when the benefit of l o w
regulated prices
m e r e l y a l l o w a p i p e l i n e to r o l l - i n h i g h
c o s t s u pplies.
Imports Are An Important Example
T h e f a c t t h a t p i p e l i n e s a r e a b l e to a v e r a g e in
hig h cost gas purchases w i t h the low cost regulated
supplies helps explain the continued purchase of imported
28
n a t u r a l g a s a t p r i c e s t w i c e t h a t of the a v e r a g e d o m e s t i c
w e l l h e a d price.
In S e p t e m b e r , 1982 the a v e r a g e d o m e s t i c
p r i c e at t h e w e l l h e a d w a s $ 2.53 p e r Mcf.
A t t he same t i m e
C a n a d i a n g a s s o l d for $ 4 . 9 4 / M M B T U at t h e b o r d e r , M e x i c a n g a s
w a s s e l l i n g at $ 5 . 0 1 / M M B T U at the M e x i c a n b o r d e r , a n d
Al gerian LNG contracts contained a landed purchase price
of $7.16 p e r MMBtu.
It is v e r y d o u b t f u l t h a t g a s w o u l d
be m a r k e t a b l e at t h e s e p r i c e s in a b s e n c e of t h e p r i c e
"c u s h i o n " p r o v i d e d b y a r t i f i c i a l l y l o w p r i c e c e i l i n g s o n
ol d g a s pri c e s .
C o n s u m e r s are w o r s e off to t h e e x t e n t
t h a t d o m e s t i c g as m i g h t h a v e b e e n p r o d u c e d
and
p u r c h a s e d - at p r i c e s l o w e r t h a n t h o s e for i m p o r t e d gas.
C o n s u m e r s h a v e e v e r y r i g h t t o q u e s t i o n t h e w i s d o m of
t r a d i n g - o f f r e l a t i v e l y c h e a p e r d o m e s t i c g a s for h i g h e r p r i c e d imports.
F u r t h e r , q u e s t i o n s of f o r e i g n p o l i c y q u i t e
o f t e n b e c o m e i n v o l v e d in a n y d i s c u s s i o n o f i m p o r t e d gas
c o n t r a c t t e rms, m a k i n g it d i f f i c u l t to o b t a i n a n y t y p e of
relief.
In fact, in m i d - w i n t e r 1980 t h e C a n a d i a n g o v e r n m e n t
e x a c t e d a 70% p r i c e i n c r e a s e for its g a s e x p o r t s t o t h e
U n i t e d S t a t e s , at a t i m e w h e n t h e U.S. s u p p l y p o s t u r e a n d
s e a s o n m a d e it i m p o s s i b l e to r e s i s t s u c h a - d e m a n d .
When the
U.S. c a p i t u l a t e d t o t h e C a n a d i a n s , t he M e x i c a n g o v e r n m e n t
i n f o r m e d u s t h a t it, too, w a n t e d t he same p r i c e f o r its
g a s e x p o r t s , in s p i t e o f t he f a c t t h a t t h o s e c o n t r a c t s h a d
b e e n c o n c l u d e d o n l y s h o r t l y before, a f t e r y e a r s o f a c r i m o n i o u s
negotiations.
The Canadian government's recent refusals to
c o n s i d e r a n y r e d u c t i o n in its e s t a b l i s h e d g a s p r i c e t o
r e f l e c t c h a n g e d m a r k e t c o n d i t i o n s is j u st t h e l a t e s t
29
e x a m p l e of t he p r o b l e m s w h i c h a r i s e w h e n t h e n a t i o n b e c o m e s
d e p e n d e n t o n i m p o r t e d g a s supplies.
Impact of Natural Gas Imports from Canada on Iowa and
The Midwest
O v e r the f i r s t t h r e e q u a r t e r s of 1982 d o m e s t i c n a t u r a l
g as c o n s u m p t i o n in the M i d w e s t h a s d e c r e a s e d 27%.
gas imports from Canada have increased,
However,
and have now
b e q u n to flow t h r o u g h the rece n t l y c o m p l e t e d p r e - b u i l d
section of the A l a s k a Nat u r a l Gas T r a n s m i s s i o n system,
bringinq additional economic pressure on domestic
producers and consumers.
T r a d i t i o n a l m a r k e t s for C a n a d i a n g as h a v e b e e n in
t he N o r t h w e s t .
However,
i n c r e a s i n g a m o u n t s of
C a n a d i a n g a s are p l a n n e d for m a r k e t i n g in the
M idwest.
A c c o r d i n g to t h e A m e r i c a n G a s A s s o c i a t i o n ,
C a n a d i a n G a s I m p o r t P r o j e c t s s e r v i n g the M i d w e s t a m o u n t e d
to 2 3 7 . 5 B c f in 1981
(see a t t a c h m e n t " A " ) .
Currently, s i g n i f i c a n t p o r t i o n s of t h e M i d w e s t g a s
m a r k e t a r e n o w b e i n g s e r v e d b y C a n a d i a n gas.
Canadian Gas Imports
A s a P e r c e n t of T o t a l
______ U t i l i t y S a l e s
State
21-496
0
Io w a
5 - 10%
Illinois
5 - 10%
Minnesota
10 - 25%
Michigan
10 - 25%
Wisconsin
10 - 25%
83
3
30
T h e i n c r e a s i n g v o l u m e s o f C a n a d i a n g a s e n t e r i n g the
M i d w e s t a n d Iowa w i l l c a u s e a d r a m a t i c r i s e in imports'
s h a r e o f p u r c h a s e d g a s c o s t s to p i p e l i n e s .
Northern Natural
G a s C o m p a n y , t h e m a j o r p i p e l i n e s u p p l i e r in Iowa, p r o v i d i n g
o v e r a t h i r d of the s t a t e ' s n a t u r a l g a s r e q u i r e m e n t s , w i l l
e x p e r i e n c e r i s i n g g a s c o s t s a t t r i b u t a b l e in l a r g e d e g r e e to
its C a n a d i a n g a s p u r c h a s e s
(see a t t a c h m e n t s "A" a n d "B")
In p u r c h a s e d g a s a d j u s t m e n t s f i l e d o v e r a 1 2 - m o n t h
period, North e r n Natural Gas Company showed a pl a n n e d
i n c r e a s e o f 64% for C a n a d i a n g a s cost.
filing
T h e liatest P G A
(January 1, 1983) for p r o s p e c t i v e g a s c o s t s i n d i c a t e s
t h a t C a n a d i a n g a s w i l l a c c o u n t for o v e r 30% o f N o r t h e r n
N a t u r a l ' s t o t a l g a s c osts.
approval,
If o n e a d d s p r o j e c t s n o w p e n d i n g
Iowa and other M idwestern states may be importing
up to 1 0 0 % m o r e C a n a d i a n g a s b y t h e e n d of 1984 t h a n in 1981.
C o m p a r e d w i t h s i m i l a r 1981 figur es , U.S. g a s i m p o r t s
r o s e 7% in the f i r s t t h r e e q u a r t e r s of 1982, a c c o r d i n g
to E n e r g y I n f o r m a t i o n A d m i n i s t r a t i o n f i g ures, w h i l e d o m e s t i c
p r o d u c t i o n o f g a s d e c l i n e d 7% in t h e sam e p e r i o d .
Until
all m a r k e t sect o r s , b o t h d o m e s t i c a n d for e i g n , a r e in
c o m p e t i t i o n w i t h e a c h o t h e r a n d w i t h a l t e r n a t e fuels, t h e r e
is n o b a s i s a n d n o i n c e n t i v e for C a n a d a to m o d i f y its e x p o r t
pricing mechanism.
N G P A ' s s u b s i d y of g a s i m p o r t s m a k e s no
e c o n o m i c sense, a n d it c o s t s A m e r i c a n g a s c o n s u m e r s
c o n s i d e r a b l e m o n e y in u n n e c e s s a r y c osts.
31
N G P A H a s F a i l e d to Spu r P r o d u c t i o n
The N G P A h a s a l s o f a i l e d to s t i m u l a t e d o m e s t i c n a t u r a l
g a s p r o d u c t i o n a d e q u a t e t o m e e t o u r n e e d s in t h e y e a r s a h ead.
O v e r t he p a s t d e c a d e a d d i t i o n s t o U.S. r e s e r v e s s h o w t h a t
w e h a v e p r o d u c e d f r o m i n v e n t o r y r o u g h l y 1.6 t i m e s m o r e
gas than we have discovered.
Natural gas pipelines and the Federal Energy Regulatory
C ommission have repeatedly expressed concern over the rapid
d e p l e t i o n of l o n g - t e r m g a s i n v e n t o r i e s .
Current pricing
p o l i c y h a s p r o v e d i n a d e q u a t e to g u a r a n t e e t h a t s u f f i c i e n t
d o m e s t i c gas s u p p l i e s w i l l be a v a i l a b l e in t h i s d e c a d e a n d
n e x t to m e e t t h e n e e d s of a r e s t o r e d a n d e x p a n d i n g eco n o m y .
M u c h G as R e m a i n s T o Be F o u n d
T h e p r o b l e m d o e s n o t lie w i t h t h e size o f t h e r e s o u r c e
base;
both the United States Geological Survey
(USGS) a nd
the P o t e n t i a l G a s C o m m i t t e e e s t i m a t e t h a t w e h a v e n e a r l y a
5 0 - y e a r s u p p l y of c o n v e n t i o n a l g a s w h i c h c a n b e t a p p e d
u n d e r a p p r o p r i a t e n a t u r a l g a s p r i c i n g policy.
B u t N G PA,
by c o n tinuing low price ceilings on m uch o £ our domestic
supply, h a s a c t u a l l y r e d u c e d the r a t e of i n c r e a s e in gas
w e l l d r i l l i n g f r o m 20% i m m e d i a t e l y b e f o r e its p a s s a g e to
o n l y 11% in t he t h r e e y e a r s f o l l o w i n g its e n a c t m e n t .
1981
a d d i t i o n s to r e s e r v e s e x c e e d e d g a s p r o d u c t i o n o n l y b e c a u s e
o f r e v i s i o n s a n d c o r r e c t i o n s in p u b l i s h e d e s t i m a t e s for
p rior years.
This statistical correction does not
i n d i c a t e t h a t t h e l o n g - t e r m d o w n w a r d t r e n d in r e s e r v e s
adds has been reversed.
32
NGPA Causes Market Disorder
M a r k e t - o r d e r i n g p r o b l e m s a l s o a r i s e f r o m the i m p a c t of
NGPA
u p o n t he h i s t o r i c a l d i s t r i b u t i o n of l o w - p r i c e d g a s a m o n g
i n t e r s t a t e p i p e l i n e s a n d b e t w e e n the i n t e r s t a t e a n d i n t r a s t a t e
p i p e l i n e systems.
In fact, t he v i n t a g e p r i c e s y s t e m
e s t a b l i s h e d o r i g i n a l l y b y the F e d e r a l P o w e r C o m m i s s i o n , a n d
v a s t l y e x p a n d e d b y the m a n y N G P A p r i c i n g c a t e g o r i e s , r e s u l t s
in f a v o r e d t y p e s o f c o n s u m e r s w h o are s u b s i d i z e d at t he
e x p e n s e of o t h e r c o n s u m e r groups; f a v o r e d p i p e l i n e s w h o s e
w e i g h t e d a v e r a g e c o s t of g a s is l ess t h a n half, t h a t of o t h e r
p i p e l i n e s ; a n d f a v o r e d p r o d u c e r s w h o r e c e i v e u p to t w e n t y
t i m e s m o r e for t h e i r g a s t h a n do o t h e r p r o d u c e r s .
Congress,
th e F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n , a n d m a n y p r i v a t e
g r o u p s h a v e s t u d i e d th e v a r i o u s m a n i f e s t a t i o n s of t h i s
m arket disorder phenomenon.
T h e r e is g e n e r a l a g r e e m e n t
t h a t m a r k e t d i s o r d e r e n s u r e s t h a t a n y d o m e s t i c b e n e f i t s of
c o n t i n u e d g as p r i c e r e g u l a t i o n w i l l b e u n e v e n l y d i s t r i b u t e d
a m o n g n a t u r a l g a s c o n s u m e r s whi l e , as p r e v i o u s l y d e m o n s t r a t e d ,
o t h e r b e n e f i t s w i l l b e c a p t u r e d b y f o r e i g n gas p r o d u c e r s .
In short, N G P A - i m p o s e d p r i c e c o n t r o l s h a v e g r e a t l y c o m p l i c a t e d
ou r d o m e s t i c g a s m a r k e t s w h i l e g a i n i n g little, if a n y t h i n g ,
fo r t h e a v e r a g e c o n s u m e r .
T h e D i s t o r t i o n s o f N G P A a n d Its I m p a c t o n A g r i c u l t u r e
A g r i c u l t u r a l p r o d u c t i o n is a f f e c t e d b o t h d i r e c t l y a n d
i n d i r e c t l y b y c h a n g e in n a t u r a l g a s p r i c e .
It is u s e d a s a
d i r e c t i n p u t in f a r m o p e r a t i o n s s u c h a s i r r i g a t i o n a n d c r o p
33
d r y i n g a n d i n d i r e c t l y it is a m a j o r input in t h e p r o d u c t i o n of
fertilizers
( e s p e c ia ll y amm o ni a, an i m p o r t a n t i n g r e d i e n t in
the p r o d u c t i o n of n i t r o g e n o u s f e rtilizers)
T he d i s t o r t i o n s p r e v i o u s l y m e n t i o n e d b e t w e e n the i n t e r
s ta t e a n d i n t r a s t a t e m a r k e t s w i l l h a v e a seve r e i m p a c t o n the
a g r i c u l t u r a l sector.
The c o n t i n u a t i o n of c u r r e n t p o l i c y u n d e r the N G P A m a y
c r e a t e a p a r t i c u l a r l y d i f f i c u l t g a s - s u p p l y s i t u a t i o n for
the a m m o n i a - p r o d u c i n g industry.
D u r i n g the e a r l y a n d m i d d l e
1970's, a m m o n i a p r o d u c e r s t e n d e d to l o c a t e on i n t r a s t a t e
pipelines
(in Texas, O k l a h o m a a n d L o u i s i a n a ) b e c a u s e of
g r e a t e r s e c u r i t y of supply.
C u r r e n t l y a b o u t 55-60 p e r c e n t of
a m m o n i a p r o d u c t i o n c a p a c i t y u s e s i n t r a s t a t e gas.
If i n v e n t o r i e s of n a t u r a l g a s c o n t i n u e to fall, c o n s u m p t i o n
o f n a t u r a l g a s w i l l be m a i n l y d e s i g n a t e d to h i g h - p r i o r i t y
r e s i d e n t i a l a n d c o m m e r c i a l use.
additions
If n o n - a s s o c i a t e d r e s e r v e
(those c o n n e c t e d w i t h d r i l l i n g for g a s only) c o n t i n u e
to d e c l i n e a l o n g w i t h t he r a t e of i n c r e a s e d g a s w e l l c o m p l e t i o n s ,
t h e l i k e l i h o o d o f g e n e r a l s h o r t a g e s is g r e a t e r for a m m o n i a
p r o d u c e r s t h a n f or o t h e r i n d u s t r i e s d u e , t o t h e i r i n t e n s i v e
c o n s u m p t i o n o f n a t u r a l g a s in i n t r a s t a t e m a r k e t s .
The
Natural Gas Policy Act has turned the advantage most gas
c o n s u m e r s in t h e i n t r a s t a t e m a r k e t e n j o y e d into t h e p o s s i b i l i t y
of those states bec o m i n g gas deficient.
34
The r e c e n t t r e n d is i l l u s t r a t e d b y the 1980 E I A r e s e r v e
study, w h i c h f o u n d i n t r a s t a t e m a r k e t c o n t r a c t c o m m i t m e n t s
o n l y 29 p e r c e n t of t o t a l c o m m i t m e n t s .
H i s t o r i c a l l y , the
i n t r a s t a t e m a r k e t h a s a c c o u n t e d for a b o u t 40 p e r c e n t of
t o t a l U.S. n a t u r a l g a s c o n s u m p t i o n .
W i t h i n the a m m o n i a - p r o d u c i n g i n d u stry, d e r e g u l a t i o n
w o u l d be l i k e l y to c h a n g e the r e l a t i v e c o m p e t i t i v e p o s i t i o n s
of p r o d u c e r s s e r v e d b y i n t r a s t a t e as c o m p a r e d to i n t e r s t a t e
pipelines.
U n d e r c u r r e n t p o l i c y , a f t e r 1985 t he i n t e r s t a t e
p i p e l i n e s w i l l h a v e l a r g e r a m o u n t s of p r e v i o u s l y c o n t r a c t e d ,
r e l a t i v e l y l o w - p r i c e gas, a n d so w i l l b e a b l e to c o m p e t e
a g g r e s s i v e l y for n e w g a s s u p p l i e s a n d r o l l in h i g h e r c o s t
n e w s u p p l i e s w i t h l o w p r i c e d " c u s h i o n " gas.
Thus, t he i n t e r
state lines could offer both better terms and better guarantees
of s u p p l i e s t h a n t he i n t r a s t a t e lines.
T h i s w o u l d p l a c e the
a m m o n i a p r o d u c e r s o n i n t r a s t a t e l i n e s at a c o m p e t i t i v e
d i s a d v a n t a g e , t h e r e b y n e g a t i v e l y a f f e c t i n g r e g i o n s of t h e
c o u n t r y w i t h l a r g e f e r t i l i z e r needs.
In g e n e r a l m o s t e x p e n d i t u r e s for n a t u r a l g a s d i r e c t
f a r m i n g a p p l i c a t i o n s o c c u r s in the W e s t S o u t h C e n t r a l
r e g i o n , p r i m a r i l y in the i n t r a s t a t e g a s market.
This
r e g i o n of the c o u n t r y / w h i c h i n c l u d e s L o u i s i a n a , Tex a s ,
Oklahoma, and Arkansas,
spent a p p r o x i m a t e l y $95.1 m i l l i o n
d o l l a r s for n a t u r a l gas, 40 p e r c e n t o f t o t a l U.S. g a s u s a g e *
35
w i t h T e x a s a l o n e s p e n d i n g $82.3 m i l l i o n for gas.
M o s t of t h e s e
c o s t s w e r e for fue l u s e d in i r r i g a t i o n , w h i c h a c c o u n t s for
96 p e r c e n t of t he n a t i o n ' s a g r i c u l t u r a l g a s use.
P r e l i m i n a r y f i n d i n g s of a stu d y b e i n g c o n d u c t e d for
the N a t u r a l G a s S u p p l y A s s o c i a t i o n
H e a d y a n d Dr,
(NGSA) b y Dr.
E a r l 0.
B u r t o n E n g l i s h at the C e n t e r for A g r i c u l t u r a l
a n d R u r a l D e v e l o p m e n t in Ames, Iowa, i n d i c a t e s t h a t I owa
f a r m e r s r e p o r t e d s p e n d i n g 1% o f the n a t i o n ' s g a s c o s t s for
agriculture.
T h i s w a s p r i m a r i l y spe n t for c r o p drying.
T h e r e f o r e , n a t u r a l g a s p r i c e i n c r e a s e s are n ot l i k e l y to
h a v e an i m p a c t o n I o w a ' s f a r m sector.
S u b s t i t u t e s for
n a t u r a l g a s use in c r o p d r y i n g e x ist, s uch as LPG,
so Iowa
f a r m e r s c o u l d c o n v e r t to a n a l t e r n a t i v e fuel for d r y i n g if
the n e e d arose.
Phased Decontrol
Is T h e B e s t S o l u t i o n
The s o l u t i o n to c u r r e n t p r o b l e m s l i e s in e x t e n d i n g the
d e c o n t r o l c o n c e p t to the p r e - 1 9 8 5 p e r i o d , a n d i n c l u d i n g o l d
ga s a m o n g t h a t w h i c h is g r a d u a l l y deregulated*.
A phased
d e c o n t r o l of a ll n a t u r a l g a s w i l l e l i m i n a t e m a r k e t d i s o r d e r
an d o t h e r e c o n o m i c d i s t o r t i o n s c a u s e d b y t h e u n e v e n
d i s t r i b u t i o n of s u b s i d i z e d o l d g a s supplies.
P h a s i n g - u p o l d gas p r i c e s to m a r k e t l e v e l s e l i m i n a t e s
t he g r o s s d i s p a r i t i e s in a v e r a g e c o s t s a m o n g i n t e r s t a t e
36
p i p e l i n e s a n d b e t w e e n the i n t e r s t a t e a n d i n t r a s t a t e n a t u r a l
g a s t r a n s m i s s i o n systems.
A s o l d g a s p r i c e s i n c r ease,
p i p e l i n e s w h i c h h a v e g a i n e d t he a d v a n t a g e s o f an o l d g a s
" c u s h i o n " t h r o u g h h i s t o r i c a l a c c i d e n t w i l l n o l o n g e r be
ab l e to b i d a b o v e m a r k e t - c l e a r i n g p r i c e s for n e w g as
supplies
(in c l u d i n g i m p o r t s ) .
In t h i s e n v i r o n m e n t a n y
above market-clearing prices actually paid would inhibit
a p i p e l i n e ' s a b i l i t y to c o m p e t e w i t h a l t e r n a t i v e fuels.
Therefore, pha s e d decontrol will over time eliminate policyi n d u c e d d i s t o r t i o n s in t h e c o m p e t i t i o n for n e w g a s s u p p lies.
It w i l l a l s o p r o v i d e a s m o o t h t r a n s i t i o n to t he c o m p l e t e l y
d e r e g u l a t e d m a r k e t a f t e r J a n u a r y 1, 1985, a n d e l i c i t
a d d i t i o n a l g a s p r o d u c t i o n a s an a d d e d di vi de n d.
A F r e e M a r k e t In G a s W i l l B e n e f i t C o n s u m e r s
A n o t h e r i m p o r t a n t b e n e f i t of d e c o n t r o l m e r i t s s e r i o u s
attention.
T h e n a t u r a l g a s m a r k e t h a s c h a n g e d g r e a t l y in
t h e l a s t year, d u e t o d e c l i n i n g r e a l w o r l d o i l p r i c e s a n d
t h e e c o n o m i c d o w n t u r n in t h i s c o u n t r y .
Gas consumers have
c o m p l a i n e d that p r ices continue to increase*despite a c urrent
gas surplus and decli n i n g competing fuel prices.
They
s u g g e s t t h a t the m a r k e t s h o u l d a d j u s t g a s p r i c e s d o w n w a r d
t o c o m p e n s a t e for t h e i n c r e a s e d s u p p l y a n d l e s s d e m a n d .
B u t w e d o n o t h a v e a f r e e m a r k e t f o r n a t u r a l gas; p r i c e s a r e
e s t a b l i s h e d a c c o r d i n g t o a f o r m u l a se t b a c k in 1978 d u r i n g
c onference committee d e l i b e rations o ver the NGPA.
The conferees
37
w e r e u n a b l e to f o r e s e e the fall o f the Shah, an i n i t i a l
r i s e in o i l p r i c e s , the I r a n - I r a q War, an e c o n o m i c
downturn,
a n d a s u b s e q u e n t fal l in the r e a l w o r l d
o i l p r i c e a n d in the p r i c e of a l t e r n a t i v e fuels.
in n a t u r a l g a s at t he w e l l h e a d w o u l d
A f ree m a r k e t
have corrected
a n d a d j u s t e d n a t u r a l g a s p r i c e s to t a k e into a c c o u n t
e v e n t s just m e n t i o n e d .
faul t e d ,
the
If the f r a m e r s of the N G P A a r e t o be
it is n o t for f a i l i n g to be o m n i s c i e n t , b u t for
b e l i e v i n g t h a t a n y r i g i d s t a t u t o r y s y s t e m of p r i c e c o n t r o l s
c o u l d i m p r o v e u p o n t he w o r k i n g s of a fre e w e l l h e a d m a r k e t
for g a s supp l i e s , a n a l t e r n a t i v e w h i c h the c o n f e r e e s c o n s i d e r e d
but rejected.
Some gas distribution companies and pipelines have
testified before Congress and federal agencies that lower
a l t e r n a t i v e f uel p r i c e s , e s p e c i a l l y t h o s e for #6 r e s i d u a l
oil, h a v e c o m b i n e d w i t h h i g h e r g a s p r i c e s m a n d a t e d b y the
N G P A to r e d u c e or e l i m i n a t e g a s s a l e s to i n d u s t r i a l cons u m e r s .
It is d i f f i c u l t to a p p o r t i o n b l a m e for a n y l o a d l o s s b e t w e e n
the d e c l i n i n g o i l p r i c e a n d t he e c o n o m i c r e c e s s i o n .
B u t in
e i t h e r c a s e t h e e n d r e s u l t is t h a t c u s t o m e r s r e m a i n i n g o n t he
s y s t e m f a c e h i g h e r c o s t s as t h e p i p e l i n e a n d d i s t r i b u t i o n
c o m p a n i e s ' f i x e d c h a r g e s a re a p p o r t i o n e d a m o n g a s m a l l e r
number of gas customers.
38
Other Reasons Why Gas Prices Are Increasing
T h e r e a re s e v e r a l a n s w e r s to c o n s u m e r s ' q u e s t i o n s as
t o w h y n a t u r a l g a s p r i c e s are p e r c e i v e d to be i n c r e a s i n g a t
t h i s time.
F i r s t is t h e c u s t o m e r s h r i n k a g e a n d the
r e a p p o r t i o n m e n t of f i x e d c o s t s p h e n o m e n o n just d e s c r i b e d .
In fact, the c o s t s o f g a s t r a n s m i s s i o n a n d d i s t r i b u t i o n
h a v e b e e n risi n g, a n d a c c o u n t for m o r e t h a n o n e - h a l f o f t h e
a v e r a g e r e s i d e n t i a l c o n s u m e r ' s bill,
A n o t h e r r e a s o n f o r h i g h e r c o s t s is the n p r m a l
d e p l e t i o n factor, a s old, l o w - p r i c e d r e s e r v e s a r e e x h a u s t e d
a n d r e p l a c e d b y g a s f r o m new, h i g h e r c o s t reser v e s .
About
t e n p e r c e n t o f t he n a t i o n ' s g a s s u p p l y is d e p l e t e d a n d r e p l a c e d
in t h i s f a s h i o n o v e r an a v e r a g e y e a r l y p e r i o d .
A third factor
is t h e i n c r e a s i n g U.S. r e l i a n c e u p o n i m p o r t e d g a s s u p p l i e s
which, as explained above, constitute a high-priced component
o f t h e n a t i o n ' s n a t u r a l g a s mix.
P r i c e s f o r n a t u r a l gas at t h e w e l l h e a d d o i n c r e a s e u n d e r
N G P A , b u t t h i s f a c t o r c o n t r i b u t e s to c u r r e n t p r o b l e m s t o a
m i n o r extent.
N G P A c o n t i n u e s to p r i c e m o s t n a t u r a l g a s at
b e l o w a p p a r e n t m a r k e t - c l e a r i n g l e vels, a n d l i m i t s m o s t
p r i c e e s c a l a t i o n s to t h e y e a r l y i n f l a t i o n level.
Insofar
as t h e N G P A r a i s e s g a s p r i c e s a b o v e t h o s e f o r m e r l y p e r m i t t e d
b y t h e FPC, w e m u s t r e m e m b e r t h a t p r e v i o u s l o w p r i c e s
r e s u l t e d in w i d e s p r e a d ^ a s s h o r t a g e s d u r i n g the 1 9 7 0 's.
C o n g r e s s d e t e r m i n e d t h a t it w a s in th e n a t i o n a l i n t e r e s t
t o r a i s e g a s p r i c e s a b o v e t h o s e l e v e l s in o r d e r to
39
e n s u r e a d e q u a t e s u p p l i e s for f u t u r e use.
Of cour s e , to
the e x t e n t t h a t a n y c u r r e n t n e w g a s p r i c e s do n o t r e f l e c t
c u r r e n t m a r k e t c o n d i t i o n s , d e r e g u l a t i o n of all g a s w i l l
r e l i e v e t h i s situation.
We have already indicated that
a b o v e m a r k e t c l e a r i n g p r i c e s p a i d f or some gas, e s p e c i a l l y
i mports,
s h o u l d d e c l i n e in r e s p o n s e to decontrol,
Such
market discipline benefits both consumers and gas p r o ducers
in a s s u r i n g c o n t i n u e d g a s m a r k e t a b i l i t y at r e a s o n a b l e
prices.
I n t e r e s t i n g l y , the o n l y p r i c e s p e r c e i v e d b y some t o b e
a b o v e m a r k e t c l e a r i n g l e v e l s w h i c h h a v e r e a c t e d to c u r r e n t
m a r k e t c o n d i t i o n s are t h o s e p a i d for "deep" n a t u r a l gas.
D e r e g u l a t e d d e e p g a s p r i c e s h a d r i s e n to l e v e l s of $ 1 0. 00 p e r
Mcf, l e a d i n g s e v e r a l p i p e l i n e s to t r i g g e r " m a r k e t - o u t "
c l a u s es , w h i c h e i t h e r r e d u c e t he p r i c e of t h i s g a s or e l i m i n a t e
it f r o m the p i p e l i n e s u p p l y mix.
T he r e c e n t a v e r a g e d e e p g a s
p r i c e w a s $7. 5 3 p e r Mcf, a n d the t r e n d is t o w a r d s a f u r t h e r
d e c l i n e in t h a t figure.
An Admi n i s t r a t i o n Deregulation Initiative Will Have Our Support
W e h a v e e x p l a i n e d at l e n g t h w h y d e r e g u l a t i o n of a l l n a t u r a l
gas at t he w e l l h e a d r e p r e s e n t s a s u p e r i o r p o l i c y a l t e r n a t i v e .
N G S A h o p e s t h a t the R e a g a n A d m i n i s t r a t i o n w i l l s o o n a n n o u n c e
its s u p p o r t for a g a s d e r e g u l a t i o n i n i t i a t i v e d u r i n g t he 9 8 t h
Congress.
P a s s a g e of a c o m p r e h e n s i v e d e c o n t r o l p a c k a g e w i l l
provide needed relief from gas market and price distortions
c a u s e d b y n e a r l y t h i r t y y e a r s of f e d e r a l i n t e r v e n t i o n in t h i s
area,
W e a p p r e c i a t e the P r e s i d e n t ' s p a s t s t a t e m e n t s in
40
s u p p o r t of n a t u r a l ga s decontrol,
H i s a s s i s t a n c e in g a i n i n g
C o n g r e s s i o n a l a p p r o v a l of a d e c o n t r o l p r o p o s a l w i l l be v i t a l
to t h e s u c c e s s of t h a t effort.
P i e c e m e a l P r o p o s a l s W o u l d Be I n e f f e c t i v e or C o u n t e r p r o d u c t i v e
Unfortunately, while decontrol represents the only
a p p r o p r i a t e p o l i c y s o l u tion, C o n g r e s s i o n a l a n d p u b l i c c o n c e r n
ha s l e d to t he c o n s i d e r a t i o n of o t h e r p r o p o s a l s w h i c h w e
believe counterproductive.
T h e s e fal l into t h r e e g e n e r a l
areas: p r i c e freezes, d i r e c t e d c o n t r a c t a b r o g a t i o n , a n d
i n d i r e c t a d m i n i s t r a t i v e r e g u lation.
We will briefly discuss
e a c h a p p r o a ch .
Gas Price Freeze Legislation
A l t h o u g h g a s p r i c e f r e e z e p r o p o s a l s r e p r e s e n t an e f f o r t
t o h o l d d o w n c o n s u m e r p r i c e increa s e s , t h e y w o u l d h a v e n o
e f f e c t o n m o s t f a c t o r s w h i c h h a v e c a u s e d an i n c r e a s e in g a s
p r i c e s t o c o n s u m e r s , for s e v e r a l reasons.
A w e l l h e a d p r i c e fr e e z e w o u l d h a v e no i m p a c t u p o n
ma n y of the pre v i o u s l y m e ntioned factors which account for
r e c e n t i n c r e a s e s in r e s i d e n t i a l g a s p r i c e s .
First, a price
freeze would not even touch a major portion of a
r e s i d e n t i a l c o n s u m e r ' s n a t u r a l g a s bill.
DOE reports
t h a t o f t h e a v e r a g e S e p t e m b e r , 1982 r e s i d e n t i a l g a s b i l l
o f $5.60, o n l y $2.53, o r 4 5 % , r e p r e s e n t s the c o s t o f g a s
i t s e l f a t the w e l l h e a d , w h i c h w o u l d b e a f f e c t e d b y a g a s
41
p r i c e freeze.
O v e r o n e - h a l f o f the r e s i d e n t i a l g a s b i l l
c o n s i s t s of t r a n s m i s s i o n a n d d i s t r i b u t i o n char g e s , w h i c h
h a v e a l s o i n c r e a s e d a n d w h i c h w o u l d be u n a f f e c t e d b y a p r i c e
freeze requirement.
If p r i c e f r e e z e l e g i s l a t i o n w e r e
e n a c t e d , the r e s u l t i n g d e p r e s s a n t e f f e c t u p o n n a t u r a l gas
production would actually increase gas prices to consumers
as s h o r t a g e s d e v e l o p e d a n d c u r r e n t g a s c u s t o m e r s l e f t the
system.
S econd, p r i c e f r e e z e p r o p o s a l s do n o t liinit t he p r i c e
p a i d for i m p o r t e d n a t u r a l g as a n d LNG, an i n c r e a s i n g l y
i m p o r t a n t a n d h i g h - c o s t c o m p o n e n t of t he r e s i d e n t i a l n a t u r a l
g a s bill.
Third, a p o r t i o n of r e c e n t p r i c e i n c r e a s e s r e s u l t s f r o m
the d e p l e t i o n of o l d gas r e s e r v e s a n d the r e p l a c e m e n t of t h i s
g as w i t h new, h i g h e r - p r i c e d supplies.
A price freeze w o uld
not a l t e r t h i s n a t u r a l p r o c e s s of r e s e r v o i r d e p l e t i o n * w h i c h
a u t o m a t i c a l l y l e a d s to an i n c r e a s e in g a s prices.
F o u r t h , N G P A - m a n d a t e d i n c r e a s e s in g a s p r i c e s t h e m s e l v e s are
t he r e s u l t of a C o n g r e s s i o n a l d e t e r m i n a t i o n t h a t F P C - i m p o s e d
r a t e s p r e v i o u s t o 1978 w e r e t o o l o w a n d c o n t r a r y t o t he
n a t i o n a l int e r e s t .
H i g h e r p r i c e s w e r e a l l o w e d f or c e r t a i n
g a s t o e n c o u r a g e its p r o d u c t i o n a n d e l i m i n a t e g a s s h o r t a g e s .
And in m a n y instances gas prices remain a bargain.
According
to D O E statistics, last year domestically p r o d u c e d gas sold
at the we l l h e a d at an average cost
(on an o i l e q u i v a l e n t b asis)
42
of l e s s t h a n 3 0 < 7 gallon.
The d e l i v e r e d c o s t of n a t u r a l g a s
t o the a v e r a g e r e s i d e n c e is o n l y 2/3 t h a t of h e a t i n g oil,
a n d 1/4 t h a t of e l e c t r i c i t y , o n an e q u i v a l e n t e n e r g y c o n t e n t
b asis.
T h i s is the r e s u l t of our h a v i n g r e g u l a t e d n a t u r a l g a s
for so l o n g at l e v e l s far b e l o w its t r u e worth.
It s h o u l d
c o m e as n o s u r p r i s e that, as p e r m i t t e d b y law, t h e a v e r a g e
p r i c e of gas in the f i e l d c o n t i n u e s to increase.
Temporary
price freeze legislation would make m uch more difficult the
i n e v i t a b l e a n d n e c e s s a r y a d j u s t m e n t to t he laws of s u p p l y a n d
d emand.
P e r h a p s the m o s t s e r i o u s c o n s e q u e n c e of a p r i c e f r e e z e
w o u l d b e its i m p a c t o n i n t e r m e d i a t e a n d l o n g - t e r m s u p p l i e s
a v a i l a b l e to c o n s u m e r s 3-5 y e a r s f r o m n o w a n d a f t e r w a r d s .
C u r r e n t g a s e x p l o r a t i o n a n d d e v e l o p m e n t p r o g r a m s are b a s e d
u p o n p r i c e s set o u t in the NGPA, c o u p l e d w i t h the e x p e c t a t i o n
o f n e w g a s d e c o n t r o l in Jan u a r y , 1985.
If t h o s e e x p e c t a t i o n s
are destroyed, exploration and development programs will be
s h a r p l y r e d u c e d , w i t h o b v i o u s i m p a c t u p o n g a s sup p l i e s .
W e e x p e c t t h a t l e g i s l a t i o n o f t h e t y p e some a r e p r o p o s i n g —
a two-year we l l h e a d price freeze and a two-year delay of the
p a r t i a l d e c o n t r o l s c h e d u l e d u n d e r c u r r e n t l a w f or 1 9 8 5 — w o u l d
r e s u l t in a v e r y s i g n i f i c a n t l o s s o f d o m e s t i c a l l y - p r o d u c e d
n a t u r a l gas.
Imported oil and imported natural gas w o u l d
h a v e t o b e s u b s t i t u t e d fo r t h i s f o r e g o n e p r o d u c t i o n .
Any
t e m p o r a r y r e l i e f f o r n a t u r a l g a s c o n s u m e r s t h u s r e s u l t s in
43
i n c r e a s e d p r i c e s for c o n s u m e r s of gas, h e a t i n g oil, m o t o r
g a s o l i n e and o t h e r r e f i n e d p r o d u c t s .
Legislative Contract Abrogation
A s e c o n d g r o u p of p r o p o s a l s w o u l d a b r o g a t e or r e s t r i c t
the o p e r a t i o n of c o n t r a c t u a l p r o v i s i o n s suc h as t a k e - o r - p a y
an d p r i c e e s c a l a t o r c l a uses.
N a t u r a l Ga s S u p p l y A s s o c i a t i o n
a d d r e s s e s in d e t a i l the c u r r e n t a n d t r a d i t i o n a l i m p o r t a n c e
o f t h e s e p r o v i s i o n s o f a ga s s a le s c o n t r a c t in a t t a c h m e n t s
to m y t e s t i m o n y w h i c h s h o u l d p r o v i d e c o m m i t t e e m e m b e r s w i t h
a full e x p l a n a t i o n of o u r p o s i t i o n on t h i s i m p o r t a n t matter.
The t a k e - o r - p a y p r o v i s i o n s in n a t u r a l g a s s u p p l y c o n t r a c t s
h a s b e e n b l o w n w a y o u t of p r o p o r t i o n .
Energy Secretary Donald
H o d e l r e c e n t l y s t a t e d t h a t b a s e d o n d a t a f r o m t h e D O E staff,
t a k e - o r - p a y p r o v i s i o n s h a v e h a d n o m o r e t h a n a 4% i m p a c t o n
r e s i d e n t i a l prices.
He s t a t e d t h a t t h e t a k e - o r - p a y p r o b l e m
"is n o t a p r o b l e m o f n a t i o n a l scope b u t r a t h e r a p r o b l e m
s p e c i f i c to i n d i v i d u a l p i p e l i n e c o m p a n i e s "
F e d e r a l L a n d s , D e c e m b e r 27, 1982, p. 5).
(Inside E n e r g y / W i t h
M o r e o v e r , it s h o u l d
be r e m e m b e r e d t h a t l e n d e r s an d i n v e s t o r s h a v e a d v a n c e d b i l l i o n s
of d o l l a r s to m a j o r p r o j e c t s in r e l i a n c e o n a g r e e m e n t s
c o n t a i n i n g t a k e - o r - p a y o r m i n i m u m - b i l l cla u s e s .
Financial
i n s t i t u t i o n s h a v e r e l i e d on t h e s e p r o v i s i o n s a s c r e d i t s u p p o r t
for f u t u r e g a s p r o j e c t s a c c o r d i n g t o J a c o b W o r e n k l e i n , a p a r t n e r
in t h e N e w Y o r k C i t y l a w f i r m o f M i l l b a n k T w e e d
(Inside E n e r g y /
W i t h F e d e r a l L a n d s , O c t o b e r 11, 1982, p. 7) a n d t o J o h n R.
T o r e l l III, P r e s i d e n t o f M a n u f a c t u r e r s H a n o v e r T r u s t C o m p a n y
(BNA D a i l y R e p o r t for E x e c u t i v e s , N o v e m b e r 12, 1982, p. A - 1 6 ) .
I s h o u l d a l s o n o t e t h a t C ong. P h i l i p R. S h a r p o f I n d i a n a
44
recently requested and received responses by pipeline
companies and producers on their efforts to renegotiate
contract provisions.
In a r e p o r t b y the sta f f t o t h e
m e m b e r s of the E n e r g y a n d C o m m e r c e C o m m i t t e e d a t e d J a n u a r y
27, 1983, the s t a f f r e p o r t e d t h a t a s i g n i f i c a n t a m o u n t of
d i s c u s s i o n h a s a l r e a d y t a k e n p l a c e w i t h r e s p e c t to t a k e - o r pay obligations and that several producers have reported
t h a t t a k e - o r - p a y r e n e g o t i a t i o n s h a v e b e e n c o m p l e t e d to
r e d u c e t he t e r m s of t a k e - o r - p a y clauses.
B r i e f l y , h o w e v e r , a t a k e - o r - p a y c l a u s e g u a r a n t e e s the
p r o d u c e r a c o n t i n u i n g c a s h f l o w o v e r w h a t m a y be a r e l a t i v e l y
l o n g c o n t r a c t p e r i o d.
In r e t u r n the p i p e l i n e r e c e i v e s an
a s s u r e d s u p p l y o f g a s o v e r t h e sam e p e r i o d .
Without a take-or-
pay provision a producer has no guarantee that a pipeline will
a c t u a l l y t a k e — a n d p a y for — g as v o l u m e s w h i c h , b y c o n t r a c t , c a n
o n l y b e s o l d to t h a t p u r c h a s e r .
In short, t h e y g u a r a n t e e the
p r o d u c e r tha t he w o n ’
t be a s k e d to stor e g a s f r e e f or t h e
pip e l i n e ' s account, e l iminating his cash flow from the shut-in
g a s at u n f o r e s e e a b l e int e r v a l s .
If a p i p e l i n e p a y s for g a s w h i c h it d o e s n o t take, m o s t
c o n t r a c t s a l l o w for a f i v e - y e a r m a k e - u p p e r i o d , w h e n t h e p r e p a i d
g a s c a n b e t a k e n at l i t t l e o r n o a d d i t i o n a l c h a r g e , d e p e n d i n g
u p o n i t s m a r k e t value.
C o n s u m e r s a r e n o t c h a r g e d for p r e p a y m e n t s
u n t i l t h e g a s is a c t u a l l y d e l i v e r e d ; i n t e r e s t c o s t s o n t h e
a m o u n t b o r r o w e d to c o v e r t he p r e p a y m e n t m a y b e p a s s e d - t h r o u g h ,
45
however.
T he c h a r a c t e r a n d e x t e n t of the t a k e - o r - p a y
o b l i g a t i o n s in a ny g i v e n n a t u r a l g a s c o n t r a c t d e p e n d u p o n
m a r k e t c o n d i t i o n s w h e n the c o n t r a c t w a s n e g o tiated.
Certain legislative proposals w o uld impose a strict
r e q u i r e m e n t t hat t he p i p e l i n e t a k e s e r i a t i m its g a s in
a s c e n d i n g o r d e r of cost, l e a v i n g m o r e e x p e n s i v e g a s s h u t - i n
if s u r p l u s to the p i p e l i n e ls c u r r e n t
market requirements.
In the m e a n t i m e , t h i s gas w o u l d be u n a v a i l a b l e for sale to
o t h e r buyers.
In s u r p l u s m a r k e t c o n d i t i o n s like t h e p r e s e n t ,
th i s c o u l d e l i m i n a t e m o s t if n o t all p r o d u c t i o n o f d e e p a n d
t i g h t s a n d s gas, a n d c u r t a i l p r o d u c t i o n o f s u b s t a n t i a l v o l u m e s
o f s t r i p p e r - w e l l g a s a n d g as f r o m n e w wells.
T h i s w o u l d l e a d to an i n e v i t a b l e d e c l i n e in g a s e x p l o r a t i o n
a n d p r o d u c t i o n , w i t h an i n c r e a s e d p r o b a b i l i t y of g a s s h o r t a g e s
o n c e the e c o n o m y r e c o v e r s .
P r o d u c e r s e x p e r i e n c i n g 100% shut-
ins w o u l d b e u n a b l e t o s e r v i c e t h e i r debts, r e s u l t i n g in
s u b s t a n t i a l d e f a u l t s o n h u n d r e d s of m i l l i o n s o f d o l l a r s in
o u t s t a n d i n g loans.
The economic implications are obvious.
In a d d i t i o n , l e g i s l a t i v e a b r o g a t i o n of t a k e - o r - p a y
requirements presents a constitutionality question which would
b e e x t e n s i v e l y l i t i g a t e d in t h e courts.
A challenge, regardless
o f t h e e v e n t u a l r e s u l t , w o u l d t a k e y e a r s to w o r k its w a y t h r o u g h
t h e c o u r t sys t e m .
21-496
0 - 8 3
U
During this period, unc e r t a i n t y will continue
46
t o p l a g u e t h e p r o d u c t i o n i n d u s tr y, r e s u l t i n g i n a s h a r p r e d u c t i o n
i n d r i l l i n g act i v i t y .
A d d i t i o n a l l e g i s l a t i v e p r o p o s a l s w o u l d i n t e r d i c t t he
o p e r a t i o n of p r i c e e s c a l a t o r c l a u s e s , w h i c h are a l s o o f c u r r e n t
a n d t r a d i t i o n a l i m p o r t a n c e i n t h e n a t u r a l gas i n d u s t r y .
Price
e s c a l a t o r c l a u s e s f u r t h e r the p u b l i c i n t e r e s t b y g u a r a n t e e i n g
p r o d u c e r s a p r i c e g e n e r a l l y r e f l e c t i v e of m a r k e t v a l u e o v e r
the course of a long-term contract.
Historically, the operation
of these clauses has been severely limited— sometimes to their
exclusion— by federal regulatory authorities.
However,
p r o d u c e r s r e l y u p o n t h e s e c l a u s e s t o g u a r a n t e e r e c e i p t o f at l ^ a s t
the h ighest r e gulated gas rate allowed by federal regulations.
A g a i n , t h i s p r i c e is u s u a l l y w e l l b e l o w m a r k e t v a l u e .
In r e t u r n
f o r t h e p r i c i n g c l ause, p r o d u c e r s h a v e b e e n w i l l i n g t o e n t e r i n t o
l ong-term contracts w h i c h are necessary to a pipeline's obtaining
financing and mee t in g future service obligations.
In the absence of legislative tinkering, producers a n d
p i pelines wi l l act to mit i g a t e the adverse impacts of any
p r o v i s i o n in existing contracts. Recent submissions b y p r o d u c e r s
t o the House Fossil Fuels Subcommittee indicate that r e n e g otiation
of problematic take-or-pay requirements has
occurred where
necessary to relieve economic hardship of pipeline purchasers.
N e w contracts will, of course, refl e c t changed m a r k e t conditions.
F o r example, recent gas contracts usually contain marke t- ou t
47
clauses and lower take o b l i g a t i o n s , emphasizing a perce i v e d
n e e d o n t he p a r t of gas b u y e r s to r e d u c e t h e i r e x p o s u r e t o
h i g h - c o s t c o m p o n e n t s of t h e i r gas supply.
Indirect Administrative Regulation
A v a r i a t i o n of' t he " d i r e c t e d take" gas r e q u i r e m e n t
a p p e a r s i n b i l l s w h i c h s e e k to e n l a r g e t he a u t h o r i t y o f t h e
F E R C to r e v i e w t h e p u r c h a s e p r a c t i c e s o f n a t u r a l g as p i p e l i n e s .
T h e C o m m i s s i o n w o u l d b e g i v e n th e a u t h o r i t y t o l i m i t o r d e n y
p a s s t h r o u g h o f p u r c h a s e d gas c o s t s w h e r e the p i p e l i n e gas
purchase contracts contain certain common pricing or take
provisions.
The N G S A opposes these indirect efforts for the same
r e a s o n s I m e n t i o n e d i n c o n n e c t i o n w i t h the d i r e c t p r o p o s a l s to
i n t e r f e r e w i t h t h e s e cla u s e s : s u c h i n t e r f e r e n c e w o u l d i m p a i r
the producer's expec t e d revenue stream, create uncertainty
and possible collapse in the investment and lending c o m m u n i t i e s ,
and have a chilling effect on further exploration and development
p r o g r a m s t h a t a r e n e e d e d t o p r o v i d e g as f o r t he f u t ure.
F o r example, some of the proposals, including one o f f e r e d
b y C h a i r m a n J e p s e n , w o u l d a d d a d e f i n i t i o n o f t h e t e r m " a buse"
a s i t i s u s e d i n s e c t i o n 601 o f t h e N G PA.
Abuse w ould include
i m p r udence o n the p a r t of a pipeline and the p r e s e n c e in any
48
existing contract of a provision w h i c h mater i a l l y prevents the
pipel i n e from responding to changes in customer d e mand or
o t h e r m a r k e t forces.
The presence of a take-or-pay percentage
g r e a t e r t h a n 70 p e r c e n t , an i n d e f i n i t e p r i c e e s c a l a t o r c l a u s e
n o t t i e d t o an e c o n o m i c i n d i c a t o r , o r a m o s t - f a v o r e d ^ n a t i o n
clause, or the absence of a m a r k et-out clause would, un d e r the
b i l l , c r e a t e a r e b u t t a b l e p r e s u m p t i o n o f abuse.
T h i s t y p e o f p r o p o s a l w o u l d a l l o w the F E R C t o d e n y a p i p e l i n e
p a s s t h r o u g h o f gas c o s t s b e c a u s e a c o n t r a c t m a y h a v e b e e n
negotiated and signed several years before this legislation
w a s p r o p o s e d o r b e f o r e t h e p a s s t h r o u g h in q u e s t i o n w a s
challenged.
I n t h e f a c e o f t h is p o s s i b l e s e c o n d - g u e s s i n g
b y C o n g r e s s a n d t h e F E R C , the p i p e l i n e m a y h a v e n o a l t e r n a t i v e
b u t t o a t t e m p t t o a v o i d t h e o b l i g a t i o n s in h i s c o n t r a c t w i t h t h e
producer.
O n t h e o t h e r h a n d , if the p i p e l i n e c o m p l i e s w i t h t h e t e r m s o f
t he c o n t r a c t , C o m m i s s i o n d e n i a l o f p a s s t h r o u g h , p r e s u m a b l y o n l y
after notice and hearing, m ay occur months after the pipeline
has p a i d the producer.
In effect, a substantial p o r t i o n o f the
payments made to producers w ou l d be subject to possible recoupment
d emands b y the pipelines.
This revenue uncertainty w o u l d
create the same type of cash flow and financing difficulties
inherent in the price freeze proposals which I discussed earlier.
There c ould be n o price c e r t a i n t y , because the rate p ro ceedings
w o u l d d r a g o n f o r years.
The uncertainty and any denials of
p a s s t h r o u g h w o u l d a d v e r s e l y a f f e c t s u p p l y and, u l t i m a t e l y , p r i c e s .
49
F o r t h e s e i m p o r t a n t r e a s o n s the N G S A d oes n o t b e l i e v e
the p roposed limitations on pipeline passthrough p r e sent a
w o r k a b l e s o l u t i o n to t he m a n y p r o b l e m s t h a t e x i s t i n t h e
n a t u r a l g as indus t r y, a l t h o u g h w e a p p r e c i a t e the g e n u i n e
c o n c e r n a b o u t c u r r e n t n a t u r a l g as p o l i c y e x p r e s s e d b y t h e
sp o n s o r s , i n c l u d i n g the C h a i r m a n o f t h i s C o m m i t t e e .
Conclusion
N G S A r e c o g n i z e s t h a t t h e r e is a n e e d to f i n d a w o r k a b l e
s o l u t i o n to t he n a t u r a l gas p r o b l e m s f a c i n g t h e n a t i o n .
We
a l s o r e c o g n i z e t he s e r i o u s a n d l e g i t i m a t e c o n c e r n s o n the
part of m a n y m e m b e r s of the Congress w h i c h have p r ompted them
to propose immediate relief for residential natural gas
c ons u m e r s .
Enact m e n t of piecemeal solutions to this m o s t complex problem,
e v e n f o r a s h o r t time, c o u l d r e s u l t i n m o r e , n o t less, d a m a g e to
the nation's consumers and to the industry that has b e e n
b u i l t to s u pply t hem w i t h this commodity.
T h e n a t u r a l gas
issue presents complex problems affecting pipeline companies,
d i s t r i b u t i o n c o m p a n i e s , large, m i d d l e - s i z e d a n d s m a l l p r o d u c e r s ,
the F e d eral Energy Regulatory Commission, state r egulatory
c o m m i s s i o n s , i n d u s t r i a l u s e r s as w e l l as r e s i d e n t i a l c o n s u m e r s .
The present law was enacted after months and months of
consideration of the ma n y aspects of this complex puzzle.
50
The N G S A firmly believes that the present market situation
c o m p e l s us t o r e p l a c e t h e N G P A w i t h a c o m p r e h e n s i v e l e g i s l a t i v e
p a c k a g e c e n t e r e d a r o u n d d e r e g u l a t i o n o f all n a t u r a l gas p r i c e s
at the wellhead.
C u r r e n t m a r k e t c o n d i t i o n s s u g g e s t t h a t w e ca n
n o w o b t a i n the s i g n i f i c a n t l o n g - t e r m b e n e f i t s o f d e c o n t r o l
w i t h m i n i m a l s h o r t - t e r m impact.
W e hope this Committee w i l l
j o i n us i n t h e c o n c l u s i o n t h a t w e l l h e a d d e r e g u l a t i o n is t h e p o l i c y
w h i c h best serves the consumer's long-term interests.
51
ATTACHMENT
"A"
A C T I V E C A N A D I A N GAS P R O J E C T S
Purchasing
Company
Service Area
(By State or
Census Region)
Canadian
Supplier
Great Lakes
Gas Trans
mission Co.
Minnesota,
Michigan
TransCanada
Pipelines
Ltd.
Inter-City
Minnesota
Pipelines
Ltd.
Northern
Minnesota
Michigan
Wisconsin
Pipeline
Co.
1981
Imports
(Bcf )
Remaining
Volumes
Under NEB
License (Bcf)
92.7
1,301.3
ICG Trans
mission Ltd.
5.5
122.9
E.North Central
W.North Central
TransCanada
Pipelines
Ltd.
13.2
172.6
Midwestern
Gas Trans
mission Co.
(Northern
System)
Minnesota,
North Dakota,
Wisconsin
TransCanada
Pipelines
Ltd.
101.1
850.8
Northern
Natural
Gas Co.
E.North Central
W.North Central
Mountain
Consolidated
Natural Gas
Ltd.
25.0
372.8
237.5
2,820.4
TOTALj
52
ATTACHMENT
"BM
NEWLY OPERATING CANADIAN GAS PROJECTS
Purchasing
Company
Service Area
(By State or
Census Region)
MichiganWisconsin
Pipeline
Co.
E.North Central
W.North Central
Canadian
Supplier
ProGas
Ltd.
Startup
Date
Contract
License
Expiration
Date
Max.
Potential
Imports
Per
Year
Total
Volume
under
NEB
Licens
(Bcf)
Fall,
1982
1987
27.4
150.5
W.North Central
Northern
Natural - . E.North Central
Gas Co. — '
PanFall,
Alberta 1982
Gas Ltd.
198 7-/
73.0
N.A.
Northern
Natural
Gas Co.
W.North Central
E.North Central
Consoli- Fall,
dated
1982
Nat.
Gas Ltd.
1987
41.6
373.0
Natural
Gas
Pipeline
Co. of
America
W.North Central
E.North Central
ProGas
Ltd.
1987—
27.4
150.5
TOTAL:
Fall,
1982
169.4
II
Start-up date represents the earliest date that importing
can occur according to the contract and the projected
completion date of the construction of the transportation
related facilities.
2/
Canadian gas is first sold to the Northwest Alaskan
Pipeline Co. and then resold to the U.S. companies.
3/
Approval is being sought that will increase deliverability
or extend the time frame of the license.
N.A.
53
A t t a c h m e n t 1 to N G S A T e s t i m o n y
TAKE-OR-PAY
Just suppose that you own a bakery.
You've Invested in ovens,
signed a lease for a building and hired employees.
And suppose somebody
offered to have the exclusive right to buy bread from .you for 20 years and
to pay you the going price for each loaf he bought.
There 1s one little
problem: he could give you no assurance that he would buy any particular
number of loaves.
Would you take his deal?
Of course not.
Just as a baker needs an assured market for his bread in exchange
for tying up his output for 20 years, a gas producer needs enough assurance
of a steady cash flow to meet his obligations to bankers, suppliers and
employees.
The mechanism that has evolved to do this 1s the take-or-pay
provisions in gas contracts.
Now, take-or-pay provisions have come under
heavy attack 1n some quarters as being "against the public Interest" and
causing market disordering problems.
In reality, the public is well served
by these provisions, since they encourage long term stability of supplies
and rational price planning and offer a cheaper alternative to storage by
pipelines.
Actually, the term "take-or-pay1' 1s misleading; 1t really should
be "take-or-prepay."
delivered later.
That is, a prepayment 1s made today for gas to be
The make up feature of take-or-pay has been largely ignored
1n recent discussions of natural gas Issues.
In the early years of the gas Industry, there was no need for takeor-pay provisions.
Gas was a comparatively valueless by-product of oil
production, and 1t was sold whenever a market happened to be available,
usually to a nearby gasoline plant.
But with the advent of large diameter,
54
long distance pipelines and greater demand for gas, gas itself could be explored
for, developed and produced as a valuable commodity.
With gas as the major
product on a lease, it had to carry the burden of all of the costs of explora
tion and production; and for this there was a real need for a steady, reliable
flow of income to the producer.
Take-or-pay was the method which buyers and
sellers developed to achieve this.
Next to the pricing provisions, the most important provisions of
a gas sales contract are those which specify the quantity of the gas to be
purchased.
The producer wants to sell his gas as rapidly as his wells will
produce it and the pipeline can take the gas into Its facilities.
Hence,
he tries to contract to require the buyer to take as high a percentage of the
capacity of his wells to deliver gas as he can.
During the shortage period
in the late 1970's, pipeline buyers, who needed more gas than they could
buy and were curtailing their customers, were willing to sign long-term
contracts providing for high percentage “takes" from the producer.
In many
cases the producers drilled additional wells to enable the gas to be produced
at a more rapid rate to meet the urgent pipeline demand.
From the viewpoint of the pipeline, 1t 1s desirable to get as many
gas reserves contracted to the pipeline as possible in order to protect the
long-term supply security of the pipeline and Its customers.
be considered with —
or balanced against —
the current demands of its customers.
That need must
the short-term need to meet all
Thus, the pipeline buyer must adjust
Its gas purchase program to continually assure Its long-term supply, while
at the same time assuring itself that it has enough gas to meet all of Its
customers* demands, but not too much gas $o that It would be found to violate
the "take" or quantity provisions of Its contracts with Its various producers.
55
The take-or-pay requirements of his contract are the producer's only protection
against predatory buying practices of a pipeline, which could, absent this
provision, tie up a producer's reserves under a long-term contract and then
refuse to permit their production by refusing to take the gas into its system.
This was the very practice that the clause was initially designed to prevent.
After all, in most cases there are not too many potential buyers close enough
to offer to purchase a new gas supply.
It is important to keep in mind that in talking about "producers"
or "sellers" we are not talking about a single company or even a small group
of companies.
Instead, pipelines buy from thousands of producers and have
individual contracts with each one.
It would not be fair, logical, or
“in the public interest" for a pipeline to favor one producer over another,
taking one person's gas while leaving another's in the ground.
In fact,
1f two or more producers are selling gas from the same reservoir, the gas
will move underground through the rock to the wells which are producing —
and away from wells which are shut-in.
This means that the producer whose
wells are not producing can actually have his gas drained away by another
producer whose wells are producing.
Furthermore, a producer, especially a small producer,• needs a steady
Income from his wells 1n order to pay his fixed costs, operating costs and
taxes.
In many instances, the steady income from existing production provides
the collateral on which a producer borrows money to continue to drill wells to
explore for and develop new gas.
It Is assumed that the existence of a take-or-pay provision 1s
solely for the benefit of the seller.
keeping an assured supply.
But,»a buyer has a real Interest 1n
Without take-or-pay, long term contracts for gas
56
supplies would be rare, leaving buyers with the inability to finance pipelines
and attract markets.
And the level of take-or-pay will in part determine the
number of wells to be drilled on a lease and the size of surface facilities to
be installed, which in turn affect the volume of gas available to the purchaser
on any given day.
A take-or-pay provision is designed to meet the needs of both the
producer and the pipeline.
It provides that the buyer must take a minimum
quantity of gas, on a daily, monthly, or annual basis, but, if he does not
take this quantity of gas, he must pay the producer as 1f he had taken it.
This does not mean that the pipeline pays more money for less gas.
The reason
1s that the pipeline has a right to "make up" the deficiencies in takes, either
at no cost or by payment of a small price differential 1f the price of the gas
has increased between the time the payment is made and the gas 1s taken into
the system.
Thus, in the normal course of events, the pipeline is able to
operate its system with necessary flexibility, Increasing or decreasing its
takes as demands of Its customers vary, because of weather conditions, economic
changes, etc.
The producer receives a steady minimum Income to meet his oper
ating costs, taxes and other obligations.
And the pipeline's customers only
see the carrying charges on take-or-pay amounts, not the full amounts paid,
in their rates.
We can speculate what the gas Industry might be like without
take-or-pay provisions.
Since take-or-pay 1s a trade-off for long term
commitments, producer/pipeline contracts would be significantly of shorter
duration.
Surely there would be a major change 1n pipeline financing, re
quiring more equity participation, shorter? amortization periods and, presumably,
higher rates to offset the greater risks of loss of gas supply.
Producers
57
could be expected to develop properties more slowly and perhaps to demand
higher prices In return for the uncertainties of cash flow.
Short-term,
spot sales could lead to shortages on one pipeline system with adequate
supplies 1n others.
In short, chaos could supplant stability —
and the
consumer 1s the loser.
One of the early methods used to set the amount of take-or-pay was
to relate the amount to be taken or prepaid (the dally contract quantity or
DCQ) to the amount of original recoverable reserves covered by the contract.
Thus, a DCQ of one Mcf per day for each 10,000 Mcf of reserves would theoreti
cally deplete the reserves in about 27 years.
The 1:10,000 formula in time
gave way to 1:8,000 (22 years) and 1:7,300 (20 years).
Other reserve based
formulas were used as well.
But problems developed in basing average daily takes on reserves.
One was the Inexact nature of reserve estimation; engineers of buyers and
sellers often disagreed on just what the recoverable reserves were.
times, arbitration was the only way to resolve differences.
Some
In any event,
having to agree on reserves every year or two resulted in an Inefficient use
of technical personnel.
Of even greater significance was the need of pipelines, not so much
for long-term supplies (which were sorely needed, too), but for gas Immediately
to serve their markets.
But the Interstate pipelines, unable to compete for
new supplies in price, found they were able to compete by offering higher
take-or-pay levels.
What then developed was a switch from reserve-based take-or-pay
levels to a method which gave buyers more gas and sellers more cash for
development.
That was the use of a percentage of daily gas deliverability to
establish the DCQ level.
Deliverability 1s easily determined and redetermined
58
by actual tests, not by estimation, an advantage 1n time and manpower to both
buyers and sellers.
The actual percentage to be used was negotiated by the
parties, and 1t has varied extensively depending on many factors, including
the number of wells to be drilled, the size of optimum surface facilities,
the capacity of the buyer's pipeline and the buyer's need for gas.
the percentage ranged from a low of 33-1/3% to a high of 90%.
average percentage was probably around 80%.
In general,
The weighted
The time over which the take-or-pay
obligation was to be met was sometimes a day or a month but most frequently
a year.
The time for make up also varied, but, since the FPC mandated at
least a five-year make up for sales under the Natural Gas Act, the five-year
make up term spread to intrastate sales as well.
term of the contract —
Make up over the remaining
and sometimes beyond that — was not infrequent, however.
Problems are now being experienced by some pipelines because the
two objectives of the pipeline purchaser find themselves 1n conflict with
each other.
Many pipelines are experiencing a "deliverability surplus" due
to the fact that the demands of their customers are less than the pipelines
anticipated due to the economic recession and the reduction 1n prices of
fuel oil, which competes with gas 1n many markets.
At the same time, these
pipelines have a continuing need to buy gas to meet their long-term needs,
5 to 15 years from now.
Thus, pipelines are Increasingly finding themselves
potentially liable under the take-or-pay provisions of their contracts to pay
for gas which they cannot currently take Into their systems.
This fact is not a cause for panic or precipitous or 111-considered
Congressional action.
The operations of the Industry and the clauses themselves
will correct this problem, 1f 1t 1s a problem, over a fairly short period of
time.
This 1s so, because:
59
1*
The make up provisions of the gas sales contracts will allow
the pipelines to receive gas supplies which they have paid for in the
future, at a time more convenient to the pipeline.
2.
The buying practices of the pipelines in new contracts will
reflect the surplus deliverability situation, and the new contracts
will have lower percentage take requirements and more liberal make up
clauses than earlier contracts.
In extreme situations, the pipeline
may simply suspend new purchases until some of the take-or-pay
balances are made up.
3.
If situations become too extreme, producers will renegotiate
these requirements on an individual contract basis to avoid pipeline
hardship.
4.
In any event, any problem that exists will disappear when the
nation's economy revives.
Much of the criticism of the take-or-pay clause comes about because
of the many different prices at which natural gas, a fungible and homogeneous
commodity, is sold.
This 1s true, not because of the contracting practices
of producer and pipeline, but because of federal regulation.
Prices paid
for gas 1n the various NGPA categories vary widely, from 45 cents per MMBtu
to over $9.00.
These prices vary between fields, between producers, and
between individual wells -- and sometimes even in the same well.
It is
Inevitable in such a system that, at times, seme 45 cent gas will be shut-in
(and paid for) while more expensive gas 1s purchased by the same pipeline
due to contract obligations and system demands and pressures.
This 1s
not done because the pipeline wants to pay'more for Its gas supply; on
the contrary, It wants to do just the opposite In order to conserve its
60
markets, meet regulatory objections, etc.
But the pipeline cannot arbitrarily
shut-in some fields because they are high priced, or for any other reason and
produce others.
It must meet its contract obligations in each field with
each different producer.
The solution to the problem is not, as some suggest, to "tinker"
with a single part of the contracts entered into between the producer and
pipeline.
Rather it is to abolish, or reduce, the artificial and meaning
less price differentials imposed by law and regulation upon gas from varying
"vintages," sources and sellers.
Over the years, there have been some suggestions that the use of
take-or-pay provisions, freely negotiated to suit the needs of buyers and
sellers, was somehow improper.
Indeed, the Federal Power Commission twice
considered the desirability of take-or-pay provisions.
In each case, t?ie FPC
concluded that such provisions were necessary in the industry and that the
level of take-or-pay was to be best left to the parties to a contract.
Again today, take-or-pay (without mentioning the make up related
to it) is being blamed for the perceived ills in gas markets.
With demand
for gas reduced because of general economic conditions, take-or-pay provisions
will work to do exactly what they were designed to accomplish —
they give
producers assured cash flows, provide a cheap alternative to storage by
pipelines, and provide a cushion of prepaid gas for make up when the
pipelines need it.
Notwithstanding contractual take-or-pay obligations, individual
sellers are reaching accommodations with their buyers 1n relaxing those
provisions.
This 1s being done in recognition of the unique circumstances
in today's marketplace.
This 1s clear evidence that, just as price signals
are being received by producers about Interfuel competition, demand signals
are being read.
The free operation of market forces 1s working —
working
far better than a legislative "solution" to a non-existent take-or-pay
problem.
61
A t t a c h m e n t 2 to N G S A T e s t i m o n y
INDEFINITE PRICING PROVISIONS
IN A GAS SALES C ON TR AC T
A.
Introduction
Indefinite pricing provisions have been an
i nt egral pa rt of m o s t gas sales co ntracts from the i n c e pt io n
of the industry.
Indefinite pricing clauses provide a
m e c h a n i s m for b u y e r s and sellers to a d j u s t the p r ice of the
g a s t o v a r i a t i o n s in its m a r k e t v a l u e o v e r t h e d u r a t i o n o f a
long-term
(15-20 y e a r s o r m o r e )
gas sales contract.
R e c e n t l y these p ro vi si on s have come u n de r attack.
Th e r a t i o n a l e for and o p e r a t i o n of these d i v e r s e
c o n t r a c t p r o v i s i o n s are not, u n f o r t u n a t e l y , w e l l u n d e r s t o o d
o utside the natural gas industry.
It is t h e r e f o r e i m p o r t a n t
to clearly understand:
1.
W h a t a n i n d e f i n i t e p r i c i n g c l a u s e is, a n d w h y
it has long b e e n a s ta ndard feature of gas sales
contracts.
2.
The various types of indefinite pricing
c l a u s e s in e x i s t e n c e and the r e l a t i v e m e r i t s and
d i s a d v a n t a g e s of each.
3.
The political history of such clauses and the
d e c i sions of the U nited States Supreme Court, Circuit
C o urts and State Courts interpreting and enforcing such
clauses.
21-496
0
83
5
62
B.
The Rationale Behind The Indefinite
Pricing Clause
W it h the cons tr uct io n of m aj o r interstate
pipelines, v a s t n e w m a r k e t s for na t u r a l gas w e r e developed.
W i t h t h e i n c r e a s e d d e m a n d f o r gas, a v e r y s i g n i f i c a n t c h a n g e
occurred.
C o n t r a c t s f o r g a s w e r e b e i n g w r i t t e n f or m u c h
longer terms than before, often for at least twenty years
a n d s o m e t i m e s m u c h l o n g e r , as in t h e c a s e o f c o n t r a c t s
c o v e r i n g the p r o d u c i n g life of a p r o p e r t y w h i c h c o uld last
fifty or m ore years.
This change to extremely long-term
c on tracts was n e c e ss it at ed by the need for si gn ificant
capital to finance these new interstate pipeline systems.
To obta in the n ec es sa ry permits, certificates, and
approvals, the FPC
Exchange Commission
(now t h e F E R C ) , t h e S e c u r i t i e s a n d
(SEC), and the investment bankers who
w e r e p r o v i d i n g the m o n e y ha d to be c on vinced that suffici en t
v o l u m e s of gas w er e commit te d to the p r o j e c t to satisfy the
p i p e l i n e ' s ma r k e t demand, amortize its indebtedness, and
provide a reasonable expectation of profit.
Both the
regulatory agencies and the pipeline companies' bond buyers
i n s i st ed up on firm lon g- te rm contr ac ts for es ta b l i s h e d
v o l u m e s of gas for the full t e r m o f the b o n d e d indebt e d n e s s .
Thus,
in o r d e r to sell hi s gas to the b u r g e o n i n g i n t e r s t a t e
narket, the p r o d u c e r w a s forced to a c q u i es ce in c on tr ac ts o f
long duration.
63
A f t e r the Supreme Co u r t d e c i s i o n in the Sunr a y
case,
1 / the c o m m i t m e n t of gas to an inters t a t e p i p e l i n e
u n d e r the N a t u r a l Gas Ac t of 1938
(NGA) b e c a m e ,
f or
p r a c t i c a l p u r p o s e s , a c o m m i t m e n t f o r th e l i f e o f t h e
r e s e r v e s , r e g a r d l e s s o f t h e t e r m o f t h e c o n t r a c t , as
auth or it y was requir e d to be g ranted by the Federal Power
Commission
(FPC) u n d e r S e c t i o n 7b o f t h a t A c t b e f o r e t h e
" s e r v i c e " c o u l d b e " a b a n d o n e d . "2/
A s t h e F P C r e f u s e d , as a
m a t t e r of practice, to grant such authority u nt il the
res e r v e s w e r e depleted, a sale to an int e r s t a t e p i peline
b e c a m e e f f e c t i v e l y a s a l e f o r t h e l i f e o f t h e field, e v e n
though new contract terms could be negotiated w hen the term
of the contract expired.
Be ca us e of the b asic req ui re me nt for a lo ng-term
contract, one of the m ost important, and most difficult,
f e a t u r e s o f a g a s s a l e s c o n t r a c t is t h e n e e d t o a r r i v e at a
fair p ri ce ove r the entir e t er m of the contract.
Pr i o r to
1 9 5 0 w h e n g a s w a s a b y - p r o d u c t d i s c o v e r e d i n t h e s e a r c h f or
o i l , a n d w a s in o v e r s u p p l y , t h e i n i t i a l p r i c e w a s v e r y low.
The p r oducer was often willing to agree to a low-initial
p rice to en co u r a g e the co ns tr uct io n of the p i p el in e to
1/
S u n r a y M i d - C o n t i n e n t O i l Co. v. F . P . C . , 3 6 4 U.S .
7T im .-------------- ----------
2/
C a l i f o r n i a v. S o u t h l a n d R o y a l t y C o . , 4 3 6 U . S . 5 1 9
“
"(IST8).----- ----------------------------------- “
137
64
p r o v i d e a m a r k e t f o r h i s gas, w i t h " e s c a l a t i o n " o r p r i c e
i n c r e a s e p r o v i s i o n s to b r i n g the gas pr i c e u p to its fair
m a r k e t v a l u e at s o m e l a t e r p o i n t i n t i m e i n t h e c o n t r a c t
period.
It w a s v e r y d i f f i c u l t
(and s t i l l is)
f or t h e
p a r t i e s t o a n t i c i p a t e , a t a n y p a r t i c u l a r p o i n t i n t i me, w h a t
t h e f a i r m a r k e t v a l u e w o u l d b e t e n t o t w e n t y y e a r s in t h e
fu t u r e .
"Fixed Escal a t i o n " p r o v i s i o n s w h i c h p r o v i d e d for a
f i x e d a m o u n t o f i n c r e a s e in t h e p r i c e a t p e r i o d i c i n t e r v a l s
p r o v e d to be b a d l y off the mark, as d e m a n d for na t u r a l gas
d e v e l o p e d r a p i d l y in t h e 1 9 5 0 's, 1 9 6 0 ' s a n d 1 9 7 0 's.
The sol u t i o n for the p r o b l e m w a s the "indefinite"
pr ic e es ca la to r clause.
It a t t e m p t s t o e s t a b l i s h t h e p r i c e
o f g a s s o l d u n d e r a c o n t r a c t as n e a r l y a s w a s p r a c t i c a l t o
t h e c u r r e n t m a r k e t p r i c e o f g a s i n a p r o d u c i n g a r e a as
r e f l e c t e d by n e w c o n t r a c t s e n t e r e d into f rom time to time.
As we shall develop, these clauses had ma n y defects, but
they came mu c h closer to reflecting the "market value" of
t h e g a s w h e n it w a s a c t u a l l y p r o d u c e d 3/ t h a n a n y f i x e d
escalator or fixed price provision.
I n so d o i n g , t h e p r i c e
for gas could be co mp a r e d not on ly w i t h the field p r ic e for
g a s b u t w i t h t h e p r i c e f o r oil , f o r p r o d u c t s ,
for coal and
for o t h e r m i n e r a l resources, w h i c h are cus to ma ri ly p r i c e d at
— .... —
3/
~
■
»»
T e x a s O i l & G a s C o r p . v. V e l a , 4 2 9 S . W . 2 d 866
(Tex. l T S T o T
65
t h e m a r k e t v a l u e at t h e t i m e t h e y a r e p r o d u c e d a n d
d e l i v e r e d , not the mar k e t v a l u e m a n y years earlier.
A n a t u r a l ga s p r o d u c e r o r d i n a r i l y o b t a i n s a l e a s e
to drill on a pe rs on 's property;
this m a y be an individual,
or the state or federal government.
In e x c h a n g e f o r t h e
le a s e , t h e p r o d u c e r is o b l i g a t e d t o p a y " r o y a l t y " t o t h e
land owner.
Many royalty agreements contain provisions
w h i c h require that the pro duc er m e as ur e his royalty payments
b a s e d o n t h e " m a r k e t v a l u e " o f t h e gas.
"Market value
r o y a l t y " c l a u s e s h a v e r e s u l t e d in a p l e t h o r a o f l i t i g a t i o n
o v e r t h e " m a r k e t v a l u e " of t h e gas.
The result in m a n y
c a s e s is a r e q u i r e m e n t t h a t a n e f f e c t i v e i n d e f i n i t e p r i c i n g
clause m u s t be part of the sales contract.
For example,
u n d e r T e x a s l a w " m a r k e t v a l u e " is d e t e r m i n e d f o r r o y a l t y
p u r p o s e s b y t h e p r e v a i l i n g m a r k e t p r i c e s on t h e d a t e t h e g as
w a s a c t u a l l y d e l i v e r e d . 4/
C.
Types Of Indefinite Esca la ti on Clauses
And Their Relative Merits.
1.
The "Favored Nations" Clause
One of the e a r l i e s t t y pes of i n d e f i n i t e e s c a l a t i o n
c l a u s e s is t h e " f a v o r e d n a t i o n s " c l a u s e , w h i c h p r o v i d e s t h a t
the price under the contract w ill increase to the price paid
b y the same b u y e r in the same m a r k e t a rea for gas of
4/
Ibid.
66
comparable quality.
The purpo se of this clause was to
i n s u r e t h a t t h e f i r s t s e l l e r s o f g a s in t h e m a r k e t a r e a
( w h i c h c o u l d b e as s m a l l as a s i n g l e field)
received the
s a m e p r i c e p a i d b y t h e b u y e r t o o t h e r s e l l e r s in t h e s a m e
area.
This was expanded to a "three-party" favored nations
c l a u s e , w h i c h r e q u ir e d an increase in the price to that paid
b y a n y b u y e r i n t h e s a m e m a r k e t a r e a f o r c o m p a r a b l e gas.
A s e a r l y a s I960, t h e F P C a n d t h e U n i t e d S t a t e s
S u p r e m e C o u r t r e v i e w e d , a n d c o n s t r u e d as a n o r m a l c o n t r a c t
provision, a two-party favored nations c l a u s e . 5/
The Court
d i d n o t r e g a r d t h e p r o v i s i o n as i n h e r e n t l y b a d o r a g a i n s t
public policy,
2.
Price Redetermination Clauses
A second type of indefinite pricing clause, used
i n l i e u o r o f in c o n j u n c t i o n w i t h t h e f a v o r e d n a t i o n s
clause, was the p rice r ed et er m i n a t i o n clause.
This clause
si mp ly a ll ow ed one p a r t y to give no ti ce to the o ther
he desi r e d to renegotiate the price.
that
A provision which
s t o p s t h e r e is o f t e n n o t s a t i s f a c t o r y f r o m t h e s t a n d p o i n t o f
t h e p r o d u c e r / s e l l e r , b e c a u s e a t t h e t i m e t h e p r i c e is
r e n e g o t i a t e d the pa rt i e s m a y no longer be in an eq ual
bargaining position.
5/
~
The field m a y be partially depleted,
Texas Gas Transmission
¿¿3 (l$60).
c6rp. v.
Shell Oil Co., 363 U.S.
67
and n e w b uy er s more di fficult to obtain.
M o r e o v e r , as t o
i n t e r s t a t e s a l e s p r i o r t o D e c e m b e r 1, 1978, t h e s e l l e r c o u l d
not sell to a nother par ty because of the Sunray decision.
Therefore,
the c l ause o f t e n set a ta r g e t for the
renegotiations,
s u c h as " t h e m a r k e t p r i c e f or g a s o f
c o m p a r a b l e q u a l i t y " i n t h e s a m e m a r k e t area.
Arbitration
c l a u s e s w e r e o f t e n a d d e d in c a s e t h e p a r t i e s c o u l d n o t a g r e e
o n w h a t t h e m a r k e t p r i c e w a s at t h e time.
Even assuming the
p a r t i e s c o u l d a g r e e o n t h e c o r r e c t " m a r k e t p r i c e " f or o n e
negotiation, the price determined becomes increasingly
i n a c c u r a t e o v e r t i m e u n t i l t h e n e x t r e d e t e r m i n a t i o n is made,
3.
Pri c e s R e f e r e n c e d To The Price Of
Compe ti tiv e Fuels.
In t h e o r y t h e c o r r e c t m a r k e t p r i c e f o r g a s a t a n y
po i n t in t i m e should be e q u i v a l e n t to the p r i c e w h i c h the
c o n s u m e r w o u l d h ave to p a y for an a l t e r n a t i v e fuel if gas
were not available.
Because of the difficulties above
d i s c us se d in a d m i n i st er in g the favored n ations and price
redetermination clauses —
d e c i d i n g w h a t g a s is " c o m p a r a b l e "
or w h a t the c o r r e c t " market va l u e " is —
additional
indefinite p ricing provisions w ere sometimes added, either
c o n c u r r e n t w i t h o r i n a d d i t i o n to, t h e o t h e r c l a u s e s a b o v e
discussed.
These clauses allowed price increases to the
l e v e l o f t h e p r i c e o f c r u d e o i l , o r No. 6 f u e l o i l o r No. 2
fuel oil or some fraction therefore, in a specific m a rket
area.
These prices had the advantage of being readily
ascertainable, because they are p u b l ished in industry or
68
governmental periodicals.
The primary disadvantage was that
s u c h p r i c e s r e f l e c t e d o n l y p a r t l y , i f a t all, t h e c o s t s o f
tr an sp o r t a t i o n and distrib ut io n of the gas to the bu rn er
t i p , w h i c h is t h e a c t u a l p o i n t o f c o m p e t i t i o n w i t h t h e
a l t e r n a t e fuel.
S u c h c l a u s e s a l s o c o u l d n o t r e f l e c t t h e c o s t of
c o n v e r t i n g e n e r g y b u r n i n g e q u i p m e n t from one fuel to
another, w h i c h v a r i e s w i d e l y w i t h the size of the e q u i p m e n t
and the end use involved.
4.
P r i c i n g C l a uses B a s e d On Indices.
A good example of a clause r elating price to an
i n d e x is t h e i n f l a t i o n a d j u s t m e n t f a c t o r w h i c h is
i n c o r p o r a t e d i n t o t h e N G P A c e i l i n g p r i c e b y S e c t i o n 101 o f
the NGPA.
This S e c t i o n is an e x p l i c i t r e c o g n i t i o n by
C o n g r e s s th a t l o n g - t e r m gas p r i c e s m u s t be a d j u s t e d at l east
to o f f s e t inflation,
fairly.
if the parties are to be treated
T h e a d j u s t m e n t i s m a d e m o n t h l y a n d is b a s e d o n t h e
Gross National Product Product Implicit Price Deflator.
5.
Area Rate Clauses.
T h i s t y p e o f c l a u s e p e r m i t s t h e c o n t r a c t p r i c e to'
c h a n g e in a c c o r d a n c e w i t h v a r i a t i o n s in a c e i l i n g p r i c e
p r escribed by law or regulation.
Th e F PC in 1960 p r o h i b i t e d
the use of indefinite pr i c i n g clauses prospectively in
c o n t r a c t s f o r t h e s a l e o f gas,.in i n t e r s t a t e c o m m e r c e f o r
69
r e s a l e as a p a r t o f i t s g e n e r a l " p r i c e f r e e z e " s t r a t e g y
u n t i l a r e a r a t e s c o u l d b e e s t a b l i s h e d . 6/
A ft er the issuance of the Permian Basin Area Rate
D e c i s i o n in A u g u s t 1965, t h e FPC, p e r m i t t e d t h e u s e o f
p r o v i s i o n s w h i c h w o u l d adjust the p r ice to the c e i l i n g rate
e s ta bl is he d by the Comm is si on for each p ro ducing area.2/
S u c h p r o v i s i o n s w e r e k n o w n as " a r e a r a t e c l a u s e s , " a n d
q u i c k l y b e c a m e s t a n d a r d in a l l i n t e r s t a t e c o n t r a c t s e n t e r e d
i n t o a f t e r t h a t date.
T h e o b v i o u s d e f e c t in t h i s t y p e o f p r o v i s i o n is
t h a t it is d e p e n d e n t o n t h e e x i s t e n c e o f a
g o v e r n m e n t a l l y - d e t e r m i n e d c e i l i n g price.
When price
c o ntrols are removed, the m e c h a n i s m to tri g g e r this
p r o v i s i o n in t h e f u t u r e w i l l n o l o n g e r e x i s t .
While a price
in ef f e c t on the d e c o n t r o l date should not be rolled-back,
such a clause can have no other prospective operation after
decontrol.
6.
"FERC-Out" Clauses.
T hus far w e have d i s c u s s e d ind e f i n i t e p r i c i n g
c l a uses w h i c h o p e r a t e for the b e n e f i t of the
producer/seller.
Gas sales contracts today commonly
6/
O r d e r No.
25 F . P . C .
(1962).
232, 25 F . P . C . 37 9 (1961)? O r d e r N o. 2 3 2 - A ,
6 09 (1961); O r ^ e r No. 242, 27 F . P . C . 339
7/
“
O r d e r No. 329, 36 F . P . C . 9 2 5 (1966), i n c o r p o r a t e d i n t o
t h e R e g u l a t i o n s a t 18 C . F . R . S 1 5 4 . 9 3 (b-1).
70
wontain two indefi ni te p r i c in g clauses w h ic h operate for the
b e n e f i t of the buyer.
"flow-through" clause.
T h e f i r s t o f t h e s e is a " F E R C - o u t " o r
It p r o v i d e s i n e s s e n c e t h a t i f t h e
FERC or other appropriate governmental agency does not
p e r m i t the p i peline p u r c haser to "flow through" the price
p r o v i d e d in t h e g a s s a l e s c o n t r a c t t o i ts c u s t o m e r s , t h e n
the price paid the produ c e r wil l be reduced by the amount
no t p e r m i t t e d to be ta k e n into the pipelines'
7.
cost base.
T h e " M a r k e t - O u t " o r " E c o n o m i c Out "
Clause.
T h e b a s i c t h e o r y o f t h e s e c l a u s e s is t o p e r m i t t h e
p i p e l i n e t o r e d u c e t h e c o n t r a c t p r i c e p a i d t h e p r o d u c e r if
t he p i p e l i n e ' s w e i g h t e d average cost of p u r c h a s e d gas, p l u s
its tr an sp or t a t i o n costs and return, excee d the m a rk et pric e
o f a l t e r n a t e f u e l s in i t s m a r k e t a r e a .
The clause takes
m a n y d i f f e r e n t forms, v a r y i n g a l l the w a y f r o m u n f e t t e r e d
d is c r e t i o n in the p i pe li ne to redu ce its price, to specific
parameters under w hich the clause can be invoked coupled
w i t h the right in the p r o d u c e r to c a n c e l the c o n t r a c t and
resell to other parties utilizing the pipeline buyer's
t r a n s p o r t a t i o n sy st em at stan da rd rates.
D.
A r e I n d e f i n i t e P r i c i n g C l a u s e s In T h e
Public Interest?
J u d i c i a l H i s t o r y Of
Issue
F r o m the f o r e g o i n g d i s c u s s i o n it is a p p a r e n t t h a t
i n d e f i n i t e p r i c i n g c l a u s e s arls a n i n d i s p e n s a b l e e l e m e n t o f a
l o n g - t e r m gas co n t r a c t w h i c h c o m mits gas for sale and
71
del iv er y in future time periods.
T h i s is so b e c a u s e t h e
e c o n o m i c c o n d i t i o n s w h i c h m a y p r e v a i l over the t e r m of s uch
a c o n t r a c t s i m p l y c a n n o t b e f o r e s e e n at t h e t i m e t h e
c o n t r a c t is e n t e r e d into.
T h e o n l y r e a l a l t e r n a t i v e is t o
a b o l i s h the l o n g - t e r m contract, and sell gas o n a "spot" or
s h o r t - t e r m b a s i s , as o i l a n d o t h e r c o m m o d i t i e s a r e sold.
Such an a p p r o a c h w o u l d be incons i s t e n t w i t h the desire of
the p i p e l i n e s and t h eir financiers to p r o t e c t the u s eful
l i f e o f t h e i r i n v e s t m e n t in p i p e l i n e s , a n d t h e d e s i r e o f t h e
end us er s to d ep endable "service" and assured gas supplies
f or t h e l o n g term.
The vi e w that indefinite pricing clauses somehow
are "against the pu bl i c interest" seems grou nd ed on several
f a l s e p r e m i s e s s u c h as:
1.
T h e i d e a t h a t t h e i n i t i a l p r i c e in a l o n g - t e r m
g a s s a l e s c o n t r a c t is t h e o n l y p r i c e b a r g a i n e d f o r b y
the parties, and that escalation clauses are somehow
a dv erse to the parties'
agreement.
A s e l l e r b a r g a i n s f o r a l l t h e p r i c i n g c l a u s e s in
the contract,
including the indefinite p r i c i n g clauses.
If the se clauses are de le te d or impaired th en the
p a r t i e s ' b a r g a i n is c h a n g e d i n a n u n f a i r a n d o n e - s i d e d
direction.
2.
The idea that the initial price has some
relati o n s h i p to the "historic" or "original" cost of
the gas to the producer and that increases in the p rice
are not "cost justified."
72
An attempt to apply a utility-type cost-of-service
approa ch to pr od u c e r pr icing has been a failure and led
to the shortages of the 1970's,
The "unit cost" of the
gas produced from one w ell can differ dramat ic al ly from
the unit post of gas p ro du ce d from another we ll and
b e a r s n o r e l a t i o n t o t h e v a l u e o f t h e p r o d u c t sold.
At te m p t s by the FPC to find some correlation, eve n on a
n a t i o n a l - a v e r a g e b a s i s , m e t w i t h t o t a l failure.
3.
The idea that a gas producer, unlike every
o ther sector of our economy, public or private,
should
n ot be allowed to realize the increased value of his
assets
(gas r e s e r v e s i n pla c e )
o v e r t i me, a n d t h a t he
m u s t pass on this increased value
( e c o n o m i c rent)
to
the gas consumers.
T h i s c o n c e p t is t h e f a t h e r o f t h e i n f l a m m a t o r y
p h ra se "windfall p rofits," w h i c h led to the ad op ti on of
the m u l t i p l e v i n t a g e p r i c i n g system.
It currently
a p p l i e s t o s o m e 25 d i f f e r e n t p r i c e s t o a n i d e n t i c a l
c o m m o d i t y , b a s e d o n s u c h e x t r a n e o u s c i r c u m s t a n c e s as
the date the well was drilled, the date the contract
w a s signed, w h e t h e r the sale w as intrastate or
interstate, the size of the p r o d u c e r / s e l l e r , whet h e r
t h e w e l l i s a n e w w e l l o r a r e c o m p l e t i o n , etc.
•
E.
Conclusion.
T h e r e a l r e a s o n why''indefinite p r i c i n g p r o v i s i o n s
m a y be v i e w e d w i t h s u s p i c i o n b y some, is th a t t h e y o p e r a t e
73
t o p r o d u c e m a r k e t p r i c e s w h i c h t h o s e p e r s o n s r e g a r d as
"unfair" or "too high" acc o r d i n g to their own p r e c o n c e i v e d
notions of price.
T h i s v i e w l ed J u d g e B r i m m e r , U n i t e d
S t a t e s D i s t r i c t J u d g e in W y o m i n g , t o h o l d t h a t i n d e f i n i t e
p r i c i n g c l a u s e s w e r e i n v a l i d as a g a i n s t p u b l i c p o l i c y . £ /
The Tenth Circuit reversed, holding that federal public
p o l i c y as r e f l e c t e d b y t h e N G P A s p e c i f i c a l l y r e c o g n i z e d a n d
p e r m i t t e d ind e f i n i t e p r i c i n g clauses to o perate u p to the
m a x i m u m r a t e e s t a b l i s h e d in t h e A c t . 9/
A s i m ilar result wa s r e a c h e d by the W y o m i n g
S u p r e m e C o u r t in A m o c o P r o d u c t i o n C o . v. S t a u f f e r C h e m i c a l
C o., 612 P . 2d 463
(Wyo. 1980).
T h e C o u r t said:
"Favo r e d n ations clauses are a comm o n
f e a t u r e o f g a s p u r c h a s e a n d sa le
contracts.
The nature of the pr oduct
an d its q u e s t i o n a b l e a v a i l a b i l i t y
e ng en de r s reluctance on the part of
producers to enter into long term
co ntracts at the p rice p r e v ai li ng at the
time of contract.
Yet purchasers
r equire long ter m c om mi tments to insure
a n a d e q u a t e s u p p l y o f gas.
A two-party
favored nations clause p ro vi de s an
i n c r e a s e in pr i c e t o m a t c h any hig h e r
price whi c h the purchaser pays to any
other seller.
A third-party favored
nations clause requires the purchase to
m a t c h any higher price contracted to be
p a i d b y any o t h e r b u y e r in the same
f i e l d o r area. • • • F a v o r e d n a t i o n s
clauses are r e c ognized by the courts."
(673 F . 2d. at 3 2 7 - 3 2 8 ) .
8/
K e r r - M c G e e C o r p . v. N o r t h e r n U t i l i t i e s , I n c . , 5 00
f*.Supp. ¿ 24 (D. W y o . 1980) .
9/
K e r r - M c G e e C o r p . v. N o r t h e r n U t i l i t i e s , I n c . , 6 7 3 F . 2 d
3 i 3 (IfitK’
cTr^ 1 9 8 2 ) , c e r t , d e n i e d Nov. i 7 ~ 1 9 8 2 , 51
U S L W 3 3 57.
74
It s e e m s c l e a r t h a t i n d e f i n i t e p r i c i n g c l a u s e s
h a v e l o n g b e e n , a n d s h o u l d c o n t i n u e t o be, a n i n t e g r a l a n d
i n s e p a r a b l e p a r t o f a n y l o n g - t e r m c o n t r a c t f or t h e s a l e o f
gas.
Such clauses are the only w a y to equitably p rovide for
t he c o n t i n u i n g sale of the gas at its approx i m a t e m a r k e t
v a l u e at t h e t i m e it i s d e l i v e r e d .
Cancel la ti on or
i m p a i r m e n t of such c l a uses in e x i s t i n g contracts m a y "trap"
the gas c o m m i t t e d by such c o n t r a c t s to inequitable sales,
bu t w i l l at the same time p r e v e n t the future sale of any
u n c o n t r a c t e d for gas un d e r l o n g - t e r m contracts.
It is t h i s
type of short-sighted attempt to "protect" the short-term
i n t e r e s t of the "consumer" w h i c h has led to the p r i c i n g m e s s
w e find o u r s e l v e s in today.
History has demonstrated that attempts to freeze
prices, whether directly through the imposition of price
controls, or indirectly through the impairment of contract
provisions which do not permit market value price increases,
is c e r t a i n t o r e s u l t i n d i s a s t r o u s e f f e c t s o n c o n s u m e r s a n d
o n t h e i n d u s t r y t h a t h a s b e e n b u i l t t o s e r v e the m .
75
Senator Jepsen. Thank you. Now, we will recognize Jerome Mc
Grath, and would you also please just quickly change chairs. Mr.
McGrath represents the Interstate Natural Gas Association of Amer
ica. Is it correct to say that this involves most of the pipeline industry ?
M r. M c G r a t h . Y es, sir.
Senator J epsen. Mr. McGrath, your prepared statement will be en
tered in the record as if read, and you may proceed in any manner you
so desire.
STATEMENT OF JEROME J. McGRATH, PRESIDENT, INTERSTATE
NATURAL GAS ASSOCIATION OF AMERICA (INGAA)
Mr. M c G r a th . Thank you. I also wish to associate myself with your
opening remarks as a very succinct and accurate assessment of the
situation. Much which has been said already by Mr. Means and Mr.
Bush I would echo. I would like to give you for the record the perspec
tive from the interstate pipeline’s point of view, if I may.
As you know, the interstate pipelines are the link between the pro
ducing segment and the distribution arm which sells to the ultimate
consumer. We operate an extensive network of pipelines in the United
States, and have for many, many years. They cost billions of dollars.
Prior to 1978, at the time that the Natural Gas Policy Act was passed,
the natural gas reserve available to the interstate market not only had
declined, they had declined to a very serious level. People have short
memories, but I ’m sure many Iowans, certainly many people elsewhere
in the United States, recall the winter of 1977 when we were closing
plants and schools in many areas because of the drop in pressure of
the lines. There were some communities threatened with being cut off
entirely from natural gas service. That never occurred, thank the
Lord, but something had to be done.
Natural gas is a vital energy commodity to this country. It is a
premium fuel, and something had to be done to reverse the downward
trend in the expiration and development for that commodity. The
Natural Gas Policy Act was passed, and it achieved some of its ob
jectives. All of us look at it today, and it truly is a monstrosity so far
as a piece of legislation is concerned, as Mr. Bush pointed out, some
28 different pricing categories for one single commodity. But it did
create the incentive for expanded expiration and development for the
producers to go out and drill the holes to find the gas you heard Mr.
Bush mention, 15,000 feet or below, drilling that deeply to find natural
gas, and the situation was turned around. Today, there are adequate
supplies of natural gas for the interstate market for the citizens of
Iowa and elsewhere.
Now, some have talked about the surplus. I wanted to clarify that
very carefully. Today, there is a surplus of natural gas. Why ? Because
of the deliverability of gas from the producing fields in the southwest
brought about by a number of factors, not the least of which is the
contract problem which was alluded to earlier requiring in certain
fields what we call take-or-pay commitments. This is that clause of the
contractual obligation that the pipelines have with the producers, and
because of the physical characteristics of certain natural gas fields,
particularly those in the Gulf of Mexico which require rather rapid
70
production, there is a very high amount of gas deliverability, deliver
able gas available to the interstate systems. And just as that is oc
curring, we have several other factors merging together, such as the
conservation, which you mentioned, which has been very significant
in all segments of usage, residential, commercial, and industrial.
We’ve also had probably the most serious recession in modem times
to hit us with the economy at a low ebb, from industrial users, which
are the backbone of the industry in terms of providing year-round
revenues, to not only the distribution companies, but to the pipelines
and producers falling off the systems like dead flies because of the
economy. Many of those industrial users will never come back. Or
others have switched to oil, which because of the rather unexpected
decline in oil prices over the past 2 years, has resulted in many areas in
selling at a price below natural gas.
Now, you have mentioned accurately the rigidities of the Natural
Gas Policy Act. They are rigid. They provide for specific price escala
tion on a monthly basis for the various categories of gas, and that is
designated or determined to be the maximum lawful price. So in the
process of acquiring gas, the pipelines have entered into contracts with
producers, and I might say, and I want to emphasize this, natural gas
is not a shelf item. You don’t run into the store or the filling station
and say, “ Give me a thousand cubic feet of natural gas.” It takes many
years of planning. The gas that the Iowans are receiving today in all
liklihood is the result of planning made in the late 1970’s, and even
going back to the 1960’s for acquiring new gas supplies, and building
new facilities to bring the gas eastwardly to market. Those are com
mitments made under long-term contracts. And if I were a producer
selling to you, a pipeline, in 1975 for delivery to Davenport, Iowa, in
1983, I would surely want to have a provision in my contract which
would allow me over that period of time to charge a price that would
reflect the increasing cost to me, as well as what the law provides for
me to have.
The problem is that the contracts, because they are tied to the Nat
ural Gas Policy Act, do not provide the ability of either the pipelines
or the distributors to go down, and that is why we say that in today’s
climate had we the freedom to negotiate absent the regulatory restric
tions, the statutory restrictions that apply, we would be able to adjust
to these market prices that you see today. We would be able to address
the high prices which the consumers in Iowa are now having to pay.
Senator Jepsen. May I interrupt just a minute, because I want to
get this in the record and make sure I understand. I heard you just
say that the 1978 act prohibits two willing partners to get together and
negotiate a change downward in the prices.
M r. M c G r a th . W e ll, it does n ot p roh ib it that, Senator, b u t it
does------ -
Senator Jepsen. I thought that’s what you said.
Mr. M c G r a th . What I ’m saying is that the contracts provide for
payment by the pipeline to the producer at the maximum lawful price
as prescribed by the Natural Gas Policy Act.
Senator Jepsen. That’s right.
M r. M c G r a t h . N ow , those are long-term contracts. N ow , it does not
prevent the pipelines and the producers fro m try in g to renegotiate
77
those contracts to void those provisions, and, as Mr. Bush has men
tioned to you, the producers and pipelines, our companies have been
negotiating with the producers now for some months. I will have to
report to you as he did, that the major success in those negotiations has
been in getting reduction in the take-or-pay volumes. Getting a reduc
tion in price has been very, very difficult. I might say that we have
something like—I don’t know the exact figure—over 30,000 contracts
between pipelines and producers; that it’s just virtually impossible to
renegotiate all of those.
Senator Jepsen. I understand. I just want to make that point to
clear it up.
Mr. M c G r a th . I ’m sorrv I misled you on that. It’s not that iron
clad, it’s just that the straitjacket is there, and trying to work our
selves out of the straitj acket is very difficult.
My time is running. I do want to say that, as I indicated, that we are
negotiating with producers to try to work these out, but in our opinion,
legislation is sorely needed. I might add that we have looked with great
interest at your bill, Senator, S. 239, and while our approach to the
problem may be somewhat different, there are many areas in which
we agree on the concept. It’s the manner in which we believe it ought
to be handled. For example, on take-or-pay, I believe your bill would
have the take-or-pay go down to 70 percent under the contracts on file
with the Commission, and the Commission would eliminate that pro
vision. We would rather go down to 60 percent of deliverability under
the contracts and provide statutorily, that higher takes ought to
be prohibited rather than leaving it up to the Federal Energy Eegulatory Commission to do so.
We would also put a pricing cap on the indefinite pricing clause in
contracts. I believe your bill would again provide for the Commission
under section 601C2 of the Natural Gas Policy Act to restrict the use
of those contracts. We would do it statutorily. So there are many areas
where your approach is similar to ours.
Something needs to be done. It needs to be done in a hurry, but it is a
combination of the law, the contract, the economy, and all these fac
tors converging at a time when natural gas prices are increasing, and
we commend you for holding these hearings. We wish to work with
you and your staff, and hopefully we can reach a resolution of these
very difficult, complex problems.
[The prepared statement of Mr. McGrath follows:]
2 1 - 4 96 0
83
6
78
P repared S tatem ent
J erome J. M cG ra th
of
Mr. Chairman and Members of the Committee:
My name is Jerome J. McGrath.
I am President of the Interstate Natural
Gas Association of America (INGAA), a national trade association whose
membership is comprised of virtually all of the major interstate natural
gas transmission companies operating in the United States.
INGAA member companies account for over 90% of all natural gas trans^ported and sold in interstate commerce.
All of our member companies are
subject to the jurisdiction of the Federal Energy Regulatory Commission
(FERC) as mandated by the provisions*of the Natural Gas Act (15 U.S.C. 717,
et seq.) (NGA) and the Natural Gas Policy Act (15 U.S.C. 3301, et seq.)
(NGPA).
I am pleased to appear before the Committee on behalf of INGAA, to
discuss our view of the current natural gas market problems.
First, I wish
to commend Chairman Jepsen, not just for convening this hearing, but for
his early and continuing efforts to focus attention on the problems that
are causing hardships for consumers of natural gas and his leadership in
the effort to achieve legislative relief from those problems.
Before getting into the detailed analysis of current market problems
and solutions, I would like to offer a few general comments.
There is no
question that in some parts of the country, including Iowa, natural gas
prices have risen sharply, more sharply than anyone expected when the NGPA
was adopted in 1978.
There is a very understandable urge to affix blame
for these increases.
Some are blaming the NGPA, others are blaming inter
state pipelines, others are blaming producers, some blame state commissions
or local distribution companies, some might even blame OPEC.
79
The truth is, there is no one person, no one segment of the business,
no one decision that can be singled out as causing today's problems.
Those
problems have resulted from a complex set of legislative, judicial, regula
tory, and industry decisions and conditions which are inextricably inter
related and much complicated by the state of our economy.
This fact was
recognized just last month by the staff of the House Subcommittee on Fossil
and Synthetic Fuels in its thorough review of the current gas market prob
lem.
In its January 27, 1983 transmittal memo to the Committee on Energy
and Commerce, the staff noted "it is probably inappropriate to point a
finger of blame at any particular party or group of interests" for these
problems.
Let us all avoid pointing fingers in blame and instead, move forward
constructively to solve the important problems that we have encountered.
In order to help us better understand where we are today, a brief
overview of the industry structure and past events may be helpful.
OVERVIEW OF THE INTERSTATE PIPELINE INDUSTRY
Interstate pipelines are one of three major segments of the natural gas
industry, the others being producers of gas and distribution companies.
Interstate pipelines are commonly regarded as being the transporters of
natural gas, the physical link between producers and local distribution
companies.
ther.
But the responsibilities of interstate pipelines go much fur
Interstate pipelines operate subject to the terms and conditions of
certificates issued originally by the Federal Power Commission and now by
its successor, the Federal Energy Regulatory Commission.
In exchange for receiving the right to construct facilities and
transport gas the pipeline assumes the responsibility to contract for
sufficient reserves and to manage the flow of gas to their local distrib
ution customers so that an adequate supply 1s available to meet customer
needs twenty-four hours a day, seven days a week, three hundred and sixty
five days a year.
80
Consumers need to understand that in order to fulfill this obligation,
pipelines must plan years in advance.
Natural gas is not a "shelf" item.
A pipeline cannot wait until gas is actually needed before it goes out and
buys it.
On the contrary, a pipeline is expected to forecast what the
demand for gas will be on its system as much as five or ten years in ad
vance.
This is particularly true if new facilities are required to attach
a new source of supply.
My point is this:
most of the natural gas flowing today is the result
of decisions made in the 1970's and even the 1960's.
When pipelines were
making these decisions, it was against a backdrop of chronic shortages and
tremendous pressures from consumers for additional supplies of gas.
When
these decisions were made, no one could foresee the passage of legislation
such at the Natural Gas Policy Act and the Fuel Use Act.
foresee the gyrations of oil prices.
No one could
No one could foresee that our nation
would be suffering through the deepest recession of modern times.
Thus,
the problems in today's natural gas markets were not reasonably anticipated
when the pipelines were making their supply decisions.
Moreover, these
problems have resulted largely from factors outside the control of the gas
industry.
In some quarters, pipelines have been accused of being insensitive to
the price of gas.
INGAA takes strong exception to this notion.
It is important to realize that interstate pipelines do not make money
on the buying and selling of natural gas itself.
They are allowed to earn
a regulated rate of return on the transportation of natural gas.
of return is not guaranteed by FERC.
This rate
If a pipeline transports less gas
than it projected in its rate filings in a given year, it will earn less
than the allowed rate of return.
If a pipeline secures relatively low-cost
gas for its customers, the pipeline does not benefit directly from its
success.
All of the benefits of the low-cost gas are flowed directly
through to a pipeline's customers.
costs are flowed through as well.
Conversely, the burdens of higher gas
81
Pipelines are caught in the dilemma of satisfying both their customers
and their suppliers.
Pipelines have both a short and a long-run interest
in keeping their purchase gas costs as low as possible.
First, once a rate
filing is in effect, a pipeline must transport the volume of gas projected
in the rate filing in order to make its allowed rate of return and stay in
business; second, by optimizing the use of Its system the unit cost of gas
to all users is lowered; and, third, a pipeline's viability is dependent on
the markets it is authorized by FERC to serve and adequate supplies to ren^
der that service.
If prices rise too high, a pipeline's current and future
market will decline and it will lose the opportunity to sell its transpor
tation service.
If the price of gas in the field is too low there is
little incentive to explore for and develop new reserves to replace those
used up.
Moreover, both the physical structure of the pipeline industry
and FERC regulation tend to tie pipelines to their existing markets.
Tnus
a pipeline has strong incentives to purchase gas at reasonable prices not
only to keep its product competitive with alternative fuels but to generate
new supplies as well,
Balancing these two critical elements of our busi
ness is a matter of great difficulty, particularly in these recessionary
times.
THE IMPACT OF THE NGPA
The roots of today's market difficulties can be traced back to the
Supreme Court's decision in 1954, that resulted in the imposition of
wellhead price controls on natural gas purchased by interstate pipelines.
Administration of these price controls proved totally unworkable and as a
practical matter, the prices that interstate pipelines were allowed to pay
were held far below market levels.
While consumers enjoyed the benefits of
cheap gas for years producers virtually stopped dedicating new reserves to
the interstate market.
Much of the new gas that was discovered was instead
dedicated to the intrastate market where it was not subject to wellhead
price controls.
The full impact of this seriously misguided policy manifested itself
during the mid-1970's.
Because the reserves of interstate pipelines had
been drained to dangerously low levels, shortages began to appear and the
82
service to many "low priority" customers such as industrial users, power
plant users, and others was curtailed.
As the record cold winter of
1976-77 swept over the nation, hundreds of factories were closed and
thousands of workers were laid off because adequate supplies of gas were
unavailable.
Clearly, a change in Federal policy was needed and it was
against this backdrop that the NGPA was considered.
The Natural Gas Policy Act of 1978 was the result of a bitter and
divisive battle in the Congress over the direction of natural gas pricing
policy.
While it is easy to criticize the Act, it is also important to
recognize that the NGPA was a substantial advance over previous policy in
three important respects:
1)
the NGPA eliminated the dual market for natural gas, i.e.,
intrastate versus interstate, that existed prior to enact
ment, thereby allowing surplus intrastate gas to flow into
the gas-short interstate market;
2)
the NGPA improved the supply situation by providing incen
tives for exploration and development of new gas supplies;
and,
3)
the NGPA clearly established wellhead decontrol as an
ultimate goal of Federal policy and provided for a tran
sition from regulation to deregulation.
The NGPA, in fact, has worked well to ease the critical supply short
ages of the mid-1970's.
of problem:
Today, however, the country faces a different kind
the problem of coping with excess natural gas deliverability
and prices which are near or exceeding market clearing levels 1n many parts
of the country.
The marketing problems facing the industry today have
resulted in a large part from the rigidity of NGPA pricing provisions which
adjust the price of gas'upward, but not downward.
In addition, the short
ages of the 1970's and Federally imposed price controls forced pipelines to
negotiate on contract terms rather than price.
These contracts, signed in
83
a seller's market, also tend to move gas prices inexorably upward by making
the price controls in the NGPA price floors rather than price ceilings.
They also threaten to trigger a fly up in gas prices on 1/1/85 if the
indefinite pricing clauses present in such contracts are not diffused,
CURRENT STATE OF THE NATURAL GAS MARKET
The current perception is that gas supply is in surplus yet gas prices
keep rising.
Observers question whether the gas market is workably com
petitive if gas prices do not fall during an apparent gas "glut."
On the supply side, there is a temporary excess deliverability of
natural gas, i.e., there is more gas available for delivery than the market
can utilize.
This short-term surplus has been brought about by three
factors:
1)
Contracting practices changed during the gas shortages of the
1970's.
Minimum deliverabilities under contracts changed
from take-or-pay clauses^ tied to a percentage of the orig
inal recoverable reserve (over a 10 to 20 year period) to a
take-or-pay clause tied to a very high percentage of daily
gas deliverability.
These new clauses encouraged the devel
opment of higher deliverability capacity.
2)
In addition, the NGPA specifically provides incentives for
faster production of existing reserves by establishing a
higher price for gas from developmental wells (Section 103
gas).
1/
A take-or-pay provision is a minimum requirement to "take" a certain
volume of gas (usually expressed as a percent of remaining reserves or
of current deliverability) or to pay for gas which is not taken.
Usually the contract allows the buyer to receive at a later date gas
which is paid for under these provisions.
84
3)
Government policies encourage maximum production from Federal
leases especially on the offshore.
In the 1970's these policies
were designed to help alleviate the shortage problems of interstate
pipelines (since offshore gas is dedicated to interstate commerce).
These factors have led to higher-than-expected gas availability at a time
when the poor performance of the economy and higher gas prices had led to
lower-than-expected demand.
However, notwithstanding the improved deliverability for gas, the
long-term reserve picture has not improved since 1978 when there was a
widespread perception of gas shortages.
In 1978, the U.S. had an 11.1 year
supply of gas at 1978 production levels; in 1981, that had declined to a
10.8 year supply at 1981 production levels.
the short-run and long-run pictures?
Why then the discrepancy in
The answer appears to be that deliv-
erability (both the physical ability of producers to draw down reserves and
the contractual obligations of pipelines to take gas quickly) has increased
far more rapidly than new reserves have been found.
Reserve additions in
1981 actually exceeded gas production (by 2.7 Tcf), leading some to become
very optimistic about future gas supplies.
But we should not forget that
reserve additions have averaged only 64% of production for the last ten
years and only 86% of production for the last five years.
Thus, the long
term supply situation, which was a major factor in persuading Congress to
vote for the price increases in the NGPA, has not changed dramatically
since the passage of the Act.
In considering any amendment to the NGPA,
therefore, such amendment must be carefully crafted not to discourage the
development of new reserves.
A major area of concern is the extent of recent price increases.
Media
attention has focused on rapid price increases on some pipeline systems in
some parts of the country.
However, according to the most recent date 2/
available from the Energy Information Administration (EIA), average domes
tic purchased gas costs.by interstate pipelines increased by $.34/Mcf (in
2/
“
See An Analysis of Post-NGPA Interstate Wellhead Pipeline Purchases,
S ep tem berrIW l, DUL7tTA-03b/, lable i; p.~6.---------------------
85
January, 1982 dollars) or 17% above inflation from mid-1981 to mid-1982.
This average rate of increase, however, includes a diverse set of pipeline
experiences with price increases.
For instance, the inflation-adjusted
rate of price change for the same period ranged from a 2% decrease up to a
44% increase.
misleading.
The rates of increase on a pipeline-specific basis can be
For example, a 50 cent increase is a 50% increase for $1.00
gas but only a 25% increase for $2.00 gas.
These latest increases are
significant but not markedly greater than historical rate of price changes.
A major cause of the price increase is the shift in volumes from
lower-cost NGPA categories to higher-cost NGPA categories.
predominantly due to the natural decline of old gas.
This shift is
For example, old gas
volumes (Section 104/106) declined by 9% from mid-1981 to mid-1982.
This
decline rate is consistent with historical average rates of depletion for
existing fields.
During the same period, high-cost gas rose slightly in
volume (from 4% of interstate purchases to 6%), but rose substantially in
contribution to cost (from 12% to 20% of total gas costs).
New gas
(Sections 102, 103, 108, and 109) maintained their share of costs (50%) and
increased slightly their share of volume (33% to 37%).
A recent General
Accounting Office (GA0) study for Congress has also examined the signifi
cance of the shift in the mix of NGPA categories for gas supplies.
The
GA0‘s analysis supports our point that the shift from low cost old gas to
higher cost new gas supplies explains a substantial share of cost
increases.
The GA0 explained its analysis as follows:
“To provide some perspective on the relative importance of prices
and proportions, we compared the actual prices and quantities for
1981 with two alternatives. First, we calculated the average
price of buying the 1981 volumes at the 1982 prices, to illus
trate the importance of changes in price; the average price went
from $2.01 to $2.10. Secondly, we calculated the average price
of buying the 1982 volumes at the 1981 prices, to illustrate the
importance of changes in proportions; the average price went from
$2.01 to $2.22.
The overall increase of $0.34 per Mcf may be compared with the
1981 quantities/1982 prices increase of $0.09 and the 1982
86
quantities/1981 prices increase of $0.21. The changes in pro
portionate quantities appear to account for about twice as much
of the overall change as the price changes. Even after the
seven-percent inflation rate between the two periods is consid
ered, the changes in proportionate quantities appear to account
for at least half the overall change. "JV
Some have argued that a major source of interstate price increases is
a selective cut-back of old gas and increased takes of high-cost gas by
interstate pipelines.
The EIA data showing that old gas volumes are on
average declining at a normal depletion rate demonstrate that this asser
tion is not supportable on an industry-wide basis.
TAKE-OR-PAY
There is, perhaps, some misunderstanding as to the role of take-or-pay
clauses in recent price increases and in the deliverability problem.
It
should first be pointed out that take-or-pay clauses play an important
function in gas contracting practices.
For the producer, such clauses
provide assurance of a minimum cash flow, which may be necessary to meet
his financial obligations.
For pipelines such clauses offer an alternative
contract bargaining element to price.
There is no question, however, that
some companies are currently faced with severe take-or-pay problems and it
is a matter of great concern to the industry.
Although there are no publicly available data on the extent to which
such clauses are affecting gas prices today the EIA did complete a study
last June that may shed some light on the problem.
That study sampled data
from several hundred producers and purchasers of natural gas in late 1981.
Table 1 below, presents EIA's estimates of weighted average take-or-pay
levels.
1/
These EIA results indicate that the average minimum take for high
Preliminary Analysis of Natural Gas Price Increases December 9, 1982,
GAO, p. 11.
87
cost Section 107 gas (75.8 percent) is lower than for lower cost Section
102 gas (87.2 percent onshore, 90.4 percent offshore).
1NGAA is working actively to develop facts on the extent of this
problem.
Table 1
Take-or-Pay Statistical Estimates Reported by EIA _1/
Weighted Average
NGPA Section
102 Onshore
Percent Take R<
87.2%
102 Offshore
90.4
103
80.1
107
75.8
108
97.8
105/106(b )
75.9
104/106(a)
92.02/
Vintage3^
Pre-1973
78.1%
1973-4/20/77
94.0
4/21/77-11/8/78
88.0
11/9/78-79
86.8
1980
79.0
\J DOE/EIA, Natural Gas Producer/Purchaser Contracts and Their Potential
Impacts on the Natural Gas Market, June 1^32, p. 41. the estimates are
based on a statistical sample taken by EIA.
2/
Data on 104 and 106(b) are not based on the Form EIA-758 data but on
the study published in December 1981. INGAA believes that the mathe
matical interpretation applied to reserve- based minimum takes exagger
ates the take requirements for 104/106(a) gas in particular and also
for other older gas supplies. The reserve- based clauses are typically
less stringent than deliverability-based minimum takes, but EIA
interpreted the reserve-based clauses as 100 percent minimum takes.
3/
These data on vintage do not include Section 104 and 106(a) data.
88
While INGAA believes that any legislative solution to th* torrent
market distortions should address the take-or-pay issue* addressing takeor-pay alone would not, in our judgse^!* correct the serious prt&Sws we
foresee and «ay not significantly benefit most consumers.
A LEGISLATIVE S01DTI0N IS 8££0£0
The industry has not been idle in the face of these warfcet distortions.
The signals fro« the marketplace fcave been loud and clear.
Today.* *ost,
if not all, companies, including these serving lew«, are neg&tiatlsg in
earnest with gas producers to revise contract provision concerning takeor-pay levels and prices.
There are thousands of gas supply contracts and
progress is likely to be steady but slow.
However, one sigft cf'tfc* commit
ment of the gas pipeline industry to controlling prices is the extent to
which pipelines have exercised »arket outs.
kt least nine pip«U<ies have
exercised market outs between the spring of 1982 and todty*
£& £ Chairman
Butler recently reported that estimates of the annual savins from market
outs approach three-quarters of a billion dollars,*^
line actions include rate decrease filings; filings
Other rmparttot pipe
to red&K* is4k#str1al
gas prices to maintain industrial user contributions t o the fixed costs of
pipeline systems, and Section 102 gas purchases at prices fcfrU* th e Section
102 ceilings.
We expect that the spring 19B3 PGA filings will show
evidence of the stronger bargaining position 1n w M c h doasestic sas buyers
now find themselves, but these results lag the point when excess
deliverability first became serious by about one year.
Some have suggested that the FE8C address these problems under its
existing authority.
1/
""
However, the f£ft€*s authority to modify sr abrogate
C, M. Butler, Chairman, F£RC, letter to Honorable Philip
Sharpy
Chairman» Subcommittee on Fossil and Synthetic Fuels, ¿aweary 2?, 1983»
p* 3. It should be noted, however, that many contracts ds trot have
market outs.
89
indefinite price escalator clauses, or take-or-pay clauses, or to insert
market out clauses in existing contracts is highly debatable and subject to
lengthy court challenge.
Legislation, in our view, is sorely needed.
The primary purpose of such legislation should be threefold:
to
untangle the intricate and rigid web of price controls and other contract
provisions which today are causing serious distortions in the market place;
to address the multifaceted contract problems which beset the industry and
which, if left uncorrected, will continue to have a serious impact on
consumers; and to insure against increasing the cost of natural gas to
consumers without destroying at the same time the incentives needed to
explore for and develop new reserves of this vital fuel.
Because the problem of increasing gas costs rests primarily with the
existing regulatory-contractual regime, proposals that would place undue
restrictions on the recovery by pipelines of their purchased gas costs are
misdirected.
problems.
Such an approach would do little to resolve current market
On the contrary, such proposals could greatly exacerbate current
difficulties by creating a regulatory nightmare.
The very solvency of the
pipeline industry could be threatened if companies had to wait months, per
haps even years, to learn if they could recover the cost of purchased gas,
costs which routinely involve huge sums.
No business in this country 1s
expected to operate in a climate of such regulatory uncertainty.
In fash
ioning legislative solutions, therefore, it is paramount that we maintain a
healthy industry so that all segments are better able to serve the public.
To this end we are anxious to work with the Congress in arriving at some
rational package that will achieve this result.
While INGAA's approach to legislation may differ somewhat from that of
the Chairman's, we have reviewed with great interest your bill, S. 239.
many respects it 1s similar to INGAA's own position.
In
For example, S. 239
would seek to limit take-or-pay clauses in producer-pipeline contracts to
70% of daily contract quantity.
INGAA believes that a rollback of take-or-
pay levels to 60% of deliverability, for a three year period is desirable.
Your bill would seek to restrict the use of indefinite price escalator
90
clauses.
It is INGAA's position that such clauses should be capped to an
appropriate indicator of market clearing gas prices that would allow prices
to fall if market conditions warrant.
S. 239 would also seek to restrict
the use of so-called third party favored nation clauses.
INGAA's position
is to apply a price cap to such clauses in existing contracts, and we are
now considering that question regarding future contracts.
Finally, S. 239
would seek to encourge the inclusion of market out clauses in gas purchase
contracts.
INGAA believes that such clauses should be inserted into
Section 107 gas contracts, the highest priced gas.
INGAA, however, would differ from the approach of S. 239 in reaching
these goals.
S. 239 would impose these standards at the regulatory level,
in proceedings regarding the recovery of purchased gas costs by pipelines.
We believe a more effective approach is to set legislative standards that
would make such changes mandatory.
slow and cumbersome one.
The regulatory process is already a
We believe that the delay and litigation that
would result from further increasing and complicating the process would not
achieve relief for consumers in a timely fashion.
On the other hand,
consumers could benefit almost Immediately if the current inflexible
contractual regime is addressed directly.
We would be pleased, of course, to work with you and your staff, Mr.
Chairman, on these and other legislative proposals of importance.
It is
critical, in our view, that the Administration and the Congress come up
with a comprehensive bill this year.
If we fail in that effort consumers,
the industry and the public at large will have been seriously disserved.
I appreciate the opportunity to appear here today and would be pleased
to respond to any questions you may have.
9,1
Senator Jepsen. Thank you, Mr. McGrath.
I would like to introduce on my right John Conrad of my Senate
staff, whose staff responsibilities include the area of natural gas prob
lems, and on my left, Chris Frenze, who is the economist from the
Joint Economic Committee and has as part of his responsibility the
problems in the natural gas area. These two gentlemen will assist in
providing information and may also at times ask some questions.
I thank the three panel members for their candid and well-thought
out, detailed prepared statements. They will add considerably to the
record. I will make both my comments and questions brief and to the
point.
My bill, on which hearings have been held, was to get at the problem
on the quickest possible basis. Parenthetically, I would point out that
under Government controls the price of gas started at 27 cents at the
pumps, and by the time they took off the controls it was a dollar and a
half. And if that’s control of the price of gasoline, then I think we may
not be helped much by that type of procedure.
That’s not typical of what happens when the Government gets
involved and tries to regulate something. The problem with the
Natural Gas Policy Act is the increase in natural gas rates which has
become the center of the controversy here. Some in the industry I
think, and I say this constructively, may be using the Natural Gas
Policy Act of 1978 as a sort of an excuse to just keep things going a
little bit longer, to maybe “get while the getting is good” before condi
tions change.
There are aspects of this Natural Gas Policy Act which encourage
higher gas prices. In this regard, one of the things that I would like
Mr. Bush to comment on is that there is what is called most favored
nation clauses. You know what I mean. That’s where the purchase
price paid by any pipeline to a producer is set by the highest price in
a particular area. If, for instance, the incentive is there and they, in
fact, have dug 15,000 feet and found natural gas in an area where there
are already producing wells that are 7,000 feet; then is that the price
paid for the natural gas from that whole area, determined by the price
and the cost that it has experienced ?
Mr. B u sh . Senator, if you look at the Deep Gas Section 107, gas is
specifically prohibited from those law clauses. But your point is still
exactly right regardless of what you attributed it to—the section 107
gas. You are driving at what in the heart is an excellent point. May I
comment on that?
Senator Jepsen. I wish you w ould. I understand that the m ost
favored nation clause— and also the highest legal price clause— sim ply
says that we take the most expensive gas in the area and set the
price fo r the rest o f the gas regardless o f whether the other folk s, the
other wells, wanted to sell it o r not.
Mr. B u sh . The Congress in passing the Natural Gas Policy Act
almost forecast what could happen with deep gas prices in section 107
as they did with a number of other things, and I think they addressed
that by prohibiting, but I would still like to address what your ques
tion really gets to and that is the market-clearing price at the wellhead
for gas because it’s very much relevant to what you just said.
92
t
The gas industry is fairly complex, and it’s a little bit different than
making basketballs and donuts in this sense, and Mr. McGrath alluded
to it in the sense that a pipeline when it was building its large systems
needed to make heavy investments, and go to the bank and borrow the
money and amortize that money over 20 or 30 years, and the bank of
course would logically ask the question. “Well, how can you tell me you
are going to be in the business 5 or 10 years from now ?” and the pipe
line would necessarily say, “Well, I have a contract here which tells me
that this producer is willing to sell me this gas for 20 or 30 years at a
given rate.” Well, for a producer to be able to say to a pipeline, “ I ’m
willing to sell you gas for 20 or 30 years,” who in the world would know
in 20 or 30 years what the price of gas would be worth, or the price of
basketballs, or any commodity. If you were to guarantee to somebody
that you were going to sell them something 20 years from now, how
would you ever arrive at what the price would be ?
What came about was an umbrella group of things called indefinite
price escalators, and they have area rate clauses, they have all kinds of
things, but one of those is called the most-favored-nations clause that
you have described, and that basically says there is a clause in the con
tract that says, “ OK, I don’t know what the price is going to be 10 or 15
years from now, but the price I get for my gas should be whatever the
price is paid for on the market at that time.” In other words, “ What
new gas is getting in that area by a pipeline buyer, when he determines
what the value of that gas is worth, my gas ought to be worth that
much, too, because it’s the same commodity.”
The only reason it gets to be a problem is because, as you have cor
rectly identified, as long as the commodity is being priced equally, that’s
all right. But when you get these weird categories, these big derivations
in price, where forever-regulated gas can maintain somewhat of a 70percent supply to some pipeline, allowing him to bid up the price of new
gas over what would be a market-clearing level, then you have the
potential of that triggering all those other contracts.
Now, basically, in our negotiations or our discussions on this issue
with Congress and with others, we’ve said that there ought to be a
way to diffuse those indefinite price escalators in 1985. There ought to
be a comprehensive approach to the problem if it would come up in
1985 when a number of these clauses would be triggered. With the
partial decontrol the fear is when all those contracts tie up, so to speak.
We’ve said that ought to be diffused as part of the commodity pack
age, but it ought to be diffused with some equity across the board so
you get an even price that people can pay. I hope that's not as con
fusing as it sounded to me as I listened to it.
Mr. M c G r a th . A s to what Mr. Bush has said, the most favored na
tions clauses are not a problem today, as he correctly pointed out.
Your section 107 gas, your deregulated gas, is specifically prohibited
by the statute from having those kinds of clauses exercised. The prob
lem now lies ahead in January 1, 1985, when, under the terms of the
NGPA, new gas as defined in that act will be deregulated and the
contracts in those categories of gas have what we call indefinite price
escalator clauses, which includes the most favored nations clause,
which, absent some statutory capping mechanism or something to
diffuse those clouds would trigger the price of natural gas up to what
we believe would be very unreasonable levels.
93
So, part of our legislative proposal that we have urged upon the
Congress is to establish a mechanism which will diffuse those clouds.
Mr. M ean s. Mr. Chairman, could I comment briefly ?
Senator Jepsen . Please.
Mr. M ean s. I think as perhaps comes from Mr. Bush’s questions,
there really are two different problems, the one which is a problem
of 1985 and is associated with those most favored nations clauses. To
day’s problem is not created by the most favored nations clauses. Most
of the contracts contain a number of different clauses, one of which
will be a clause allowing the producers to get at least the maximum
lawful price, and he would get that price no matter what other prices
were being negotiated in his area. What has changed over the past
year is that that clause alone, with the increasing price ceilings on one
hand, and declining world oil prices on the other hand, has brought
us to market-clearing prices without even getting to 1985 and the de
control to which Mr. McGrath alluded.
The most favored nations clauses are potentially useful clauses if
they were drafted so that the price can go down with new field prices
as well as up. Indeed we would be much better off today if gas was
governed by most favored nation clauses that could go down in the
current soft market as well as up in a tight market. The problem cur
rently is that the price is being determined by contract clauses that
have nothing to do with any price being negotiated anywhere, any time,
but are referenced only to the price ceiling economically, as you say,
and very rigidly established by the Natural Gas Policy Act.
Senator Jepsen. We have about 10 more minutes here. Can you tell
me what the mix of policies would be that would benefit the consum
ers most in the long run ?
Now, what is the mix ? What could be done quickly to get to the
point where the marketplace provides and governs the price of nat
ural gas more accurately ?
Mr. M c G r a th . Mr. Chairman, we have for some time felt that ulti
mately we should and must get to a decontrolled environment. Unfor
tunately, the connotation of decontrol is a very adverse one in the
minds of many people and it’s understandable that it would be, but
we think that unless you eventually get to a decontrolled market at the
wellhead, that you are still going to have the distortions, the problems
that beset all of us today.
Now, how do you get there ? We feel that it has to be a gradual transi
tion to a decontrolled environment over time, and we think that the
NGPA is a major barrier to achieving those goals in its present form.
We would address it in this fashion. In addition to the provisions that
are set forth in your bill, S. 139, which we have reviewed and found
that-----Senator Jepsen. S. 239.
Mr. M c G r a th . S. 239, excuse me, very close to ours in many respects
dealing with take-or-pay, with the indefinite price escalators and so
forth. We feel that new gas, as we would define it, should be decon
trolled. That would be gas that’s newly discovered under new con
tracts after a date—say, date of enactment which would then do the
one thing on one side, create the incentive for the exploration and devel
opment for new gas reserves.
2 1 - 4 96 0
83
7
91
I might digress here by saying that at this time because of the eco
nomic situation, drilling is not only down to very, very low levels, but
there are very few interstate pipelines now buying gas, and for the
future I don’t think that portends very well because we are using up
the gas each day that we sell, gas to the homeowner and to the indus
tries. That has to be replaced if we are going to continue in business so
that to the extent that the drilling isn’t going on we are not supplying
gas. We think in the long run this is going to be very harmful, so we
think one major step would be to open up the drilling for new gas,
and we sincerely believe that the pricing will reflect the market con
ditions of the day.
We would phase up the date of decontrol for section 102 and 103
gas, your new gas, from 1985 to 1984 with a price capping mechanism
to prevent the escalator clauses that you were describing earlier in
questioning from being triggered, and it would also have the effect,
we believe, of preventing the statutory increases, the inflation plus 4
percent automatic adjustments that are now in the act from occurring
in 1984 and so on until such time as the contracts are renegotiated or
terminated and those indefinite pricing contracts are eliminated.
Senator Jepsen. Now-----Mr. B u sh . Can I comment on that, or do you want-----Senator Jepsen. Yes, I would like that. I don’t know how everyone
else is doing with the numbers and the laws and the reflations, but I
gather from the testimony given here that we’re buying and paying
$4.94 for Canadian gas, Algerian gas is $7, someone else’s is $10, while
much of our gas is sitting here in this country at about $2 and some
thing. Now, just kind of keeping those figures in mind, how come we
aren’t using our own gas and the consumers aren’t paying that price
that’s based on the $2 range instead of the $5, the $7, or the $10 range?
Mr. M c G r a th . Well, if you didn’t take the gas from Canada, for
example, the Pacific Northwest wouldn’t have gas. All of its gas comes
from Canada. In the Midwest there is a good bit of Canadian gas com
ing in that’s needed. I f you take your supply projections, looking down
the road, we will need every bit of energy we can find in this country
and in Canada.
The LNG is another story. That’s a situation that unfortunately has
developed, but it is felt to be needed by the systems that have imported
that gas. Now the Canadian border price of $4.94 was established by
the Canadian Government and the U.S. Goverfiment in negotiations a
few years ago, which we believe was most uu fortunate. The Canadians
in their spirit of nationalization, I guess, felt that they were going to
get whatever the market would bear in their mind. It was $4.94.
Negotiations, I understand—maybe that’s not the right term to
use—but discussions at least, are either in progress or about to be,
between the U.S. Government and the Canadian Government for a
reduction in those border prices. But the Canadian gas today, and
looking down the road, is going to be a very important contributor to
U.S. supply.
Senator Jepsen. What can we do about the high prices of foreign
gas? And the second part of the question, is it a fact that we have gas
that’s capped in this country that we are not using at the same time
we’re buying all this------
95
M r. M c G r a th . There could be some. I don’t think there is too much
in the Southwest. There may be some in the Appalachian area, yes.
There is some. But again, we are going to the commitments that were
made, not only on this side of the border, but on the other side for
faults that have to be paid for in some fashion.
Senator Jepsen. I s it the industry’s view that they are doing the
country a service and so on by securing gas for, conceivably, the next
quarter century, or half century. I ’m asking that very constructively.
What is the industry’s reason for taking the foreign gas and paying
the high prices when we have lower-priced gas not being used right
here in our own country? Just if you can in a one-liner or two.
Mr. M c G r a th . Well, it’s difficult to explain in a one-liner. It is a
contractual commitment of long standing to acquire reserves to meet
the needs of the various market areas. As I mentioned, for example,
the Pacific Northwest is supplied almost entirely by Canadian gas.
The Midwestern States take much less Canadian gas. Now, to the extent
that more expensive gas may be taken on some systems proportionately
to your lower cost is because of the commitments under the contracts
to pay for that gas if they don’t take it, and those are the take-or-pay
clauses that we are now seeking to renegotiate, and we’ve been reason
ably successful in the last several months. You get some of those high
takes reduced which will relieve the pipelines of the obligation to take
the higher-cost gas so that you could have a greater mix of your lowercost gas.
Senator Jepsen. N ow , Mr. Bush, you represent the gas producers
in this country. What’s your thought on that ?
Mr. B u sh . I thought you would never ask. I have to disassociate
myself a little bit from some of the remarks, and when you used the
word industry, I assumed you were talking about the pipeline indus
try and not the producing industry, because we have a very different
way of looking at things.
Simply put, there are a couple things that are necessary to under
stand. One is that one of the items that Mr. McGrath left out of the
formula that he gave on how he would approach decontrol is the
famous bugaboo of that forever-regulated, so-called old gas, section
104 gas. As you correctly alluded to, the more you get into this the
more you see people trying to protect self-interest. You can see in some
cases—well, you know I have constituents. I have producers who have
produced section 107 deep gas, and they kind of like the way things go
when you get $8 an Mcf, and they probably aren’t happy to hear me
talking about destabilizing price by decontrolling.
The key element is that, the Pacific Northwest notwithstanding, the
cost of gas is a problem that’s growing in Iowa and the Midwest, and
there is no reason it should. The only reason it is is because the pipe
line that supplies this State and this area, Northern Natural, is a heavycushioned pipeline. I f I ’m not mistaken, 70 percent of its supplies are
made up of forever-regulated domestic gas held well below whatever
would be a market price, giving them the incentive to go seek future
supplies from Canada at $4.94.
Now, we have been in all kinds of negotiations with Canada, but
if I were the Canadians, I would tell us to go shove it. Why should
they lower their prices when we are so absurd as to not even straighten
96
out the mess we have in this country with domestic gas prices? It
isn’t a price that they thought this market could bear; it’s a price
that we were willing to pay.
Pipelines buy that gas for $4.94 Mcf and then talk about how
wrong it is for a producer that has gas that he’s selling and could
sell at 50 cents to be able to get $1.50 or $2. There could be domestic
reserve. This country is rich in natural gas reserves, 900 trillion cubic
feet, by some estimates, of domestic gas reserves that can be brought
forward. The only thing that we're lacking is an efficient and logical
policy to bring it forward. We pursue policies that encourage people
to buy gas at $1.94 and $7 and roll these prices in.
Senator Jepsen. Who is “ we” ?
Mr. B u sh . Well, the Natural Gas Policy Act.
Mr. M c G r a th . Mr. Bush’s bleeding heart gets to me, but the pro
ducers are the ones that pay for the pipelines. “This is what we will
sell you the gas for, either buy it or we will sell it to somebody else.”
Comments about the pipelines are terribly misleading to you, Mr.
Chairman, and to the people of Iowa and everyone.
Mr. M eans. Mr. Chairman, could I comment on the imported gas
for a moment? The problem is this consists of three parts. One is the
price, which is clearly too high. Discussions are now going on and
the consumers are extremely sensitive about it. As a practical matter,
I think Mr. Bush is correct. Unless we revise our own pricing so that
there is not domestic price setting governing the border price, it will
be very difficult to renegotiate the Canadian prices down. Nevertheless,
discussions are going forward. Potentially, Canadian gas is probably
the cheapest source of supply for much of the Midwest, the North
west, and when they are renegotiated down, the Northeast,
Senator J e p s e n . Excuse me for interrupting, but I don’t fully under
stand. You said that the Northwestern part of the country potentially
is going to have the best deal from Canada? What do you mean?
M r. M ean s. I f the Canadian price is brought down to reasonable
levels, the fact that the Canadian reserves are simply closer to these
markets than the southwestern gas, but this assumes that the price
is renegotiated down. At the moment it is not a good deal except in
very narrow boundaries.
Senator J epsen . S o the reason fo r sale is because o f the lo g ic in
v olved w ith the g eog ra ph y o f the nearness o f the su pp ly ?
M r. M ean s . T h a t is correct.
Senator J epsen . But they have to reduce the price.
Mr. M eans. The price must be reduced, I think, in some way or an
other. It will be greatly facilitated by reducing our own prices so that
they would no longer be able to point to a limited amount of U.S.
domestic gas.
Senator Jepsen. Y o u mean they point to this gas act of 1978, too ?
Mr. M eans. Yes; they point to the tight sands price that we’ve es
tablished that we are in the process of reviewing, and they point to the
deregulated gas price.
Senator Jepsen. I was just trying to make a point.
M r. M eans. Your point is a fair one. People are using it as an ex
cuse for not acting, but I think in the negotiations it will be easier to
negotiate when we can say: “ You are alone up there at $4.94.”
97
The second and third points concern supply. At the moment, I be
lieve indirectly the pipelines are taking, in general, the minimum
amount that they are contractually obligated to take under the con
tracts on the Canadian imports. That is for the present. The reason
that the pipelines are going forth with plans for additional imports
for the latter part of this decade is that there is some prospect of a
supply decline from domestic sources. The contracts make sense, but
only if they are negotiated at a price which is a price that makes sense
in terms of the United States.
Senator Jepsen . Why, in your opinion, did those pipelines sign such
open-ended commitments to buy very expensive gas '(
Mr. M ean s. Your point earlier was precisely correct, I think, about
the Natural Gas Policy Act and these contracts.
Senator Jepsen. I asked for your opinion, not my point. Why do
you think they did that ?
Mr. M eans. T w o reasons. They were integrated. One, I think none
of us, including myself, ever foresaw times when you could not market
all the gas you could lay your hands on. The second was that, as Mr.
Bush has pointed out, because they didn’t look forward to paying the
high prices because they were relying on their cushions.
Senator Jepsen. Mr. McGrath, why do you think that your pipelines
did that ? Same reason ?
M r. M c G r a th . Let me say that it’s not an open-ended agreement,
and I go back to the time when most of the contracts that are the basis
of supply today were entered into. That was around the early and
middle 1970’s and up to today, where there w^as a severe shortage of
natural gas. There was a seller’s market. The pipelines were running
out of gas. And, whenever they could get gas, they signed a contract
for supply to start building up their reserve again, and, as Mr. Bush
had pointed out and I alluded to earlier, when a producer sells gas to
a pipeline that is going to be used many years later, and having the
Natural Gas Policy Act in place which establishes by law a maximum
lawful price, that the seller is putting provisions in the contract that
he is entitled to receive that maximum lawful price, and it’s the opera
tion of those contracts and the escalators in the law which auto
matically increase the cost as time goes on.
Now, in the Canadian supply that goes back to many, many years of
supply arrangements also, but as I mentioned earlier, the decision to
establish the border price was not of our making or that of the United
States; it was the Canadian Government that established that price,
and it’s now hopefully where the Governments will get together and
see the light of day and put it down to reality.
Senator Jepsen. Governments ?
M r. M c G r a th . We understand the price was set, not to the pipelines
negotiating with the producers in Canada; the price was established
through Government-to-Government negotiations through the U.S.
State Department and the Canadians.
Senator Jepsen. A couDle o f quick questions, then we’re going to
assemble the next panel. You can tell when we get all parties involved,
we do get constructive discussions. How much have producers’ profits
risen in the last year, Mr. Bush ?
Mr. B u sh . They have fallen. I think they are about $4 million. The
combined profits of the top 25 companies that basically produce all gas
98
have had falling profits, largely attributable, I will quickly add, to the
rapid decline in oil prices, not necessarily attributable to gas price.
But again, to be perfectly candid, even while some companies may—
their total profits are down, gas rev.enues are down, in many cases they
are not split out, but I will tell you there are an awful lot of independ
ent producers who, like farmers, are in a depression, not in a recession.
Senator Jepsen . Let’s expand that to 2 years. How have they done in
the last 2 years, and what has been their return on investment ?
Mr. B u sh . If you take the past 10 years, if you measure by share
holder’s equity, if you measure it by return on assets, the top 25 com
panies, again, oil and gas companies, were, I think, 6 out of the 10 years
were below—I ’d rather want to be exact, and I would submit the exact
numbers for the record, and by and large their return on assets, their
return on shareholder’s equity is right about the same which happens
for all manufacturing. The reason, Senator, that people have a hard
time believing that is because of the size of the revenues generated, but
the costs are just as huge.
Senator Jepsen . In the last 2 years, that’s when the price has been
skyrocketed.
M r. B u sh . W h en OPEC prices fe ll and when we decontrolled o il and
we put heavy pressure and really cracked OPEC and b rou gh t the p rice
o f o il dow n, there has been m uch low er o il prices, and as a result profits
have gone dow n. B u t that’s not bad because costs are g o in g dow n.
Senator Jepsen. Constructively, I ’m used to dealing with Washing
ton, and it’s hard to get an answer there—in the 2-year period of invest
ment return we’re talking about, a time when those of us out here on the
ranch and on the firing line have experienced this rapid increase, how
have profits been over those last 2 years ?
Mr. B u sh . The industry profited in 1981.
Senator Jepsen . Just generally, has it been above average, average,
or below average ?
Mr. B u sh . Four percent above—compared to total manufacturers—
for the past 3 years; and below for the prior 3 years. Above for the
prior 2 years to that; and below for the other years. It’s just not that
different.
Senator Jepsen . Mr. McGrath, how are the pipelines doing in the last
couple years?
M r. M c G r a th . As you know, Senator, their return is regulated by
the Federal Energy Regulatory Commission, and established after
hearing and consideration by the Commission of the rate structure,
and we make no money on the sale of natural gas itself as a commod
ity. Our return is based upon the investment and the transportation
of the gas. I would say in the last couple of years they have been kind
of flat. Now, to the extent that the parent company, for example,
might have different operations, different businesses, maybe the parent
profits may be up or down, but generally as far as the transmission
companies, either down or flat.
Senator Jepsen . As you know, I ’m an advocate of profit, and I am
also an advocate of the private sector. However, last night on the net
works there was a story about Panhandle Gas Co. You probably know
the one I’m referring to.
M r. M c G r a th . Panhandle Eastern Pipeline.
99
Senator Jepsejst. OK. I just get pieces; that’s what a lot of people
do. Panhandle Eastern, anyway, was spending $1 million to build a
country club for its employees and all this money a year for the
maintenance, and it would appear this facility would have been a
luxurious club to belong to. Panhandle has asked for a rate increase.
You put all these things together in these times, and I can’t blame
people for ringing my phone off the wall and saying: “ What’s the
matter?5’ What do we do?
Mr. M c G r a th . Well, I didn’t hear the details of the story you
mentioned. I did hear about it this morning, and I don’t know the
facts. It’s my understanding that that facility was on land owned by
the pipeline company for many, many years, and it’s out in Kansas,
and it is basically an overall employee recreation center that was put
up for the benefit of the employees, the union-nonunion employees,
and the retired company people. It does have a golf course, I under
stand.
Senator J e p s e n . I don’t expect you to have to explain something in
detail, nor is the detail particularly the issue. I mean, companies build
things for the employees and that’s applauded all the time, but it’s the
way that his example was presented and the way that the public sees it.
M r. M c G r a th . Yes, I can understand this.
Senator Jepsen . And the question that is logical to ask is: “ How come
prices are going to continue to go up? Is this fair this is happening?”
And getting off of this theme to a more general one,, one we know
best about in Iowa, I think about 1 year ago this time when Northern
Natural announced projected increases of somewhere in the neighbor
hood of 33 percent, and 2 days later announced $400 million profits,
its highest profit in American history. You put those two things to
gether and what are the folks supposed to believe ?
Mr. M c G r a th . Again, I go to the point you made earlier on North
ern Natural, for example. InterNorth is a major diversified company.
I ’m not familiar with it’s nonpipeline business. I do know that their
pipelines which I represent are controlled by FERC. How much that
contributes to their total profit I don’t know. But let me make a com
ment to the gas prices; 10 years ago, for example, the purchase gas
cost component of a pipeline’s rate was about 17 percent. In other
words, 17 cents out of every dollar was for purchased gas. Today the
numbers are about 80 percent to John Daniel’s company, Iowa-Illinois,
for example, and he may have more exact figures, but it’s in that
neighborhood. The purchased gas cost, that is, your wellhead cost of
gas comprises about 80 percent or 80 cents out of that dollar. And
that’s where you are seeing the increases in the cost to the consumers.
Now, it’s a combination of a lot of factors which we have been talk
ing about today, but I think one thing that has to be kept in mind is
that we started from a very, very low base on natural gas. It’s the rea
son we are running out. Twenty to 25 cents in the field where it just
didn’t make any sense in the fields for a producer, for an entrepreneur
to go out and to commit himself to millions of dollars to drill a well
when his price could be regulated as it was at 20 to 25 cents per thou
sand cubic feet. That gas was the biggest buy, the biggest bargain in
the country and it is today. Natural gas today in this country is con
siderably below the price of oil in many areas. Now we’re seeing that
gap close rather quickly.
100
Senator J e p s e n . Dramatically.
Mr. M c G r a th . Due to the sudden drop in the price of oil, and un
fortunately, what goes on in the Middle East and OPEC and Saudi
Arabia could have a very serious impact on our own lives and on the
price that we pay for energy.
We’ve conveyed to you it is a very complex problem. It has a lot of
areas in it where areas of judgment have been made. We are not cer
tain we have made the wisest moves, but we have provided services,
and have natural gas now to serve our customers; whereas in 1977-78,
we were on a very steep decline, one where we were running out of gas.
Senator J e p s e n . Well, I thank the three of you. We could continue
here. The Natural Gas Policy Act has permitted gas prices to increase.
It’s only fair that it change; that it be fair to permit the price to
decrease. That, I guess, we all agree on.
We all agreed also that—not that we necessarily have to agree, but
for the record here to capsulize this, that the Natural Gas Policy Act
does not prohibit, for the most part, activities by parties to a contract
of sitting down and renegotiating contracts. That, however, is some
what complicated because of the involvement of foreign agreements
that have been made both from our neighbors to the north and to the
south, and we didn’t talk a lot about Mexico. But we all agree that
natural gas prices are not really reflecting what at the present the law
of supply and demand would dictate in the marketplace, and so any
thing and everything that can be done, for everyone to lock arms and
work together to get at this problem now, is what we are attempting
to do.
Certainly my proposed legislation is not perfect by any means, but
it certainly was something that we could move to give to FERC, to
make some things in the industry work better.
For a few minutes there the thought occurred to me that producer
and pipeline people could be in cahoots, but it didn’t sound that way a
time or two this morning. [Laughter.] I just say that in a light vein
because that’s the impression that some people have. But that isn’t
necessarily true, as the old axiom states: “We can shed some light on
things if we sit down and reason together and get the facts laid out
before us.” All Americans really want to make the American system
work, and I ’ll tell you there isn’t any system anywhere in the world
that’s like it, and it’s up to us to make it work. I ’m encouraged and
optimistic. Thank you very much.
I hope you will be able to stay and hear our next panel also because
that’s part of the reason we got everything together. Thank you very
much.
We will take about a 3 minute break while we change panels and
name signs and give our reporter over here a time to rest her fingers.
[A short recess was taken.]
Senator J e p s e n . On this next panel we welcome Christine Hansen
from the Iowa Commerce Commission, Dean Kleckner from the Iowa
Farm Bureau Federation, John Daniel, Iowa-Illinois Gas & Elec
tric, and Linda Blanchard from Cedar Rapids, who as I understand, is
president of the Citizens for Community Improvement, and Gordon
Dunn, vice president. Constance Berka and Opal Morrow are from
United Neighbors. Again, I would respectfully advise the panel that
101
we tried to have a 10-minute limit on statements. You see how easily
that escapes and gets away from us. We hope that you will consolidate
and summarize your prepared statements so that we can have more
time for questions and exchanges. The written remarks that have been
submitted by all of the panel members will be entered into the record
as if read, and, therefore, as we move now among the panel members
you can proceed to summarize your remarks as you see fit.
We started our last panel with the representative of the Federal
Energy Regulatory Commission, and I would prefer, if we may, to
start out with the Iowa Commerce Commission representative to kind
of set the stage and work from there this time. Christine Hansen, you
may proceed.
STATEMENT OF CHRISTINE A. HANSEN, COMMISSIONER, IOWA
STATE COMMERCE COMMISSION, DAVENPORT, IOWA
Ms. H a n sen . Thank you, Senator Jepsen. I want to thank you for
bringing this here to Iowa, and I want to thank you for your continued
support for the efforts of the Iowa Commerce Commission in the natu
ral gas area. You have worked with us the last couple years; John Con
rad, of your staff, has been very cooperative and mostly unsung because
natural gas wasn’t the issue on everyone’s lips until recently. So we
appreciate your long-standing efforts in this area and the continued
assistance of your staff.
The Iowa Commerce Commission has a couple of primary points we
would like to make. One is that we think the industry could be working
to solve this problem themselves and they are clearly not going to.
And the other is we have some great concern for the continued financial
viability of local distribution companies as the natural gas market
changes as rapidly as it is.
The heating season, as you know, Senator, in the upper Midwest is
bitter, and the feelings of Iowans on the subject of natural gas have also
been genuinely bitter. The natural gas consumers in this State, both the
large volume consumers and the small volume consumers, are getting
so bitter about the price of gas that they are doing quite a bit about it.
The cause of this bitterness is simply that natural gas has reached its
market-clearing price in Iowa. You have heard here already this morn
ing that there is a feeling that gas has reached its market-clearing price
on some systems. I submit that gas has reached its market-clearing price
on all of the Iowa pipeline systems. While I recognize that we get a
price of gas that is considerably below some in other parts of the coun
try, even our relatively low-priced gas is above the market-clearing
price, and the public is bitter because the market is not able to respond
to the fact that they have passed the market-clearing price. The Fed
eral Government must respond quickly to correct these errors because
nobody else is going to do it.
There is a continuing misconception in the natural gas industries
that prices have some room to move upward. Our major supplier,
Northern Natural Gas Pipeline, which is not the supplier here in the
Quad Cities area, but it’s a major supplier in Iowa, has recently pre
dicted that we will see no large increases from them in 1983 and 1984.
That company estimates an increase in both of those years at a level
102
about 10 percent above inflation. Such an increase will not be tolerated
by the present market. Such an increase is absolutely not a response
to the present market.
The natural gas industry also fosters the misconception that what
we are experiencing is a temporary surplus, and former levels of con
sumption will make the surplus vanish as soon as we have an economic
recovery. That is nonsense.
The Iowa Commerce Commission has developed a natural gas task
force which researches natural gas topics of importance, and I have
included a copy of their report from last year. It contains some of the
most statistically solid results of natural gas pricing and price reac
tion that are available nationally. The Iowa Commerce Commission
regulates six investor-owned gas and electric utilities, five gas-only
utilities. Iowa is serviced by 24 gas and electric municipal utilities and
17 gas-only municipals. The commission is charged only with assuring
adequate service provided by the municipals. We do not regulate the
rates of those municipals. In all, we regulate 412 utilities in Iowa,
and in addition, we regulated more than a thousand grain dealers and
grain warehouses.
By far our greatest volume of complaints for all that regulatory
authority stems from the price of natural gas. The commission has
been as frustrated as the average consumer concerning natural gas
rates, and we have tried to do something about it through cooperating
with your office in helping with legislation, through communicating
with our congressional delegation. We have moved one o f our
attorneys, as you know, to Washington, D.C., full time, and we are
one of three States in the Nation that intervenes full time for the
Federal Energy Regulatory Commission. The other States are New
York and California.
However, prices are still too high. More than 80 percent of the resi
dential natural gas bill of the typical Iowa consumer is set in Wash
ington, D.C. The Commerce Commission thus has about 20 percent—
and that amount is declining rapidly—of the price that we can regu
late in Iowa. That price reflects primarily fixed costs of the system of
the distribution company that are difficult to cut.
Not surprisingly for you, Senator, who know Iowa consumers quite
well, the consumers have been providing most of their own relief to
the problem. I have some charts here [indicating] that show the lowaIllinois system and the price reaction. Here is the price of natural ft& s
on the Iowa-Ulinois system corrected for inflation, 1979 through 1981.
This is a consumer reaction to that price. That’s what consumers did by
1981; that’s how much natural gas the average household was using
compared to what it used in 1969.
Senator Jepsen . I would like to ask, if you have no objection, if you
could make these charts part of the record ?
Ms. H a n se n . Certainly. I would be glad to do that. I also have, at
tached to my prepared statement, a breakdown of my comments that
reflects the total natural gas consumption and conservation in the State
of Iowa. In 1970, total sales in Iowa were more than 307 million Mcf,
with company total revenue of more than $176 million. By 1981 we
saw a substantial drop in total sales to 27 million Mcf, but an accom
panying astronomical jump in total revenue to $731 million; $176 mil
103
lion to $731 million, with that kind of a drop in consumption during a
period wiien 100,000 customers were added to the natural gas system
in this State.
I predict that Iowans are going to continue to react to the increased
patural gas price in the same way. A fact which I have not seen well
documented outside of Iowa is that our residential customers have
just as much price elasticity as our industrial customers. When an in
dustrial customer goes off the system it’s one big jump downward. Res
idential customers are reacting in exactly the same way to the price as
industrial customers.
In Iowa the marketing problems resulting from natural gas price
reaction are particularly noteworthy in the industrial and the residen
tial sectors, but the commercial sector, the small business sector, in the
last year has been playing a very fast catchup. Their total consumption
was down 5.3 percent in this State in the last year, and commercial
sales were down 16 percent. Now, that is not all due to the economic
problems, as some people in the gas industry would like us to believe.
We also have shut down some large plants using great quantities of
natural gas in the production process, such as farm fertilizer pro
ducers. Some of those plants are never going to come back on line in
the State. They are never going to be able to produce anhydrous am
monia at a price that’s competitive. In other Iowa industries we’ve wit
nessed loss of large loads due in part to the incremental pricing, which
encouraged fuel switching to both coal and fuel oil. The primary fuel
switch going on in the State is to coal and fuel oil, but now we are see
ing some switching to electricity.
On the residential and commercial side, natural gas usage has been
cut primarily through energy conservation, though there certainly is
some fuel switching on the residential side as well. What we are cre
ating at lightning speed is a natural gas distribution system which has
extreme weather sensitivity. That is, residents, industrials, and com
mercials might heat with kerosene space heaters, process heat, and
electric heat pumps until the temperature dips below 20 degrees, and
then they will all switch to gas heat, creating very uneven load and
volume demands even the best of weather forecasters could not plan for.
There is no question that we were an energy-wasteful country when
natural gas was so cheap, and this was particularly true because it was
an underpriced commodity. In Iowa we are beginning to correct pat
terns of waste with vigor, as Iowans always do. Continued mispricing
of natural gas will only speed the current pace of changed usage pat
terns, and will ultimately result in ruining the natural gas market. The
fact is that we are not going to return to the good old days of low pric
ing, and we are not going to return to the good old days of sales at the
level that they were. Thank you, Senator.
[The prepared statement of Ms. Harden, together with appendixes,
a report, exhibits, and an attachment, follows:]
104
P repared S tatem en t
of
C h r istine A . H ansen
The Iowa State Commerce Commission has a vital interest in federal
natural gas policy because of its enormous impact on our state.
We are
pleased to have an opportunity to present testimony concerning the state
of natural gas markets and hope you will consider the Iowa Commerce
Commission as an ongoing resource to your committee on the subject of
natural gas.
I am particularly pleased that the Joint Economic Committee chose to
bring this hearing to Iowa, a state which is particularly hard-hit by the
escalating price of natural gas.
is long and bitter.
The heating season in the Upper Midwest
Natural gas consumers in this state— both large and
small volume consumers— are getting as bitter as the weather about the
price they pay for fuel.
The cause of this bitterness is simply that
natural gas has reached its market clearing price— has exceeded its market
clearing price for the most part— and the market is absolutely unable to
respond to the consumer reaction.
The federal government must respond quickly to correct those errors
which prohibit the natural gas market from operating correctly.
There is
a continuing misconception in the natural gas industry that prices have
room to move upward.
Our major supplier, Northern Natural Gas Pipeline, has recently
predicted that we will see no large increases from them in 1983 and 1984.
105
That company estimates an increase in each of those years at a level about
10 percent above inflation.
Such an increase will not be tolerated by this
market,
The natural gas industry also fosters the misconception that what we
are experiencing is a temporary surplus, and former levels of consumption
will make the surplus vanish as soon as we have an economic recovery.
That
is nonsense.
The Iowa Commerce Commission has developed a Natural Gas Task Force
which researches natural gas topics of importance to Iowa.
The findings
of this group, however, are some of the most statistically solid results in
the country and are clear evidence that the twin theories of the industry—
that prices have room to move upward before drastic damage is done to the
market and that the temporary surplus will disappear with economic
recovery— are wrong.
I have attached a copy of one of the comprehensive
reports of our Natural Gas Task Force to this testimony and recommend that
this committee study the detailed economic conclusions reached therein.
The Iowa Commerce Commission regulates the rates of six investor-owned
gas and electric utilities and five gas only utilities.
Iowa is also
served by twenty-four gas and electric municipal utilities and seventeen
gas only municipals.
The Commission is charged with assuring adequate
service is provided by the municipals, but we do not regulate their rates.
We regulate 412 utilities in Iowa, 81 for rates and service and 331 for
service only.
In addition, we regulate more than a thousand grain dealers
and grain warehouses.
By far our greatest volume of complaints stem from the prices charged
for natural gas.
The Commission has been as frustrated as the average
consumer concerning natural gas rates, but we have been able to do something
106
about it,
We have met repeatedly with most members of the Iowa Congressional
delegation, have suggested legislation which Senator Roger Jepsen has intro
duced and strongly advocated in the Senate and which the entire Congressional
delegation introduced in the House.
We are one of three states in the nation with a full-time attorney
stationed in Washington, D.C.
(the other states are New York and California).
The Commission has intervened in every case before the Federal Energy
Regulatory Commission (FERC) which has potential impact on Iowa, and our
attorney has been extremely effective for the citizens of Iowa.
However, prices still are too high.
More than 80 percent of the
residential natural gas bill of the typical Iowan is set in Washington.
After this year's round of rate hikes, that will be closer to 90 percent.
So, the Iowa Commerce Commission has 10 to 15 percent of the price to
regulate and that represents primarily fixed system costs, safety, repair
and billing charges.
That leaves the Commission in an extremely frustrating
position— we get all of the heat and have none of the avenues to provide
meaningful relief to consumers.
Not surprisingly for those of you who know lowans, the Iowa consumers
have been providing most of their own relief.
The Iowa reaction to dramatic increases in natural gas prices since
enactment of the Natural Gas Policy Act in 1978 has been equally dramatic.
The attached Appendix A demonstiates that market reaction.
In 1970, total
sales in Iowa were more than 307 million MCFs, with accompanying total
revenue of more than $176 million.
By 1981, we have seen a substantial
drop in total sales to 217 million MCFs, with an accompanying astronomical
jump in total revenue of $731 million.
customers in Iowa increased by 100,000.
During that same period, total
Also attached as Appendix A is a
breakdown of total Iowa sales and use figures by industrial and residential
classes.
107
Iowans will continue to react to increased natural gas prices in that
same way.
A fact which I have not seen well documented outside of Iowa is that
our residential customers have just as much price elasticity as industrial
and commercial customers.
Granted, the shock to a distribution company's
system of a large industrial load being dropped is stronger than the
gradual eroding of residential customer use.
However, the gradual
residential load loss may, in the long run, be the loss which bleeds the
distribution system toward financial ruin.
In Iowa, the marketing problems resulting from natural gas price
reaction are particularly noteworthy in the residential and industrial
sectors, but I predict the commercial sector is going to be playing some
very fast catch-up.
For the twelve months ending November 1982, total
MCF sales in Iowa were down 5.3 percent, while commercial sales dipped
more than 16 percent for the same period.
November 1982, as compared to
November 1981, demonstrated a total Iowa decrease in natural gas consump
tion for the month of 3.2 percent, while the drop in commercial sales was
more than 8 percent.
In the industrial sector, we have seen a loss of interruptible and of
firm sales with a consequent deterioration of the load factors for the
local utility companies.
Iowa has also seen the shutdown of some large
plants using great quantities of natural gas in the production process—
such as farm fertilizer,
Dr. Charles Nevaril, Vice President of Terra Chemicals International
of Sioux City, Iowa, testified before a joint Iowa Commerce Commission-FERC
hearing in Des Moines last Monday concerning the hammerlock in which
natural gas prices hold .the future of his company.
Three manufacturers of
108
nitrogen fertilizer have already closed in Iowa, and three remain open but
threatened.
This is a national problem, and many of the closed plants will
never reopen.
In other Iowa industries, we have witnessed the loss of large loads
due in part to incremental pricing which really encouraged fuel switching
to both coal and fuel oil.
We are seeing some fuel switching in all seg
ments of natural gas use to electricity.
We are uniquely situated in Iowa
with excess electrical capacity generated by coal and nuclear, at costs
which are generally below the national average.
On the residential and commercial side, natural gas usage has been
cut primarily through energy conservation.
However, there has certainly
been plenty of conservation in Iowa industry, and there is escalating fuel
switching in the residential sector— along with a great deal of fuel sub
stitution for base load heating.
We have seen extensive weatherization and retrofitting of homes, as
well as significant increases in the energy efficiency of new construction.
What we are creating at lightening speed is a natural gas distribution
system which has extreme weather sensitivity.
That is, residents,
industrials and commercials might heat respectively with kerosene space
heaters, process heat and electric heat pumps until the temperature dips
below 20 degrees.
Then, they will all switch on the gas heat, creating a
very uneven load and volume demands even the best of weather forecasters
could not plan.
There is no question but that we have been an energy wasteful country.
This has been particularly true of natural gas usage because it was an
underpriced commodity for so many years.
In Iowa, we are beginning to correct patterns of waste with the vigor
reserved to Iowans when they tackle a problem collectively.
Continued
109
mispricing of natural gas will only speed the current pace of changed usage
patterns, and could well result in ultimately ruining the natural gas market.
The fact is, the natural gas market will never return to the "good old
days" of high sales volumes— because it will not return to the "good old
days" of low prices.
In Iowa, we are seeing greatly increasing sales of equipment which uses
gas more efficiently such as energy-saver water heaters and gas stoves.
There are continuing advances in gas appliances, such as the well-known
Lenox pulse combustion furnace and the new Amana energy-saving furnace.
Both are more than 90 percent efficient,
The Lenox is manufactured in
Marshalltown, Iowa and has been a bright spot in our state's economic
picture.
A second shift had to be added at the Lenox plant, and all the
furnaces they can manufacture this winter have already been sold.
I know
of several people who have ordered them and are content to wait months for
delivery.
This furnace is vented with a plastic pipe out the side of the
basement, rather than a metal pipe up the chimney, because of the minimal
heat loss.
The Lenox furnace alone, per unit, will conserve 25 to 30 million
BTUs of natural gas energy each year,
That furnace is but a single eXsitiaple
of hundreds of products on the market today— and thousands of products to
follow in the near future— which have had and are going to continue to have
an impact on total natural gas demand.
No economic turnaround will halt the production and purchase of those:
gas-saving appliances.
No Iowan is going to rip the storm windows off or
throw the blankets of attic insulation out.
And, now that Iowans are be-,
coming aware of the importance of weather-stripping, caulking and keeping
the thermostat turned down, we are going to continue to do those things
year after year.
21-496 0
83
8
110
Since the mid 1970s, we have seen a conservation effort on a per
customer basis of about 25 percent.
And, we have a great deal of conser
vation yet to do in this state.
While I personally applaud this conservation effort, as a commerce
commissioner I must deal with the natural result of reduced demand.
The
fixed costs for the Iowa utilities are spread over lower sales volumes
which means higher and higher prices for customers.
This is particularly
true for those utilities which are losing substantial industrial loads
completely due to fuel switching.
We have a concern that this will
eventually threaten the financial integrity of local utilities.
Iowa has four gas distribution companies with total industrial sales
representing more than 70 percent of their total load— and -two companies
where industrials represent more than 80 percent of the load.
Percentage
sales by class for each company, based on 1981 Iowa sales, are as follows:
Residential
Percentage
of Total
Sales
Allerton
Great River
Interstate
Iowa Electric
Iowa-Illinois
Iowa Power
Iowa Public Service
Iowa Southern
Minne, gas co
North Central
Peoples
16%
17
15
35
34
46
30
44
62
7
33
Commercial
Percentage
of Total
Sales
3%
9
9
23
19
35
17
25
38
8
21
Industrial
Percentage
of Total
Sales
81%
74
76
41
45
18
51
31
0
85
46
Percentage
of Other
Sales
0%
0
0
1
2
1
2
0
0
0
0
Residential percentages range from 7% of North Central's total sales to
is sales. Commercial
46% of Iowa Power’
s sales and 62% o f Minnegasco’
s sales
percentages range from 3% of Allerton’
s sales to 35% of Iowa Power’
and 38% of Minnegasco’
s sales. Industrial percentages range from none of
s
s sales to 85% of North Central’
Minnegasco’
s sales and 18% of Iowa Power’
total sales.
I believe this, demonstrates the dilemma for the state regulator.
We
are the .focus of criticism from consumers and state legislators, though we
I ll
have control over a fraction of the price and have held that part of the
price below the inflation level, and we see a gloomy financial picture for
the state’
s natural gas utilities which all parties— including the utilities—
seem quite unconcerned about.
What the state regulator would most like to see happen as soon as
possible is for the natural gas market to be permitted to work.
We would
like to see the six inches of insulation someone just put in their attic
last year result in the correct economic conclusion— a lower bill this winter.
The federal government simply must permit the market to work through
modification of the Natural Gas Policy Act (NGPA). As we have seen with the
Iowa experience, the NGPA did solve the supply problem which it set out to
solve, and it did permit the market to react to real changes in natural gas
pricing.
The continued existence of long-term producer-pipeline contracts with
market frustrating clauses will prohibit efficient market reaction.
Unless
flexibility is forced into these long-term supply contracts, they will not
reflect accurate demand and price levels in the future— as they do not
reflect them today.
Any "wait and see" attitude on the part of Congress at this juncture
will escalate the problem.
If the marketing problems are not solved be
ginning this year, we will soon be looking at a very different natural gas
market which, in the end, will hurt consumer, distributor, pipeline and
producer.
112
Appendix A
Page 1
Iowa Natural Gas Usage, Revenue, and Customers
By Year*
Total Sales
Year
Total Sales
in MCF's
Total Revenue
Total Customers
Heating Degree Days
1970
307,419,180
176,340,658
590,610
7062
1971
306,896,792
191,541,067
602,614
6828
1972
309,210,287
211,867,483
614,771
7528
1973
297,543,895
221,464,828
625,260
6261
1974
300,441,607
245,592,387
635,489
6610
1975
284,786,256
290,830,232
644,824
67Q2
1976
261,694,084
327,829,317
654,172
6884
1977
240,613,893
384,768,101
661,645
6585
1978
238,051,663
461,685,136
670,227
7567
1979
237,719,553
557,513,996
682,006
7443
1980
226,218,129
626,029,467
695,833
6897
1981
214,012,621
731,402,534
705,331
6232
*covers approximately 97% of statewide sales
113
Appendix A
Page 2
Iowa Natural Gas Usage, Revenue, and Customers
By Year*
Industrial Sales
Year
Industrial Sales
in MCF's
Industrial Revenue
Industrial customers
Heating Degree Days
1970
121,698.950
44,144,798
1,446
7062
1971
119,545,766
47,594,007
1,542
6828
1972
119,205,654
53,208,471
1,550
7528
1973
122,808,987
62,509,863
1,577
6261
1974
124,659,725
73,198,013
1,551
6610
1975
112,450,770
79,961,510
1,464
6792
1976
105,034,983
103,007,431
1,481
6884
1977
97,997,617
128,425,547
1,551
6585
1978
89,192,566
144,708,000
1,542
7567
7443
1979
90,919,971
183,039,844
1,551
1980
93,324,810
227,049,986
1,560
6897
1981
94,811,624
287,199,250
1,575
6232
*covers approximately 97% of state w ide sales
114
Appendix A
Page 3
Iowa Natural Gas Usage, Revenue, and Customers
By Year*
Residential Sales
Year
Residential Sales
in MCF's
Residential Revenue
Residential Customers
Heating Degree Days
1970
86,917,625
83,603,777
527,366
7062
1971
87,680,403
89,550,077
537,750
6828
1972
93,002,039
99,411,495
548,146
7528
1973
83,407,522
97,111,409
557,406
6261
1974
84,674,669
103,881,592
566,304
6610
1975
86,607,865
122,723,618
574,588
6792
6884
6585
1976
86,503,702
138,466,517
583,228
1977
83,876,796
162,136,153
590,465
1978
89,731,983
201,496,165
598,748
7567
1979
89,251,223
238,778,199
609,648
7443
1980
79,407,523
250,661,357
621,664
6897
1981
72,046,569
281,116,995
629,361
6232
*covers approximately 97% of statewide sales
115
NATURAL GAS POLICY TASK FORCE OF
THE IOWA STATE COMMERCE COMMISSION
REVISED
FIRST REPORT
Task Force M e m b e r s :
Robert Latham
Michael May
Diane Mclntire
Joseph Murphv
John Pearce
Donald Stursma
August 4, 1982
116
SECTION I
THE PHYSICAL NATURAL GAS SUPPLY SYSTEM IN IOWA
Natural Gas is delivered to Iowa by three interstate natural gas
pipeline companies:
Northern Natural Gas Company (Northern Natural),
Natural Gas Pipeline Company of America (Nat. Gas Pipeline Co.), and
Michigan Wisconsin Pipeline Company (Mich.-Wis.).
Northern Border
Pipeline Company will commence deliveries of gas in Iowa this fall, but
all deliveries to utilities will be through Northern Natural.
Natural gas enters Iowa on main line transmission pipelines, and is
delivered to the point of sale by lateral pipelines.
Northern Natural's
practice has been to own and operate all laterals up to the community
served (except for several low-pressure lines) although "contributions
in aid of construction" were made by distribution companies for many
laterals.
Nat. Gas Pipeline Co., with a few exceptions, sells gas from
the main line and requires the purchaser to provide the lateral to the
distribution center.
Michigan Wisconsin is a mixture of the two practices.
A map of Iowa pipelines would show:
Northern Natural has a far-flung
many-branched transmission network providing gas service to approximately
two-thirds of Iowa's geographic area, while the laterals of Nat. Gas
Pipeline Co. and Mich.-Wis. are, except for high density population
areas, fairly short with few connections.— ^
The following table shows the sales volumes of the pipelines
serving Iowa for 1981— ^ (numbers of customers served by each company
are not available).
— ^See Appendix B for a detailed listing by Company of natural gas
pipeline sizes and mileage.
2/
— FERC Form No. 2: Annual Report of Natural Gas Companies (Class A
and Class B) 1981.
117
1981 Natural Gas Sales in Iowa (Bcf)
Direct
Distribution
____ Sales
Field &
Main Line
Industrial
Sales
InterNorth
(Northern)
27.7*
8.9
Natural
-
Mich-Wisc.
-0-
Sales
for
Resale
Total
100.8
137.4
.02
0-
-0-
60.6
60.96
60.98
26.9
28.38
28.38
226.76
100.0
12.5
(*Peoples Natural Gas Company)
Natural gas delivered by the interstate pipelines in Iowa is resold
to end users by 10 investor-owned utility companies, one privately owned
company, and 41 municipal utilities.
As of 1980, the last year for
which full data compilation is available, the number and type of customers
and the volumes of gas purchased are as follows:
Number of customers by Class of Service - 1980
(Thousands)
Residential
Commercial
Industrial
Other
All Iowa
664.5
89.15%
78.6
10.55%
1.9
0.26%
0.3
0.04%
8 Largest
Iowa Util.
640.6
89.21%
75.9
10.57%
1. 6
.22 %
.02
Total
745.4
100 %
718.1
100
%
Sales Volumes by Class of Service - 1980
(Bcf)
All Iowa
Residential
Commercial
Industrial
Other
Total
84.4
33.2%
51.2
118.3 (a)
46.4%
0.7
0.3%
254.6
4.5
246.6
1.8%
100.0
2 0 . 1%
100
(b)
8 Largest
Iowa Util.
(a)
(b)
80.8
32.8%
50.7
2 0 . 6%
110.6
44.8%
Value includes 3.4 Bcf Electric Generation
Differences between Industrial and Other volumes in the two
cases appear due to different definition of terms. Note:
sum of percentages almost identical.
%
118
Industrial and Commercial gas usage can be further broken down as
follows:
Iowa Firm and Interruptible Gas Sales Volumes - 19802/
Volume (Bcf)
%
% Total Sales
Commercial
Firm
Interruptible
Total
41.6
9.6
51.2
81
19
100
16.3
3.7
20.1
Industrial
Firm
Interruptible
Total
84.1
34.2
118.3
71
29
100
35.0
13.4
46.4
The following table shows, for the 8 largest Iowa utilities, total 1981
customers and sales volumes and the amount of gas received from each
supplier.
As was previously noted, data on the number of customers
served off each supplier were not available.
Customer Sales, and Supplier Data - 1981
8 Largest Iowa Utilities
(1)
Company
Peoples Nat. Gas
Customers
(2)
Util.
Sales
(Bcf)
(3)
Suppliers
(A)
Supplier
Sales
(Bcf)
(5)
%
116,614
36.62
NNG
NGP
36.51
0.52
98.6
1.4
37,773
9.03
NNG
NGP
MW
0.73
1.90
6.70
7.8
20.4
71.8
IPS
109.494
36.03
NNG
36.8
Iowa Power
132,835
29.6
NNG
NGP
26.65
3.51
88.4
11.6
Iowa-Illinois
158,052
47.16
NNG
NGP
6.18
41.13*
13.1
86.9
Iowa-Electric
118,971
33.42
NNG
NGP
MW
18.32
14.44
0.92
54.4
42.9
2.7
Interstate Power
31,592
22.16
NNG
NGP
5.12*
17.04*
23.1
76.9
North Central PSC
12,813
1.64
.06
16.39
9.1
0.03
90.6
Iowa Southern
NNG
NGP
MW
—3/American Gas Association, "Gas Facts", 1980.
17.94
100
119
Col. (1)
Summary of Information Compiled by ISCC Staff (Accounting)
from Utility Company Annual Reports for the 8 largest
companies which account for 97% of Iowa Customers and
sales: Peoples Natural Gas, Iowa Southern, Iowa Public
Service, Iowa Power, Iowa-Illinois, Iowa Electric,
Interstate Power, North Central PSC.
Col. (2)
Annual Reports - Rate Regulated Gas Utilities, 1981.
Col. (4)
Unless otherwise noted, these are pipeline company sales
to utilities. Totals will exceed Utility Sales by 2-3%
due to,unaccounted for gas. ^Indicates Utility Sales
figure; adequate pipeline sales data not available.
Col. (5)
% of total pipeline purchases.
The following two tables show for 1981 the revenues of the pipeline
suppliers from Iowa sales and plant and revenue information for the
largest Iowa utilities.
No data were available by state for interstate
pipeline plant in service.
1981 Interstate Pipeline Revenues
From Total Sales in Iowa
Company
Revenue(s)
%
Avg. Price
Per Mcf ($)
Northern
$410,389,420
61.5
2.9868
158,968,576
23.8
2.6076
98,298,926
14.7
3.4634
Natural
Mich-Wisc.
Plant and Revenue Data - 1981
8 Largest Iowa Utilities
Avg Rev
Per Mcf
($)
Revenue/
Plant
Ratio
Total Plant
In Service($)
%
Peoples
71,564,123
16.1
125,976,140
15.9
3.44
1.76
Iowa Southern
16,765,276
3.8
35,067,859
4.4
3.89
2.09
Company
Revenue
($)
%
IPS
71,930,370
16.2
115,484,267
14.6
3.20
1.61
Iowa Power
88,660,385
20.0
105,682,746
13.3
3.57
1.19
Iowa-Illinois
111,870,231
25.2
173,897,896
21.9
3.68
1.55
Iowa Electric
57,316,113
12.9
111,494,235
14.0
3.34
1.95
Interstate
17,899,896
4.0
64,199,449
8.1
2.89
3.59*
7,266,178
443,272,572
1.6
62,084,181
793,486,753
7.8
3.46
8.54**
North Central
PSC
* Distorted by $46.2M in sales to large industrial users.
**Distorted
$55.5M
in sales
to large
customer isbynot
currently
using
gas? industrial users.
uscis.
Lareest
120
SECTION II
THE TARIFFS AND CONTRACTS GOVERNING
THE TRANSPORTATION AND SALE OF NATURAL GAS IN IOWA
Review of filed tariffs and contracts^ made thereunder has been
criticized as both wrong and irrelevant:
Only in the world of regulation are contracts the
Talmud as commission rules and orders are the Torah.
A scholastic preoccupation with contract terms is,
therefore, a predictable quirk of utility officials,
commission staffs, and lawyers who have never practiced
in that other world in which firms compete with one
another and are occasionally allowed to fail. In that
outside world where the gas industry will presently
find itself, contracts that do not make sense are
routinely walked away from, repudiated, or renego
tiated — and without the prodding or support of
special legislation, rules, or orders.
The author of the above quote subsequently identifies as one defense to
a bad contract in that "other world", that of a seller attempting to
collect from an "insolvent utility incapable of raising its rates because
of consumer resistance. ".§/
Obviously, identification of such a disas
trous "remedy" demonstrates a continued need to review contracts which
are expressly subject to the authority of FERC and this Commission in
order to exhaust less disastrous remedies than utility insolvency.
Bearing in mind the foregoing "other world" criticism of contract
and tariff analysis as well as possible limitation on commission
— E.g., Foster Associates, Inc.. Washington, D.C., "Pricing Provisions
for Natural Gas Sales Contracts — A Statistical Report" prepared for
The Natural Gas Supply Association, April, 1982. Study analyzed
producer contracts including the frequency of utilization of such
items as kick-out clauses (i.e., contract form permitting buyer to
escape a contract on the basis of economic, marketing or regulatory
conditions).
— ^Tussing, A. R. and Connie C. Barlow, "The Rise and Fall of Regulation
In The Natural Gas Industry," Public Utilities Fortnightly, March 4,
1982 at 18.
- I d . at 22
121
authority to redress things such as "take or pay" provisions,— / useful
analysis can still be had on this subject.
Because the majority of the 109 contracts^-/ filed in respone to a
data request are standard contracts made under FERC approved tariffs the
focus of the following analysis is the FERC tariffs.
It is under the
FERC tariffs and the broader domain of FERC jurisdiction that such
current controversies as take or pay contracts^-/ are being actively
addressed.
— ^State ex. rel. Pow. Co. v. Department of Pub. Serv. Reg., 548 P. 2d
136 (Montana 1975). The case which found that a regulatory authority
had exceeded its authority in effectively forcing a utility to break
"take or pay" contracts is not satisfactory because it dealt with a
temporary agency decision and the correct opinion is somewhat conclusory
in its discussion.
8/
— The figure of 109 contracts reviewed does not include amendments
to those contracts or the blank form contracts used by gas utilities
under the Commission’
s jurisdiction.
—9 /E.g., It is FERC policy to consider "take-or-pay" penalties as bearing
on requests by pipelines for authorization to make off-system sales.
Natural Gas Pipeline Company of America, Docket No. CP81-392-000,
"Findings and order after statutory Hearing Issuing Certification of
Public Convenience and Necesity and Granting positions to Intervene,"
(Issued November 13, 1981) 17 FERC § 61,133. FERC also monitors
compliance that contractural "take-or-pay" provisions comply with FERC
regulations:
We will deny rehearing and reconsideration. As we explained
in our February 9, 1981 orders, Exxon’
s take-or-pay provisions
do not comply with Section 154.103 because the monetary credit
provided for therein operates in a different fashion than the
gas make-up provision prescribed in Section 154.103. Specifically,
Exxon’
s make-up provision treats the purchaser’
s prepayment as a
loan, the repayment of which is not completed until the expiration
of the contract term. Since there is no interest charge applied
to the load, the recoupment arrangement can be extremely burden
some to the purchaser, particularly where the recoupment is
allowed to occur over a period of some 10 or 15 years.
The Commission recognizes, of course, that a standard
Section 154.103 gas make-up provision has has the effect of
providing the producer with interest-free capital. Unlike
the Exxon situation, however, the duration of such an
interest-free loan is limited to the period of time elapsing
between the time the prepayment is made and the time the
buyer is in a position to make up the gas-in most cases,
no more than a few years.
Exxon Corporation, Docket Nos. CI-78-758, at. a l , "Order Denying
Rehearing and Reconsideration" (Issued May 28, 1981)
15 FERC 61,179.
122
An instructive initial step in reviewing the FERC approved tariffs
is a brief definition of the gas rates:
(a) two-part rate, (b) one-part
demand rate and (c) one-part commodity rate.
A tw.o-part rate is composed of a demand rate and a separate commo
dity rate.
The demand rate is usually applied to some contractual
"maximum daily entitlement" from the pipeline (or maximum storage
withdrawal volumes), to determine the monthly demand charge.
This
demand charge serves as a minimum monthly charge, independent of the
actual, monthly volume taken (or withdrawn from storage).
The actual
monthly volume taken is then applied to the commodity rate to determine
the monthly commodity charge.
The total monthly charge, then, under the
two-part rate, is the sura of the separately determined demand charge and
commodity charge.
A demand rate is analogous to the "demand rate" portion of the twopart rate.
Therefore, under a one-part demand rate, the purchaser will
pay a uniform m onthly charge, regardless of the actual monthly volumes
taken (or withdrawn from storage).
As seen in the following table, the
only instance of this rate is for storage services.
A one-part commodity rate, then, is analogous to the "commodity
rate" portion of the two-part rate except that it normally includes
demand components at an assumed load factor, and serves as the sole
means of determining the monthly charge, as applied to actual monthly
volumes taken.
Therefore, under a one-part commodity rate, there is no
minimum monthly charge (unless the sales contract contains a minimum
"take-or-pay" provision).
The utilization of these types of rates can be seen in the following
table.
123
BILLING METHODS APPLIED TO DIFFERENT
CLASSIFICATIONS OF GAS SERVICE IN IOWA
Gas
Service
Two-part
Rate
NATURAL
DMQ-1
G-l
WS-1
WS-2
AOR-1
One-Part
Commodity
Race
Demand Rate
X
xi
XI
X
X3
S-l
MS-1
MS-2
MS-3
LS-1
LS-2
LS-3
X
X
X
X
X
X
NORTHERN
CD-I
SS-1
WPS-1
PS-1
AOS-1
ACDS-1
ERS-1
X
X
X
X
X2
X2
MICH-WISC
CD-I
SGS-1
LVS-1
OS-1
X
X
X
^Take-or-pay; Take is required, pay is conditional on *takef
^Demand Portion of Rate is the nomination charge.
^Multi-part rate - Demand, Commodity, Injection and Withdrawal Charges.
Nat. Gas Pipeline’s Daily Ma x i m u m Quantity Service Rate (DMQ-1)
Northern N a t u r a l ’
s contract Demand Service Rate (CD-I) and Mich-Wisc.
contract Demand Service Rate (CD-I) are virtually identical with one
exception.
That exception -- a 75% M take-or-payM provision in Mich-
Wisc. CD-I service —
doesn’t apply in Iowa.
124
The DMQ-1 and CD-I rates are for standard gas service, available on
a firm twelve-month basis and billed according to a two-part rate.
Seventeen of the contracts reviewed were of this type and nine of the
CD-I contracts run until 1991-1992.
Natural Gas Pipeline Co.’
s General Service rate (G— 1) is comparable
to Mich-Wisc.’
s Small General Service Rate (SGS-1).
doesn’t have a comparable rate.)
(Northern Natural
The G-l and SGS-1 rates provide
standard gas service to comparatively small volume purchasers (i.e.,
users not using more the approximately 6,000 Mcf per day), only three of
this type of contract were found.
Winter service rates are offered by Natural Gas Pipeline Co. and
Northern Natural while Mich-Wisc. makes no separate provision for this
service.
Eighteen contracts for winter service were found and most will
not expire until 1991.
Natural Gas Pipeline C o ’
s Winter Service rates (WS-1 and WS-2) are
available to DMQ-1 and G-l purchasers on a firm 120-day basis, based
upon reserves available from specific tracts.
A purchaser contracts for
a maximum daily volume from the pipeline, and must take and pay for the
equivalent of at least 100 days of this maximum daily volume.
The rate
is billed on a one-part commodity rate.
N orthern Natural has three narrowly distinguished winter service
rates:
Seasonal Service Demand (SS-1):
This is available to CD-I pur
chasers on a firm 4-month basis, from November 27 through March 26 of
each heating season.
It is billed according to a two-part rate.
Winter Period Service (WPS-1) and Peaking Service (PS-1):
Available
to CD-I purchasers on a firm 3-month basis, from December 15 through
March 15 of each heating season.
This is billed according to a two-part
125
rate.
Commodity is billed on a monthly rate, but demand is billed on a
three-month rate (to be paid in three monthly installments).
WPS-1
demand is not to exceed 10% of purchaser’
s CD-I demand.
Natural Gas Pipeline Co., Northern Natural and Mich-Wisc. have
various authorized over-run services which are virtually identical.
Natural Gas Pipeline Co.’
s A0R1 rate is typical and is available to DMQ1 or G-l purchasers on an interruptible, day-to-day basis.
The availa
bility of A0R-1 on a given day is based on the pipeline's ability to
meet its firm load requirements for that day.
The rate is billed on a
one-part commodity rate.
Two services deserving of mention (other than Natural Gas Pipeline
Co's storage rates set out in Appendix C) are Northern Natural’
s Agri
cultural Crop Dryer Service (ACDS-1) and Mich-Wisc.’
s Large Volume
Special Industrial Service (LVS-1).
The ACDS-1 rate is available to CD-I purchasers on a firm basis
when available, for the limited purpose of drying seed grain and other
crops.
A purchaser determines the availability of ACDS by requesting
(nominating) specified ACDS volumes from the pipeline, in advance.
The
availability of volumes varies daily, based on the pipeline’
s firm load
requirements.
These are billed according to a two-part rate:
a commo
dity rate and a small nomination charge.
The LVS-1 rate is available to CD-I purchasers on a limited firm
12-month basis, for resale to a specified large volume customer whose
contract demand is not less than the greater of 6,000 dth or 3% of
purchaser's CD-I contract demand.
Service is limited firm in that the
pipeline may curtail up to 40% of the LVS-1 daily contract demand, to
meet its other firm load requirements.
commodity rate.
2 1-496 0
83
9
This is billed on a one-part
126
The foregoing preliminary review suggests at least one troublesome
area, i.e., the duration of existing contracts into the 1990's and the
consequent diminished flexibility available to jurisdictional utilities
to deal with the changing market conditions of deregulation.
Although
this inflexibility is expressly subject to FERC jurisdiction, it still
is a potential difficulty.
The monthly minimum charge feature of the tariffed rates gives
meaning to contract duration and minimum quantity.
All the major con
tracts have minimum charge provisions (e.g., the demand portion in the
CD-I rate).
If the FERC moves towards reflecting more of demand costs
in the demand charge, these minimums will become relatively more
important in affecting bills.
The reasonableness of these monthly
minimum charge provisions is an open question and becomes more important
particularly where substantial reductions in demand and commodity
purchases are expected as prices rise.
127
SECTION III
OBSERVED IMPACTS AND EXPECTED IMPACTS OF CHANGES IN
WELL-HEAD PRICES ON NATURAL GAS CONSUMPTION IN IOWA
A.
This report is a summary of a study of the relationships in Iowa
between yearly natural gas usage on a per customer basis and the factors
which are observed to affect such usage.
The purpose of this study is
to predict the extent to which natural gas usage per customer in Iowa,
by major customer class, is expected to be affected by changes in real
retail prices and real well-head prices of natural gas.
In the study,
other factors affecting usage by customer classes are also considered.
These additional factors include real income, heating degree days, and
the real price of fuel oil.
the years 1969-81.
Data used in the study are yearly data for
Data are for each of the eight major Iowa natural
gas utilities (Interstate, Iowa Electric, Iowa-Illinois, Iowa Power,
Iowa Public Service, Iowa Southern, North Central and Peoples).
Together, these utilities account for approximately 97% of Iowa sales
and customers of gas utilities.
All price and income data are in real (1967) terms, being deflated
by the Consumer Price Index - Wage Earners.
Data include average usage
per customer for each major customer class (residential, commercial,
industrial and "other" including electric generating plant usage).
Per
capita personal income data by county by year were used, with the per
capita personal income for a given utility reflecting weighted averages
of the income figures for the counties in its service territory.
Yearly
heating degree days from seven weather stations around the state were
used, weighted by individual utility sales in each region, to arrive at
yearly measures of heating degree days for each utility.
Yearly fuel
oil prices are reflected by the North Central Region index of #2 heating
128 '
oil prices.
Retail natural gas prices by year by utility by customer
class were determined as average prices by dividing customer class
revenues by class M C F ’
s.
Well-head prices of natural gas by utility by customer class were
more difficult to estimate.
As seen in the discussion in Sections I and
II of this Report, nearly all distribution (retail) utilities purchase
gas from more than one transmission pipeline.
Therefore, for each
customer class for each distribution utility, the percentage of natural
gas originating from each transmission pipeline was determined.
Average
yearly well-head prices per transmission utility were weighted by these
percentages to obtain a weighted well-head price of gas for each retail
customer class for each utility.
Given these data, a number of questions were addressed.
What
changes in per customer usage, real retail prices, and real well-head
prices have occurred over the 1969-81 period?
Second, what is the
relationship between real well-head prices and real retail prices for
each customer class for each utility?
Have these relationships changed
through time as the well-head prices and pipeline price structures have
changed?
The third question is what is the impact of changes in real
retail prices on customer class usage after making appropriate adjust
ments for heating degree days and current real oil prices and real
incomes?
Next, since retail prices are expected to be related to well
head prices, how does retail usage change as well-head prices change?
Finally, what are the likely changes in usage by customer class and in
total for each utility as real well-head prices change?
B.
Changes in Usage, Prices and Income between 1969 and 1981 - For the
1969-81 time period', considerable change has occured in the variables
which may be affecting the usage of natural gas in Iowa.
The experience
129
of Iowa Electric, as an example of the impact on one utility, is instruc
tive.
Results differ, of course among Iowa utilities.
Table I
Iowa Electric 1969 vs 1981
(Real 1967 Dollars)
Variable
1969
Residential Sales (MCF)
13,239,144
Residential Customers
79,503
Usage per Residential
Customer (MCF) - Actual
166.5
Customer (MCF)
Weather normalized
161.8
Real Retail Price Residential/MCF
$0,813
Real Well-Head Price Residential/MCF
$0.140
Commercial Sales (MCF)
7,999,363
Commercial Customers
11,070
Usage per Commercial
Customer (MCF)
722.6
Real Retail Price Commercial/MCF
$0,565
Real Well-Head Price Industrial/MCF
$0.140
Industrial Sales (MCF)
21,479,439
Industrial Customers
239
Usage per Industrial
Customer (MCF)
89,872
Real Retail Price Industrial/MCF
$0,288
Real Well-Head Price Industrial/MCF
$0.145
Other Sales (MCF)
9,538,702
Other Customers
10
Usage per Other Customer(MCF)
953,870
Real Retail Price Other/MCF
$0,252
Real Well-Head Price
Other/MCF
$0.145
Total Sales (MCF)
52,256,648
Total Customers
90,822
Usage per Total Customer(MCF)
575.2
Real Retail Price - Total/MCF
$0.457
Real Well-Head Price Total/MCF
$0.143
Real Electric Price Residential/kWh
$0.0223
Real Electric Price Commercial/kWh
$0.0232
Real Electric Price Industrial/kWh
$0.0123
Real Electric Price - Other/kWh
$0.0268
Real Fuel Oil Price (index)
97.00
Real Income/Capita
$3206.74
Heating Degree Days (yearly)
7443
Heating Degree Days
(69-81 yearly average)
7089
1981
11,774,476
102,457
114.9
123.7
$1,385
$0,687
7,539,662
16,054
469.6
$1,245
%0.689
13,796,649
451
30,591
$1,115
$0,742
309.053
9
34,339
$1,183
$0,742
33,419,840
118,971
280.9
$1,240
$0,711
$0.0229
$0.0244
$0.0167
$0.0244
251.26
$3815.61
6255
7089
130
For these utilities as a whole, the following results were obtained
by comparing 1970 results with those of 1981:
Table II
Iowa Totals - 8 Major Utilities
(Real 1967 Dollars)
Variable
Residential MCF
Commercial MCF
Industrial MCF
Other MCF
Total MCF
Res. Usage/Cust.
Comm. Usage/Cust.
Ind. Usage/Cust.
Other Usage/Cust.
Total Usage/Cust.
Res.-Real Retail Price
Comm.-Real Retail Price
Ind.-Real Retail Price
Other-Real Retail Price
Total-Real Retail Price
Res.-Real Well-Head Price
Comm.-Real Well-Head Price
Ind.-Real Well-Head Price
Total Real Well-Head Price
1970
88,375,773
52,996,785
134,649,607
47,525,729
323,547,894
164.6
842.4
92,925.9
3,168,381.9
538.0
$0,829
0.589
0.313
0.242
0.488
0.143
0.142
0.147
0.144
1981
73,290,448
46,656,693
110,012,632
2,232,849
231,955,006
114.4
614.4
69,584.2
131,344.1
323.0
1.452
1.304
1.145
1.129
1.272
0.699
0.695
0.738
0.718
As a further basis for comparison, Iowa prices by customer class
were compared with U.S. average prices for 1980.
These results are
presented in Table III.
In summary, considerable changes did occur during this period
both in the market for natural gas and in markets for gas substitutes,
particularly fuel oil.
Our next problem is to identify why usage per
customer changed the way it did.
C.
Relationships between Real Well-Head Prices and Real Retail Prices
by Customer Class by Utility.
To be able to predict the expected impact
of a change in well-head prices on usage in Iowa, it is instructive and
necessary to establish the relationships between real well-head prices
and real retail prices.
Plots of the relationships between these
Table III
AVERAGE PRICES $/MCF (1980)
City Gate
(Ave. Pi pel ine Rate)
Residential
Commercial
Industrial
All Sectors
(1) U.S.
3.61
3.34
2.81
3.13
2.41
(2) Iowa
3.20
2.85
2.51
2.81
2.34
(3) 9 Largest
Investor Owned
Utilities in
Iowa
3.15
2.82
2.51
2.78
2.38
3.02
2.68
2.23
2.64
2.25
Natural
3.36
3.08
2.66
2.95
2.34
M-W
3.58
3.24
2.91
3.04
2,82
By Pipeline
Northern
Sources:
(l) and (2):
(3):
Gas Facts 1980, American Gas Association (AGÄ)*
1980 IG-1 reports from Great River Gas Co., Interstate Power Co., Iowa Electric
Light and Power Co., Iowa-11linois Gas and Electric Co., Iowa Power and Light Co.,
Iowa Public Service Co., Iowa Southern Utilities Co., North Central Public Service
Co., Peoples Natural Gas Co.
* AGA states that 1981 data will be available in October or November 1982.
132
v a r ia b le s
suggest that, as real well-head prices have increased in
recent years, real retail prices have also increased, but
ably smaller percentages.
these relationships.
by consider
Exhibits I - V are instructive in noting
(These exhibits reflect real retail prices
(RGPR’
s) plotted against real well-head prices (WTWHPR's)
by customer
class - R=Residential;, C=Commercial, I=Industrial, 0=0ther, and T=Total).
The following estimated equations provide empirical relationships
for the plots from Exhibits I-V.
These
cross section-time series
relationships were estimated for the time period 1969-81 for the eight
major gas utilities.
Table IV
Real Re tail/We11-Head Price Relationships
Residential
Commercial
Industrial
Total
(All
Real Retail Price = 1.511 (Real
Real Retail Price = 1.486 {Real
Real Retail Price * 1.492 (Real
Real Retail Price * 1.502 (Real
coefficients are significant at
WH Price)fa.311) R^ » .86
WH Price)fa*469) &2 _
WH
= «95
WH Price)(0<563} R •= .87
the .01 level)
In interpreting these equations, the power on real well-head price of
"Total” of 0.563 implies that for every one percent increase in real
well-head prices, there is a 0.563 percent increase in real retail
price.
No significant differences among utilities were observed.
These
models, of course, were estimated over the range of actual data and
caution is required in projecting these relationships for real well-head
prices considerably beyond the range of experience.
It should be noted,
however, that these relationships have been highly consistent through
significant changes in pipeline pricing practices, changes in the cost
of capital, and periods of curtailments.
In summary, the ratios between real retail prices and real well
head price have changed considerably since 1969 as well-head costs have
constituted a greater percentage of retail prices.
The relationship
133
between these have exhibited obvious patterns.
Simple estimating
equations (log-linear models) are useful in estimating these relation
ships.
D.
Impact of Real Retail Price Changes on Customer Class Usage by
Utility
Yearly usage per customer has exhibited significant change
(decrease) since 1969.
Real retail prices have increased dramatically,
especially for industrial customers.
With minor changes in real income
and real electric prices, effects on gas usage of changes in real retail
prices and real prices of substitute fuels (fuel oil, in particular)
should be observed after adjusting for heating degree days.
In this
study, demand models were estimated for each major customer class
(excluding "Other") and for utility "Total" per customer usage as a
whole.
Individual models were tested over data ranging from 1969-81 to
1977-81 to determine if significant structural changes have occurred
(oil embargo "shock" or post 1977 gas decontrol).
Models for Commercial,
Industrial and Total are generally insensitive to time period chosen
while Residential models are insensitive to time period over the 1972-81
period.
Dependent variables (to be explained) were per customer usage per
year by customer class, to reduce problems of heteroscedasticity.
Real
retail price, real income, real price of electricity, real price of fuel
oil, and heating degree days were used as independent variables in loglinear models.
(The real price of electricity was not significant in
these models).
Dummy variables reflecting each individual utility were
used to account for differences in customer class composition (defini
tions of commercial and industrial customers may differ, for example, by
134
utility).
Dummy variables took on values of 1 or 0, with 1 used to
reflect the specific utility.
The following is a summary of repre
sentative models by customer class.
q = Ar PG<A2)
where
Y (A3>
Pq (A4>
All models are of the form:
HDD(A5)
e(AJ-DJ)
Q = Average yearly usage per customer per utility
Pg = Real average retail gas price
Y = Real per capital personal income
Pg = Real price index for fuel oil
HDD = Yearly heating degree days
DJ = Dummy variable reflecting the J = (8-1) utilities
A^ = Intercept/multiplicative variable
A 2 = Price elasticity for gas
A 3 = Income elasticity
A 4 = Cross-price elasticity with fuel oil
= HDD elasticity
Aj = Coefficient on the J-th dummy variable.
A$ = IPS; A 7 = INT; Ag = PNG; A9 * I-I; A 1 0 * IPWR; Au = ISOU;
A 1 2 = NCENT; IE is the basic model.
Representative results are the following:
(Standard errors are in parenthesis)
Table V
Variables Coefficients
Model
Residential
(74-81)
Log Aj A 2
A3 A4
-4.18 -0.42
.48
(0.94) (.03) (0.17)
A
A5
A7
A9
A 10
A6
h
AU
12
.0 2
.0 2
.59 -.04
.08
.1 0
.05
.15
0.91
(.1 0 ) (.0 2 ) (.0 2 ) (.0 2 ) (.0 2 ) (.0 2 ) (.0 2 ) (.0 2 )
Commercial
(74-81)
-2.74 -0.36 0.38
(1.74) (.04) (.31)
.2 2
.67
.07
-. 46
.54
.34
.2 0
.77 0.96
(.17) (.03) (.04) (.03) (.03) (.03) (.03) (.03)
Industrial
(74-81)
8.01
.55
(0. 76) (0.08)
.45
(-14)
Total
(74-81)
1.61 -.49
(2.23) (.07)
.1 2
.40
.54
.06
.06
.07 -.14 - . 1 2 1.48
(.1 1 ) (.2 0 ) (.04) (.04) (.04) (-04) (.05) (.05) (.04)
.28 1.99
.40 1.30
.75 - . 2 2 4.44 0.99
(.07) (.07) (.07) (.07) (-07) (.17) (.07)
Models for "Other" consumers were not estimated, since this market is,
to a great extent, being phased out.
The inclusion of "Other" in the
total does, however, may have the effect of causing a slight upward bias
in the total price elasticity as is noted below in the well-head price
models.
From these models, total customers as a group, a price elasticity^A^
of approximately -.49 is estimated.
As such, for a one percent increase
135
in the real price of gas, total usage per customer would be expected to
fall by about 49/100 of one percent, everything else equal.
E.
Impact of Real Well-Head Price Changes on Usage by Customer Class
by Utility. - From Sections B and C above, estimation has been presented
regarding relationships between well-head and retail prices and between
retail prices and usage by customer class.
From these two sets of
estimated equations, it is possible to estimate the relationship between
usage and real well-head prices.
If usage is a function of real retail
price and retail price is a function of real well-head price, then usage
is a function of real well-head price.
Let R =
0 ^ 2
then Q = a 3 (ajW012) •l/*1* = a 3 *cx^1+w a2
= a 5W 6,L
where R is the retail price, W is the well-head price, L is a factor
reflecting other variables, and Q is the quantity consumed.
The well
head price elasticity, a6 , would simply equal the retail price elasticity(a4)
times a2.
Table VI
Model
Residential
Commercial
Industrial
Total
c*2
cti+
a2*a »t“a6
.311
.469
771
.563
-.42
-.36
-.55
-.49
-.13
-.17
-.42
-.28
As such, using this method, well-head "price elasticities should
range from -.13 to -.42 depending on the customer class.
If, indeed, a functional relationship exists between retail and
well-head prices, the relationships between usage and well-head prices
could be directly estimated rather than inferred as presented above.
The
136
following is a summary of the results of these independent estimates.
eAj'Dj
Q = B P ®2
YA3 P A4 HDDA 5
V
1 WH
0
where variables are as previously defined except that real well-head
prices are used.
Well-Head Prices Models
(Standard Errors in parenthesis)
Table VII
Variable Coefficients
a9
Model
Residential
(74-81)
Log Bj
a3
b2
.50
-5.25 -. 17
(0.84) (.0 1 ) (.15)
Commercial
(74-81)
.17
-1.71 -. 17
(1.75) (.0 2 ) (.32)
Industrial
(74-81)
6.87 -.46
( .99) (.07)
.62
(.18)
Total
(74-81)
1.09 -.34
(2.51) (.05)
-.2 1
-.14 1.54 .98
.61
.0 1
.0 1
.28
.46
.03
(.14) (.2 2 ) (.04) (.04) (.04) (.04) (.04) (.05) (.04)
Total
(Exc. Other) -1.03 -.34
(2 .2 2 ) (.04)
(74-81)
.0 2
1.96 .99
.32
.56
.0 2
.04
-.2 0
-.1 1
.63
(.1 2 ) (.2 0 ) (.04) (.04) (.04) (.04) (.04) (.05) (.04)
A4
-.07
.04
A10
.07
A 11
.0 2
A 12
-.0 2
(.09)
A7
.03
*8
.6 6
.0 2
.0 2
.0 1
.0 1
,0 2
.0 2
.0 1
A5
A6
.15
.19
.42
.34
.74
.73
.2 0
.53
.03
(.18) (.03) (.04) (.03) (.03) (.03) (.03) (.03)
.38 1 . 2 2
.72 - . 2 1 4.47 .99
.25 2.05
(.07) (.07) (.07) (.07) (.07) (.07) (.07)
A comparison of the predicted well-head price elasticities (Table VI)
with the actual estimated elasticities (Table VII) suggests that the
estimates and predicted are similar for all models.
It should also be
noted that Table VII includes a model of "Total" (excluding "Other)
which, as expected, has a slightly lower (not observed here due to
rounding) price elasticity than the total model.
For predictive pur
poses, this model should be used since the "Other" category has become
insignificant in recent years.
In sum, it is estimated that for each one percent increase in real
well-head prices, retail residential and commercial sales volumes per
customer would be expected to fall by 13-17/100 of a percent, industrial
sales per customer would fall by 44/100 of a percent, and total sales
per customer would fall by 35/100 of one percent.
137
Since 1978, the real weighted well-head price of gas has risen at a
compounded rate of greater than 20 percent per year in Iowa.
From this,
a seven percent (34/100 x .20) yearly decrease in total sales volumes
per customer in Iowa would be expected if the 20 percent real compounded
rate continues.
Industrial sales per customer would fall by approximately
nine percent per year while commercial and residential sales per cus
tomer would fall by about three percent yearly.
These estimates assume
normal heating degree days, no change in real income, and no change in
the real price of fuel oil.
Normal heating degree days must, of neces
sity be used; no change in real income or in the real price of heating
oil differs from recent experience in which both of those have fallen.
If these should continue to fall, expected natural gas sales must
accordingly be further reduced.
Obviously, these estimates are conditional upon the anticipated
real compounded changes in well-head prices.
It is unrealistic to
expect that real compounded price increases would continue at a 20%
rate indefinately.
Who would buy the gas?
For 10 percent real well
head price increases, the expected yearly percentage reductions in sales
would be one half of the reductions estimated above.
F.
Summary - This study has suggested and provided empirical support
for the factors affecting the quantities of natural gas demanded in
Iowa.
As real retail prices rise, as real income falls, as real fuel
oil prices fall, and as heating degree days fall, natural gas usage per
customer falls in Iowa by customer class by utility.
Little change in
the structure of these responses has occurred since 1969, suggesting
that even with significant events occurring over the time period,
138
customers appear to respond to real prices, real income, and real
prices of substitutes in a reasonably consistent manner,
What this
study has added is a method of estimating by how much usage changes as
these factors change.
Further, logical links have been made between
real well-head prices and real retail prices and between real well-head
prices and usage.
The primary results of these links are that con
sistency exists between methods and that estimates can be made of how
much usage would change in Iowa as real well-head prices change.
Results have been presented which allow such predictions to be made by
customer class by utility and by utility total.
The primary result is
that overall usage per customer will fall by about 3.4% for each 10%
increase in real well-head prices, everything else equal.
The response
by industrial customers would be considerably greater while responses by
residential and commercial customers would be less in percentage terms.
139
APPENDIX B
PIPELINE MILEAGE
NATURAL GAS
SUPPLIERS
Michigan-Wisconsin
309.40
10.50
22.60
13.00
23.80
106.62
96.22
3.00
2.00
miles
miles miles miles miles miles miles miles miles -
24»
16”
12”
10”
8”
6”
4”
3”
2”
587.14 miles
Natural Gas Pipe Line
256.00
315.39
4.87
257.00
40.60
8.39
3.48
4.19
4.05
12.43
11.74
7.14
3.15
miles
miles miles miles miles miles miles miles miles miles miles miles miles -
24»
36”
30”
26”
20”
16”
12”
10”
8”
6”
4”
3”
2”
928.43 miles
Northern Natural Gas
433.94
325.02
228.98
332.97
349.62
45.78
237.19
195.22
610.56
649.95
517.21
352.58
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
_
-
-
-
-
30”
26”
24”
20”
16”
12”
10”
8”
6”
4”
3”
2”
4,279.09 miles
UTILITIES (INVESTOR OWNED)
Great River Gas
1. 20 miles 10.80 miles 12.77 miles —
8"
6"
4"
24.77 miles
5,794.66 miles
140
PIPELINE MILEAGE
NATURAL GAS
UTILITIES (INVESTOR OWNED) ( Cont'd.)
Interstate Power
1.00
4.00
10.49
0.02
8.55
5.95
2.50
miles
miles
miles
miles
miles
miles
miles
- 16"
- 12«
- 8"
- 6"
- 4”
- 2«
- 1"
32.5
-
193. 79 miles
miles
Iowa Electric
2.00
37.30
99.96
14.53
40.00
miles
miles
miles
miles
miles
8"
6"
4”
3"
2"
Iowa--Illinois
41.42
18.10
104.53
38.87
37.48
80.28
65.64
10.00
5.06
miles
miles
miles
miles
miles
miles
miles
miles
miles
- 16"
- 12"
- 10"
- 8"
- 6"
- 4"
- 3"
- 2"
- 1"
401. 38 miles
miles
miles
miles
miles
miles
miles
- 16"
- 8"
- 6"
- 4"
- 3«
- 2"
119. 44 miles
Iowa Power
7.00
15.00
17.01
12.69
30.62
37.12
Iowa Public Service
3.66
4.69
0.40
0.04
0.02
miles
miles
miles
miles
miles
- 16"
- 10"
- 8"
- 6"
- 4"
8.81 miles
Iowa Southern
22.58 miles 31.48 miles 23.68 miles -
4"
3"
2"
77. 7- miles
141
PIPELINE MILEAGE
NATURAL GAS
UTILITIES (INVESTOR OWNED) ( Cont’
d.)
North Central Public Service
2.32 miles 10.25 miles 8.00 miles -
6”
3”
2"
20.57 miles
Peoples Natural Gas
8.70 miles - 4"
30.30 miles - 3"
8.02 miles - 2"
47.02 miles
926.03 miles
UTILITIES (MUNICIPALLY OWNED)
Bedford
Brighton
Clearfield
Corning
Lenox
Montezuma
Morning Sun
Moulton
Tipton
Wayland
Wellman
Winfield
21-496 0
15.66
14.09
6.50
9.50
21.00
14.70
4. 70
1.34
2.00
5.10
0.26
10.40
7.40
4.62
83 - 10
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
miles
- 3"
- 2"
2”
- 4'*
- 4"
4"
- 3”
- 2”
- 1”
- 2”
4”
2"
- 3”
- 2n
117.27 miles
117.27 miles
6,837.96 miles
142
APPENDIX C
NATURAL GAS PIPELINE COMPANY*S STORAGE SERVICES
Storage Service [S-l]
S-I is available to DMQ-1 purchasers.
Separately purchased DMQ-1
volumes are injected into Natural storage facilities.
withdrawn for use between November 1 and April 30.
to a two-part rate.
Volumes injected are
S-l is billed according
The basic monthly demand charge is composed of:
(1)
the Section 3.2 Demand Charge applied to the maximum daily withdrawal
quantity; and (2) the Section 3.3 Storage Capacity Charge applied to 45
times the maximum daily withdrawal quantity.^
The basic monthly commodity charge is composed of:
(1) the Section 3.4
Volume Injection rate applied to the volume injections in that month;
and/or (2) the Section 3.5 Volume withdrawal rate applied to the volume
withdrawals in that month.
Storage Service [MS-1]
MS-1 is available to DMQ-1 or G-l purchasers.
Separately purchased
DMQ-I or G-l volumes are transported and injected into Michigan-Wisconsin
Pipeline Company storage facilities (based on a transportation and storage
agreement between Natural and Michigan-Wisconsin).
Volumes injected are
withdrawn for use between November 1 and February 28.
NaturaV according to a one-part demand rate.
MS-1 is billed by
The basic monthly demand
charge is the Section 3 Demand Charge applied to the maximum daily
withdrawal quantity.®
A.
This basic monthly demand charge is decreased or increased
according to any deficiency in withdrawal deliveries by Natural,
or any requested withdrawal deliveries in excess of the maximum
daiTy withdrawal quantity, respectively.
B.
This basic monthly demand charge is decreased or increased
according to any deficiency in withdrawal deliveries by Natural,
or any authorized overrun withdrawal deliveries in excess of the
maximum daily withdrawal quantity, respectively.
143
Storage Service [MS-2]
MS-2 is available to DMQ-1 or G-l purchasers.
Separately purchased
DMQ-1 or G-l volumes are transported and injected into Michigan-Wisconsin
Pipeline Company storage facilities (based on a transportation and storage
agreement between Natural and Michigan-Wisconsin, different from the
agreement upon which MS-1 is based).
Volumes injected are withdrawn for
use between November 21 and February 28.
according to a one-part demand rate.
MS-2 is billed by Natural
The basic monthly demand charge is
the Section 3 Demand Charge applied to the maximum daily withdrawal
quantity.^
Storage Service [MS-3]
MS-3 is available to DMQ-1 or G-l purchasers.
Separately purchased
DMQ-1 or G-l volumes are transported by Michigan-Wisconsin Pipeline Company
to
Michigan Consolidated Gas Company storage facilities (based on a
transpor tation agreement between Natural and Michigan-Wisconsin, and on a
storage
agreement between Natural and Michigan Consolidated).
injected are
withdrawn for use between November 1 and March 31.
billed by Natural
demand charge is
according to a one-part demand rate.
Volumes
MS-3 is
The basic monthly
the Section 3 Demand Charge applied to 1/12 the sum of
the maximum monthly
withdrawal quantities.0
C.
This basic monthly demand charge, in a given month, can be: (1)
decreased or increased according to any deficiency in withdrawal
deliveries by Natural, or any requested withdrawal deliveries in
excess of the maximum daily withdrawal quantity, respectively; (2)
increased according to any additional volumes provided by Natural,
at the request of the purchaser, to compensate for injection
volume deficiencies by the purchaser; and/or (3) increased
according to any requested withdrawal deliveries which exceed both
the maximum daily withdrawal quantity and the maximum withdrawal
quantity for the withdrawal period.
D.
This basic monthly demand charge is decreased according to any
deficiency in withdrawal deliveries by Natural.
144
Storage Service [LS-1]
LS-1 is available to DMQ-1 or 6-1 purchasers.
Separately purchased
DMQ-1 or G-l volumes are injected into Natural storage facilities.
injected are withdrawn for use between December 1 and March 31.
billed according to a one-part demand rate.
Volumes
LS-1 is
The basic monthly demand
charge is the Section 3 Demand Charge applied to the maximum daily
withdrawal quantity.E
Storage Service [LS-2]
LS-2
is the same as LS-1 above, only charged according to different
tariff rates.
Storage Service [LS-3]
LS-3 is available to DMQ-1 or G-l purchasers.
Separately purchased
DMQ-1 or G-l volumes are injected into Natural storage facilities.
Volumes injected are withdrawn for use between November 1 and March 31.
LS-3 is billed according to a
demand charge is the Section 3
one-part demand rate.
The basic monthly
Demand. Charge applied to the maximum daily
withdrawal quantity.^
E.
This basic monthly demand charge is: (1) decreased according to
any deficiency in withdrawal deliveries by Natural; and/or (2)
increased according to any additional volumes provided by Natural,
at the request of the purchaser, to compensate for injection
volume deficiencies by the purchaser.
F.
This basic monthly demand charge is decreased according to any
deficiency in withdrawal deliveries by Natural.
02: IPS
O 0 :N
C 3 : 1P t L 0 4 M E 0 5 M A * I L L 0 6 : I A - S 0 U 0 7 : I N T E R
PL G TS FOR THE F U L i 1969 THRU 1980 CAT ASET
PLCT
OF RGPR_R*WTWHPR..R
SYMBOL
IS
VALUE
C EN T R A L
8:29
T h u r s d a y i.
JUNE
OF U T I L
‘ _LtPJ>_ P..J
T
'
_1 #5_
8
.
5
11
6
'
W4
_ ___4.1
85
8
2
l
" 1 . 7
8
7
I
............
..........
1
1
5
i
.
2
;
A
.t
6
7
5
47
13
2
4
7
8
"
1
2
1 .1
7
4 5
Ol
6
8
5
8
- ‘" w o
3
47
8
5
8
8
8
..
6
63
6
5 .
1. 1
i 35
24 2
6
4
131
3< » 2
4
5
2 7
33
4
7
0 .6
—
13
2
6
4
-
7
»
0. 7
'•
0 .6
0. oc
o .c t
0 .1 2
0 .1 8
C .2 4
C .3 0
0 .3 6
0 .4 2
C .4 e
ii*Twi-PR_R
“ AC
LI.1.
__ J_C.C5_.tAC
JM S S INC
VALUE S
ie . CBS H lC C E N
0 .5 4
0 .6 0
0..6 6
0 .7 2
0 .7 8
0 .8 4
EXHIBIT 1
O l: P E O P L E S
OliPEOPLES
0 2 : 1 PS
C 3: IP €L 0 4 : J E 0 5 ^ I A = i l l 0 6 : 1 A - s £ l T l ) 7 : IK T ER
P L O T S F O R T H E F G L L 1,969 T H R U 1 9 8 0 O A T A S E T
PLCT ~C F~ R Q P R ~ C T W H PR _T
___ L.
I
I
SYMBQL
_
14 2 132
___ 14186.4__
33e
.78 .
C .4 ?
C .4 e
KTW hFP_C
fr.CJ.EJ.________Z _ C B S > A C H I S S I N G
VALUES
22 CES H l C C E N
I S ” V A L U E ~ C F U ^ it ”
08:N
CENTRAL
8:29
THURSDAY,
JUNE
24 ,
2
1 93 2
C 3 : I P C L O A i l E 0 5 i I A * l L L 06 s I A - S C U 0 7 : I N T E R
P L O T S F O R THE FU L L 1969 T H R U i9 60 O A T A S E T
PL CT CF RC PR_I*V«TWHPR^I
5
0 .9
...
SYfBCL
16
______ 3...
0 8 *N C E N T R A L
6:29
THURSDAY,
JUN E
3
2<*. 1 9 82
IS V A L U E CF U T I L
6*
I
2
-8___________
1 RGPB. I
_£*.a... .
i5
5
5
5
66
26
<,
7
141A6666
2*37 _8
1*7
IA 7
O .b e
0 .1 2
0 .1 8
0 .2 *
0 .3 0
0 .3 6
0 .4 2
C .4 0
Mv,f-PP_i
2 CDS hAC
KISSING VALLES
cfc C E S H I C C E N
0.5<i
0 .6 0
0 .6 6
0 .7 2
0 .7 8
0 .3 4
0 .9 0
3
00
88
EXHIBIT
C 1 : P E 0 P L E S 0 2 : 1PS
O Z il'P T T T T T R L
04 : IE
05:1-»= I L lT T r 6 T r S - 5 C 0 '0 7 :'IT ,T P R
“
0 8 :7 T C £ N T R A L
8:29
PLOTS FOR THE FULL 1969 THRU 1980 DATASET
plo t
TTf
Rg p r Ic ^ wfw h p r ^o
sYMeoL~TT'Va l u F
CF
u t i l
THURSOAY,
JU NE
24 .
1982
'
R G P R .C
1.6
-‘-•-V_
1 .4
1 .3
I*.
00
-- ~3-- ■
2
4
5 424
42 3
24 5
24
_c_.3_
C. 2
EXHIBIT
-Jr.I
_C.?C_
4
“ O T sPE D P LtS
J
.0 0
0 .0 6
C . 12
0 .1 8
0 .2 4
0 .3 0
0 .3 6
0 .4 2
0 .4 8
V*TWHPR_0
.MUEJ.
...4 fi„ GbS..>.AD. K I S S I N G
VALUES
14 C I S H I C C E N
0 .5 4
0 .6 0
0 .6 6
0 .7 2
0 .7 8
0 .8 4
0 .9 0
EXHIBIT
5
150
Attachment
To provide a visual representation of thé results of the real
retail price models and of the real well-head price models, represen
tative demand curves resulting from these models were developed.
Electric usage data were used.
Iowa
The results are based on the total
models, which provide estimates of yearly natural gas sales per cus
tomer, where "customers" are simply Iowa'Electric's total number of gas
customers.
In preparing these demand curves, 1969-81 average heating
degree days were used along with the 1981 index of real fuel oil prices.
Of course, if heating degree days or real fuel oil prices were higher,
there would be horizontal outward shifts in the demand curve.
Retati Rate
Iowa Electric Light & Power Company Predicted Demand Curve
for Yearly Natural Gas Usage Per total Customer
(All Prices in Real 1967 terms)
(Average Yearly Heating Degree Days and 1981 Real Fuel Oil Prices Assumed)
Zo
.AO RFOIL*12
«o ita !K
J 0*
**'
ßec».(
DeUKectc)
20
A»
15
u$
i-o
.15
.5
Wellhead Price
Iowa Electric Light & Power Company Predicted Demand Curve
for Yearly Natural Gas Usage Per Total Customer
(A.11 Prices in Real 1967 terms)
(Average Yearly Heating Degree Days and 1981 Real Fuel Oil Prices Assumed)
153
Senator Jepsen. Thank you. I would like to move along and make
sure that all the panelists have adequate time. I will now welcome
Dean Kleckner, president of the Iow^a Farm Bureau.
I can remember, Dean, in 1976-77 I used to visit those areas quite
frequently where we had some grain elevators. There were piles of
grain on the ground to be dried and the dryers were running out of
natural gas in some areas. As you know, a grain that is put in big piles
and stored, with the high moisture for too long a time, is in danger of
spoiling, or in danger of starting a fire. It’s a loss of dollars and a lot
of other things, and there were times when in those days we didn’t have
enough natural gas and they had to shut those dryers off. In fact, they
didn’t have to shut them off; the gas was shut off. You may proceed,
Mr. Kleckner.
STATEMENT OF DEAN KLECKNER ON BEHALF OF THE IOWA FARM
BUREAU FEDERATION, DAVENPORT, IOWA
Mr. K le c k n e r . Thank you, Senator, and I appreciate the fact that
you are having this hearing on this matter. I am Dean Kleckner. I
farm in north-central Iowa at Rudd, and I serve as president of the
Iowa Farm Bureau Association, and I ’m testifying on behalf of our
150,000 farm-family members of our Farm Bureau Federation. I
commend you Senator, and I do remember those days that you spoke
of because my co-op elevator was shut off.
We do have an interest in our Nation’s future natural gas policy
decisions. We not only rely on gas to heat our homes and dry our
crops, but natural gas is a vital raw material for the production of
fertilizers and farm chemicals. I ’m not going to read everything in
of because my co-op elevator was shut off.
Prior to the enactment of the Natural Gas Policy Act, our Nation
was in a desperate search for new sources of natural gas. The artifi
cially low price of natural gas over-stimulated the demand for the
product. The gradual decontrol of some production under the NGPA
has resulted in an expansion of supply and reserves, and we’ve already
heard that documented today. In Iowa now, the present availability of
natural gas far outdistances the demand. Now, as I go on in the bottom
of that paragraph I say that we Iowans have reacted to market pres
sures in that we have just simply cut back. However, just as the farm
economy has not been the perfect market as envisioned by Adam
Smith, so too has the market for natural gas been unduly influenced
by Government intervention and take-or-pay clauses inserted in pro
ducer pipeline long-term contracts. Each of these influences has caused
an imbalance in the working of the market system.
At our recently conducted meeting of the Farm Bureau Federation
in Dallas, we adopted a policy which states in part—and I go down to
the middle of the paragraph—“ Government regulations and punitive
taxes levied on energy producers only serve to make the United States
more dependent on foreign nations to supply our energy needs,” and I
believe the basic part of our policy is what I have underlined. “We
support deregulation of natural gas prices. We support legislation
which will permit natural gas transmission lines to renegotiate take-
154
or-pay contracts that artificially inflate the price of such gas.” We
believe that the free-market system is the best allocator of energy
resources and the best provider of incentives for energy development
and conservation.
Some analysts predicted astronomical price increases with the
phased removal of price controls on crude oil. With price control on
crude oil completely eliminated in January 1981, and with consequent
reliance on the market system for pricing, the Nation has seen crude
oil prices stabilized, and recently, actually falling. U.S. production has
stabilized from its long decline, and conservation has been encouraged.
And, given the current inability of the OPEC nations to effectively
control the price and quantity of oil each of its members produce, we
may see a further decline in the price of oil, and I believe we are
seeing it today.
As natural gas prices are decontrolled, a similar outcome may result.
Natural gas is a basic energy source and is a close substitute for other
fuels. Its price will be influenced by the cost of our energy sources.
Many industrial users presently have the capability to readily switch
from natural gas to oil. This ability will force natural gas producers
to competitively market their product so as not to price themselves
out of a substantial share of the energy market, and I quote two people
there, and that’s included in this as an appendage that, “ The majority
view today is that the value of gas in an unregulated market is deter
mined by the cost of substituting residual fuel oil for industrial and
electric utility use.”
While the price of natural gas will be influenced and determined by
many factors, we must not neglect situations wherein pipeline com
panies are in a monopoly or near-monopoly position. Most Iowa com
munities have but one pipeline supplying its natural gas and at present
there is no suitable substitute for natural gas for the production of
nitrogen fertilizer. Care must be taken in these situations to assure
that the pipeline companies do not abuse their advantageous bargain
ing position to the detriment of captive consumers. Caution must also
be exercised so that producers facing a pipeline monopoly will re
ceive a fair return on their investment.
I point out then that the American Farm Bureau Economic Re
search Division published a report less than a year ago that explored
the effect deregulation would have on the cost of anhydrous ammonia.
Nearly 95 percent of the anhydrous ammonia produced in the United
States uses natural gas in its manufacture. The price of natural gas
used in this process will be influenced by the cost of other energy
sources I ’ve already mentioned.
Now, at least one study has predicted huge increases in the price
of nitrogen fertilizer when natural gas prices are decontrolled, but
these estimates were based on the assumption of $50-a-barrel crude oil.
I want to make this very clear, that those $600 and $800 prices per ton
of anhydrous ammonia that we hear about are really speculative today
in view of today’s energy situation. Let’s assume that there would be
some increase from the ¿982 estimate to $255 per ton. What would be
the effect on the farmer? And I suggest in 1983 it’s going to be less.
Our research economists postulate that using current average nitro
gen application rates, the cost of production would increase. They fur-
155
ther state that even if ^prices rise to cover the extra cost, farmers will
use less fertilizer simply because it improves profits. There are other
circumstances that are coming into play. Assuming then that product
price increases match the ammonia price increase, we believe, and I be
lieve, the nitrogen fertilizer use will decline. I don’t believe we are
going to be using the amounts in the future that we are using now.
Reduced nitrogen use will reduce expenses and reduce yields. The re
duced production will strengthen prices, and with higher nitrogen
prices there will be new incentives to improve the efficiency ofm trogen application. All we’re talking about here, SenatprfIs a market
system at work.
Now, going on, the study that our staff conducted was prior to the
announcement of the PIK program, the crop swap. Participation in
this program will idle row-crop ground, thereby further reducing the
demand for nitrogen fertilizer. Again, I predict that there will be real
bargains on anhydrous ammonia and chemicals as we have less acres
and we have suppliers fighting for the market that remains.
We are going to react to increases in gas prices in other ways as well,
and I list there six ways that I see that farmers will react to higher gas
prices. We’re going to use more soil testing and analysis of fertilizer
requirements for various crop alternatives. This is going to lead to
more efficient use of nitrogen fertilizer and other fertilizers. There will
be an increased demand for technology that will enhance efficient use
of fertilizer. Senator, I remember back when nitrogen was 7 or 8 cents
a pound and we just poured it on as we saw fit and if some escaped
from the soil because it was a little too wet or cold it didn’t bother me.
It does bother me now, and we have better equipment. So that is a func
tion of price on the market, the improved equipment and cutting back
a little bit and more efficiently using what’s there.
Same thing with natural gas, LP gas in my case on the farm. When
the price goes up I look for more efficient ways to utilize that. In
creased use of legume coverage crops which produce nitrogen that can
be used by succeeding crops. We’ll be seeing that this year with the
crop swap or the PIK program. We’re going to be sowing alfalfa
and sweet clover and putting back 80 pounds per acre that we won’t
have to buy next year or the year after. We’re going to see some reduc
tion in irrigation. Not a matter in Iowa, but much of the Nation uses
a lot of irrigation, and a lot of gas is used in that irrigation process
of driving those engines. We are adding insulation and weather
stripping to buildings and homes heated with gas and other energy
sources right now. Some switching to supplemental solar heat for low
temperature grain drying to replace natural gas or LP. Use of heat
lamps, electricity, as a substitute for heated farrowing houses as a
substitute for gas.
While none of the above adjustments alone will offset the expected
price increase, when these alternatives are totaled, a market price
impact will certainly be realized, and I think Ms. Hansen’s com
ments on the declining-use point to some of that that has been in the
farm in the rural areas as we are doing these things.
Some fear that natural gas prices will fly up in 1985 when most
sources of natural gas are deregulated. However, assertions by econ
omists and others have lessened the fear of a fly-up. In fact, some
156
have stated that the price of natural gas has indeed reached the mar
ket-clearing level. Ms. Hansen, I do believe we have reached market
levels now.
Issues of supply and deregulation of gas have been in the past few
months put on th back burner in Iowa, and the subject of long-term
producer pipeline contracts containing take-or-pay clauses have come
to the fore.
Take-or-pay contract clauses were included in producer pipeline
contracts at a time when there was a perceived shortage in the supply
of natural gas. I won’t go on here because our previous panel has
already covered the take or pay.
As I close out my comments I quote Christine Hansen in her testi
mony before the Federal House Subcommittee on Fossil and Synthetic
Fuels, and I would just like to go down, if you have a copy of my tes
timony, Senator, toward the bottom, what we would want you to do.
We urge the Joint Economic Committee to seriously consider imme
diate deregulation of all natural gas prices and legislation that will
permit natural gas transmission lines to renegotiate those contract
clauses. I quote Milton Copulos, director of studies at the Heritage
Foundation, “ I f there is one lesson to be learned from the history of
natural gas regulation in the United States, it is that the market works
best.” And something that’s not on there, a quote from Dean Kleckner,
“ There is no shortage of anything anywhere in the world where the
market sets the price.”
Senator, I have asked economists of noted scope if that’s a true state
ment and no one disagrees. Shortages don’t exist where the market sets
the price. Thank you.
[The prepared statement of Mr. Kleckner, on behalf of the Iowa
Farm Bureau Federation, follows:]
157
P repared S t a t e m e n t
I owa F
of
D ean
arm
B
K
leckner
ureau
F
on
B
ehalf
of
the
e d e r a t io n
On behalf of the 150,000 farm family members of the Iowa Farm Bureau
Federation, I would like to express my appreciation to the Joint Economic
Committee, and its chairman, Senator Roger Jepsen, for the opportunity to
comment on our nation’
s natural gas supply and marketing situation.
name is Dean Kleckner,
My
I am a farmer from Rudd, Iowa, and have had the
honor of serving as a president of the Iowa Farm Bureau Federation since
December, 1975.
Iowa farmers have an interest in our nation1s future natural gas policy
decisions.
We not only rely on gas to heat our homes and dry our crops,
but natural gas is a vital raw material for the production of fertilizers
and farm chemicals.
Prior to the enactment of the Natural Gas Policy Act (NGPA), our nation
was in a desperate search for new sources of natural gas.
The artificially
low price of natural gas over-stimulated the demand for the product.
The
gradual de-control of some production under the NGPA has resulted in an
expansion of supply and reserves.
In Iowa, the present availability of
natural gas far out-distances the demand.
Since 1974, according to Iowa
state commerce commission figures, the total amount of natural gas consumed
in Iowa has steadily declined, while the total revenue from the sale of
natural gas has sky r o c k e t e d . ^
Due to the dramatic increase in price,
Iowans have greatly increased their appreciation for, and use of, energy
conservation measures.
pressures.
21-496
0
83
11
Simply stated, Iowans have reacted to market
158
However, just as the farm economy has not been the perfect market as
envisioned by Adam Smith, so too has the market for natural gas been
unduely influenced by government intervention and take-or-pay clauses
inserted in producer-pipeline long-term contracts.
Each of these influ
ences has caused an imbalance in the working of the market system.
At the 1983 American Farm Bureau Federation convention, the delegates
adopted a resolution on energy which states in part:
"It is imperative to the nationrs long-term best interest that govern
ment and private industry work cooperatively and immediately to develop all
possible sources of energy.
market should be eliminated.
Bureaucratic interferences in the energy
Government regulations and punitive taxes
levied on energy producers only serve to make the United States more depen
dent on foreign nations to supply our energy needs.
Congress should
encourage capital investment for the development of domestic oil and gas
exploration by the competitive enterprise system and deregulation.
support deregulation of natural gas (prices).
We
We support legislation
which will permit natural gas transmission lines to renegotiate take-orpay contracts that artificially inflate the price of such gas."
We believe that the free market system is the best allocator of energy
resources and the best provider of incentives for energy development and
conservation.
Some analysts predicted astronomical price increases with the phased
removal of price controls on crude oil.
With price control on crude oil
completely eliminated in January 1981, and with consequent reliance on the
market system for pricing, the nation has seen crude oil prices stabilized,
and recently, actually falling.
U.S. production has stabilized from its
long decline and conservation has been encouraged.
And, given the current
159
inability of the OPEC nations to effectively control the price and quantity
of oil each of its members produce, we may see a further decline in the
price of oil.
As natural gas prices are decontrolled, a similar outcome may result.
Natural gas is a basic energy source and is a close substitute for
other fuels.
sources.
Its price will be influenced by the cost of other energy
Many industrial users presently have the capability to readily
switch from natural gas to oil.
This ability will force natural gas produ
cers to competitively market their product so as not to price themselves
out of a substantial share of the energy market.
According to Arlon
Tussing and Connie Barlow, in an article published by the Public Utility
Fortnightly, "The majority view today is that the value of gas in an
unregulated market is determined by the cost of substituting residual fuel
oil (for) industrial and electric utility (use)."
( 2)
While the price of natural gas will be influenced and determined by
many factors, we must not neglect situations wherein pipeline companies are
in a monopoly or near monopoly position.
Most Iowa communities have but
one pipeline supplying its natural gas and, at present, there is no
suitable substitute for natural gas for the production of nitrogen fer
tilizer.
Care must be taken in these situations to assure that the pipe
line companies do not abuse their advantageous bargaining position to the
detriment of captive consumers.
Caution must also be exercised so that
producers facing a pipeline monopsony will receive a fair return on their
investment.
The American Farm Bureau Federation Economic Research Division
published a report in the March 8, 1982, Farm Bureau News, exploring the
effect of deregulation on the cost and use of nitrogen fertilizer.
160
Nearly 95 percent of the anhydrous ammonia produced in the United
States uses natural gas for its manufacture.
The price of natural gas
used in this process will be influenced by the cost of other energy sour
ces, as I have already mentioned.
At least one study has predicted huge increases in the price of nitrogen fertilizer when natural gas prices are decontrolled.
(o)
however, were based on assumption of $50 barrel crude oil.
These estimates,
This assumption
is quite speculative in view of today’
s energy situation.
However, let us nevertheless assume that there would be some increase
in the cost of nitrogen fertilizer from the 1982 estimate of $255 per ton.
What would be the affect on farmers?
The American Farm Bureau Research Division economists postulate that
using current average nitrogen application rates, the cost of production
would increase.
They further state that even if prices rise enough to
cover the extra cost, farmers will use less fertilizer simply because it
improves profits.
Income maximizing producers will increase nitrogen costs
until the cost of additional fertilizer needed to produce an additional
bushel of grain is equal to the value of that additional bushel.
Unless
product price increases match the ammonia price increase, nitrogen fer
tilizer use will decline.
reduce yields.
Reduced nitrogen use will reduce expenses and
The reduced production will strengthen prices.
With higher
nitrogen prices, there will be new incentives to improve the efficiency of
nitrogen application.
Furthermore, the study of the AFBF staff was conducted prior to the
announcement of the PIK program.
Participation in this program will idle
row crop ground, thereby further reducing the demand for nitrogen fer
tilizer.
161
The farm community will react to increases in gas prices in other ways
as well.
1.
The responses will take to forms of:
More soil testing and analysis of fertilizer requirements for
various crop alternatives.
This will likely lead to more efficient use of
nitrogen fertilizer and other fertilizers.
There will be an increased
demand for technology that will enhance the efficient utilization of
fertilizer;
2.
Increased use of the legume cover crops which produce nitrogen that
can be used by succeeding crops;
3.
Some reduction in irrigation and a search for techniques to improve
irrigation efficiency;
4.
Add insulation and weather stripping to buildings heated with gas;
5.
Some switching to supplemental solar heat for low temperature grain
drying to replace natural gas or LP gas; and
6.
Use of heat lamps (electricity) as a substitute for heated
farrowing houses.
While none of the above adjustments alone will offset the expected
price increase, when these alternatives are totaled, a market price impact
will certainly be realized.
Some fear that natural gas prices will "fly up" in 1985 when most sour
ces of natural gas are deregulated.
However, assertions by economists and
others have lessened the fear of a "fly up".
In fact, some have stated
that the price for natural gas has indeed reached the market clearing
level.
Issues of supply and deregulation of natural gas have been, in the past
few months, put on a backburner in Iowa, and the subject of long-term pro
ducer pipeline contracts, containing take-or-pay clauses, have come to the
fore.
162
Take-or-pay contract clauses were included in producer pipeline
contracts at a time when there was a perceived shortage in the supply of
natural gas.
These contract clauses dictate that pipeline companies agree
to buy a certain percentage of newly found gas.
In order to take the
amount of gas contemplated by these clauses, pipeline companies have cut
back the purchase of "old" cheaper gas.
Today’
s supply of natural gas and
the demonstrated ability of the natural gas consumer to react to market
pressures, lead to the conclusion that these clauses are but another market
skewing device.
Commissioner Christine Hansen of the Iowa state commerce commission, in
her testimony before the House Subcommittee on Fossil and Synthetic Fuels,
stated,
"As we have seen with the Iowa experience, the Natural Gas Policy Act
did solve the supply problem and did permit the market to react to real
change in natural gas pricing.
The existing long-term producer-pipeline
contracts will prohibit efficient market reaction.
Unless flexibility is
forced into these long-term contracts, they will not reflect accurate
demand and price levels in the future.
The gluts of natural gas are not
going away until contract inflexibility is mitigated."
We urge the Joint Economic Committee to seriously consider immediate
deregulation of all natural gas prices, and legislation that will permit
natural gas transmission lines to renegotiate these contract clauses.
Allow me to end my statement with a quote from Milton Copulos, Director
of energy studies at the Heritage Foundation in Washington, D.C.,
"If there is one lesson to be learned from the history of natural gas
regulation in the United States, it is that the market works best." (5)
163
Footnotes
^See testimony of Commissioner Christine Hansen before the House
Subcommittee on Fossil and Synthetic Fuels, August 9, 1982, Appendix A.
2Arlon
R. Tussing and Connie C. Barlow, "The Rise and Fall of Regulation
in the Natural Gas Industry," Public Utilities Fortnightly, March 4,
1982, p . 18.
^See, "The Impact of Old Gas Decontrol on Iowa’
s Farms," released by the
Iowa Citizen/Labor Energy Coalition, September 12, 1982.
4
See footnotes 1 and 2.
5
Milton Copulos, "The Controls Are On You," Inquiry, August 1982, p. 33.
Other References
Barry P. Brownstein, "Natural Gas: The Case For Immediate Deregulation,"
Policy Report (Cato Institute), August 1982.
Sheila S. Hollis and Paul E. Strohl, Jr., "Squaring the Circle:
Implementing the Agricultural Use Exemption from Incremental Pricing Under
the Natural Gas Policy Act," Natural Resources Lawyer, Vol. XV, No. 2, 1982.
Steve Mufson, "Gas Consumer Say Pipelines Are Paying More Than Necessary
for Their Supplies," Wall Street Journal, November 11, 1982, p. 46.
Natural Gas Policy Task Force of the Iowa State Commerce Commission,
Revised First Report, August 4, 1982.
William Baldwin, "Paying the Piper," Forbes, November 22, 1982, pp. 42-43.
164
Senator J e p s e n . N o w I will recognize John Daniel
Gas & Electric. Welcome, John, you may proceed.
STATEMENT
of
Iowa-Illinois
OF JOHN DANIEL, VICE PRESIDENT-OPERATION,
IOWA-ILLINOIS GAS & ELECTRIC CO.
Mr. D a n i e l . We appreciate the opportunity to make a statement
before this committee. My name is John Daniel, and I am vice president-operation for Iowa-Illinois Gas & Electric Co.
In the structure of the gas industry we are a distributing company,
and many of our customers, I ’m afraid, don't fully comprehend that.
We do not produce gas, neither do we transmit it. We distribute nat
ural gas to about 225,000 customers in the Quad Cities, Iowa City,
Cedar Rapids, Fort Dodge, Ottumwa, and several smaller municipali
ties. At each city we have only one available pipeline supplier. In the
Fort Dodge area the supplier is Northern Natural Gas Co. In each
of the other areas it is Natural Gas Pipeline Co. of America. They are
not common carriers, but sell us gas they have under contract at rates
set by the Federal Energy Regulatory Commission.
Our goal at Iowa-Illinois is for our customers to have a dependable
supply of natural gas at an affordable price. In an effort to accomplish
this objective, our company is in frequent communication with its sup
pliers as to our supply requirements and the price of gas. We partici
pate in hearings before the Federal Energy Regulatory Commission
regarding rate increases of our pipeline suppliers, particularly with
regard to matters of rate design. We take this action to protect the
interests of the company, which are also our customers’ interests. The
rates paid to producers by the pipeline companies currently are estab
lished by the Federal Energy Regulatory Commission and by Congress
through the enactment of the Natural Gas Policy Act.
Pipeline and producer costs represent about 80 percent of the retail
customer’s bill. The producer costs alone represent about 60 percent
of the bill, and it has been this component of the cost which has been
increasing at the greatest rate in recent years and is largely respon
sible for the significant increases in gas prices.
At Iowa-Illinois, as Commissioner Hansen has indicated, in regard
to Iowa we are fortunate that the price we pay for natural gas is well
below the national average. We purchase the gas requirements for most
of our service territory, as I indicated earlier, from Natural Gas Pipe
line Co. of America, a pipeline company currently with the second low
est cost of gas among the 26 major pipelines in this country. This has
led to residential rates which in 1982 were 9 percent below the national
average.
The real price of natural gas for residential use has risen 55 percent
since 1960. That increase is due to the conscious national decision to
decontrol the price of gas at the wellhead to assure an adequate supply
and let it rise to its true competitive value. In real terms, with the cost
of gas reflecting the costs we as a distributing company control, has de
clined 34 percent since 1960.
The level at which natural gas should be priced is a complex issue.
The balance between supply and price is very delicate. Earlier regula
tion kept wellhead prices so low that severe shortages and curtailments
were experienced during the 1970’s. Had the price of natural gas been
165
permitted to rise to its true competitive value in other years, many of
the conservation measures being undertaken would have been in place.
As a result, customer bills likely would have been less and supply ample.
Iowa-Illinois, along with other gas distributors, has spent consider
able time and effort to combat actions that might lead to unnaturally
high gas costs. Iowa-Illinois has joined with otiier gas utilities in urg
ing the Federal Energy Regulatory Commission to curb escalating gas
prices, and we have urged congressional action which may be necessary
to deal with pricing problems m the short run. We must, however, pro
ceed with caution lest action be taken that will be necessary again.
In the longer run, we believe the marketplace should determine the
price o f natural gas. Natural gas is in competition with oil and must
respond to changes in oil prices which would materially affect gas
sales. We are seeing an increasing trend by industrial customers to
switch from natural gas to oil, or, where possible, to coal. As indus
trial sales are lost, an even heavier burden falls on the distribution
company and its residential and small commercial consumers. Regula
tion has difficulty responding to the changing market conditions in a
timely manner. We do not believe that extending wellhead price con
trols beyond the existing legislative period is in the best interests of
our customers.
We are very concerned with rising gas prices and the impact on
customers. We also recognize that contracts with gas producers hav
ing clauses that now contribute to an undesirably high gas price were
entered into with good intention, and I ’ll not go into them. They have
been discussed by other panelists. Some contracts with producers are
being renegotiated to modify such troublesome contract terms as has
been indicated previously. We urge and support such negotiations.
Increases in gas prices appear to be moderating, and we believe they
will continue to moderate as long as oil prices remain relatively stable.
However, we believe the gas industry and Federal agencies should
work together for a solution that would slow down the spiraling cost
of gas, but which would be fair for the producers and the pipeline
companies. That concludes my statement.
Senator J e p s e n . Thank you, John. Now, to move along, I w^ould ask
Linda Blanchard and Gordon Dunn to come to the table and I under
stand you both have some statement you would like to make.
Ms. B l a n c h a r d . Right.
Senator J e p s e n . You may proceed.
STATEMENT OF LINDA BLANCHARD, PRESIDENT, IOWA CITIZENS
FOR COMMUNITY IMPROVEMENT, DES MOINES, IOWA
Ms. B l a n c h a r d . Thank you, Senator. Senator Jepsen, members of
the Joint Economic Committee, ladies and gentlemen, thank you for
the opportunity to present testimony on behalf of the Iowa Citizens
for Community Improvement. Iowa CCI is a network of community
organizations which include CCI groups in Cedar Rapids, Council
Bluffs, Des Moines, Waterloo, and the Coalition for Community Re
form in Sioux City.
Increasing numbers of Iowans are cold, hungry, and angry; 95,000
Iowans are now unemployed and seeking a job. Over 10,000 Iowa
farmers are being forced by creditors to sell their land and/or equip
166
ment; 204,000 Iowans received food stamps in December; 80,000
Iowans applied for federally funded fuel assistance.
These figures are in striking contrast to the conditions reported by
the utility companies, pipelines, and natural gas producers doing busi
ness in Iowa. Iowa Resources, parent company of Iowa Power & Light,
reports a net 1982 income of $36 million. InterNorth, parent company
of Northern Natural and Peoples Natural Gas Co., experienced record
profits in 1981, and earned $3.01 per share in 1982 despite holding out
$64 million in the fourth quarter of 1982 for bad management deci
sions. Exxon, the Nation’s largest natural gas producer, reported prof
its of $1.48 billion in the final 3 months of 1982; 20 corporations owned
in excess of 70 percent of our natural gas supply. The board members
of these corporations appoint each other to sit on the boards of the
country’s largest banks, insurance companies, and other major in
dustries.
Low and moderate income families worry themselves sick, and in
some cases to death, over basic survival decisions concerning food,
shelter, health, and warmth. Meanwhile, corporation fat cats are flying
to Jamaica and other warm places to plot additional ways to control
our lives.
There is no economic justifiction for today’s expensive natural gas
prices. The consumer is at the mercy of the utilities, the pipelines, the
producers, and State and Federal regulators. Iowa CCI insists that
the State and Federal agencies and our elected representatives act in
the best interest of the American people. This means saying no to the
few greedy, powerful, middle-aged white men who sit on the boards of
Exxon, Arco, Texaco, Standard, Shell, Mobil, and about 14 other
companies who continue to put their regard for profits above our
Nation’s security and the well-being of people all over the world.
While we do believe in miracles, it is very doubtful that the Federal
Energy Regulatory Commission, the U.S. Justice Department’s Anti
trust Division or other agencies charged with protecting the interests
of the general public will take the corrective action necessary to put
natural gas prices under responsible control.
Therefore, Iowa CCI ioins with National Peoples’ Action and other
community groups from across the country in calling for the follow
ing comprehensive legislative changes:
One, extend controls on natural gas. Since big oil controls the sup
ply, the Federal Energy Regulatory Commission should start con
trolling the price in the interest of the American people.
Two, place controls on all gas. The producers now cap cheap gas and
intentionally dig deep wells in order to get the highest price.
Three, roll back prices on natural gas to the 1978 price levels. The
political deal that was cut in 1978 in order to get the Natural Gas
Policy Act through Congress has turned into a raw deal for the Ameri
can people. Roll back prices in order to check the greed of the big oil
companies.
Four, eliminate take-or-pay contracts. A thorough investigation of
the producers and pipeline companies will reveal that their interests
are so entwined that price-fixing and self-dealing practices are the rule,
not the exception, in the contract negotiations.
Five, cap expensive gas and require pipelines to purchase the least
expensive gas. This will encourage producers to make the least ex
167
pensive gas available instead of the most expensive gas, the way the
current system is working.
{Six, eliminate lndeiiiiite escalator clauses. Producers should be al
lowed only tnose increases which can be justified by actual production
costs, not irrelevant economic indicators.
Seven, shut the back door on FERC. The Federal Energy Regula
tory Commission has tried to raise the ceiling prices on various cate
gories of gas and decontrol other categories. FERC’s authority to
make rule changes which result in higher prices must be stopped.
Eight, ruling on purchase gas adjustments. Pipelines and utilities
should not be allowed to collect PGA rate increases unless they are
approved by FERC. No interim increases should be allowed.
It is time for our elected representatives to stand up to the big oil
corporations and stand up for the American people. Iowa CCI calls for
immediate and comprehensive action to stop the fraud and abuse which
is causing so many people to suffer while a privileged few gain.
Thank you.
Senator J e p s e n . Thank you. Gordon Dunn, now, from CCI.
STATEMENT OF GORDON DUNN, VICE PRESIDENT, CITIZENS FOR
COMMUNITY IMPROVEMENT, CEDAR RAPIDS, IOWA
Mr. D u n n . Thank you for inviting us here to speak. I have an
adaptation of remarks that I presented to the Federal Energy Regula
tory Commission.
The decontrol of natural gas prices has been the goal of the fuel
industry since long before the various energy crises. During the 1960’s,
the industry fought the development of pricing rules by the Federal
Power Commission, even though gas discoveries and reserves had been
constantly increasing. Then in 1968 the Supreme Court upheld the
right of the Federal Power Commission to control the prices, along
with the provision that the FPC would allow producers to increase
the price of their gas whenever the gas association’s figures showed that
the rate of new discoveries has decreased.1
The gas association’s figures soon began to show declining reserves.
This data was very hard to verify because it was provided by the
producers themselves and there were obvious incentives to fudge the
figures. Thus, Congressman John Moss’ Commerce subcommittee
found that in the early 1970’s the gas association had not reported
8.8 trillion cubic feet of discovered natural gas. Of course there are
other reasons why the fuel industry might want higher prices. Most
of the gas is produced by oil companies who also have substantial
holdings in coal. These fuels will be much easier to sell at their present
high prices if natural gas escalates to an equally expensive price.
In 1978 the petroleum industry achieved its goal with the aid of a
very clear-cut political deal. Since all parties to this contract agreed
that low- and moderate-income households would be hurt by steep
price increases, the deal included a package of energy assistance,
weatherization grants and low-interest loans for solar improvements.
These programs were to be funded by part of the windfall profits tax,
thus lessening the impact of this massive transfer of wealth from
poor to rich.
5 “ Who Owns The Earth” , James Ridgeway, 1980, Public Resource Center.
168
The assault of the present administration on programs designed to
help people who are trying to improve their homes has turned this
arrangement into a raw deal. The administration has impounded and
then reduced funding for low-income weatherization. These pseudo
economists have slashed the financing of low-interest loans for home
conservation and even attacked the tax credits for solar energy. At the
same time, the Government has increased direct subsidies to the energy
industry to a level of $10 billion a year. Along with ridiculously high
interest rates, these so-called cutbacks are stripping natural gas con
sumers of their ability to cope with price increases. Since the admin
istration and energy lobby have broken their contract with the Ameri
can people, we demand that the increase in natural gas prices be rolled
back to 1978 levels and the basic deal be renegotiated.
We come now to the role of the regulatory agency in energy policy.
The bottom line of the regulatory process is to insure accountability
and equity in situations which are not controlled by normal market
forces. Wherever there is economic concentration in industry, there
is even a partial monopoly, there should be close regulation, for with
out it the chances for abuse become facts of abuse.
Iowa CCI alleges collusion in the energy industry between producers
and distributors of natural gas. The purpose of this conspiracy is to
accelerate the rise in natural gas price levels beyond the schedule set by
the Natural Gas Policy Act of 1978. The energy conglomerates have
made these decisions with the knowledge that conservation options are
being closed off to consumers, and that this abuse is a form of economic
piracy. Thank you.
Senator J e p s e n . Thank you. We will now welcome Constance Berka,
United Neighbors of Davenport.
STATEMENT OF CONSTANCE J. BERKA, SPOKESPERSON, UNITED
NEIGHBORS, INC., DAVENPORT, IOWA
Ms. B e r k a . Senator, it is indeed an honor to be here today, and we
thank you and your office for letting us have the pleasure of speaking
before your committee.
I am Constance J. Berka. I live at 618 Myrtle St., Davenport,
Iowa. I am a member of United Neighbors, and also a community
advocate.
United Neighbors is an inner-city based community organization
with 3,400 active household members. Recently United Neighbors
formed an ad hoc committee to deal with the utility crisis because the
cost of utilities has become the number one survival problem in our
neighborhoods. As you are well aware, Senator Jepsen, we do not live
in southern comfort, we live in Iowa and it gets cold here in the winter
time. The reason I am speaking here today is because I represent the
typical, low income, inner-city utility consumer. Davenport is serviced
by Iowa-Illinois Gas & Electric Co., whose supplier is Natural Gas
Pipeline Co. of America.
Paying my utility bill is a hardship one month to the next. I am
on a fixed income, as are many others in the area. In Davenport for
1982, Iowa-Illinois mailed out 49,764 disconnect notices. Of those,
4,371 households were actually disconnected, which gives you a dis
169
connection rate of 8.78 percent. Besides putting a strain on me, it is
definitely putting a burden on the agencies that give direct assistance.
The Scott Couty General Relief Office has assisted 155 individual
family members with $11,000 already this fiscal year just for utilities.
Last year the Scot County General Relief Office spent approximately
$33,000 on utility assistance, with the projected expenditure of $44,000
to $48,000 for this current fiscal year. United Neighbors itself has
assisted 558 households with utilities in 1982 alone. Iowa East Cen
tral T.R.A.I.N., our local energy assistance agency, has received 4,200
calls for assistance this year. Clients call in to give their name, their
address and their phone number, and then are placed on a waiting
list; 2,800 applicants have been approved thus far this year. The
demand for assistance is far greater than the money available, and,
therefore, T.R.A.I.N. is expected to run out of money.
It seems that Iowa-Illinois is out to get a profit at any cost. For
example, the Louisa plant. Why pay for something that we don’t
need? We feel that Federal legislation must be pased to stop these
increases in natural gas prices. We feel the company is forgetting
who is paying th bills and in turn is making a profit for the company.
We, the consumers, ask you, what do we get in return? High bills
and rate increase. We have rights too. That is why people are organ
izing and fighting back, because they are fed up with the way the
ssytem is run. I want you to know that there are other States fighting
with the utility companies, as well as with their commerce commis
sions. We feel that these rate increases have gone out of proportion.
I recently heard of a case where an elderly person was sitting in
her home with the thermostate set at 58 degrees, wrapped in sweaters
because she could not afford to pay the utility bill. This is just one ex
ample of how hard it is hurting people on fixed incomes. My house
has been insulated by T.R.A.I.N., our local energy assistance program.
I have storm windows, and I try very hard to conserve energy. In the
summer my bill runs $40 to $45. In the winter my bill runs $350.
So you can understand why I am upset.
Davenport is being hit by high unemployment. November 1982 fig
ures were 12.6 percent for Davenport and 17.5 percent for the Quad
Cities. For the month of December 1982 the unemployment rate
for the Quad Cities was 18.8 percent. Due to this high unemployment
rate, outrageous utility rates are hurting the Davenport consumer, who
is already having a hard time making ends meet.
United Neighbors is against any further rate increases. We would
like to see a weathherization program sponsored by the utility com
pany without the cost being passed on to the consumer. In addition,
Senator Jepsen, we understand that you want to do something about
high natural gas prices. We are requesting that you introduce a bill
in the Senate which is similar to the “ Freeze Prices, Not People” leg
islation that Cardiss Collins from Chicago is introducing in the House.
This is a comprehensive bill which includes the following points: No. 1,
extend controls on natural gas; No. 2, roll prices back to the 1978 level
and then work on readjustment of prices: No. 3, eliminate take-or-pay
contracts; No. 4, close the back door on FERC; No. 5, eliminate auto
matic purchase gas adjustments; and No. 6, put all categories of nat
ural gas under control.
170
We will be monitoring you, Senator, Jepsen, to see that you are
actively working on this legislation and that you do vote in favor of
cutting natural gas prices. We are glad that politicians such as you
in Washington, D.C., and in the Iowa State Legislature are trying to
pass utility reform. I say it’s been time for a long time. We just don’t
want to sit there and listen. We want you to do something. There is a
saying all over the country, when it comes to utilities you either freeze
or you eat. Which do you choose ?
Before me I have a ballot used in a national campaign, “ Freeze
People or Freeze Prices.” We are not asking for your signatures now.
When you get back to Washington, D.C., wre the constituents of Iowa
Avili know by the way you vote, and we sincerely hope we have your
support in this campaign. I sincerely thank you.
Senator J e p s e n . Thank y o u , Constance.
Now, Opal Morrow may proceed. Ms. Morrow. Opal Morrow, is that
correct ?
STATEMENT OF OPAL MORROW, MEMBER, UNITED NEIGHBORS,
INC., DAVENPORT, IOWA
Ms. M o r r o w . Opal Morrow, Senator Jepsen. I am Opal Morrow,
and I live at 1012 Arlington Ave. in Davenport, Iowa. I ’m a member
of United Neighbors, and also a member of the Machinists Union, Lo
cal No. 388. I was a production worker at Bendix for 4 years, but on
January 29,1982,1 was laid off. I have been unemployed now for over
1 year and currently I am receiving unemployment benefits. To be
quite honest, I don’t know what I ’m going to do when my benefits are
terminated in 6 weeks.
During the 4 years I was employed at Bendix I was earning $8.30
per hour, and the thought of not being able to pay my utility bill never
entered my mind. Now, however, due to the increases in natural gas
prices and my inability to find employment because of the poor econ
omy, I am unable to pay my utility bill. This year for the first time
I had to apply for energy assistance through Iowa East Central
T.R.A.I.N. our local energy assistance program. T.R.A.I.N. has ap
proved my application and will be assisting me with $160, however,
my accumulated utility bill is $250.
I am one of thousands of laborers in this area who has been hurt
by the poor economy. Efficient use of energy is essential for a healthy
economy. Local industries such as Case, International Harvester, John
Deere, and Caterpillar are huge consumers of energy, and also the most
wasteful. These factories are encouraged by the pricing structure to be
wasteful because the more they use energy the less they pay per unit.
Increases in natural gas prices do affect all sectors of our local econ
omy, business, industrial, municipal, and residential. Industries pass
on production cost increases to the consumer, thereby driving up in
flation. People can’t afford to buy and inventories go up. When in
ventories go up, workers get laid off. As utility costs increase, pro
duction costs increase for industry. These increases are passed on to
the consumer as higher prices. The consumer is forced not only to pay
more for their own utilities, but also to pay for industries’ increased
utility costs. This adds to inflation, large inventories, and, finally,
171
high unemployment. The Quad Cities is a classic example of this.
This high cost of energy takes away money that would be paid for
wages and benefits. I ’m an example of how high energy costs are hurt
ing the American laborer.
Our municipal governments also pass on their increased utility
costs to us through fewer services or higher taxes. Higher taxes lessen
the consumers’ buying power. This, plus fewer city services once again
increase high unemployment in our cities.
Senator Jepsen, you must help us in our battle against high utility
bills by introducing Federal legislation that would control all cate
gories of natural gas. Second, we ask that you be more creative when
looking at the energy problem. For example, the Federal Government
could encourage industry to conserve and subsidize industry and
small businesses to develop alternative energy sources such as solar
and wind. Also, tax breaks for weatherization and funding for mass
transit.
A campaign to create jobs through energy conservation and alter
native energy sources would be a major boost for the economic condidition of low- and moderate-income consumers and working people.
Such a program would help slow down inflation and stabilize the econ
omy. According to the former director of the Iowa Energy Policy
Council, 85 percent of the money spent on inported energy leaves the
State, while only 15 percent of the money stays in the State in the
form of wages, and taxes, and so on. On the other hand, of the dollars
spent on conservation and other nonenergy expenditures such as retail
sales or goods, 60 percent stays in the local economy and is, therefore,
more productive. Such a program of conservation and alternative
energy sources would create jobs, save energy, help fight inflation, and
create a greater economic self-sufficiency.
President Reagan has stated that he wants to strengthen the economy
and bring inflation down. As a U.S. Senator supporting our President,
your only alternative to realize these goals is to sponsor legislation
that would control natural gas prices and short alternative energy
source.
Thank you.
Senator J e p s e n . Thank you.
I ’d like to pose a question for either Ms. Blanchard, Mr. Dunn,
Ms. Berka, or Ms. Opal Morrow; you can decide among you who would
answer it. Two point question. Would you freeze natural gas prices at
the 1978 level if you knew that indeed that would result in a shortage
of natural gas ? With the recommendation in your bill, if it was taken
to its complete and full legislative impact, we would have reasonably
close to Government control of the gas industry. Is that indeed what
you would recommend ?
Mr. D u n n . Perhaps I can address the question of the shortage situa
tion. We are in the position of having to depend on the gas industry
for the estimates of services and those seem to vary according to what
sort of prices they are willing to go for.
Senator J e p s e n . Excuse me, if I may interrupt, and I appreciate
what you are saying, but my question is this, would you support a price
freeze at the 1978 level if you knew that a severe shortage would
result?
172
Mr. D u n n . I f it’s that tightly linked, we couldn’t because—if you
are saying that that would automatically bring about a shortage—we
would be facing that sort of shortage situation, but I think you can
also look to the remarks that several of the speakers have just made
which point to the ability of industry to switch to other fuels and the
efforts of consumers to conserve.
Senator J e p s e n . Do you want to answer the second part?
Mr. D unn. State it again, please.
Senator J e p s e n . Should the gas industry be taken over by the
Government?
Mr. Dunn. Well, it’s a situation for the most part of monopoly. I
don’t know of any legal situation where several companies are drilling
to try and tap the same pool of gas that may exist. In situations where
you have monopolies you have to have regulation. You don’t have
normal market forces going on, and who regulates in that case is the
Government. Now, you are saying that that legislation we advocate
would mean a total takeover of the gas industry.
Senator J e p s e n . It approaches it.
Mr. D u n n . Yes. If that’s w h a t it takes in order to bring a fair
situation into the supply of the pricing structure.
Senator J e p s e n . There are about 26 pipeline companies. How many
should there be ? What would you say the number should be to avoid
having a monopoly?
Mr. D u n n . I ’m not saying necessarily that you can’t avoid having a
monopoly. I ’m saying that you have to regulate the monopolies that
exist.
Senator J e p s e n . D o you consider that 26 companies is a monopoly ?
I ’m just getting this for the record.
Mr. D u n n . I would say so.
Senator J e p s e n . Any others care to comment on that? I f the Gov
ernment took it over—let’s pursue this a little bit further. I f the
Government to6k it over, then we would have one Government pipe
line. Would that be a monopoly when they own it all?
Mr. D u n n . Well, now, you are saying that we’re advocating that the
Government take over the entire industry, is that what you are saying?
You seem to believe we’re saying—we’re just meaning-----Senator J e p s e n . I ’m really basically asking would that be all right
or would that be wrong?
Mr. D u n n . Let me try to understand what we’re getting at.
Senator J e p s e n . Well, why shouldn’t the Government take over the
pipeline industry ?
Mr. D u n n . Well, it would be a pretty difficult process right now.
We’re asking for fairness in the regulation; we’re not asking neces
sarily for the Government to take over the company, to buy them out.
Is that what you think we’re asking?
Senator J e p s e n . I don’t k n o w h o w it might be done, and I don’t
want to be belaboring it or debating it: I ’m just trying to clarify the
thoughts of the extent of the specific legislation that you had recom
mended in the five or six----Ms. B l a n c h a r d . I don’t believe that we’re asking for a Government
takeover of the natural gas companies. But right now, the pricing isn’t
equitable, and the low- and moderate-income people are suffering at the
173
expense of large company profits. Now, Northern Natural Gas Pipeline
is entirely owned by InterNorth. There is such and—and at the same
time InterNorth owns—wait a minute. In 1981, InterNorth’s annual
report said investments in Mobil Oil common stock, $61,.884,000. The
regular consumer does not have a chance. We’re at the mercy of one
pipeline that supplies us. We’re at the mercy of one utility who distrib
utes it, and we’re at the mercy of one producer that the pipeline and the
distributor purchase from. Now, we just want an even break, and right
now we haven’t been receiving it when our rates have been doubling in
the last 4 years. Our rates have doubled. At the same time, people are
making large profits. We are not asking for national legislation. We’re
asking for solutions to the problem, and we’re giving solutions that we
think will be helping. Now, to make blanket statements as to say we
want to nationalize, you are missing the entire point. We want to help
you solve a problem that is affecting the American people today. We’re
not asking for the Government’s takeover.
Senator J e p s e n . I understand, and Linda, I would remind you I was
asking that question, if you thought that was wrong.
Ms. B l a n c h a r d . I ’m sorry, Senator, but those types of statements,
it’s like us and them, and that’s not what America was built on is us,
management and labor, the rich and the poor, it’s everyone working
together, and when you start thinking of blanket statements you are
not going to reach the solutions that are going to benefit all. Now, the
suppliers, the producers, the distributors, they have given their testi
mony so that they can aid you in making a decision, and we would like
to do the same thing, and we think that this will be the proper solution
to those, and we want you to think about them because there are more
people in this country besides those people, the distributors, the pro
ducers ; there is the consumer who has to pay it.
Senator J e p s e n . That’s why you were represented here today, and
I thank you for your statements.
Ms. B l a n c h a r d . Thank you.
Senator J e p s e n . And I know and am pleased to see the unity of all of
us, and we say it takes all people in this country to make America work,
and we’ve got to work together to make it work. We indicated that
early on.
Ms. B l a n c h a r d . We also had 40,000 signatures on petitions th a t
we presented at the FERC hearing that people have signed, that
Iowans have signed, saying that they need help. They need some legis
lation. They need something done about these high natural gas prices,
and so we are not standing alone, and I ’m sure those other 40,000
people are not asking for blanket legislation such as taking over th e
national prices either, or the industry.
Senator J e p s e n . Is there anyone that has any additional comments
they would like to make ? Yes, Christine Hansen.
Ms. H a n s e n . Senator, you did mention when you opened this hear
ing that you didn’t have a specific representative from industry, and
we don’t leave the committee with an erroneous impression about what
industry is doing in this State and how important they are to the
natural gas distribution companies in this State.
Ms. Morrow said that she felt industry was extremely wasteful, and
the facts are to the contrary in Iowa. John Deere, for instance, w h ic h
21-496
0
83
12
174
is our largest manufacturer in the State, has cut their total cost of
production in energy use by 40 percent. The cost of John Deere trac
tors, I understand, is still pretty high, but that’s not because they
haven’t conserved to the very highest degree.
We have four companies in the State with total industrial sales
representing more than 70 percent of their total load; we have two
gas companies in the State with industrial sales representing more
than 80 percent of their total load, and we have one large gas distri
bution company, Iowa Public Service, that serves Sioux City and
Waterloo, that has 20 percent of their load serve one company. Terra
Chemicals, which manufactures farm chemicals, that company has
some financial problems in marketing its product at the price it can
charge, and there is a potential there for one distribution utility to
lose 20 percent of its load with one company closing down. It would
have a substantial impact on the rest of consumers too. I do want
you to know that industry is very important to the natural gas load
in this State.
Senator J e p s e n . Dean Kleckner, please.
Mr. K l e c k n e r . Senator, farmers are massive users of energy too.
And I don’t know anybody that’s happy with the cost of whatever
energy source they are using today, whether it’s natural gas, LP gas,
diesel fuel, anyway, it’s too high. We start out knowing that. I hap
pen to also believe that it was too low for a number of years. I just
loved buying my LP for 8 cents a gallon. I don’t know what that con
verts to, but it’s gone up 12 times from the 1970’s. I loved buying gaso
line for my car at 25 cents for a gallon. Four for a buck. I remember
those days. Frankly, those prices were too low. The Government was
regulating back then and they shouldn’t have been. The market should
be establishing the price. It would have been lower today had the
market established the prices in those areas of all those energy com
modities. We would have now developed the alternatives. Solar, wind,
we’d have those today.
I say to you the 1978 Natural Gas Policy Act was a mistake. It may
have seemed like it was working for a year or two. It didn’t work.
Don’t for heaven’s sake put on more band aids by the Natural Gas
Policy Act of 1983, if that’s what you end up with. It will be a mis
take too. The Government doesn’t do things very well; the market
does. We’ll have lower priced natural gas for all these consumers, for
all these farmers, for all industries if the market takes over because
it’s now at that market price. The time to deregulate is when you have
an excess, and that’s now. Probably the time not to regulate if you first
make the mistake of regulating is when you have a shortage. There is
no shortage today. Let’s get out of business. The market is going to
give us the best price.
Senator J e p s e n . Anyone else have a closing comment ?
Mr. D a n i e l . I would just like to add on what Commissioner Hansen
has said with regard to the industrial load. Our feeling is, as I men
tioned in my oral statement, we have one customer who represents
a very substantial portion of our total sales, industrial sales. I f we
lose that customer it will hurt us greatly. Not only do industrial cus
tomers switch, but you also have the hazard of the customer going out
of business, and this is particularly true in the case of the fertilizer
installations. And that makes jobs for the areas that we serve.
175
Senator J epsen . I s there anyone else that would like to make a
closing statement for the record ?
Ms. B er k a . Senator, I just feel from listening to Mr. Daniel from
the Iowa utility company, if he would care as much about the con
sumer, me, the low paying one, as he does about his bigger companies,
I have just as much right as the bigger companies do, and I feel I ’m
just quite upset about it.
Senator J epsen , All right. Any other comments, Mr. Dunn?
Mr. D u n n . No. Thank you.
Senator J epsen . Linda Blanchard ?
Ms. B lanchard . No.
Ms. B e rk a . We put just as much profit in his company as the bigger
industries do in this area.
Senator J epsen . I appreciate the comments, and I thank you all
for participating, Christine Iiansen, Dean Kleckner, John Daniel,
Linda Blanchard, Gordon Dunn, Constance Berka, and Opal Morrow.
Everyone recognizes also that we do need to provide a solution to the
natural gas pricing problem of today. I think that is one thing that
everybody on both panels agree on, that we do have a problem of the
pricing and we need to find a solution.
Iowans have seen their natural gas prices increase nearly a hundred
percent in the last 3 years. They have a right to expect that their
conservation efforts and the natural forces in the marketplace work
properly and fairly in their behalf. Clearly it is not the situation now,
and at the same time we have found today that when we have repre
sentatives from the producers, from the pipelines, the transmitters,
the utility companies, and so on, they too are concerned about the
problem. Although they do not totally agree about the solution, they
have given us some of their views with regard to providing natural
gas or heat. When you turn on your switch or your stove, whether it
be 30 below or 30 above, you want to be able to depend on it. And
that takes some long-range planning in both the distribution and the
amount of reserves that one must have. This is everybody’s problem,
and everybody in this country has got both a right and a need to have
input, and if we lock arms and we all work together we will solve it.
I do thank you very much. I want to express my appreciation for the
conduct and the thought that has gone into all the testimony here
today. We will see that the compiled reports here and the consensus
that has been brought up and summarized from them will be presented
to the Joint Economic Committee and to the various subcommmittees
in the Congress that deal with this problem, as well as the Iowa Com
merce Commission, and will be presented to each and every one of the
participants here today. I thank you all for coming, and have a safe
trip home.
The hearing is adjourned.
[Whereupon, at 12:31 p.m., the hearing was adjourned, subject to
the call of the Chair.]
[The following information was subsequently supplied for the
record :]
176
STATEMENT O F THE PROCESS GAS CONSUMERS GROUP
The Process Gas Consumers G r o u p (PGC) is an org a n i z a
tion of industrial consumers of natural gas organized to p r o
mot e the d e v e lopment and adoption of coordinated, rational,
and consistent federal and state p olicies with respect to gas
use.
Representing m a n y of the N a t i o n ' s basic industries,
our memb e r companies own and operate hundreds of plants in
virt u a l l y every state and purchase natural gas directly or
indirectly from both interstate and intrastate pipelines, with
m os t of our facilities on the interstate system.
I.
STATEMENT O F POSITION
W h i l e the range of uses in which P GC members use
natural gas is quite broad, PGC's views wit h respect to natural
gas issues reflect p r i m arily its members' use of natural gas in
industrial processes in which alternate, non-gaseous fuels
cannot reasonably be utilized.
From this perspective, there
are two paramount natural gas issues:
and (2) price.
of reliability —
(1) security of supply
The first issue involves primarily the mat t e r
consumers' ability reasonably to depend upon
their suppliers to satisfy their gas requirements.
The second
issue encompasses not only price levels vis-a-vis alternate
fuels, but also the effects of pricing policies and rate design
on the relative rates paid by various classes of gas consumers.
177
PGC's concern with supply security m ay seem to some
to be unwarranted, particularly during this period when (1)
interstate pipelines appear to be madly scrambling to find
ways to dispose of their excess gas supplies, and (2) we are
repeatedly told that the United States'
conventional gas re
source base remains sufficient to m e e t current levels of demand
for several decades.
However, neither current supply sur
pluses nor these gas resource forecasts give industrial users
any significant comfort.
The promising supply forecasts by and large assume
the existence of a free market at the wellhead and, thus,
prices for gas which in fact approximate its "market-clearing"
price.
Today, however, the partially-regulated "market" under
the N G P A is characterized by wildly disparate prices —
some
far below "market clearing" and others absurdly above it.
Some pipelines are already experiencing real industrial load
losses as they purchase expensive supplies under strict takeor-pay provisions and turn away cheaper supplies.
High-cost
supplies are being produced before lower-cost supplies, further
depressing demand and distorting the signals sent back to
producers as to future gas needs.
Thus, so long as substantial
volumes of natural gas remain subject to distorting price con
trols -- which insulate gas prices from the realities of the
m a rket and inexorably push some prices higher while others
remain artificially low —
industrial users are not comforted
by large estimates of conventional domestic gas resources
178
which are producible at reasonably stable, free market p r i c e s .
PGC is confident that the free m a r k e t —
ings w ith the current scheme —
not "quick fix" tinker-
will w o r k to produce those re
sources and bring supply and demand into balance.
But, until
such a free market exists, PGC has no such confidence in long
term gas supply reliability.
The same observations may be made with respect to the
gas surpluses currently being experienced in some parts of the
country.
PGC believes that such surpluses are in part the
product of the unstable conditions which have been fostered by
the Nat u r a l Gas P olicy Act of 1978 (NGPA)
The perpetuation
of such conditions is no basis upon which to make energy p o l
icy, and such conditions are inimical to restoring industrial
user confidence in the gas m arket's ability stably to m e e t
their long-term needs.
PGC's concern with supply security, of course, does
not reflect industrial users' will i n g n e s s to pay any price for
such reliability.
However, while we are no more anxious than
anyone else to see our gas bills increase, we are ready and
willing to pay true free-market prices for gas because we
anticipate that such prices will be more stable —
in the long run —
and lower
than would be the case under the NGPA.
We
also believe that such free-market prices will be lower than
the costs that we (and the Nation) will incur if energy policy
r egresses to the reimposition of price controls with the at
179
tendant risks of renewed supply shortages and resultant eco
nomic and social dislocations.
Thus, PGC believes that wellhead price controls must
be removed if supply and demand in the gas m arket are ever to
be brought into balance.
However, we must emphasize that,
while we are willing to pay free-market prices for gas, we are
strongly opposed to (1) paying prices higher than those which
would be commanded in a truly free market, and (2) paying a
disproportionate share of higher gas costs so that other gas
consumers can be subsidized, such as through so-called
incremental or marginal cost-based pricing schemes.
As consumers, we are concerned about the impact of
higher gas prices on our businesses, our customers, and our
employees.
But it is precisely that concern which leads PGC
to support comprehensive legislation to deal with the serious
defects in the N GPA and the resulting harmful distortions in
natural gas markets.
PGC does not believe that its goal of
obtaining adequate gas supplies at reasonable prices will be
achieved under the N G P A in its current form.
But, even more
important for purposes of today's hearing, we do not believe
that the kinds of partial, stop-gap "solutions" which many
are currently proposing are solutions at all,
The temptation
to attempt to deal only with portions of the natural gas prob
lem is indeed strong, but the risks are high that the problem
will only be exacerbated if Congress yields to that temptation.
180
In our view, half a loaf in these circumstances is worse than
none.
For the reasons discussed below, therefore, PGC
r espectfully urges that the Congress decline to adopt the kind
of myopic, "quick fix" proposals which have recently been
advanced and, instead, turn its attention to consideration of
natural gas legislation which will deal boldly and c o m p rehen
sively with the problems now facing the gas industry and gas
consumers.
Now is the time to take steps to get us out of the
mess created by the NGPA.
Congress must resist the temptation
to adopt superficial measures which will only sink us deeper
into that mess.
Set forth below are PGC's comments on certain of the
gas legislation proposals which have recently been introduced.
Following those comments, PGC sets forth in broad outline the
elements of comprehensive gas legislation which it believes
should be endorsed by this Committee and enacted expeditiously.
11•
COMMENTS ON PENDING LEGISLATIVE PROPOSALS
PGC approaches the current natural gas crisis as in
dustrial gas consumers who pay the bills.
We also approach
the situation as manufacturers who need assurances that n a t u
ral gas —
as well as all other forms of energy —
will be
available for us to purchase in the quantities we need and at
prices we are willing to pay.
With o u t that kind of long term
energy market stability, we cannot rationally plan the invest
ments we need to make to get this country's economy solidly
181
back on its feet for good.
Unfortunately, price regulation
at the wellhead is anathema to stable prices and supplies.
The Natural Gas Act produced shortages, and the N G P A is
producing the current mess.
Consequently, PGC opposes adoption of myopic bills
which would simply tinker with the NGPA's misguided scheme of
price controls in the hopes of extending their operation.
Now
is the time to stop trying to run the marketplace from W a s h i n g
ton and to call an end to all wellhead price regulation once
and for a l l .
Price regulation didn't work for oil; it didn't
work for the economy as a whole; and it isn't working for
natural gas.
With respect to the many bandaid bills which have
been introduced, each is seriously flawed.
Each will produce
serious adverse consequences in both the short and long term,
and each will have your constituents back at your door in
relatively short order.
The provisions of the various bills that are cur
rently pending or were introduced in the last Congress m ay be
grouped for convenience in three general categories:
prehensive NGPA reform;
(1) com
(2) wellhead price freeze and extension
of controls; and (3) relief from pipeline/producer contract
terras.
PGC believes that the impact of the latter two types
of proposals (either alone or in combination) on the gas m a r
kets would be significantly adverse and that they should be
182
rejected in favor of legislation which deals with the N G P A in
a mor e comprehensive and long-term fashion.
A.
The first category of bills (i.e. , comprehensive
N G P A reform) includes S. 2074, introduced in February 1982 by
S enator Johnston.
W ith the exception of certain problems d i s
cussed below, PGC believes that S. 2074 represented a reasonable
and w o r k a b l e compromise for eliminating the serious price, sup
ply, and financial problems arisinq under the NGPA.
Although
there are provisions of this bill which we would prefer be m o d i
fied, we believe that it is the only one of the various p r o p o
sals introduced so far which has the potential to restore sta
bility to the gas market.
The bill's provision for phased, but
full, decontrol of wellhead prices promises that such prices
will be more stable —
case under the NGPA.
prices —
and likely lower —
than would be the
By moving toward free-market wellhead
rather than away from them, as is proposed by the
other bills —
S, 2074 avoids the other proposals' substantial
risks of renewed gas supply shortages and resultant costly e co
nomic and social dislocations.
The J o h nston bill's repeal of the Fuel Use Act, Title
II of the N G P A ("incremental pricing"), and Title III of the
Public U t i l i t y R e gulatory Policies Act are all critical ele
m ents of gas reform legislation.
These artificial demand re
s traints on selected sectors of the gas market have proven to
be utter failures in holding down the rates of favored c onsum
183
ers? they have created an enormously complex regulatory morass;
and they will become even less important as we move toward a
freer mar k e t at the wellhead.
PGC does believe, however, that Sections 304 and 305
of S. 2074 were ill-conceived.
These provisions would, in v i r
tually all circumstances, guarantee that pipelines and dis t r i
bution companies will be able to recover whatever gas costs
they m a y incur, even if such costs are incurred as the result
of abusive gas purchasing practices.
These guaranteed cost
p assthrough provisions would be seriously damaging to consum
ers' ability to exert meaningful influence on the purchasing
behavior of their gas suppliers.
They would distort both
supply and price since producers would be effectively insulated
from knowing how much consumers actually value natural gas.
The rationality of a truly free market can never be
established at the wellhead if consumers are rendered helpless
to challenge the gas purchasing behavior of suppliers who
abuse their natural monopoly status and their general ability
to pass through the costs which they incur.
PGC believes,
therefore, that the grounds (set forth in N G P A Section 601(c)
(2)) upon which pipeline gas purchase costs may be denied p ass
through treatment should be expanded, not restricted in the
manner proposed by S. 2074.
Nevertheless, as discussed below,
PGC does not believe that simply broadening N GPA Section 601(c)
184
(2) alone w o u l d constitute a sufficient legislative response to
the current chaos in the gas market.
As stated in its further detail below, PGC believes
that complete deregulation of wellhead prices must be a c c o m
panied by a m a r k e t -oriented resolution of the so-called "con
tract problem." V
While pleased that Senator Johnston included
in S. 2074 a proposal for dealing with the contract problem,
PGC believes that a more straight-forward approach might be
more effective, such as an approach which (as discussed e l s e
where in this testimony) would encourage producers and p u r
chasers voluntarily to renegotiate their existing contracts
and which would facilitate such renegotiation.
Although the
contract conversion approach contained in S. 2074 is appealing
because it would operate in a manner similar to the seller-buyer
dynamics in a free market, that approach is extremely complex
and therefore, as a practical matter, could create problems of
its own.
Moreover, its complexity aside, even if the bill's
contract conversion approach were revised specifically to
prevent the operation of above-market fixed price escalators
(in addition to indefinite price escalators), there is little
assurance that the provision could be framed to give gas p u r
chasers effective protection against all kinds of problem conjV Alt h o u g h H.R, 131, introduced by Congressman Gramm, c o n
tains many key provisions necessary for comprehensive legisla
tion, it is defective insofar as it fails to deal with the
contract prob l e m at all.
185
tract clauses drafted to fall outside the bill's definition of
"commodity escalator clause" (Section 404(b)), and such clauses
could escalate prices above market clearing levels and lead to
the kind of market disruptions the bill is intended to avoid.
N otwithstanding, however, these specific criticisms
of certain provisions of the bill, PGC does believe that, if
revised consistent with the foregoing, S. 2074 represents a
generally sound compromise of the issues which have arisen un
der the NGPA.
Enactment of such legislation would give rise
to more stable and likely lower gas prices for all consumers;
would allow gas supply and demand to come into balance (insur
ing adequate long-term gas supplies after the current short
term surplus ends); permit less volatile and more secure market
revenues for pipelines and distribution companies; permit gas
producers the cash flow they need to finance gas exploration
and development activities; and eliminate the incentives which
gas producers now have to produce high-cost gas resources b e
fore lower-cost resources.
B.
The second general category of bills provides for
a temporary or permanent freeze on wellhead prices.
For example,
S. 60 (introduced by Senator Kassebaum) and H.R. 583 (introduced
by C ongressman Glickman) both provide generally for a two-year
price freeze and two-year delay of the N G PA's scheduled d e r e g u
lation of certain gas categories; H.R. 619, introduced by Con
186
g r e s s m a n K a s t e n m e i e r , c a l l s for a p e r m a n e n t fr e e z e and p e r m a
nen t c o n t i n u a t i o n of p r i c e c o n t rols.
A freeze on wellhead prices would, at best, simply
halt the inexorable price increases being experienced under the
N G P A ; it would not allow gas consumers to see any reduction in
their gas bills.
Moreover, any price relief which is e x p e r i
enced may likely be short-lived.
This is due to the fact that
freezing price ceilings at mid- to late-1982 levels would be
an invitation, if not an order, for renewed gas s h o r t a g e s .
It
would severely undermine exploration and development for new
reserves and, at the same time, send a signal to users to in
crease consumption.
With the elimination of incentives and the
gradual erosion of price ceilings by inflation, these freeze
p rovisions would send a message to producers that Congress
cannot be trusted to fulfill its commitment to deregulation
and that permanent regulation might occur.
As shortages d e
velop, there w o u l d be greater demand not only for imported
oil, but also for imported gas at unfrozen prices.
Thus, any
potential cost savings resulting from the freezing of domestic
gas prices would be reaped by foreign p r o d u c e r s , not by gas
consumers —
just as was the case in the pre-NGPA era.
In addition, the rigidity of these price freeze p r o
posals would deprive the gas market of all flexibility to meet
changed circumstances until a new crisis forced Congress back
into the picture —
creating the potential for a replay of
1978*s sorry experience with gas legislation.
187
By returning to a fully price-controlled environment,
the financial situation of all sectors of the gas industry,
would suffer as market volatility makes it substantially more
difficult to plan exploration, purchasing, and m a rketing a c
tivities .
Today's gas market problems are due in large part
to the fact that, in 1978, Congress did not go far enough, not
because it went too far.
The solution, therefore, to today's
problems do not lie in regressing to the pre-NGPA price-controlled approach, but rather in fixing the flaws in the N G P A
in order to permit the transition to a fully decontrolled m a r
ket to be effected more smoothly and effectively.
C.
The third general category of the legislative
proposals includes those which reflect the belief that a D r a
conian solution to the "contract problem" is all that is needed
to "fix" the NGPA.
This category includes S. 239 (introduced
by Senator Jepsen) and several others introduced in the 97th
Congress (e.g. , S. 3028 (introduced by Senator M e t z e n b a u m ) ,
S. 3070 (introduced by Senators Danforth and E a g l e t o n ) , S. 3076
(introduced by Senator Specter), and S. 3088 (introduced by
Senator C h a f e e ) ,
These proposals range from outright blanket
prohibitions against all take-or-pay clauses and indefinite
price escalators to a broad expansion of the grounds upon which
the FERC m a y block the passthrough of pipeline purchase costs
and act to revise or annul contract terms.
(Some of these bills
188
also provide certain reporting requirements under which pipelines
report to FERC their progress in achieving the lowest possible
weighted average gas acquisition c o s t . ) V
Altho u g h PGC agrees that piplines' take-or-pay o b l i
gations are unreasonably high in m a n y contracts negotiated un
der the NGPA, we also recognize that take-or-pay clauses p r o
vide producers (particularly independents) with some income
stability and the cash flow needed to finance new exploration
and development.
A blanket prohibition against take-or-pay
clauses would, therefore, cause an immediate reduction in ex
ploration and development and then eventual shortages.
More
over, such a prohibition would be yet another boon for foreign
gas producers who would be exempt under it (s e e , e . g . , S. 3076).
An outright ban on all take-or-pay clauses would also
result in rising gas prices as producers lose cash flow stabil
ity and markets begin to tighten up.
In exchange for their
S. 60 c o m b i n e s its p r o p o s e d " c o n t r a c t p r o b l e m " s o l u t i o n s
w i t h a p r o p o s e d p r i c e freeze.
T h i s c o m b i n a t i o n of p r o p o s a l s
m a k e s it e v e n less d e s i r a b l e than b i l l s w h i c h p r o p o s e s i m p l y
o n e o r the other.
S. 60 w o u l d d e v a s t a t e g a s e x p l o r a t i o n and
d e v e l o p m e n t and i n e v i t a b l y lead to s u p p l y c u r t a i l m e n t s to g as
consumers.
Faced w i t h f r o z e n p r i c e s , p l u s a loss of t a k e - o r p a y c o m m i t m e n t s (and the a p p e a r a n c e tha t C o n g r e s s w i l l k e e p
e x t e n d i n g c o n t r o l s ) , d o m e s t i c p r o d u c e r s w o u l d s l a s h the i r
e x p l o r a t i o n and d e v e l o p m e n t budgets.
S i g n i f i c a n t g as c u r t a i l
m e n t s c o u l d b e g i n q u i c k l y in some a r e a s of the c o u n t r y and a d
versely affect meaningful economic recovery.
Again, Canadian,
M e x i c a n , a nd A l g e r i a n p r o d u c e r s w o u l d be in the b e s t p o s i t i o n
to t a k e a d v a n t a g e of s u c h ‘
shortages by raising their prices
w h i l e U.S. p r o d u c e r s are p r o h i b i t e d fr o m r a i s i n g t h e i r s and
e l i c i t i n g g r e a t e r d o m e s t i c s upplies.
189
added risks, producers would demand higher sales prices to
justify their investment in exploration and development, and
the tighter markets would enforce those demands for higher
prices.
(If a freeze proposal were also enacted, the higher
prices would not be avoided; they would simply be collected by
foreign gas sellers.)
dealt a double blow:
As a result, gas consumers would be
forced to pay both the higher charges
commanded by foreign or domestic producers plus a larger share
of the pipelines' and distributors' fixed costs as their m a r
kets shrink.
Further, apart from the enormous administrative bur
den which would result from the proposed exemption provisions
(see S. 3070 and S. 3076), pipelines which are totally freed
from take-or-pay obligations would be placed in a strong posi
tion to favor their own gas production affiliates at the expense
of potentially lower-priced gas from independent producers.
Finally, although PGC certainly supports measures
to encourage pipelines to purchase first the cheapest gas
available, the rigid "cheapest-first" rule being proposed (see
3076, S. 3070) would be extremely complicated and expensive to
implement.
It would require many pipelines to adopt complex new
operating procedures and to install expensive metering equipment
—
all of which would be paid for through higher rates to con
sumers.
Moreover, it would inevitably lead to extensive litiga
tion which, apart from the costs which it too would impose on
21-496
0
-
83
13
190
ratepayers, would create the kind of uncertainty which seriously
undercuts the ability of the gas m a r k e t to develop and deliver
secure long-term supplies.
Wi t h respect to proposals to expand the terms of
N G P A §601(c)(2), PGC believes that the intent of such p r o v i
sions in S. 239 (and in last session's S. 3028, and S. 3054)
is certainly laudable.
Customer resistance to high gas prices
is an essential element in bringing gas supply and demand into
balance and keeping them there.
Since interstate pipelines and
local gas utilities are still subject to regulation (and will
remain so even after full wellhead price d e c o n t r o l ) , the ability
of gas consumers to challenge excessive gas acquisition costs
in r e g ulatory forums is essential if pipeline purchasing p r a c
tices are to be restrained, especially during the transition to
full decontrol.
Thus, it is entirely appropriate that Congress include
in gas reform legislation provisions to safeguard consumer's
interests in this mann e r —
and reject the FERC's very narrow
reading of Section 601(c)(2) which v i r t u a l l y wrote "abuse or
similar grounds" out of the statute.
in S. 239 —
"abuse" —
Senator Jepsen's proposal
which would include a rebuttable presumption of
seems to be the mos t reasonable approach, allowing
p i pelines both (1) to know in advance which specific actions
will render them potentially vulnerable under Section 601(c)(2),
and (2) to rebut a charge of "abuse" by showing that an agreement
191
to the disfavored contract terms is justified under the cir
cumstances or is otherwise offset by other more favorable con
tract terms.
It must be emphasized, however, that while P GC be
lieves that the approach taken in S. 239 is a good one, we
also believe that adoption of such a measure alone will not be
a sufficient legislative response to the problems of the gas
market.
In contrast, if the Jepsen bill were substituted for
existing Sections 304 and 305 of S. 2074 (the J o h nston bill
last session) , the result would be the kind of comprehensive
legislation which would improve the long-term health and sta
bility of the natural gas industry and its customers.
111•
PGC PROPOSAL FOR N A TURAL GAS LEGISLATION
In t h e i r " D e a r C o l l e a g u e " l e t t e r of D e c e m b e r 8, 1982,
S e n a t o r s E a g l e t o n a n d D a n f o r t h c i t e d the e c o n o m i c a l l y i l l o g i c a l
fact t h a t "a s u b s t a n t i a l s u r p l u s of g a s on the m a r k e t "
is c u r
r e n t l y a c c o m p a n i e d by s i g n i f i c a n t g a s p r i c e i n c r e a s e s and the
s h u t t i n g in of lar g e v o l u m e s of l o w e r - c o s t s u p plies.
served:
They ob
"At the time of p a s s a g e of the N a t u r a l G a s P o l i c y Act,
no o n e a n t i c i p a t e d this k i n d of b r e a k d o w n in the o p e r a t i o n of
the free m a r k e t . "
V
In contrast, the approaches suggested in S. 3028 and S.
3054 appear to be too open-ended and, therefore, too uncertain
to afford either meaningful protection to consumers or m e a n
ingful guidelines for pipelines.
192
Whi l e PGC certainly agrees that it was not anticipated
in 1978 that such inconsistent economic events could occur sim u l
taneously, PGC vigo r o u s l y disagrees with the premise that these
events have resulted from a breakdown in the operation of the
free market.
The N G P A did not create a free gas m a r k e t , and
the N ation's sad experience under the NGPA teaches us nothing
about how free markets operate.
At best, the N G P A has taught
us that a part-regulated/p a r t - d e r e g u l a t e d "market" severely
distorts the exploration and development, distribution, and
price of natural gas; causes rapidly rising wholesale and
retail prices without inducing corresponding increases in gas
supplies; produces surpluses in some locations and shortages
in others; and contributes to the demand for energy imports,
such as exorbitantly p riced LNG from Algeria.
In short, the free market has not broken down; the
mess in which we currently find o urselves is simply the result
of gas producers, pipelines, distributors, and consumers all
attempting to pursue their legitimate self-interests and ful
fill their obligations in a h o p e l e s sly-confused pseudo-market.
W hile perhaps no one could have p r e d icted in 1978 that things
would go as far awry as they have, Congress'
failure to d e r e g
ulate natural gas at that time could reasonably have been
expected to deprive the gas mar k e t of the flexibility needed
to respond to dynamic and unforeseen changes in the economy,
oil prices, and other factors bearing on gas supply and demand.
193
PGC believes that it is time to give the m a r k e t a
chance to work.
Therefore, in order to increase the stability
of the gas industry, enhance service to gas users, hold down
prices for all consumers, avoid future supply shortages, and
eliminate the market distortions caused by the NGPA, PGC ad
vocates the adoption of comprehensive gas legislation contain
ing the following key provisions:
(1)
Remove wellhead price controls from all natural
gas as of J a nuary 1, 1 9 8 5 .
For the reasons discussed in greater
detail in Section IV of this testimony, PGC believes that d e
regulation of all gas, in contrast with NGPA-type deregulation
of only some gas or the reimposition of price controls, is the
prime element of a package that would produce the fairest and
most economically efficient solution to the problems confront
ing the Nation's gas markets.
Any effort to retain controls
on some or all categories of supplies will inevitably yield
m arket distortions analogous to those experienced under the
Natural G as Act and the NGPA.
(2)
Complete deregulation of wellhead prices must
be accompanied by a market-oriented resolution of the muchdiscussed "contract p r o b l e m ."
PGC recognizes that extreme
contract terms which were induced by the NGPA's scheme of par
tial regulation will have to be modified if the transition to
d e r egulation is to be effectuated smoothly and successfully.
While m a n y suggestions have recently been aired as to how the
194
c o n tract p r oblem should be resolved, PGC favors the type of
a pproach which would encourage producers and purchasers vol u n
tarily to renegotiate their existing contracts and which would
facilitate such renegotiation.
PGC believes that such an a p
proach is preferable to others which have been suggested both
(1) because it best simulates the opera t i o n of a free m a r k e t
immediately even though the transition to a fully free m arket
is still in progress, and (2) because, in contrast with c ompli
cated caps and contract clause conversion options, this ap
proach is straightforward, easy to understand and, therefore,
e asier to implement wit h o u t extensive regulatory (and judicial)
oversight.
R enegotiation by the parties will produce better
results than w ill Congressional efforts to structure gas p u r
chase and sales arrangements by fiat from Washington, D.C.
In
v iew of the substantial surplus of deliverable supplies that
now exists, consumers should be the principal beneficiaries of
r enego t i a t i o n at this time, while both producers and consumers
will benefit from wellh e a d price d e r e g ulation over the longer
term.
As envisioned by PGC, a renegotiation clause would
be inserted in all contracts in existence on day of enactment
w hich cover sales by a producer to a buyer for resale to third
parties;
the renegotiation clause would enable either party to
request reopening of the contract for renegotiation.
If a
195
resolution satisfactory to both parties is not achieved w i t h
in a specified period (e . g . , 90 days from the request for re
opening) then either could opt out of the contract and seek
other buyers or sellers of gas.
To provide supply stability to pipelines, it would be
reasonable to give pipelines a right of first refusal in cases
in which a producer opts out in favor of another buyer.
How
ever, to protect independent producers from potential bad faith
bargaining tactics, pipelines would not be given a right of
first refusal in cases in which the pipelines was the one to
opt out of a contract.
Similarly, to protect independent pro
ducers from abuses of pipelines' m o n o p s o n y power, pipelines
would have to be obligated to provide transportation services
at "just and reasonable" rates approved by the FERC in the event
a p r o ducer sold gas to a third party.
This type of solution would be similar to the "mar
ket out" clause m e c h anism whic h some pipelines and producers
have included in their contracts for deregulated gas in recent
years.
Those clauses recognize that, while parties desire long
term contracts, they must be free to adopt price and non^price
terms to meet changing market conditions over time.
By inserting these clauses in all contracts existing
at the time of enactment, all parties to wellhead gas sales con
tracts would be able to insist on renegotiating their contracts.
Consequently, any party with an unfavorable contract relative
196
to prevai l i n g m a r k e t conditions would be able to bring its
c ontract in line with the current market.
Self-interest should
assure that this is done and should prevent any party from
overre a c h i n g during the difficult transition to full d e c o n
trol.
Thus, it would be unlikely that Congress would have to
get back into the picture.
However, to assure a continuing
vehicle for contract adjustment, the legislation would provide
that the renegotiation clauses would remain in all contracts
(including new ones) for at least one y ear after the completion
of phased decontrol.
At that p o i n t
,
the m arket should be well
balanced, and buyers and sellers will likely voluntarily in
clude m arket out clauses as a routine matter.
Monitoring should be done by FERC.
FERC would be
authorized to collect data on contract renegotiations and would
require public filing of existing and new contracts.
There
should be a clarification of FERC's p o wer to protect consumers
from prices which result from abuses of a pipeline*s m a n a g e m e n t
di s c r e t i o n or its duties to its customers.
The purposes of
this action would not be to permit "backdoor" producer reg u l a
tion, but solely to p r o tect consumers from an aberrant pip e
line's efforts to use its m o n o p o l y p osition to pass through
ex cessive costs resulting from serious errors of manage m e n t
judgment.
Customers of regulated pipelines should not have to
absorb higher gas costs than the p ipelines could charge if they
resold gas in a competitive market.
197
(3)
Repeal the incremental pricing program (N GPA
Title II) and the Powerplant and Industrial Fuel Use A c t .
Repeal of these measures should be accomplished in such a way
that their effects cease immediately.
(4)
Provide for the manda t o r y filing with the FERC
of all natural gas purchase contracts between producers and
pipelines and make them available for public inspection.
(5)
Provide expanded access to natural gas supplies
by all pipelines, distribution companies, and end-users.
Finally, any gas reform legislation should not include
any so-called "windfall profits t a x ” on natural gas.
The con
cept of taxing away so-called "windfall" profits is fundamen
tally repugnant to PGC members.
Regardless of when and how
natural gas is decontrolled, natural gas producers should be
permitted to charge and retain the full free-market price of
such gas.
IV.
FURTHER COMMENTS ON THE NEED FOR FULL DECONTROL
A.
Experience W i t h Partial Wellhead Price Controls
T he relative desirability of total wellhead price
deregulation is m ost obviously demonstrated by the m i s e rable
experiences this Nat i o n has had with partial regulation of well
head prices.
Under the Natural Gas Act, wellhead purchases by
interstate pipelines were regulated, while purchases by intra
state pipelines were not.
Nearly a decade of interstate gas
shortages resulted, while the intrastate market demonstrated
that the free market works.
198
In c o n t r a s t , w h i l e it e x t e n d e d r e g u l a t i o n to the i n t r a
state market,
t he N a t u r a l G a s P o l i c y A c t s i m u l t a n e o u s l y d e r e g u
l a t e d w e l l h e a d p r i c e s for n a t u r a l g as in c e r t a i n c a t e g o r i e s , and
it w i l l d e r e g u l a t e o t h e r m a j o r c a t e g o r i e s of g a s in 1985 and
1987,
T h i s p a r t i a l d e r e g u l a t i o n s t r u c t u r e has had the u n f o r t u
nate results of
(1) t r i g g e r i n g e x o r b i t a n t
(c u s h i o n s u p p o r t e d )
p r i c e s for n a r r o w c a t e g o r i e s of S e c t i o n 107 g a s and (2) c r e a t i n g
a p o t e n t i a l l y e x p l o s i v e set of c o n t r a c t t erms for g a s to be d e
r e g u l a t e d in 1985.
A l r e a d y , c o n t r a c t s for d e r e g u l a t e d g as h a v e
c r e a t e d s e r i o u s and g r o w i n g m a r k e t l o s s e s for some p i p e l i n e s .
In 1985, when several times as much gas will be deregulated, the
results could be highly destructive.
T h i s s o - c a l l e d " c o n t r a c t p r o b l e m " r e s u l t s fro m w i d e
s p r e a d g a s p u r c h a s e c o n t r a c t s c o n t a i n i n g b o t h (1) i n d e f i n i t e
p r i c i n g c l a u s e s w h i c h l i n k d e r e g u l a t e d n a t u r a l g as p r i c e s to
the h i g h e s t g a s p r i c e s b e i n g p a i d in a d e f i n e d a r e a o r to the
p r i c e o f o t h e r f u els, s u c h as No.
2 f u e l oil, and (2) t a k e - o r - p a y
c l a u s e s w h i c h r e q u i r e p i p e l i n e s to p a y f or 85%-90% of t e n d e r e d
s u p p l i e s e v e n if t h e r e is no r e s a l e m a r k e t .
(Extreme "definite"
p r i c i n g c l a u s e s , w h i c h b e g i n f r o m a h i g h flo o r and e s c a l a t e
a c c o r d i n g to i n f l a t i o n or to f ixed p e r c e n t a g e s , are a l s o s e r i o u s
problems
in som e c o n t r a c t s )
T h e s e p r o b l e m s w o u l d be r e s o l v e d if w e m o v e d to a
t o t a l l y d e r e g u l a t e d e n v i r o n m e n t at the w e l l h e a d , w h i l e t a k i n g
s t e p s to u n d o the c o n t r a c t d i s t o r t i o n s c r e a t e d b y fo u r y e a r s of
199
partial regulation under the Natural G as Policy Act and by man y
pipelines'
imprudent gas contracting practices.
Moreover, in a
deregu la te d environment, supply and demand would be kept in
balance and the severe problems of the past would not recur.
B.
Uneven Distribution of the Cushion
Deregulation of all gas, as opposed to N G P A -type de
regulation of only some gas, will put all pipeline purchasers of
natural gas on a relatively equal footing, with all having to
compete with other energy sources available to consumers.
Most
obviously, elimination of the so-called "old gas cushion" will
largely eliminate a major government-created advantage which is
very unevenly distributed among gas companies.
A partial deregulation structure implies that those
pipelines with the largest blocks of cheap regulated gas will
have lower average resale rates and a greater ability to pur
chase new natural gas (i .e. , an ability to pay relatively higher
prices without seeing average retail rates exceed alternate fuel
prices),
In this way, partial deregulation imparts significant
economic advantages to gas companies and consumers in some areas
of the country and disadvantages to others for no reason other
than g o v e r n m e n t fiat and h i s t o r i c accident.
P GC does not accept the theory that the "cushion" is
no longer meaningful because high priced gas contracts have
totally offset it.
First, although no one has accurately asses
sed all pipelines' cushions, it appears that not all pipelines
200
have used up their cushions.
Thus, some pipelines will have
significant advantages in future years.
Second, the observation
that some pipelines have already offset their old gas cushions
with expensive deregulated gas does not mea n that the cushion
can be forgotten.
If either (a) as is expected, lower d e r e g u
lated gas prices result from a resolution to the contract p r o b
lem, or (b) notwithstanding the current potential downward trend,
p e t r o l e u m prices were to increase significantly, the importance
of the old gas cushion could q u ickly be reestablished to the
advantage of some pipelines over others.
That, in turn, would
lay the foundation for a new cycle of excessive bidding on new
supplies —
i . e . , for a new contract problem —
parallel to the
one from whi c h we are now trying to extricate ourselves.
PGC submits that the Nation and the gas industry as a
whole would be better served if these artificial differences are
removed as soon as possible.
C.
Equivalent or Cheaper Retail Prices
Deregulating the price of all natural gas will not
raise the average retail gas price any higher than will partial
d e r e g u l a t i o n of new gas only.
Competition with alternate fuels
at the retail level will establish the upper limit for retail
prices regardless of whether wellhead prices are d e regulated in
whole or in part.
That is, the average w ellhead price will
settle at w h a tever level is needed to sell the total volume of
de l i verable natural gas supplies at the retail level.
201
Consequently, the primary effect of restricting some
gas wellhead prices at below the average market level is simply
to produce above-average prices for the remaining, deregulated
volumes of gas.
In other words, in a setting of partial price
controls, p roducers of deregulated gas and foreign gas e x p o r t
ers will get the principal economic advantage of the regulated
cushion, not u s e r s .
The exorbitant price of Section 107 gas
under the NGPA amply demonstrates this fact.
Large sums of
capital have been diverted to drilling deregulated gas deeper
than 15,000 feet rather than cheaper sources in shallower re
servoirs, solely in order to capture the special economic bene
fits afforded by the NGPA's cushion of regulated gas.
In fact, the N G P A ' s c o m p l e x m i x of p a r t i a l p r i c e
r e g u l a t i o n and p h a s e d d e r e g u l a t i o n is p r o d u c i n g h i g h e r o v e r a l l
p r i c e s than w o u l d p r e v a i l in a t o t a l l y free w e l l h e a d market.
D e r e g u l a t i o n of all s u p p l i e s a c c o m p a n i e d by a s o l u t i o n to the
N G P A - c r e a t e d c o n t r a c t p r o b l e m w o u l d p r o d u c e l ower r e t a i l gas
p r i c e s than u n d e r t he N G P A ,
D.
in b o t h the s h o r t and lon g - t e r m s .
Lower Long-term Industrial Rates
T o t a l d e c o n t r o l of w e l l h e a d p r i c e s w i l l l i k e l y h o l d
d o w n i n d u s t r i a l r a t e s in a n o t h e r way.
This benefit will
r e s u l t b e c a u s e the d a n g e r of d i s c r i m i n a t o r y rate sc h e m e s ,
s u c h as i n c r e m e n t a l p r i c i n g , e n d - u s e r a t e s c h e d u l e s , m a r g i n a l
c o s t p r i c i n g and i n c l i n i n g b l o c k r a tes, w i l l be s u b s t a n t i a l l y
r e d u c e d if all n a t u r a l g as is b e i n g sold at r o u g h l y e q u i v a l e n t
w e l l h e a d prices.
202
T h o s e types of disc r i m in a to ry rate schemes would al
locate a d isproportionate share of relatively high cost s u p
plies to industrial users on the basis of the m i s leading claims
that industrials are the "cause" of high-cost gas purchases and
that they are "marginal users" who should keep new supplies in
line ( i.e. , "order the market") while other users burn regulated
cheap gas at below average cost.
By eliminating the m a j o r basis
for d i s c r iminating on gas cost allocations, true cost-of-service
ratemaking will be more easily and consistently implemented
for the benefit of all consumers.
A l t hough some have suggested that the dangers of d i s
c r i m inatory rates are lower today as a result of widespread
con.cern about the Nati o n ' s poor economy and the risk of plant
shutdowns, industrial users doubt this.
Even now, in today's
economic circumstances, such discri m i n a t o r y theories are espoused
by some States (e . g . , C a l i f o r n i a ) , by some so-called "consumer
groups," and even by some distributors (e . g . , Laclede),
(See
comments filed in the PERC's Notice of Inquiry, RM82-26),
More
over, industrials are concerned that these arguments will be
still more wid e l y made, in healthier economic times, if there
remains a wide range of wellhead gas prices.
Consequently,
ending the root cause of the p r o b l e m — i . e . , artificial d i f f e r
ences in w ellhead p r i c e s — will help to produce greater long-term
price stability for pipelines, d i stribution companies, and c o n
sumers.
That greater assurance of consistent, fair treatment
203
w i l l h e l p i m m e a s u r a b l y to r e s t o r e i n d u s t r i a l users'
confidence
in the n a t u r a l g a s system.
E.
G r e a t e r S t a b i l i t y for the E n t i r e G a s I n d u s t r y
J u s t as i n d u s t r i a l u sers w o u l d b e n e f i t , m o r e c o n s i s t e n t
i m p l e m e n t a t i o n of true c o s t - o f - s e r v i c e r a t e m a k i n g and e c o n o m i c
ally rational pricing of wellhead sales will also produce greater
l o n g - t e r m s t a b i l i t y for d i s t r i b u t o r s , p i p e l i n e s , p r o d u c e r s and
non-industrial consumers.
L o n g - t e r m g a s p r i c e s w i l l be e a s i e r to
p r o j e c t b e c a u s e the r e w i l l be no a r t i f i c i a l p r i c e d i s c o n t i n u i t i e s
b e t w e e n c a t e g o r i e s o f gas; a nd r e g u l a t o r y g a m e s m a n s h i p , s u c h as
" c a t e g o r y creep"
(in w h i c h o ld g as is r e c l a s s i f i e d into h i g h e r
p r i c e c a t e g o r i e s ) , s h o u l d c e a s e to be a prob l e m .
M o r e o v e r , even-
h a n d e d i m p l e m e n t a t i o n of c o s t - o f - s e r v i c e r a t e m a k i n g w i l l p r o d u c e
the g r e a t e s t l i k e l i h o o d of s t a b l e r e s a l e m a r k e t s ,
including
i n d u s t r i a l m a r k e t s , w h i c h ar e v i t a l to the l o n g - t e r m h e a l t h of
the n a t u r a l g a s industry.
Similar Production Levels
It is s o m e t i m e s a r g u e d that d e r e g u l a t i n g o n l y n e w g a s
w i l l e n h a n c e e x p l o r a t i o n and d e v e l o p m e n t of n e w s u p p l i e s b e c a u s e
p r i c e s f or n e w s u p p l i e s w o u l d be s u b s i d i z e d by c o n t r o l l e d o l d
ga s pric e s .
At first glance,
proposition,
e s p e c i a l l y to t h o s e w h o s u f f e r e d f r o m c u r t a i l m e n t s
in the 1 970's.
this s o u n d s li k e an a t t r a c t i v e
H o w e v e r , w h i l e it is o b v i o u s t h a t d e r e g u l a t i n g
o n l y "new" g a s w i l l a f f e c t the p a t t e r n of p r o d u c t i o n , e x p l o r a
t i o n a n d d e v e l o p m e n t , it is less c l e a r w h a t the n et e f f e c t w i l l
204
be o n o v e r a l l p r o d u c t i o n le v e l s , as c o m p a r e d to the p r o d u c t i o n
w h i c h w o u l d o c c u r if all g a s is d e r e g u l a t e d .
It is l i k e l y that d e r e g u l a t i n g o n l y "new" g a s w i l l
s i m p l y r e s u l t in a s i t u a t i o n in w h i c h w e l l h e a d c o n t r a c t s s i g n e d
in the f i r s t y e a r or tw o f o l l o w i n g s u c h p a r t i a l d e r e g u l a t i o n
w i l l c o m m a n d a p r i c e p r e m i u m w h i c h e f f e c t i v e l y l o c k s - u p the
e c o n o m i c b e n e f i t s of the o l d ga s cush i o n .
New contracts signed
t h e r e a f t e r w o u l d c o n t a i n l o w e r p r i c e s w h i c h w o u l d n o t be m a t e r
ial l y a b o v e the e x p e c t e d l o n g - t e r m m a r k e t c l e a r i n g level.
fact,
In
th e r e is s i g n i f i c a n t e v i d e n c e t h a t this p a t t e r n is o c c u r
ri n g u n d e r the JJGPA:
p r i c e s in n e w S e c t i o n 107 c o n t r a c t s h a v e
r e p o r t e d l y f a l l e n s u b s t a n t i a l l y f r o m t h e i r 1 9 8 0 - 1 9 8 1 l evels, and
c o n t r a c t s w i t h e x t r e m e d e r e g u l a t i o n p r o v i s i o n s are s t a n d i n g by
to o f f s e t a n y r e m a i n i n g v o l u m e of o l d g a s c u s h i o n in 1985.
T hus,
the N G P A ' s r e l a t i v e l y l a r g e r d r i l l i n g i n c e n t i v e s for n e w g a s m a y
h a v e a l r e a d y c o m e to an end; and the N G P A ' s l o n g - t e r m e f f e c t o n
s u p p l i e s m a y be m i n i m a l .
O n the o t h e r hand,
if all s u p p l i e s w e r e d e r e g u l a t e d ,
o n e m i g h t e x p e c t t e m p o r a r i l y a c c e l e r a t e d d e v e l o p m e n t and p r o d u c
tion of o l d s u p p l i e s , s i n c e t h a t w o u l d be the c h e a p e s t w a y for
p r o d u c e r s to o b t a i n the b e n e f i t s o f d e r e g u l a t i o n in the s h o r t
term.
However,
that w o u l d soon be f o l l o w e d b y i n c r e a s e d e x p l o r
a t i o n for, and d e v e l o p m e n t of n e w s o u r c e s as p r o d u c e r s s a w t h a t
the o l d g a s s u p p l i e s w o u l d n e e d to be r e p l a c e d w i t h n e w rese r v e s .
In a d d i t i o n , s o m e w h a t e n h a n c e d r e c o v e r y o f g a s f r o m o l d r e s e r v e s
205
\
w o u l d p r o b a b l y e n s u e f r o m t otal d e r e g u l a t i o n ,
i m p r o v i n g g as
s u p p l y a v a i l a b i l i t y to so m e extent.
C o m p a r i n g t hese a l t e r n a t i v e s ,
it is d i f f i c u l t to
d e c l a r e w i t h a n y c o n f i d e n c e that o ne y i e l d s g r e a t e r s u p p l y
a v a i l a b i l i t y than the other.
The principal differences between
the two a l t e r n a t i v e s m i g h t s i m p l y r e l a t e to the t i m i n g o f r e
se r v e a d d i t i o n s and p r o d u c t i o n from p a r t i c u l a r s o u r c e s of s u p
ply, n ot to t otal g as d e l i v e r i e s at a n y p a r t i c u l a r time.
T h us, w i t h o u t m o r e , a r g u m e n t s that d e c o n t r o l l i n g o n l y n e w
gas w o u l d i n c r e a s e s u p p l y m o r e e f f e c t i v e l y than w o u l d c o m p l e t e
d e c o n t r o l ar e n o t p e r s u a s i v e .
M o r e o v e r , e v e n if the i m p l i c i t s u b s i d i e s f r o m an old
g as c u s h i o n u n d e r p a r t i a l d e r e g u l a t i o n i n c r e a s e d n e a r - t e r m
e x p l o r a t i o n for, and d e v e l o p m e n t of n e w gas, t h e r e b y e n h a n c i n g
s u p p l i e s for a p e r i o d ,
the l o n g e r t e r m e f f e c t m i g h t s i m p l y be
h i g h e r g as c o s t s f o l l o w i n g e x h a u s t i o n of the cushion.
This
c o u l d r e s u l t if m o r e rap i d p r o d u c t i o n o f n e w s o u r c e s d u r i n g the
p e r i o d o f old g as s u b s i d i e s l e a v e s the N a t i o n w i t h r e l a t i v e l y
m o r e c o s t l y s o u r c e s to d e v e l o p , w i t h o u t the b e n e f i t of s u b s i
d i es, ther e a f t e r .
V.
CONCLUSION
O n b a l a n c e , c o m p l e t e d e r e g u l a t i o n of all w e l l h e a d
p r i c e s for n a t u r a l ga s by a d a t e c e r t a i n , c o m b i n e d w i t h a
m a r k e t - o r i e n t e d r e s o l u t i o n to the N G P A ’s c o n t r a c t p r o b l e m ,
and
p r o m p t e l i m i n a t i o n of d e m a n d r e s t r a i n t s , w i l l p r o d u c e the fair-
21-496 0 - 8 3
14
206
es t a nd m o s t e c o n o m i c a l l y e f f i c i e n t s o l u t i o n to the p r o b l e m s
c o n f r o n t i n g the N a t i o n ' s g a s m a r k e t s .
The long-term health
and s t a b i l i t y of the n a t u r a l g as i n d u s t r y and its c u s t o m e r s ,
i n c l u d i n g i n d u s t r i a l c u s t o m e r s , w i l l be i m p r o v e d by tha t a c
tion.
A n y e f f o r t to r e t a i n c o n t r o l s o n some or all c a t e
g o r i e s of s u p p l i e s w i l l i n e v i t a b l y y i e l d m a r k e t d i s t o r t i o n s
a n a l o g o u s to t h o s e e x p e r i e n c e d u n d e r the N a t u r a l G a s A c t and
the N GPA.
are not.
Som e of th o s e d i s t o r t i o n s a r e p r e d i c t a b l e ; o t h e r s
Experience indicates, however,
that the N a t i o n w i l l
be h u r t m o r e by an e x t e n s i o n of full o r p a r t i a l c o n t r o l s th a n
by e n d i n g o u r u n f o r t u n a t e e x p e r i e n c e w i t h w e l l h e a d p r i c e r e g u
l a t i o n as s o o n as p o s s i b l e .
T h e P r o c e s s G a s C o n s u m e r s G r o u p a p p r e c i a t e s this
o p p o r t u n i t y to p r e s e n t its v i e w s to th i s C o m m i t t e e .
We will
w e l c o m e the o p p o r t u n i t y to w o r k f u r t h e r w i t h the M e m b e r s and
S t a f f of the C o m m i t t e e in a d d r e s s i n g t h e s e v i t a l l y - i m p o r t a n t
n a t u r a l g a s issues.
F e b r u a r y 10, 1983
ECONOMICS OF NATURAL GAS DEREGULATION
F R ID A Y , A P R IL 15, 1983
C ongress op th e U nited S tates ,
J oint E conomic C om m ittee ,
Washington, D.C.
The committee met, pursuant to notice, at 10:25 a.m., in room SD138, Dirksen Senate Office Building, Hon. Roger W, Jepsen (chair
man of the committee) presiding.
Present: Senator Jepsen and Representative Lungren.
Also present: Chris Frenze and George R. Tyler, professional staff
members.
OPENING STATEMENT OF SENATOR JEPSEN, CHAIRMAN
Senator J epsen . I ’d like to welcome the distinguished witnesses that
have given their valuable time to come before us-this morning. We’ll
hear their views on the controversy over natural gas regulation.
Obviously, something is wrong. Natural gas prices are continuing to
move to record highs, even as surplus supplies accumulate.
That’s just not supposed to happen. Water is not supposed to run
uphill. Prices are not supposed to rise when the commodity is in sur
plus. But it is happening and the Joint Economic Committee would
like to know why.
It seems apparent that, at least in the natural gas industry, the Con
gress has been successful in repealing the law of supply and demand.
Perhaps we ought to try instead to repeal the law of gravity and then
the oil and the gas would simply bubble up out of the ground and we
wouldn’t have to pay for those expensive drilling rigs.
The Natural Gas Policy Act of 1978 was supposed to provide
enough deregulation to encourage exploration for new supplies, but
maintain enough regulation to protect the consumer from predatory
pricing.
Unfortunately, the law has failed miserably on the second point. The
American consumer is being taken to the cleaners. Last winter, too
many Americans were forced to choose between food and fuel. And
I ’m convinced that only the relatively mild winter saved us from the
probability of a consumer revolt across the frost belt.
I
do hope our witnesses here this morning will address themselves
to the question of how we can assure the consumer that adequate sup
plies o f gas will remain available without subjecting them to the cer
tainty o f evermore drastic price increases.
Two aspects of the current national gas crisis merit our special at
tention : the “ take or pay” clauses in producer-pipeline contracts; and
the indefinite price escalators in the Natural Gas Policy Act.
(207)
208
A take-or-pay clause obligates a pipeline to purchase a certain per
centage of a production facility’s output whether or not the pipeline
can transmit this gas. Hence, the term “take or pay.” Currently, many
pipelines are committed to buying expensive gas they can’t afford to
take or pay for and the take levels frequently exceed 70 percent. Since
many pipelines are locked into expensive gas, they aren’t at liberty to
switch to the cheaper gas available.
The indefinite price escalator clauses make this situation even worse.
One version, for example, ties the price of the natural gas to whatever
the maximum lawful price is. Unfortunately, the Natural Gas Policy
Act of 1978 price-ceiling formulas assume that oil prices would re
main at an inflation-adjusted $15 per barrel. But when oil prices shot
up over $30 per barrel soon thereafter, this allowed the maximum
lawful prices of the 30 or so categories of natural gas to jump also.
Many contracts were liked to the various ceilings established by the
National Gas Policy Act. This drove consumer natural gas costs sky
high, regardless of market conditions. The NGPA has a number of
other problems which we intend to explore in detail today.
As we all know, our people don’t want to be subjected to another
drastic natural gas price rise next winter. We don’t have the luxury
of having any more time to waste. We must change the Natural Gas
Policy Act of 1978 now so it will work.
At this time I recognize Manuel Johnson, who I understand will
present the administration’s case for its deregulation package. Wel
come, and thank you for coming. You may proceed.
And please know that any statement you have in writing, if you
have one that has been submitted, will be entered in the record and you
may proceed in any way you may so desire.
STATEMENT OF HON. MANUEL H. JOHNSON, ASSISTANT SECRETARY
OF THE TREASURY FOR ECONOMIC POLICY
Mr. J ohnson . Thank you. I do have a prepared statement to submit
for the record and I will read a shorter statement, so as not to take up
too much time.
Mr. Chairman and members of the committee, it’s a pleasure for me
to be here today to discuss with you the natural gas deregulation
question. In the late 1970’s, the President and the Congress realized
tiiat the existing regulatory arrangement regarding the pricing of
natural gas was leading to increasingly serious shortages of crisis pro
portions. In response, the Natural Gas Policy Act was enacted into
law. This act had two primarily elements. First, it imposed Federal
price regulation on the intrastate gas market, thereby integrating the
interstate and the intrastate market. And, second, it provided for a
scheduled phasing in of price increases in order to avoid an abrupt
increase in prices, yet achieve ultimate decontrol of prices for certain
categories of natural gas.
Unfortunately, the NGPA has several flaws. Perhaps the most
serious flaw is the linkage of natural gas prices to a target market
price of oil based on a forecast for 1985. This provision thwarted the
intent of the legislation if the price of oil behaved differently than the
actual forecast. And indeed, that is exactly what has happened. A
209
dramatic increase in the price of oil in 1979 and further subsequent
increases made the prospect of a smooth transition less likely. And, in
fact, there has been considerable concern in the past few years that
these developments would result in a dramatic jump in the price of
gas when it is partially deregulated in 1985.
Since 1980, however, the United States and other world economies
have been in recession, although the U.S. economy is now on the road
toward recovery.
The supply of oil has exceeded demand, which has fallen from pre
vious high levels. Crude oil prices have actually declined and there’s
considerable agreement that a market clearing price for natural gas
upon decontrol would be much lower than had been anticipated just
2 years ago.
Indeed, the weight of the evidence indicates that market clearing
prices for natural gas are now below current regulated prices in many
areas and current prices would actually decline in real terms if exist
ing contracts between producers and pipelines are renegotiated and oil
prices remain at current levels.
Gas prices have escalated sharply in recent years in part because
they had been held so far below market clearing levels, but also in part
because of the interaction of provisions of both the NGPA and private
contracts. Contract clauses stipulate wellhead prices as a function of
Government-controlled prices and have caused NGPA price ceilings
to actually function in many cases as price floors. Thus, as those ceil
ings are gradually lifted according to NGPA formulas wellhead gas
prices are driven upwards, regardless of the current state of demand
or the current trend in substitute oil prices.
Past controls may also have encouraged the writing of very high per
centage take-or-pay clauses. With previous price ceilings below market
resulting in a situation of excess demand for gas, pipelines were pre
cluded from bidding up the price to obtain supplies and had to resort
entirely to offering producers higher levels of guaranteed demand;
that is, higher percentages of take-or-pay contracts in order to obtain
secure sources of gas.
Pipelines and consumers are now bearing the burden of these various
contractual arrangements. As gas prices have escalated sharply, even
in the face of declining demand, some users are starting to switch from
gas back to oil. Because of high take-or-pay contractual obligations,
however, some pipelines have found it necessary to take the most ex
pensive gas supplies and shut in the less expensive supplies that are
available.
Under take-or-pay, they must pay for the contracted percentages of
both types of gas. But due to pipeline regulation, they can only pass
on directly the cost of gas that’s actually taken. Regulation, therefore,
has had the perverse effect of driving prices higher at a time when
falling oil prices and competition should be leading to lower gas prices.
Long-term contracts may, by themselves, lead to situations where
average gas prices differ from those prices being paid on new contracts.
The existence of price controls exaggerates this effect by limiting the
extent to which automatic contract provisions may allow prices for
gas being sold under existing contracts to adjust to current market
conditions. Also, where the prices of some types of gas are not con
210
trolled, legislation causes producers to search for and develop these
high, cost sources of supply rather than more easily obtainable supplies
that, because of controls, yield a lower return.
Pipelines with access to significant supplies of cheap price controlled
gas, on the other hand, are able to bid up the price of new high cost,
uncontrolled gas to levels significantly above the average price. This
is because they’re able to roll in or average the high price gas with the
cushion of controlled or low price gas and still market their product
at competitive prices.
The primary consequence of the regulation of natural gas is an
inefficient use of economic resources. In prior years when the price of
gas was kept below its opportunity cost, there were two effects. First,
the present consumers of natural gas, who, for historic or other acci
dental reasons, had access to comparatively cheap energy, tended to
use it in an economically inefficient manner. Other potential users,
because of the price controls, were unable to secure access to the re
source due to the lack of adequate supplies at control prices.
Second, price controls made it uneconomical, in many instances, to
develop and market old reserves of regulated gas. Thus, producers
concentrated on high-cost new-gas development, even though there
may be plentiful reserves of lower cost gas to be developed.
Although the NGPA was well intended, it was flawed and has pro
duced distortions and inefficiencies. The perpetuation of this situation
does not serve the best interests of the Nation and must be corrected—
by moving toward an environment where market forces determine
demand, supply, and prices.
In the years before NGPA, wellhead controls only on gas destined
for interstate commerce resulted in artificially low prices and pro
duced depressing effects on exploration and drilling activity for the
interstate market. Circumstances created a situation where the demand
for gas exceeded the supply that producers were willing to make avail
able. In effect, the controlled or administered price of gas was below
the equilibrium or market clearing price. The resulting supply short
ages led to passage of the NGPA.
After the NGPA was enacted, certain conditions changed dra
matically. Natural gas prices have been rising as a result of scheduled
price escalation under the NGPA and various contractual arrange
ments between producers and pipelines in spite of the fact that the
demand for gas has been falling. Decline in demand is partly because
of depressed economic activity and partly because the price of oil has
declined in both nominal and real terms since 1981.
In addition, as the price of gas rises, the demand for gas is reduced.
At present, the price of natural gas is most likely being held above
its equilibrium or market clearing price, a situation that is consistent
with current excess supply conditions.
If the administration’s proposal is enacted into law, controls are
removed, and contracts are renegotiated or eventually voided, I would
expect that natural gas prices would decline to the market-clearing
price, if that actually took place. This assumes the continuation of rela
tively low oil prices which I think is a reasonable assumption, given
current conditions of the market.
The fall in natural gas prices would reduce the rate of inflation
modestly and increase real economic growth and employment. Also,
211
lower natural gas prices consistent with lower cost of supply would
result in greater efficiency in the use of energy throughout the economy.
Total-factor productivity could increase somewhat, and the shift of
users from oil to lower priced gas would result in reduced oil imports.
As economic recovery takes hold, it is possible that natural gas prices
could rise in real terms as the demand for gas rises. It’s possible. I f oil
prices escalate little or not at all or even decline over the next few years,
the demand for gas would not rise as rapidly as otherwise would be the
case and natural gas prices, therefore, would not increase significantly.
It is important to realize, though, that even if the economic recovery
substantially increases gas demand and gas prices rise, this situation
would also occur under the continuation of NGPA, not just because of
market decontrol.
Under current law, I think that we can expect natural gas price in
creases until and probably even after partial deregulation takes place
in 1985. Underlying these gas-price increases are certain provisions in
existing contracts that cause the price ceilings under the NGPA to act
as price floors that rise with the rate of inflation.
After 1985 and partial deregulation under NGPA, one would expect
gas prices to continue rising. NGPA price controls on old gas after 1985
would continue to subsidize the uneconomic purchase of more expen
sive, decontrolled gas.
At a time of large budget deficits, the imposition of a windfall-profit
tax on decontrolled natural gas might be tempting. Even though Treas
ury supports a smaller budget deficit, we cannot support a windfall tax
on decontrolled natural gas.
A windfall tax rests on the notion that, once a well is drilled, all costs
have been sunk and the production rate and production life of the well
are actually fixed. Therefore, any increase in price for the gas being
produced from an existing well is pure surplus or windfall and can
be taxed without negative supply implications. This is not entirely
accurate.
While there may be some windfall profits involved, it is impossible
to determine the precise amount of these profits. A windfall tax could
easily take more than the windfall gain, and thus provide a supply
disincentive.
At the other extreme, a windfall tax probably would not take into
account windfall losses incurred by some producers.
As production continues from a gas well over an extended period
of time, many things can happen to a well which may cause it either
to reduce or even cease its production of natural gas. Nevertheless,
there are a number of actions which can be taken to increase recover
able reserves. These actions, of course, require further capital expendi
tures. I f the price of gas is subject to a windfall tax, the incentive to
increase production from decontrol is significantly lessened.
I f a natural gas windfall tax were to take a form similar to the oil
windfall tax in which even new supplies of gas on the market would be
subject to additional tax, the discentive supply effects would even be
more apparent. It follows that the tax would lower gas supplies along
several different production margins, implying higher energy imports
and higher gas prices for consumers.
Another reason for not supporting a windfall tax is that the reve
nues may not be significant enough under currently accepted oil price
212
assumptions to justify the expense needed to administer the tax. Fur
ther regulations would be needed to define, identify, and collect the
revenue obligations, counter to the objective of this administration to
reduce Government regulation and market intervention in this
administration.
Finally, I would like to comment on the effect of gas deregulation
on financial institutions. The natural gas decontrol bill should have
little, if any, effect upon the banking sector. The only comment that
we have heard from the banking community concerns the bill’s over
ride of existent contract provisions, such as the maximum level on
take-or-pay percentages. Companies that specialize in producing deep
and other categories of high price gas may experience declining gas
revenues due to the decontrol.
As a consequence, such producers could have trouble servicing their
loans. However, those incidents would cause significant problems for
individual banks only if such banks had concentrations of loans to
those specialized gas producers in their portfolios.
Wc anticipate that if such cases exist, they will be rare. We note,
too, that the expected deterioration of income of such producers is
already occurring. Pipelines have stopped contracting for new sup
plies at high prices and have negotiated down and actually walked
away from high price contracts, and have even reduced take-or-pay
purchases across the board on all contracts.
Mr. Chairman, this concludes my statement and I would be happy
to answer any questions that you or your committee may have. Thank
you.
[The prepared statement of Mr. Johnson follows :]
213
P repared S tatem ent
of
H o n . M an u el H . J ohnson
E c o n o m i c s of T h e N a t u r a l G a s M a r k e t
Mr. C h a i r m a n a nd m e m b e r s of the Commit t e e ;
It is a p l e a s u r e for m e to b e h e r e t o d a y to d i s c u s s w i t h you
the n a t u r a l g as d e r e g u l a t i o n question.
Background
P u b l i c p o l i c y h a s h a d a m a j o r impact on the s t r u c t u r e and
e v o l u t i o n of t he n a t u r a l gas indu s t r y .
The F e d e r a l Pow e r C o m m i s s i o n
(FPC) w a s o r i g i n a l l y g i v e n the a u t h o r i t y to r e g u l a t e i n t e r s t a t e
natu r a l gas t r a n s p o r t a t i o n an d sales for r e s a l e in 1938.
The
F P C w a s r e q u i r e d at that tim e to r e v i e w r a t e s and c h a r g e s to
d e t e r m i n e w h e t h e r t h e y w e r e "just a n d r e a s o n a b l e . "
The F P C d i d not
i n t e r p r e t this a u t h o r i t y as r e q u i r i n g o v e r s i g h t o f w e l l h e a d pricing,
In 1954, in r e s p o n s e to a S u p r e m e C o u r t d e c i s i o n (The Phillips
Case), t he F e d e r a l P o w e r C o m m i s s i o n as s u m e d the a u t h o r i t y to r e g
u late t h e w e l l h e a d p r i c e s o f n a t u r a l gas w h i c h was sol d a c r o s s
state linesc
T h i s a c t i o n d i v i d e d the natu r a l gas m a r k e t into
two d i s t i n c t s t r u c t u r e s :
(1) an i n t e r s t a t e m a r k e t in w h i c h w e l l
h e a d p r i c e c e i l i n g s w e r e imposed, and (2) an i n t r a s t a t e m a r k e t
in w h i c h the p r i c e was p r i m a r i l y d e t e r m i n e d b y m a r k e t forces.
The i m p l i c a t i o n o f thi s d e c i s i o n w a s b e c o m i n g e v i d e n t d u r i n g
the e a r l y 1 9 7 0 's w h e n t h e u n r e g u l a t e d p r i c e o f i n t r a s t a t e gas rose
R-3032
214
a bo v e the r e g u l a t e d p r i c e of i n t e r s t a t e gas*
As a result, gas p r o
d u c e r s ten d e d t o s h i f t t h e i r o u t p u t i n c r e a s i n g l y to the i n t r a s t a t e
market.
However, it was n o t un t i l t h e m i d - 1 9 7 0 ' s , the oil e m b argo,
and t h e d r a m a t i c i n c r e a s e in the p r i c e o f oil, t h a t the full
i m p l i c a t i o n s o f t h i s d u a l m a r k e t s t r u c t u r e b e c a m e clear.
Si n c e
n a t u r a l gas is a c l o s e s u b s t i t u t e for oil in m a n y uses, e s p e c i a l l y
w h e n us e d as a fuel for b o i l e r s b y i n d u s t r y a n d u t i l i t i e s , the
p r i c e of n a t u r a l g as in t he i n t r a s t a t e m a r k e t ros e s u b s t a n t i a l l y
as u s e r s s h i f t e d o ut o f h i g h - p r i c e d o il into n a t u r a l gas.
As
the p r i c e d i f f e r e n c e b e t w e e n the t w o m a r k e t s i n c reased, th e
a m o u n t o f n e w g a s d e d i c a t e d to t he i n t e r s t a t e m a r k e t d e c l i n e d
and, b y ' t h e m i d - 1 9 7 0 ' s , s h o r t a g e s d e v e l o p e d .
In the late 1970's, t h e P r e s i d e n t a n d the C o n g r e s s r e a l i z e d
t h a t the e x i s t i n g i n s t i t u t i o n a l a r r a n g e m e n t r e g a r d i n g t h e i n t e r
s t a t e m a r k e t w a s l e a d i n g to i n c r e a s i n g l y s e r i o u s s h o r t a g e s o f
crisis proportions»
Thus, t h e N a t u r a l G a s P o l i c y Act (NGPA) w a s
e n a c t e d into law.
T h i s Act h a d t w o p r i m a r y elements.
F i r s t , it
i m p o s e d F e d e r a l p r i c e r e g u l a t i o n o n the i n t r a s t a t e m a r k e t , t h e r e b y
i n t e g r a t i n g t he i n t e r s t a t e a n d t he i n t r a s t a t e m a r k e t s and, s e c o n d
it p r o v i d e d for a s c h e d u l e d p h a s i n g i n o f p r i c e i n c r e a s e s in
o r d e r to a v o i d an a b r u p t i n c r e a s e in p rices, y e t a c h i e v e u l t i m a t e
d e c o n t r o l o f p r i c e s for c e r t a i n c a t e g o r i e s o f n a t u r a l gas.
Thi s
l e g i s l a t i o n r e p r e s e n t e d a c o m p r o m i s e b e t w e e n gr o u p s w h o w a n t e d
to a l l e v i a t e the s h o r t a g e in the i n t e r s t a t e m a r k e t b y s i m p l y
e x p a n d i n g p u b l i c j u r i s d i c t i o n ove r the t o t a l m a r k e t a n d g r o u p s
w h o w i s h e d t o s o l v e t he p r o b l e m b y r e m o v i n g p r i c e c o n t r o l s from
the i n t e r s t a t e ma r k e t .
U n f o r t u n a t e l y , t h e N G P A h a s s everal flaws.
Perhaps the most
seri o u s f l a w is the l i n k a g e of n a t u r a l gas p r i c e s to a t a r g e t
m a r k e t p r i c e o f o il b a s e d on a f o r e c a s t for 1985.
This provision
t h w a r t e d the i n tent of t h e l e g i s l a t i o n if t h e p r i c e o f oil b e h a v e d
d i f f e r e n t l y t h a n forecast.
And i n d e e d t h a t is e x a c t l y w h a t h a s
happened.
Ch a n g i n g w o r l d e n e r g y c o n d i t i o n s q u i c k l y m a d e the p l a n
ob s o l e t e .
W h e n th e l e g i s l a t i o n w as p a s s e d in 1978, t h e p r i c e o f
oil w a s abo u t $15 p e r barrel.
Th e i n c r e a s e s in n e w g as c e i l i n g s
s c h e d u l e d b y t he l e g i s l a t i o n w e r e d e s i g n e d to b r i n g t h e p r i c e s
o f n e w gas c l o s e to the B T U - e q u i v a l e n t p r i c e of oil b y th e t i m e
w e l l h e a d p r i c e s w e r e to b e c o m p l e t e l y d e c o n t r o l l e d in 1985.
The
d r a m a t i c in c r e a s e in the p r i c e o f o il d u r i n g t h e I r a n i a n c r i s i s
in 1979, a n d f u r t h e r s u b s e q u e n t increases, m a d e t he p r o s p e c t of
a sm o o t h t r a n s i t i o n less likely, and in fact t h e r e h a s b e e n c o n
s i d e r a b l e c o n c e r n in th e p a s t few y e a r s th a t t h e s e d e v e l o p m e n t s
w o u l d result^ in a d r a m a t i c jump in the p r i c e o f g a s w h e n it is
p a r t i a l l y d e r e g u l a t e d in 1985.
Sin c e 1980, t he U n i t e d States and o t h e r w o r l d e c o n o m i e s h a v e
b e e n in recess i o n , a l t h o u g h t h e U.S. e c o n o m y is n o w o n t h e r o a d
215
toward reco v e r y .
The s u p p l y of o il h as e x c e e d e d demand, w h i c h
h as fallen from p r e v i o u s highs.
As a result, crude oil p r i c e s
h a v e d e c l i n e d in b o t h n o m i n a l a nd rea l te r m s since the first
q u a r t e r o f 1981c
T h e r e is c o n s i d e r a b l e a g r e e m e n t tha t a m a r k e t
c l e a r i n g p r i c e for n a t u r a l gas u p o n d e c o n t r o l w o u l d b e m u c h
lower t h a n h ad b e e n a n t i c i p a t e d just two y e a r s ago.
Thus, t h e r e
are n o w m i x e d o p i n i o n s o n w h e t h e r or not a n d b y h o w m uch, if
any, gas p r i c e s w o u l d i n c r e a s e w h e n p a r t i a l d e c o n t r o l t a k e s place.
Indeed, t h e w e i g h t of t he e v i d e n c e i n d i c a t e s th a t m a r k e t c l e a r i n g
prices- for na t u r a l gas ar e n o w b e l o w c u r r e n t r e g u l a t e d p r i c e s in
m a n y areas a n d tha t c u r r e n t p r i c e s w o u l d a c t u a l l y d e c l i n e in real
terms if e x i s t i n g c o n t r a c t s b e t w e e n p r o d u c e r s and p i p e l i n e s a r e
r e n e g o t i a t e d a nd o il p r i c e s r e m a i n at c u r r e n t levels in rea l terms.
The D e p a r t m e n t of E n e r g y h a s esti m a t e d , for example, t h a t
the A d m i n i s t r a t i o n ' s n a t u r a l gas p r o p o s a l w o u l d a c h i e v e a n e a r l y
4 p e r c e n t d e c l i n e in the real a v e r a g e w e l l h e a d p r i c e of n a t u r a l
gas in its first y e a r o f o p e r ation.
Indeed, this e s t i m a t e a s s u m e s
oil p r i c e s that c o u l d e a s i l y p r o v e to be t o o high.
A more plau
sible o il p r i c e f o r e c a s t u t i l i z e d b y D O E yi e l d s a real a v e r a g e
w e l l h e a d p r i c e d e c l i n e o f o v e r 11 p e r c e n t in the first y e a r of
decontrol.
M ark e t C h a r a c t e r i s t i c s
U n l i k e the oil m a r k e t in w h i c h c o n t r a c t s are s h o r t - t e r m and
w h o s e a n a l y s i s c an be u s e f u l l y a p p r o x i m a t e d b y a spot ma r k e t ,
the natural gas m a r k e t is c h a r a c t e r i z e d b y l o n g - t e r m c o n t r a c t s .
M a n y of t h e s e c o n t r a c t s i n c l u d e v a r i o u s t ypes of e s c a l a t o r c l a uses
and r e q u i r e m e n t s that p i p e l i n e s p a y for a h i g h p e r c e n t a g e o f the
d e l i v e r a b l e gas, w h e t h e r or n o t t h a t gas is a c t u a l l y t a k e n in s u b
sequent years.
T he n e c e s s i t y o f t hese " t a k e - o r - p a y " c o n t r a c t
c l a u s e s stems from s e v e r a l factors:
p i p e l i n e s are r e q u i r e d to
co n t r a c t for c e r t a i n g a s r e s e r v e levels in o r d e r to m e e t a n t i c
ip a t e d future demand, a n d the i r large f ixed cos t s h a v e e n c o u r a g e d
the p i p e l i n e s to be h i g h l y c o n c e r n e d ab o u t the c o n t i n u i t y o f
supply.
P r o d u c e r s are a l s o i n t e r e s t e d in l o n g - t e r m cont r a c t s ,
in ord e r to p r o t e c t t h e i r i n v e s t m e n t b y e n s u r i n g t h a t p i p e l i n e s
ca n n o t a r b i t r a r i l y w a l k a w a y from c o n t r a c t s to b u y gas.
Gas p r i c e s h a v e e s c a l a t e d s h a r p l y in re c e n t y e a r s in p a r t
b e c a u s e t h e y h a d b e e n h e l d so far b e l o w m a r k e t c l e a r i n g levels,
but also in p a r t b e c a u s e of the i n t e r a c t i o n o f p r o v i s i o n s o f
b o t h the N G P A a n d p r i v a t e contra c t s .
C o n t r a c t c l a u s e s th a t
s t i p u l a t e w e l l h e a d p r i c e s as a f u n c t i o n o f g o v e r n m e n t c o n t r o l l e d
pr i c e s h a v e c a u s e d N G P A p r i c e c e i l i n g s to function, in m a n y
cases, as p r i c e floors.
Thus, as th o s e c e i l i n g s a re g r a d u a l l y
l ifted a c c o r d i n g to N G P A fo r m u l a s — o f t e n at rates in e x c e s s of
the g e n e r a l rat e of i n f l a t i o n — w e l l h e a d gas pr i c e s are d r i v e n
upwards, r e g a r d l e s s of t he cu r r e n t state o f d e m a n d or the c u r r e n t
trend in s u b s t i t u t e oil prices.
216
Past c o n t r o l s m a y al s o h a v e e n c o u r a g e d t h e w r i t i n g o f v e r y
h i g h p e r c e n t a g e t a k e - o r - p a y clauses.
With'effective price ceil
ings r e s u l t i n g in a s i t u a t i o n of e x c e s s d e m a n d for gas, p i p e l i n e s
w e r e p r e c l u d e d fro m c o m p e t i n g on the b a s i s of p r i c e and h a d to
r e s o r t e n t i r e l y to o f f e r i n g p r o d u c e r s h i g h e r leve l s o f g u a r a n t e e d
d e m a n d — t h a t i s f h i g h e r p e r c e n t a g e s in t a k e - o r - p a y c o n t r a c t s —
in o r d e r to o b t a i n s e cure sour c e s o f gas supplies.
P i p e l i n e s and c o n s u m e r s are n o w b e a r i n g the b u r d e n of t h e s e
v a r i o u s c o n t r a c t u a l a r r a n g e m e n t s which, as e v ents w o u l d h a v e it,
h a v e not tu r n e d out to be in th e i r b e s t i n terests.
As g a s p r i c e s
h a v e e s c a l a t e d sharply, even in the face o f d e c l i n i n g demand, some
users are s t a r t i n g t o s w i t c h from gas to oil.
B e c a u s e of h i g h
t a k e - o r - p a y c o n t r a c t u a l o b l i g a t i o n s , however, some p i p e l i n e s h a v e
found it n e c e s s a r y to take the m o s t e x p e n s i v e ga s su p p l i e s and
shut in the less e x p e n s i v e su p p l i e s t h a t are available.
They
m u s t p a y for the c o n t r a c t e d p e r c e n t a g e s o f b o t h t y p e s of g a s b u t
can o n l y p a s s on d i r e c t l y the co s t of gas a c t u a l l y taken.
Obvi
ously, m o s t p r o d u c e r s o f thi s e x p e n s i v e g a s are r e l u c t a n t to let
the p i p e l i n e s d i s r e g a r d this t a k e - o r - p a y c o n t r a c t u a l o b l i g a t i o n .
Regulation, t h e r e f o r e , h a s h ad t h e p e r v e r s e e f fect o f d r i v i n g
gas p r i c e s h i g h e r at a t i m e w h e n f a l l i n g o i l p r i c e s a nd c o m p e t i
ti o n s h o u l d be l e a ding t o lower g as prices.
In the oil m a r k e t it w as e x p e c t e d t h a t o n c e t he p r i c e o f
oil w a s d e r e g u l a t e d , d o m e s t i c m a r k e t p r i c e s w o u l d a d j u s t to the
w o r l d m a r k e t p r i c e and, in fact, t h a t is what h a p p e n e d .
In c o n
trast, in the n a t u r a l gas ma r k e t , e v e n if c o m p l e t e d e r e g u l a t i o n
w e r e i m p l e m e n t e d w i t h o u t r e n e g o t i a t i o n o f contracts, m a n y d i f f e r - 0
ent p r i c e s c o u l d c o e x i s t b e c a u s e of c o n t r a c t s that w e r e n e g o t i a t e d
a t d i f f e r e n t p o i n t s in t i m e w i t h d i f f e r e n t p r i c e p r o v isions,
The i n c r e m e n t a l p r i c i n g p r o v i s i o n s o f the N G P A h a v e also
been counterproductive.
D e s i g n e d to s h i e l d r e s i d e n t i a l c u s t o m e r s
from p r i c e i n c r e a s e s b y s h i f t i n g t h e c o s t s o f e x p e n s i v e g a s to
i n d u s t r i a l users, t h e s e p r o v i s i o n s h a v e i n d u c e d i n d u s t r i a l us e r s
— th e na t u r a l gas c o n s u m e r s w h o m a y m o s t e a s i l y s u b s t i t u t e
a l t e r n a t i v e fuels for g a s — to tur n a w a y from gas.
As a result,
r e s i d e n t i a l c u s t o m e r s h a v e b e e n f o rced t o b e a r a g r e a t e r p e r c e n t a g e
of the fixed c o s t s o f p r o d u c i n g and d e l i v e r i n g n a t u r a l gas than
the y w o u l d h a v e otherwise.
L o n g - t e r m c o n t r a c t s may, b y the m s e l v e s , lead t o s i t u a t i o n s
w h e r e a v e r a g e gas p r i c e s d i f f e r from th o s e p r i c e s b e i n g p a i d on
n e w contracts.
The e x i s t e n c e of p r i c e c o n t r o l s e x a g g e r a t e s
this ef f e c t b y l i m i t i n g the extent to w h i c h a u t o m a t i c c o n t r a c t
p r o v i s i o n s m a y a l l o w p r i c e s for gas b e i n g sol d u n d e r e x i s t i n g
c o n t r a c t s to a d j u s t to c u r r e n t m a r k e t condit i o n s .
Also, w h e r e
the pr i c e s of some t ypes o f g as — dee p ga s in the case of the
N G P A — are not c o n t r o l l e d , the l e g i s l a t i o n causes p r o d u c e r s to
se a r c h for and d e v e l o p th e s e h i g h c o s t s o u rces o f supply, r a t h e r
217
t h a n m o r e e a s i l y o b t a i n a b l e s u p p l i e s that, b e c a u s e o f controls,
yie l d a l o w e r return.
P i p e l i n e s w i t h a c c e s s to s i g n i f i c a n t s u p
p l i e s o f cheap, p r i c e c o n t r o l l e d gas, o n the other hand, are
able to b i d u p the p r i c e of new, h i g h - c o s t , u n c o n t r o l l e d gas to
levels s i g n i f i c a n t l y a bove the a v e r a g e p r i c e o f gas.
This is
b e c a u s e t h e y a r e able to "roll in" o r a v e r a g e the h i g h - p r i c e d
gas w i t h the c u s h i o n o f c o n t r o l l e d or o l d l o w - p r i c e d gas and
still m a r k e t th e i r p r o d u c t at c o m p e t i t i v e prices.
I m p l i c a t i o n s o f R e g u l a t i o n and D e r e g u l a t i o n o f N a t u r a l Gas
The p r i m a r y c o n s e q u e n c e of the r e g u l a t i o n o f n a t u r a l gas is
an i n e f f i c i e n t use of e c o n o m i c resour c e s .
In p r i o r years, wh e n
the p r i c e of g a s w a s k e p t b e l o w i ts o p p o r t u n i t y value, i.e., its
free m a r k e t price, t h e r e w e r e two effects.
First, p r e s e n t c o n
sumers o f n a t u r a l gas, w h o for h i s t o r i c or o t h e r a c c i d e n t a l
reas o n s h a d ac c e s s to c o m p a r a t i v e l y c h e a p energy, t e n d e d to use
it in an e c o n o m i c a l l y i n e f f i c i e n t m a n n e r .
O t h e r p o t e n t i a l users,
b e c a u s e o f the p r i c e c o n t rols, w e r e unab l e to secure ac c e s s to
the r e s o u r c e d u e to the lack o f a d e q u a t e s u p plies o f c o n t r o l l e d
prices.
Second, r e g u l a t i o n h a s r e s u l t e d in less s u p p l i e s t h a n
w o u l d be o p t i m a l b e c a u s e of r e d u c e d p r o f i t o p p o r t u n i t i e s .
In
addition, u nder NGPA, r e g u l a t i o n h a s r e s u l t e d in a m i x of supp l i e s
that is m o r e c o s t l y t h a n nece s s a r y .
For example, c o n t r o l s e n c o u r
a g e d p r o d u c e r s to s e a r c h for d e e p gas w h i c h w a s c o m p l e t e l y d e r e g
ulated u n d e r N G P A and t o ne g l e c t o t h e r typ e s of gas.
Pr i c e
c o n t r o l s m a d e it u n e c o n o m i c a l in m a n y i n s t a n c e s to d e v e l o p and
m a r k e t r e g u l a t e d gas? thus, p r o d u c e r s h a v e c o n c e n t r a t e d o n h i g h c o s t gas d e v e l o p m e n t ev e n t h o u g h t h e r e m a y be p l e n t i f u l r e s e r v e s
of l o w e r - c o s t g a s to be developed.
Administration Proposal
A l t h o u g h the N G P A w a s w e l l intended, it w a s flawed and h a s
produced distortions and inefficiencies.
The p e r p e t u a t i o n of
this s i t u a t i o n does not serve the b e s t i n t e r e s t s of the n a t i o n
and m u s t be c o r r e c t e d — b y m o v i n g t o w a r d an e n v i r o n m e n t whe r e
m a r k e t forces d e t e r m i n e demand, s u p p l y and prices.
Because weak
gas d e m a n d a n d p r i c e i n f l e x i b i l i t i e s a r i s i n g from the N G P A h a v e
r esu l t e d in e x c e s s s u p p l i e s of na t u r a l gas w h i l e oil p r i c e s are
declining, t h e r e m a y n e v e r be a b e t t e r t i m e to start this transition.
In the y e a r s b e f o r e NGPA, w e l l h e a d c o n t r o l s o n l y o n g as d e s
t i n e d for i n t e r s t a t e c o m m e r c e r e s u l t e d in a r t i f i c i a l l y l o w prices
and p r o d u c e d d e p r e s s i n g e f f e c t s o n e x p l o r a t i o n and d r i l l i n g
a c t i v i t y for the i n t e r s t a t e mark e t .
This r e g u l a t o r y envi r o n m e n t ,
along w i t h g r e a t e r d e m a n d for gas d u e to O P E C oil p r i c e i n c r e a s e s
a n d h a r s h w i n t e r weat h e r , c r e a t e d a s i t u a t i o n whe r e the d e m a n d
for gas e x c e e d e d the s u p p l y that p r o d u c e r s w e r e w i l l i n g to m a k e
available.
In effect, the c o n t r o l l e d or a d m i n i s t e r e d p r i c e of
gas wa s b e l o w t h e e q u i l i b r i u m or m a r k e t c l e a r i n g price.
The
r e s u l t i n g s u p p l y s h o r t a g e s led to p a s s a g e of the NGPA.
218
Aft e r the N G P A w a s en a c t e d c e r t a i n c o n d i t i o n s c h a n g e d d r a m a t
ically, l e a d i n g to the s i t u a t i o n tha t e x ists today.
N a t u r a l gas
p r i c e s h a v e b e e n r i s i n g as a r e sult of s c h e d u l e d p r i c e e s c a l a t i o n
under the N G P A a nd v a r i o u s c o n t r a c t u a l a r r a n g e m e n t s b e t w e e n p r o
d u c e r s and p i p e l i n e s in s p ite of the fact that the d e m a n d for
gas h a s b e e n falling.
This r e s u l t is p a r t l y b e c a u s e o f d e p r e s s e d
e c o n o m i c a c t i v i t y a nd p a r t l y b e c a u s e the p r i c e of oil h a s d e c l i n e d
in b o t h n o m i n a l and rea l t e r m s s i n c e 1981«
In a d d i tion, as the
p r i c e of g a s rises, t h e d e m a n d for gas is reduced.
Thus, gas
p r i c e e s c a l a t i o n h a s o c c u r r e d in s pite o f d e c l i n i n g demand, d ue
to the w o r k i n g s o f the NGPA.
At present, t h e p r i c e o f n a t u r a l
gas is m o s t l i k e l y b e i n g h e l d above its e q u i l i b r i u m o r m a r k e t
c l e a r i n g price, a s i t u a t i o n that is c o n s i s t e n t w i t h c u r r e n t e x c e s s
s u p p l y cond i t i o n s .
If t h e r e w e r e e x c e s s demand, and w e k n o w
th e r e is not, o n e w o u l d ex p e c t the p r i c e of ga s to b e b e l o w th e
m a r k e t c l e a r i n g price, as it was p r i o r to the e n a c t m e n t of NGPA.
U n d e r the A d m i n i s t r a t i o n ' s prop o s a l , w e l l h e a d p r i c e s o f
n a t u r a l gas in a n y n e w o r r e n e g o t i a t e d c o n t r a c t s b e t w e e n p r o d u c
ers and p i p e l i n e s w o u l d b e a l l owed to f u n c t i o n u n d e r t h e i r o w n
terms.
T h e r e are i n c e n t i v e s for p r o d u c e r s a n d p i p e l i n e s to
r e n e g o t i a t e e x i s t i n g c o n t r a c t s to re f l e c t c u r r e n t m a r k e t c o n d i
tions.
For c o n t r a c t s t h a t are n ot r e n e g o t i a t e d , t h e r e w o u l d b e a
gas cap d e t e r m i n e d b y the av e r a g e p r i c e for gas in n e w l y n e g o t i a t e d
and r e n e g o t i a t e d c o n t racts.
A f t e r J a n u a r y 1, 1985, b u t b e f o r e
J a n u a r y 1, 1986, a n y c o n t r a c t not r e n e g o t i a t e d c o u l d b e b r o k e n
b y e i t h e r party.
If a p i p e l i n e is a p a r t y to an a b r o g a t e d c o n
tract, it w o u l d be o b l i g a t e d to f a c i l i t a t e t r a n s p o r t a t i o n of
gas to a n o t h e r p u r c h a s e r .
Take or p a y r e q u i r e m e n t s in c o n t r a c t s
c o u l d i m m e d i a t e l y b e r e d u c e d to 70 p e r c e n t , r e l e a s i n g a n y g a s so
a f f e c t e d to be sold to a n o t h e r party.
E s c a l a t o r c l a u s e s in c o n
t r a c t s that p r o v i d e for a u t o m a t i c i n c r e a s e s in the g a s p u r c h a s e
p r i c e o f c o n t r o l l e d gas w o u l d be l i m i t e d so that p r i c e s c o u l d
not rise h i g h e r tha n the g a s cap.
This l i m i t a t i o n w o u l d b e g i n
fo u r m o n t h s a fter the b i l l is e n a c t e d an d ex p i r e o n J a n u a r y 1, 1986.
Co n s umers w o u l d be aid e d b y a p r o v i s i o n t h a t w o u l d p r o h i b i t
p i p e l i n e s from a u t o m a t i c a l l y p a s s i n g t h r o u g h to c o n s u m e r s t he
c o s t of g a s p u r c h a s e d if the in c r e a s e is g r e a t e r t h a n the ra t e of
inflation.
La r g e r i n c r e a s e s w o u l d h a v e to be r e v i e w e d b y the
Fe d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n in a pu b l i c hearing.
The p r o p o s a l a l s o w o u l d e s t a b l i s h a "c o n t r a c t carr i a g e " p r o
v i s i o n w h e r e b y F E R C c o u l d order an i n t e r s t a t e p i p e l i n e to t r a n s
p o r t gas o n b e h a l f of a n y p r o d u c e r a n d purcha s e r .
Thi s p r o v i s i o n
w o u l d a l l e v i a t e some of the p r i c e i n f l e x i b i l i t y p r o b l e m s i n h e r e n t
in the c u r r e n t i n s t i t u t i o n a l a r r a n g e m e n t s that r e l y o n l o n g - t e r m
contracting.
Finally, the i n c r e m e n t a l p r i c i n g p r o v i s i o n u n d e r c u r r e n t l aw
w o u l d be elim i n a t e d , as w o u l d the r e s t r i c t i o n s on gas use under
the Fuel Us e Act of 1978.
219
If t he A d m i n i s t r a t i o n ' s p r o p o s a l is e n a c t e d i n t o law, c o n
t r ols are removed, an d c o n t r a c t s a re r e n e g o t i a t e d o r e v e n t u a l l y
voided, I w o u l d e x p e c t t h a t n a t u r a l gas p r i c e s w o u l d d e c l i n e to
t h e m a r k e t c l e a r i n g pric e .
Thi s a s s u m e s the c o n t i n u a t i o n of r e l
a t i v e l y l o w o il prices, w h i c h I t h i n k is a r e a s o n a b l e a ssumption,
T h e fall in n a t u r a l gas p r i c e s w o u l d red u c e the r a t e of
i n f l a t i o n m o d e s t l y a n d i n c r e a s e s o m e w h a t real e c o n o m i c g r o w t h and
employment.
Also, l o w e r n a t u r a l gas prices, c o n s i s t e n t w i t h
lower co s t s of supply, w o u l d r e s u l t in g r e a t e r e f f i c i e n c y in the
use of e n e r g y t h r o u g h o u t t he economy.
T o t a l fac t o r p r o d u c t i v i t y
c o u l d i n c r e a s e somewhat, a n d the s h i f t o f u sers f r o m o il to
l ower p r i c e d gas w o u l d r e s u l t in r e d u c e d o il imports.
Secretary
H o del has t e s t i f i e d tha t o il i m p o r t s c o u l d fall b e l o w c u r r e n t
p r o j e c t i o n s b y 1 0 0 , 0 0 0 to 2 0 0 , 0 0 0 b a r r e l s p e r d ay in t he f irst
y e a r f o l l o w i n g e n a c t m e n t of the proposal.
A t a b o u t $30 p e r
b arrel, a n d t a k i n g t h e m i d p o i n t of this estimate, th e s a v i n g s in
our oil i m p o r t b i l l c o u l d b e as m u c h as $1.5 b i l l i o n p e r year.
A s e c o n o m i c r e c o v e r y takes hold, it is p o s s i b l e t h a t na t u r a l
gas p r i c e s c o u l d r i s e in real t e r m s as the d e m a n d for gas rises.
T h e m a g n i t u d e w o u l d d e p e n d to so m e e x t e n t o n w h a t h a p p e n s to oil
prices.
If o il p r i c e s e s c a l a t e l i t t l e o r n ot at all or eve n
d e c l i n e o v e r t h e n e x t f ew years, t h e d e m a n d for gas w o u l d not
rise as r a p i d l y as o t h e r w i s e w o u l d b e the cas e a n d n a t u r a l gas
p rices, th e r e f o r e , w o u l d not i n c r e a s e s i g n i f i c a n t l y .
In o t h e r
words, c o n t i n u e d l o w oi l p r i c e s w o u l d te n d to t e m p e r n a t u r a l gas
p r i c e i n c r e a s e s b y o f f e r i n g a p r i c e - c o m p e t i t i v e a l t e r n a t i v e to
gas a n d t h e r e b y h o l d d o w n the d e m a n d for gas.
It is i m p o r t a n t
to r e a l i z e t h a t e v e n if e c o n o m i c r e c o v e r y s u b s t a n t i a l l y i n c r e a s e s
gas demand, a n d gas p r i c e s rise, this s i t u a t i o n w o u l d a l s o o c c u r
u n d e r the c o n t i n u a t i o n of the NGPA.
A n y r e i m p o s i t i o n of c o n t r o l s
in this s i t u a t i o n w o u l d c a u s e s e v e r e shortages.
Implications of Continued Controls
U n d e r c u r r e n t law, i.e., NGPA, I t h i n k we c a n e x p e c t n a t u r a l
gas p r i c e i n c r e a s e s un t i l a n d p r o b a b l y e v e n a f t e r p a r t i a l d e r e g u
l a t i o n takes p l a c e in 1985.
T he p r i c e i n c r e a s e s s h o u l d not be
d r a m a t i c so long as oil p r i c e s do n ot e s c a l a t e sharply.
Underly
ing t h e s e gas p r i c e i n c r e a s e s are c e r t a i n p r o v i s i o n s in e x i s t i n g
c o ntracts, i . e . t e s c a l a t o r clauses, th a t c a u s e the p r i c e c e i l i n g s
u n d e r the N G P A to act as floors t h a t rise w i t h the rat e of inflation.
A f t e r 1985 a n d p a r t i a l d e r e g u l a t i o n un d e r NGPA, o ne w o u l d
e xpe c t gas p r i c e s to c o n t i n u e r i s i n g a l t h o u g h not v e r y rapidly.
P i p e l i n e s w o u l d c o n t i n u e to p a y h i g h p r i c e s for d e c o n t r o l l e d gas
b u t the y w o u l d h a v e c o n t i n u i n g s u p p l i e s of o l d gas, w h i c h w o u l d
r e m a i n r e g u l a t e d a n d cheap, t h a t t h e y c o u l d roll in w i t h this
h i g h e r p r i c e d gas so t h a t a v e r a g e gas p r i c e s r e m a i n c o m p e t i t i v e
w i t h o il prices.
Thi s means, in effect, that N G P A p r i c e c o n t r o l s
220
on o l d gas a f t e r 1985 w o u l d c o n t i n u e to s u b s i d i z e the u n e c o n o m i c
p u r c h a s e of m o r e e x p e n s i v e d e c o n t r o l l e d gas as is n o w a n d h a s b e e n
the c a s e s i n c e the e n a c t m e n t of NGPA.
As s u p p l i e s of o l d gas
a r e exhaus t e d , h o w e v e r , t h e r e w o u l d b e less of a c u s h i o n to o f f
set this h i g h e r p r i c e gas.
Windfall Profits Tax
A t a ti m e of l a r g e b u d g e t d e f i c i t s the i m p o s i t i o n o f a w i n d
fall p r o f i t t ax ( W P T ) o n d e c o n t r o l l e d n a t u r a l gas w i l l b e tempting.
E v e n t h o u g h T r e a s u r y s u p p o r t s a s m a l l e r b u d g e t d e ficit, w e c a n n o t
s u p p o r t a W P T o n d e c o n t r o l l e d n a t u r a l gas.
A WPT r ests o n t h e n o t i o n that, o n c e a w e l l is d r i lled, all
costs h a v e b e e n sunk, a n d the p r o d u c t i o n ra t e a nd p r o d u c t i o n
l ife of t he w e l l a r e fixed.
T h erefore, a c c o r d i n g t o this notion,
a n y i n c r e a s e in p r i c e for the gas b e i n g p r o d u c e d f r o m an e x i s t i n g
w e l l is p u r e s u r p l u s or w i n d f a l l a n d c a n be t a x e d w i t h o u t n e g a t i v e
supply implications.
This, h o w ever, is n ot e n t i r e l y accurate.
First, w h i l e t h e r e m a y b e some w i n d f a l l p r o f i t s i n volved, it
is i m p o s s i b l e to d e t e r m i n e the p r e c i s e a m o u n t of t h e s e p r o f i t s .
Thus, a W P T w o u l d p r o b a b l y take m o r e tha n t he w i n d f a l l gain, thus
providing a supply disincentive.
A t the o t h e r extreme, a W P T
p r o b a b l y w o u l d not t a k e in t o a c c o u n t " w i n d f a l l losses" i n c u r r e d
b y s o m e p r o d u c e r s — in some cases, the v e r y same firms e a r n i n g
w i n d f a l l pr o f i t s .
As p r o d u c t i o n c o n t i n u e s from a gas w e l l o v e r an e x t e n d e d
p e r i o d of time, m a n y t h i n g s c an h a p p e n to a w e l l w h i c h m a y c a u s e
it e i t h e r to r e d u c e or e v e n c e a s e its p r o d u c t i o n o f n a t u r a l g a s .
W a t e r or sa n d i n t r u s i o n a re examples, as a re c h a n g i n g r e s e r v o i r
pressures.
N e v e r t h e l e s s , t h e r e a r e a n u m b e r of a c t i o n s w h i c h c a n
b e t a k e n to i n c r e a s e r e c o v e r a b l e reserves.
T h e s e actions, of
course, r e q u i r e f u r t h e r c a p i t a l expen d i t u r e s ,
If t h e p r i c e of
gas is s u b j e c t to a W P T t he i n c e n t i v e to i n c r e a s e p r o d u c t i o n
fr o m d e c o n t r o l is lessened.
In addition, if a n a t u r a l gas W P T w e r e to take a f o r m
s i m i l a r to the oil W P T in w h i c h e v e n n e w s u p p l i e s o f gas on the
m a r k e t w o u l d be s u b j e c t to a d d i t i o n a l tax, t h e d i s i n c e n t i v e
s u p p l y e f f e c t s w o u l d be e v e n m o r e apparent.
It foll o w s t h a t the
W P T w o u l d low e r gas s u p p l i e s a l o n g s e v e r a l d i f f e r e n t p r o d u c t i o n
ma r g i n s , i m p l y i n g h i g h e r e n e r g y i m p o r t s a n d h i g h e r gas p r i c e s
for consumers.
T he b e n e f i t s of d e c o n t r o l o n s u p p l y w o u l d b e
g r e a t l y m i t i gated.
A n o t h e r r e a s o n for not s u p p o r t i n g a W P T is t h a t the r e v e n u e s
m a y n ot b e s i g n i f i c a n t e n o u g h und e r c u r r e n t l y a c c e p t e d oil p r i c e
a s s u m p t i o n s to j u stify the e x p e n s e n e e d e d to a d m i n i s t e r t he tax.
Fo r example, a d m i n i s t e r i n g the t ax w o u l d b e c o m p l i c a t e d b y the
221
large n u m b e r of c o n t r a c t s b e t w e e n gas p r o d ucers, p r o c e s s o r s and
buyers.
F u r t h e r r e g u l a t i o n s w o u l d b e n e e d e d to define, i d e n t i f y
and c o l l e c t the r e v e n u e o b l i g a t i o n s .
This, too, w o u l d b e c o u n t e r
to an. i m p o r t a n t o b j e c t i v e of d e control, i.e., r e d u c i n g g o v e r n m e n t
r e g u l a t i o n a nd m a r k e t i n t e r v ention.
Effect on Financial Institutions
Finally, I w o u l d like to c o m m e n t o n the ef f e c t of gas d e
r e g u l a t i o n on f i n a n c i a l ins t i t u t i o n s .
T h e n a t u r a l gas d e c o n t r o l
b i l l s h o u l d h a v e little, if any, e f f e c t u p o n the b a n k i n g sector,
The o n l y c o m m e n t w e h a v e h e a r d fro m the b a n k i n g c o m m u n i t y c o n
cerns the b i l l ' s o v e r r i d e of e x i s t e n t c o n t r a c t p r o v i s i o n s , such
as the m a x i m u m le v e l o n t a k e - o r - p a y perc e n t a g e s .
C o m p a n i e s that
s p e c i a l i z e in p r o d u c i n g d e e p a nd o t h e r c a t e g o r i e s of h i g h - p r i c e d
gas m a y e x p e r i e n c e d e c l i n i n g gas r e v e n u e s d ue to d e control.
As
a c o n s e q u e n c e , such p r o d u c e r s c o u l d h a v e t r o u b l e s e r v i c i n g t h e i r
loans.
However, t h o s e i n c i d e n t s w o u l d c a u s e s i g n i f i c a n t p r o b l e m s
for i n d i v i d u a l b a n k s o n l y if such b a n k s h a d c o n c e n t r a t i o n s of
loans to t h o s e s p e c i a l i z e d gas p r o d u c e r s in the i r p o r t f o l i o s .
We
a n t i c i p a t e t h a t if such cases exist, t h e y w i l l be rare.
We note,
too, t h a t the e x p e c t e d d e t e r i o r a t i o n o f i n c o m e of such p r o d u c e r s
is a l r e a d y occu r r i n g .
P i p e l i n e s h a v e s t o p p e d c o n t r a c t i n g for n ew
suppl i e s a t h i g h p rices, h a v e n e g o t i a t e d d o w n and w a l k e d a w a y
f rom h i g h - p r i c e d c o ntracts, a nd h a v e e v e n r e d u c e d t a k e - o r - p a y
p u r c h a s e s a c r o s s the b o a r d on all contracts.
Mr. C h a i rman, this c o n c l u d e s m y p r e p a r e d statement,
I would
be h a p p y to a n s w e r a n y q u e s t i o n s t h a t y o u or the C o m m i t t e e m a y
have.
21-496 0
83
15
222
Senator J e p s e n . Just semantics, but for clarification, did you con
sider the so-called windfall profits tax on oil an accurate description
of what the tax really was?
Mr. J ohnson . N o. I think that it was clearly an excise tax.
Senator J epsen . I think so, too. But a lot of people were led to be
lieve it was a windfall profits tax. The profit had nothing to do with it.
Mr, J oh nson . That’s correct. It was a variable excise, and it did not
relate well to taxes on windfalls.
Senator J epsen . We’re here to talk about how do we bring about a
market price related to supply and demand for natural gas.
Natural gas markets are skewed, distorted, and way out of whack
right now.
Mr. J o hnson . Right.
Senator J epsen. D o you think that the price of natural gas would
rise or fall in the long run under the administration’s plan ?
Mr. J o h nson . Well, as I stated in my prepared statement, under the
administration’s proposal, we think that it’s most likely that the price
of natural gas would fall rather than rise. There are several reasons
why we believe this, but certainly, current market conditions indicate
that there’s an excess supply of natural gas in the market. New con
tracts are being negotiated at prices below the controlled price. Pipelines are trying to renegotiate existing contracts and, in some cases,
have walked away from existing contracts, which would indicate that
competitive conditions are such that there is an excess supply in the
marketplace, not an excess demand.
This would simply demonstrate that the market clearing price is
below the currently contracted prices and the controlled price and,
therefore, there would be every reason to suspect, that under a de
control situation, prices would fall to the market clearing level.
We’re not certain about the situation in the long run. It’s always
possible that prices could rise again because of a Mideast disruption,
some sort of a cutoff of oil supplies to the United States. But if that
were to actually occur, we would be much better off under a decontrol
environment than a control environment because we would be produc
tion incentives for natural gas which would increase the availability of
natural gas and provide a ready substitute for crude oil.
So I think that either way, whether prices rise in the long run or
whether they fall, we’re better off under a decontrol environment.
Representative L ungren . Mr. Johnson, I ’d like to ask a question
with respect to—a general energy question. There are some who have
been in to see me, constituents and so forth, who are very concerned
that if we go to decontrol there will be no upper limit on what the
price is going to be, and suggest that somehow, there’s no competition
in the natural gas market.
Could you comment on that? My thought is that our experience
with petroleum, both before we decontrolled and thereafter, suggests
that within our economy there is a tremendous amount of potential
substitution. Likewise, if natural gas is ultimately decontrolled, there
would be competition among alternative or substitute sources of energy
and that natural gas producers would have to compete with producers
of other forms of energy.
Mr. J ohnson . Well, I think it is quite true that the energy industry
is a highly competitive industry. There are large numbers of producers
223
of both natural gas, crude oil, and obviously, there are thousands,
millions of consumers.
Certainly, it would be very difficult for any producer to try and set
price, in some monopoly fashion, above what the market clearing price
would be, simply because of the competitive nature of the market.
Such a producer would be undercut by other competing producers and,
therefore, forced to reduce the price back to the market clearing level.
I think it’s very clear that we have that kind of arrangement in the
energy market. This has certainly been the case with crude oil and all
the other close substitutes.
So I would think that without artificial regulations that might
insulate markets from each other, that we would certainly have some
thing resembling market conditions.
In terms of natural gas in particular, there are some technical differ
ences between natural gas markets and crude oil. Natural gas is not
easily traded in the spot market. The pipelines that transport the gas
have very high fixed costs and they have to cover these costs by insur
ing constant availability of supply.
In order to insure supply, the pipelines are willing to negotiate long
term contracts, much longer than the crude oil market. And therefore,
it’s quite possible that you could have specific contract prices that
might lie above the current market price for natural gas for at least
the duration of that contract. Under the market environment for
natural gas, it would be highly unlikely that general contract prices,
once those contracts were renegotiated or new contracts were negoti
ated, would stay above the market clearing price.
There are more rigidities in the natural gas market, but it’s still a
competitive market and it certainly works over any reasonable period
of time toward keeping prices in line with supply and demand condi
tions.
I think it would be unreasonable to assume that the price of natural
gas could be maintained well above the market clearing level unless
there was some sort of artifically controlled mechanism that did so.
Senator J epsen . For the record, let’s explore this comparison that’s
often used between natural gas and the oil markets with respect to
decontrol.
I ’ll make some statements that I think are true and please verify
them. First, there are about 100 pipelines. Generally, most communities
are served by a single natural gas pipeline. About 25 of the 100 U.S.
pipelines probably conduct the lion’s share of the business. And in the
gas distribution business, we have hundreds of thousands of gas
stations.
For now, let’s just have the record show those—I don’t want to
debate the difference, but there is a difference.
Mr. J ohnson . That’s correct, yes, sir.
Representative L ungren . Under present law, which mandates con
trols, isn’t it true that because of the substitution availability, we’ve
had the phenomenon of a significant number of industrial users switch
ing from natural gas to alternative sources, which then has the effect
of distributing the cost, which, as you’ve indicated is sometimes above
the market clearing level, on the residential users. If we were unregu
lated and you didn’t have that incentive for the industrial user to go
outside that market, you would not have the increased costs being
borne primarily by the residential user.
224
Mr. J oh n son . I think that’s accurate. The fact is that the higher
cost natural gas has caused substitution back toward oil and there
has also been a decline in demand resulting from the recession that
we’ve just come out of. The higher price natural gas due to contract
arrangements tied to the NGPA control accelerator clause has been a
very important factor in depressing demand for natural gas.
Therefore, regulation for natural gas has resulted in substitution
toward cheaper types of energy. Industry has become very efficient in
designing technology, fuel technology that allows it to shift among
energy alternatives. Artificially high gas prices have caused consum
ers to bear the brunt of natural gas costs because these costs have to be
spread over the entire rate base. And if there are fewer industrial
users, due to substitution, then these costs have to be allocated among
a narrower group. And if this narrower group consists of residential
consumers, then they experience increases in their rates and regula
tion is partly a result.
Senator J epsen . Why do you think this change took place with the
industrial users ? Most of them I ’ve talked to indicate that natural gas
has some attributes that are on the plus side when you come to han
dling and cleanliness, and so on.
Mr. J ohnson . Sure.
Senator J epsen . So they sure don’t change because they don’t like
it.
Mr. J o h nson . I agree. I think that there are a lot of industrial users
that might prefer natural gas as an energy source. But I think the
major problem is the perverse incentives that have come out of the
Natural Gas Policy Act, where you have had decontrol of new gas and
the actual controls remaining on old gas which has already been dis
covered and is in reserve. Under take-or-pay clauses, the pipelines
have to pay for the natural gas, whether it’s low cost or high cost,
whether they take it or not. And because the regulation on natural
gas pipelines requires that you can only pass on the cost of the gas
that you actually take, pipelines have a strong incentive to actually
take the high cost gas, leaving the low cost gas in place. Pipelines are
able to pass the higher costs on to consumers and thus, increase the
cost of natural gas, simply because they would rather pass on the cost
of this high priced gas if they have to pay for both, which they have
to do under take-or-pay contract. And this creates a problem.
As long as you have low cost gas or old gas consistently regulated at
lower prices than new gas, then there’s always an incentive to develop
and purchase new higher priced gas and even bid up the price of that
gas well above the market clearing rate because you can roll in that
high price gas with the lower priced gas that you may have purchased
and have the average price still stay close to the market price.
So there are really perverse incentives under the very complicated
arrangement of controls and I think that this has a lot to do with why
industrial users have been forced by high priced natural gas to sub
stitute for other types of energy fuels.
Senator J epsen . Is it true to say that today we find nrnny pipelines
locked into long-term commitments to purchase expensive gas they
can’t sell ? Is that an accurate statement ?
Mr. J oh nson . That’s correct.
225
Senator Jepsen. H o w will the administration’s proposal remedy
that?
Mr. J o h n son . The administration proposal would, beginning in
1985, allow the decontrol of all new contract arrangements, and the
actual decontrol of all current contract arrangements, if they’re re
negotiated voluntarily before 1985. There would be an allowance pe
riod for the voluntary renegotiation of all existing contracts, which,
would most likely be at the market clearing level. We anticipate that
market clearing prices will be below the current contractual level.
I f pipelines and producers do not choose to renegotiate contracts
voluntarily, rather than have the price of natural gas rise at the rate
tied to the NGPA escalator clauses, there would be a cap placed on
the prices of the natural gas under continued contractual arrange
ments that would require that the price not be allowed to rise faster
than some weighted average of the prices agreed to in new and re
negotiated contracts.
After 1985, there would be an allowance—if contracts were not
voluntarily renegotiated, which we expect they probably will be, be
cause that’s already happening even without our proposed legisla
tion—for either party of a contract to walk away from that contract.
The proposal gets technical at this point, because the pipeline would
be required, if it walked away from, or if either party walked away
from a contract to transport that natural gas to a user, or to some dis
tributor, on behalf of the original producer, simply because of the
way pipeline contracts work. Usually, producers negotiate with a
single pipeline. They don’t have other alternative sources to transport
their gas. So there would be some requirement that the pipeline
actually transport the gas, even though the contract has been broken.
The administration proposal would provide some financial incentive
for the pipeline to actually transport that natural gas.
Representative L ungren . Mr. Johnson, if you talk to the average
person on the street, and you ask them the question, are you for energy
independence for the United States, and they’d say, absolutely. And
then you suggest to them that that might cost them a little bit more,
and they’d say, well, let me think about it again.
When we were debating the whole issue of deregulating petroleum,
many of us who argued on behalf of it suggested that that would help
us in our effort toward energy independence and if there were one
thing that we could do to break the back of OPEC, it would be to de
control petroleum. I happen to think that that is one of the reasons that
we had some influence on that situation in the overall price.
But it’s awfully tough to argue in economic terms to your constitu
ents, to the consumer out there. You’ve done a fine job of showing that
you’re an economist and showing how complicated this is. But how do
you answer the question of someone who says to you, look, I have to
rely on natural gas to heat my home. Prices have been going up. Sure,
inflation’s down, but I ’m worried about this down the line. And now
you folks in Washington, right at the time that I see some light at the
end of the tunnel, are saying to me, hey, the best thing for you now is to
decontrol natural gas. And I ’m a consumer and all that. All I know
about decontrol is that means the Federal Government isn’t going to
protect me against higher prices.
226
Any answer to that ?
Mr. J ohnson . First of all, I think that, the Federal Government has
done a fairly poor job of protecting them against higher natural gas
prices, if that was the purpose. .In fact, the result of the NGPA under
current market conditions has been to actually keep the price up above
what the market would allow.
So I think that, clearly, decontrol would be to the benefit of every
one, consumers and producers.
Second, I think that even if the price were to rise because of declines
in supplies due to some sort of disruption, or just simply an increase
in demand, one thing that’s guaranteed by market-determined price
levels is the permanent availability of natural gas for those people who
want it.
Representative L u ngren . Can I just butt in there ?
Mr. J ohnson . Yes.
Representative L un gren . You talk about the prices could g o up if
we have some problem in the Middle East, if there’s some interdiction
of oil supplies here.
Isn’t it a fact that, to the extent that we could have any impact, a
more plentiful supply of natural gas, of which we have a much more
available supply than petroleum in relative terms, would basically be
the best cushion we’d have.
Mr. J ohnson . Well, absolutely. Even under periods of rising prices,
the increase in the market equilibrium price would certainly provide
additional incentives for producers to explore and develop new sources
of natural gas and, therefore, make more available domestically. This
would continue to alleviate our dependence on foreign sources of
energy.
Representative L u n g r e n . Let me just ask one last thing, then. The
chairman has pointed out that there are differences, obviously, in get
ting the product of natural gas to the consumer, the ultimate con
sumer, as opposed to petroleum products. But you’ve indicated that in
the proposal for the administration, with respect to that question, you
have made some requirement for the pipeline owner to have a continu
ing or additional obligation to make available that pipeline to a pro
ducer in the event that the pipeline owner walks away from that con
tract ; is that correct?
Mr. J oh nson . That’s correct.
Representative L ungren . And that’s an accommodation to the fact
that there is a difference in terms of the distribution network ?
Mr. J ohnson . Yes, because of the method of distribution, pipelines
would, if, in fact, they have capacity available, be required to transport
natural gas for the producer. The pipeline would actually receive a
fee that would cover their costs, plus, I think, an additional 5 cents
per thousand cubic feet for transporting the natural gas.
Representative L ungren . Thank you.
Senator J epsen . Thank you, Mr. Johnson. I have been advised that
you are also to testify before the Banking Committee this morning.
You’re a man on the move and in demand. We may come back again
at a later hearing and ask you to return. I thank you for your testi
mony today.
227
Do you have any closing statement or anything that you would like
to add?
Mr. J ohnson . No, I think that does it.
Senator J epsen . Thank you.
Mr. J ohnson . Thank you very much, Mr. Chairman.
Senator J epsen . Thank you. Now Mr. MacAvoy of Yale University,
Joshua Twilley of the National Association of Regulatory Utility
Commissioners, and Mark Cooper, Consumer Energy Council of
America, if you would come forward, we will receive your testimony.
I also advise, Mr. MacAvoy, that we will hear the statements of all
three and then we will ask that any questions for you be given to me,
because I have been apprised of the fact that you do have a meeting
at the White House at 12 noon. And we certainly don’t want you to be
late for that.
I would respectfully suggest that we might limit your remarks, your
opening remarks, to 10 minutes, if you can, or less. I would also, for
the record, advise you that your prepared statements will be entered
in the record.
So you may proceed in any manner that you wish. We’ll start with
Mr. MacAvoy—do I pronounce that correctly, MacAvoy ?
Mr. MacAvoy. Yes, thank you, sir.
Senator J epsen . You may proceed.
STATEMENT OF PAUL W. MacAVOY, FREDERICK WILLIAM
BEINECKE PROFESSOR OF ECONOMICS, YALE UNIVERSITY
Mr. MacAvoy. Thank you very much, Senator. I certainly agree
that there’s no reason for me to reread my statement. I would, in
substitute for that, take very few minutes to make five remarks con
cerning the current situation and then attempt to undertake some
projections on the future situation based on a small-scale economic
model of the natural gas industry that I have been working on at Yale
with my graduate students and associates in recent months.
The five initial remarks of a sentence each can be divided between
three remarks on the current regulatory condition and two remarks
on the supply-demand condition.
With respect to the regulatory conditions, first of all, it’s difficult for
a professor to understand the present condition of astonishment in
the House and Senate with natural gas prices rising out of keeping
with supply and demand conditions, because in the universities we
spend considerable time describing exactly those conditions with re
spect to a number of the regulated industries. One can determine at
the present time that basic exchange charges for the use of telephone
service in this country are doubling without regard to demand or sup
ply conditions, that electricity charges in recent years have been sub
ject to the so-called ratchet, which are really the recovery of earlier
year cost increases without regard to the recessionary conditions the
economy has been in since 1980.
With respect to airline services, before substantial deregulation oc
curred there, it was called the classic ratchet, that there was a tendency
under regulation for rates to increase as capacity utilization. In that
case, passenger fares to increase as capacity utilization declined.
228
So this is not at all unusual and I believe is part of a classic pattern
of regulatory response under conditions of a soft economy.
Second, I wish specifically to state that the take-or-pay and favorednations clause aspects of the contracts with which you gentlemen are
so concerned today are a product of the regulatory process. One does
not find contracts calling for take or pay at the 90 to 95 percent level in
the unregulated market conditions that existed before the passage of
the NGPA in intrastate contracts, nor is it possible theoretically to
conceive an argument for those in the absence of regulation.
But when regulation establishes vintage conditions of pricing by
which some prices are lower than other prices, and the new contract
prices have the highest level in the vintage, then the sellers under the
new contract have to have take or pay in order not to be withheld or
stopped.
Because of the vintaging of the price, we have the take-or-pay and
favored-nations clauses. And if we had not vintaged prices in the 1978
NGPA, we would not have this current condition of prices rising
without regard to market conditions because of the take or pay.
The NGPA has a number of misfiring missiles as part of the basic
structure of that act. Incremental pricing is unfounded. It has had a
tendency to create ratchets with respect to consumer prices. The index
ing of 102, 103 section field supply prices on oil price increases was,
as you have already stated, totally unfounded as a set of forecast
conditions.
The allocation of markets for industrial consumption of energy un
der the FUA, the Fuel Use Act, and the PURPA, has had a tendency
to cause the development of a lag structure putting over excessive
price increases on consumers.
The only way that one can, within the university context, describe
these conditions is essentially that in the Carter administration, and
I wish not to go back and dwell on their sins, that there was a certain
arrogance of ability to handle a highly complex market through a
piece of statute legislation that was supposed to last for a decade that
one does not now see. And I wish that we would move forward within
the context of a bit more humility with respect to how these compli
cated markets work to make changes in the future.
In present time, demand for natural gas is building ominously. I f
one goes through the contract commitments of the major pipelines to
retail utility delivery companies and to industry. I think you get the
notion that in this period of soft demand, a great deal of field activity
is being undertaken by the wholesalers and retailers to build markets,
to build markets without regard to future market conditions of supply
availability.
My meager records in New Haven indicate there’s been a tendency
to add about 3 to 4 percent additional consumers to the stock of
demanders facing the pipelines each year since 1978. This has not been
manifest in growth of demand of 4 plus, 5, 6 or 7 percent because
of the impact, the negative impact, of the highly depressed conditions
in the manufacturing sector, principally in the Midwest part of the
country, since the beginning of the recession in 1980.
The demanders are there. They are not purchasing in keeping with
full employment conditions of utilization of energy. When we return
229
to full employment, if ever, then we will have a situation where not
only the existing deman ders, but future commitments to new
demanders will cause the rate of growth for demand for natural gas
to rise more rapidly than in keeping with the recovery under the
business cycle.
At the same time, regardless of thousands, if not millions, of words
of rhetoric with respect to incentives for increasing supply that were
supposed to come out of the Natural Gas Policy Act, or out of changes
in the Federal Power Commission area rates before the act, supply as
a production condition has been diminishing over time. The expro
priation of the unregulated intrastate gas creating the so-called gas
bubble of 2 to 3 trillion cubic feet, made available after the NGPA
to the interstate users, has essentially been completed.
I f one looks at reserve, accumulation experience, our reserves are
still declining in this country. Productive capacity has to decline with
a decline of recoverability from existing reservoirs.
So that, essentially, demand is building and supply is diminishing
at the present time.
What does this say about the future? You’ll see in my testimony
some attempts to divine that from a very small scale econometric
model of the economy, which essentially can be summarized as fol
lows. With respect to the reserve availability condition, if prices were
to stay at present levels, which is the baseline forecast, then reserve
availability will be sufficiently reduced to reduce production capacity
by almost 2 percent per year, 1984,1985, 1986,1987.
With respect to the demand conditions, the primary determinant of
demand change according to this model over the next 5 years is going to
be the sensitivity of response of demand to rising gross national prod
uct and per capita incomes. I essentially produced a measure of the
sensitivity in the range of 50 percent, so that for any 1-percent increase
in GNP, you’ve got a half-percent increase in the demand for gas in the
residential, industrial, electric utility, and transportation sectors. That
is a gross sensitivity measure across different measures that are given
in footnote 5 of my prepared statement.
Price elasticity is much lower than income elasticity and the combi
nation of the two lead me to believe that if we were to believe the admin
istration’s forecasts on recoverability, we should experience an increase
in demand from the existing stock of consumers of between 3 and 5 per
cent per annum each year in the next 5 years. That’s essentially about
three-fourths to a trillion, a full trillion cubic feet in each year of that
period.
At the same time, because of this growth in the customer stock that
I mentioned earlier, I believe we should get another 2-percent increase
in demand for those reasons as well. That says a couple percentage
points’ decline in supply each year and 5-plus percentage points’ in
crease of demand.
If we were to continue the NGPA in place* over the next 5 years,
according to this model projection, at least, with moderate GNP growth
and no real price increase in crude oil, we won’t get very much price
increase next year. In real terms, at the wholesale level, it will be some
thing of the range of 1 to 1y 2 percent. I f you add 4 or 5 percent of infla
tion recovery and you realize that this is at the wholesale level and does
230
not take account of the cost of retail delivery, which may be one-third
or one-half of the total, then we’re talking about a minus 5-percent
increase according to the NGPA. But over a 3-year period, that should
be about a 34-percent increase. And over a 5-year period, about a 92percent real increase.
Those are, again, with moderate oil price changes, zero oil price
changes in effect, and the baseline Feldstein, more or less pessimistic
GNP growth forecast.
I don’t believe that Feldstein is going to make it and that the low
GNP growth forecast, in keeping with the massive budget deficit now
being built by Congress, is going to result in price increases that are
much less than that because the demand for gas will grow much more
slowly than under recovery of the economy.
That demand growth, however, is sufficient in this projection to bring
the real price of gas in 5 years up by about 55 percent of the present or
1983-dollar level. There I ’m talking about an increase on a base of about
$2.70 an mcf of another $1.35.
If, however, we were to deregulate gas, and that is not to pass the
administration’s bill, because I do not believe that that is a deregula
tion bill, but rather, we were to eliminate take-or-pay clauses and
favored-nations contracts, and put 102 gas on the same basis as 104
gas, as 107 gas, within the near future, which would be toward the
end of the fourth quarter of this year, I would predict that we would
get again some slight price increase the first year. In the second year,
however—I ’m sorry—in the first 3 years, however, according to my
table 2, rather than a one-third price increase in keeping with the
NGPA, you’d get only a 20-percent price increase. And, again, with
the Feldstein projections, rather than a 93-percent price increase in 5
years, you’d get the 82-percent increase.
Given my projection of the terrible state of this economy, because
of the fiscal deficit and the tight money policies of the Federal Reserve,
I would expect that we would have essentially no price increase under
deregulation in the first 3 years. That contrasts strongly with the con
tinuation of the ratchet under the NGPA, but over a 5-year period,
because of the systematic decline of supply of 1 or 2 percent a year,
even with deregulation, you’re going to get a 40-percent price increase
rather than a 50- to 55-percent price increase under the low GNP
forecast.
I can only add a couple points with respect to the administration’s
bill as a third scenario. First, I don’t understand the bill because it
has many more complications than the NGPA and is in the tradition
of the Carter administration’s proposals that when faced with political
resistance to deregulation, you lay down a smokescreen of incredibly
difficult, complex clauses in the legislation which is supposed to buy
off some small special interest group, in return for which you get the
bill passed, but in return for which you have no idea where it’s all
going to come out.
In this case, there are provisions to lock in prices in the form of the
price cap, which I would take to be a reverse of the NGPA and more
regulation. On the other hand, they claim that there might be some
deregulation resulting from renegotiation of existing contracts.
231
I can’t conceive that 107 contracts will be renegotiated, since under
take or pay, at a price of $7 an mcf, they’re receiving prices that are
much higher than the market clearing levels. I can’t conceive there
will be substantial renegotiation of any contract in the 102 or 103
category above the present average price level because the present
average price level is too high. So renegotiation would take those
prices down as well.
So I don’t see what the gains are from renegotiation. I see that there
will be substantial caps created by using any average price to ratchet
old contract prices.
With respect to the incremental pricing provision being eliminated
under the PURPA and FUA, I would expect that that would result
in additional gas demands.
So by controlling price, adding to demand, you might work out a
part of the ratchet because you might get all the take-or-pay clauses
under 90 percent operating and go back to consuming a little bit more
of the old gas. But with the market conditions being already those of
very rapid increases of demand, as the economy partially recovers, and
reductions in supply, as reserves run out, this kind of control can only
produce a price explosion in 1985, when most of the requirements come
off.
I think this is postponing the issue. It’s complicating the issue. It
has some of the arrogance associated with the Carter administration’s
approach in the NGPA of thinking that you can manipulate specific
contracts in a highly predesigned way against a complicated market
and make the system succeed. And consequently, I am confused by the
administration’s position.
With all those kind remarks, I ’m willing to turn it over to Mr.
Cooper, who is known to be even more inclusive on these issues than I.
[The prepared statement of Mr. MacAvoy follows:]
232
P repared S tatem en t o r P a v i . W
My name is Paul W. MacAvoy,
M ac A voy
and I am Frederick William Beinecke
Professor of Economics at Yale University.
In recent years I have
carried out extensive research on the regulated sector of the economy,
particularly with respect to the oil and natural gas industries.
While
serving as a member of President Ford's Council of Economic Advisors,
I was co-chairman of the President's Task Force on Regulatory Reform,
which considered issues of natural gas deregulation.
Earlier as a
faculty member at the Massachusetts Institute of Technology, I built
the first large scale model of the natural gas industry with National
Science Foundation auspices.
My statement centers on the failures of the Natural Gas Policy
Act and the need to deregulate natural gas sales at the wellhead.
Regulation, which kept prices too low and thus caused severe shortages
in the late 1970's, is now causing substantial price increases without
regard to the current natural gas surplus.
When Congress passed the
NGPA, it was to provide disincentives for the reworking of old wells
to generate additional supplies of cheap gas but strong incentives to
produce and sell gas from the most expensive deep wells and tight sand
sources.
In 1981 new contracts were signed for as much as $10.00 per
Mcf, twice the cost of energy equivalent supplies of oil,
Because of
this price structure, the NGPA created severe disparities in charges
to consumers across regions of the country.
consisting of the
inexpensive old gas,
significantly among the pipelines,
The natural gas "cushion,"
has varied in availability
so that the average or "rolled-in"
cost of natural gas at the wellhead varied between the regions serviced
by different pipeline transmission companies.
233
Even so, the most dramatic impact of the NGPA has been caused by
the "take or pay" clauses in supply contracts.
Pipeline contracts have
included clauses that have prevented them from eliminating high cost
sources from their supplies of natural gas as demand has declined over
time.
The combination of "take or pay" or "minimum monthly bill"
clauses, and the rules for passing through natural gas acquisition costs
force pipelines to take expensive gas in order that they may pass the
costs on to their customers.
Pipelines have found it cheaper to shut
in cheap gas supplies than to eliminate high cost supplies.
The distortions existing in the natural gas market today can be
credited to "phased deregulation" under the NGPA.
In fact, the NGPA
is a more complex version of regulation than any that preceded it.
In order to evaluate its effects on the gas industry I have developed
a computer model to forecast conditions in gas markets under varying
policy and economic assumptions.
In this model the supply of natural gas is divided into eight
different pricing
categories
as defined by
the NGPA.
Production,
reserve additions, developmental and exploratory drilling are measured
for each category.
The average price of natural gas is the weighted
average of the price
ceilings
for each category.1
The price
of
deregulated natural gas adjusts to equilibrate supply and demand.
Supply for each category is an exponential function of the amount
of reserves,
the rate of production to reserves and the production
associated with new drilling.
This supply function reflects the gradual
i m p o r t e d natural gas, offshore gas, and Alaskan Prudhoe Bay
natural gas are treated separately in addition to the eight NGPA
natural gas categories.
234
decline in the rate of production from a fixed stock of reserves.
In turn, total reserves are the sum of the previous level of the stock
and of new discoveries less the previous level of production.
additions
from new discoveries
exploratory drilling.
are proportional
This proportion,
to the
Reserve
level of
the amount of natural gas
discovered per foot of exploratory drilling,
declines over time as
cumulative drilling increases.^
exp(-St-1/Rt-1)]
Reserves R
are as follows:
a)
Rt - V i + NRt
b)
new discoveries NR^
c)
with drilling DR such that
t-1
(Ft )(DRt )
^ pt
¿p »t
+
= eT
DRt
and
NS^
P
LDC
G
DC,
*1
DR,
t-1
= average wellhead price in year t
DC « average drilling costs per foot in year t
d)
find rate
where
*=
¿1
+
S2
exp(-
DRt >
DR^ is cumulative drilling since 1970.
Supply Equation Parameters:
€p - Gas Price Elasticity
- Cost Elasticity
- Lagged Drilling Coefficient
Developmental
Drilling
New Field
Exploratory
Drilling
Other
Exploratory
Drilling
,38
-.001
.41
.10
-.002
,71
,18'
-.026
.61
New Gas
Old Gas
(103-104)
Deep Gas
(107)
0
ft
%
600
50.38E-6
.53
17180
(102)
30.0
684.0
0.25E-4
,77
7121
,77
5067
235
There are other sources of additions to reserves besides those from
drilling more wells.
Most of these are extension and revisions, and in
distinction from discovering sources of reserves additions, they remain
a constant percentage of new discoveries.
Development drilling adds to production without generating new
reserves.
Production from new successful development wells is added
to production from old wells to give total production.
But production
from new wells also increases the production to reserve ratio and
consequently increases the rate of production from a natural gas field
in future years.
Certain
4
trends
relationships.
follow
from
present
conditions
and
these
Assuming no increase in the price of gas, and given
the 1982 stock of reserves along with the expected level of new reserve
discoveries, production capacity will fall almost two percent per year
in 1984 and 1985.
But increases in the average price of gas expected
under the NGPA in 1983 and 1984 have to be introduced into this
framework.
These increases reduce the rate of decline in production,
but do not maintain the level of deliverability that will be needed
to meet demand increases in the late 1980's.
4New well production NSt
*
(W^)(S’
^/W )
where if is the number of new wells drilled that year, and S' /Vi
t
2
t t
average production from a new well that year. But W equals:
a)
where
Wt
=
is the
fW p 2
is the parameterized success rate of producing wells and P 2 is
average depth per development well.
236
Thus, equally critical in determining natural gas price changes
is demand growth.
The magnitude of increase in demands from customers
presently on distribution systems can be estimated using this model,
for each major sector of the economy,
industrial,
transportation,
residential and commercial,
and electric utility.
The
controlling
elements of-such demands are price, the price of oil, and national
income levels.
The level of capacity utilization replaces GNP in
the industrial demand equation as the principal measure of economic
activity.^
With customer growth of one percent per year, and additional
use per customer based on economic recovery, total demands should grow
by more than two percent per year.
With annual growth rates of three to four percent in income, it
follows that residential,
commercial,
and industrial demands for gas
increase by between three and five percent in each of the next three
years.
^The form of the demand equations' for each of four sectors is as
follows :
4 Si-
-i =
st
.
à1
f-
♦ * 2
‘ 1
‘
A p0
— 2
po
♦ oC3
'
¿ pt
f-£
pt
.
.
A St-l
'2
st-i
♦ V:
where I is a measure of income,
is the price of free oil, and S^, P^
are as given in the supply equations.
Demand equation parameters:
Residential/
Commercial
V
Gas price elasticity
Income elasticity
Oil price elasticity
Lagged demand coefficient
-.11
.65
.05
79
Industrial
-.13
.32
0
0
Electric TransporUtility tation
-.11
.48
.11
.58
-.20
0
.26
.60
237
These trends in supply and demand are sensitive to price changes,
economic growth, and the price of oil, but they are clearly in the
direction of increasing demand and falling supply.^
confused with the present surplus condition.
They are not to be
An estimated one to two
trillion cubic feet of natural gas production capacity is currently in
surplus.
Pipelines have had to cut back gas acquisitions to below "take
or pay" minimum levels and entirely eliminate production from their own
gas wells.
This current condition will be exacerbated by the continuation of
the NGPA.
Price ceilings will continue to rise and pipelines will
continue to take expensive gas because of contract obligations even when
cheaper gas is available.
Table One shows the effect on prices after
one year of the status quo NGPA condition.
Under moderate growth and
oil price conditions, the status quo is expected to add from 1.1 to
1.4 percent to real or constant dollar gas wholesale prices.
The high
cost supplies expand by enough to more than match any increases in
demands, so that cheap gas shut in by contract take-or-pay obligations
won't return to full capacity for several years.7
Tables Two and Three
There is the additional question as to whether excess demand in
1984-1985 could be effectively eliminated by additional imports of gas
principally from Canada.
The answer is exceptionally difficult to
determine because availability and price of Canadian gas is entirely a
political matter. Given a history of substantial delays it is unlikely
that imports of 250 to 500 billion cubic feet per annum could be added
to Canadian supplies on short notice.
7The gas model described above and used to generate the forecasts
in Table One takes advantage of data and forecasting models collected
and used by the Department of Energy. The most relevant sources are:
Production of Onshore Lower-48. Oil and Gas Model Methodology and
Data Description. DOE/EIA-0345, June 1982, Office of Oil and Gas.
Natural Gas Monthly. DOE/EIA-0130.
Monthly Energy Review. DOE/EIA-0035
21-496
0
83
16
238
TABLE ONE
CHANGES IN PRICE AFTER ONE YEAR
ASSUMING MODERATE OIL PRICE INCREASES
NGPA
Deregulation
(percentage change)
Moderate GNP Growth*
1.19
0.82
Low GNP Growth
1.35
0.98
NOTE:
Under high oil price conditions and moderate GNP growth price
changes would be 1.02 percent and 0.64 percent, respectively, for
the NGPA and Deregulation cases. Under low oil price conditions
price changes would be 1.34 percent and 1.05 percent, respectively.
Because of the surplus of cheap gas high oil prices and high GNP
growth will lower average prices by allowing pipelines to purchase
more inexpensive gas already under contract.
*Assumptions for GNP growth:
High:
4-5% per year
Moderate:
3-4% per year
Low:
2% per year
Assumptions for oil price changes:
High:
+5% per year
Moderate:
0% per year
Low:
-4% per year
The inflation rate assumed is eight percent per year.
SOURCE:
Model simulations based on parameter values shown in the
footnotes. All estimates are percentage changes in real
or constant dollar wholesale average national price.
239
TABLE TWO
CHANGES IN PRICE AFTER THREE YEARS
ASSUMING MODERATE OIL^ PRICE PROJECTIONS
NGPA
Deregulation
(percentage change)
High GNP Growth
47.24*
33.36
Moderate GNP Growth
34.12
21.50
Low GNP Growth
11.23
0.46
♦Under the NGPA, high GNP growth and high or moderate oil price growth
will result in a natural gas shortage of .2 to .5 trillion cubic feet
at the end of 1984. This shortage is cleared from the market in 1985
as a consequence of the partial decontrol scheduled under the Act.
NOTE:
Under high oil price conditions and moderate GNP growth price
changes would be 45.83 percent and 32.47 percent, respectively,
for the NGPA and Deregulation cases.
Under low oil price
conditions price changes would be 24.23 percent and 12.91 percent,
respectively.
SOURCE:
Model simulations based on parameter values shown in the
footnotes. All estimates are percentage changes in real
or constant dollar wholesale average national price.
240
TABLE THREE
CHANGES IN PRICE AFTER FIVE YEARS
NGPA
Deregulation
(percentage change)
High Oil Price
High GNP
Moderate GNP
Low GNP
129.59
103.94
78.37
120.53
95.89
67.94
116.25
92.54
65.01
107.07
82.93
54.47
106.81
83.17
54.10
96.90
73.02
43.55
Moderate Oil Price
High GNP
Moderate GNP
Low GNP
Low Oil Price
High GNP
Moderate GNP
Low GNP
SOURCE:
Model simulations based on parameter values shown in the
footnotes. All estimates are percentage changes in real
or constant dollar wholesale average national price.
241
show the longer term effects of the NGPA, for several growth and oil
price assumptions.
The alternative case is one in which all natural gas prices are
deregulated and allowed to go to market clearing levels.
It is
assumed that contract clauses such as "favoured nations" clauses do not
cause prices to rise above market clearing levels, and that "take or
pay" clauses do not prevent the price of high cost gas supplies from
falling.
This is not the same as the Reagan plan, under which only new
contracts and renegotiated contracts are deregulated,
so that only a
small share of natural gas production will initially be at the market
clearing price.8
The price increase after the first year of deregulation is from
0.5 percent to 1.0 percent, somewhat less than that expected without
deregulation.
Because of the gas surplus it is particularly hard to
forecast this first year price increase.
It is assumed that the surplus
is not worked off, but new contracts are still signed for $2.72 per mcf.
But if all of the surplus gas was used, the price of new gas contracts
would fall below $2.72 per mcf, to a level in keeping with the marginal
costs for much of the new volumes available.
That level of new contract
price would likely be close to $2.00 per mcf, which implies the average
For a more complete description of the lagged adjustment process
used in the demand and drilling equations, see Paul MacAvoy, Crude Oil
Prices as Determined by OPEC and Market Fundamentals (Cambridge, Mass.:
Ballinger Publishing Company, 1982), page 26.
Historical levels of drilling and drilling costs were obtained from
the American Gas Association publications.
8
The "price cap" imposed by the Reagan plan will prevent the upward
ratcheting of prices under favoured nations clauses. This however is
a second best solution.
Renegotiating such contracts would be more
efficient and would exert more downward pressure on price the setting
a price ceiling. The "price cap only effects prices for cheap gas and
does nothing to help bring down prices of deep and imported gas.
242
price decrease of 20 percent.
This is the lower bound of the likely
price effect of deregulation, and results from complete recontracting.
In
following
years,
as described
in Tables
Two
and Three,
deregulation consistently keeps prices below those from the NGPA.
The three year, forecast under moderate conditions puts natural gas
prices 13 percent lower given immediate deregulation.
Under high growth
conditions, the'deregulated price level is again 13 percent lower and
that is achieved without the deliverability shortage in 1984 caused
by the NGPA.
In the five year forecast, the prices under deregulation
are still lower but the relative magnitude of the difference is less
severe as in the intervening years.
Under moderate growth and oil price
conditions NGPA prices will grow to 92.5 versus price increases of 82.9
percent under deregulation, a difference of ten percent, less than the
difference after only three years.
The
Reagan Plan will
achieve
the
same
long run results
as
deregulation, but will fall short of immediate decontrol price savings
in the short run.
Since the Administration plan immediately deregulates
only "new" and renegotiated gas, a small fraction of the total supply,
it is unlikely that competitive pressures will bring gas prices down
as rapidly as decontrol.
Some old gas’will remain at low NGPA price
ceilings until 1985 or 1986, but the "price cap" set by the Reagan Plan
will be higher than the equivalent deregulated price level.
9
The
Administration Plan would achieve the same price gains and efficiency
improvements as complete deregulation, after four or five years when all
gas is decontrolled.
9
The price cap is the average of the deregulated prices, however
with less deregulated gas there is less price competition to provide
lower pricesf.
243
Senator J epsen . Mr. Twilley, going from right to left, you’re next.
You’re in the middle.
STATEMENT OP JOSHUA M. TWILLEY, MEMBER, NATIONAL ASSO
CIATION OP REGULATORY UTILITY COMMISSIONERS
Mr. T w il l e y . Thank you, Mr. Chairman and thank you for the
opportunity to appear here. It’s my first experience before a congres
sional committee and it’s quite exciting for me.
I oome here today as a footsoldier in the front line of regulation.
I am a commissioner. I am a commissioner from a State which does
not have any gas wells. We have distribution companies. I speak on
behalf of the National Association of Regulatory Utility Commission
ers, of which I am a member. I was also chairman of the committee
that drafted the bill which is now S. 823.
Senator J epsen . For the record, what State are you fro m ?
Mr. T w il le y . Delaware, the first State in the Union.
Senator J epsen . Good.
Mr. T w il l e y , Last November, the National Association of Regula
tory Utility Commissioners became very alarmed, as they had been
for some time, in regard to what was happening under the Natural
Gas Policy Act, And it seemed appropriate that as a group, we should
try to offer some assistance to Congress in finding solutions. And it
was at that time that a staff subcommittee of NARUC, composed of
State commission staff personnel throughout the United States in
most States, from California to New York, I might add, met to begin
work on a proposal. There were a number of meetings, not only with
the staff subcommittees, but also with commissioners representing all
sections of the country. And it eventually resulted in this bill. It is
a consensus bill. Many of us individually would have preferred a
stronger bill, perhaps, or a weaker bill. But regulatory commissioners
are very practical people. We are the ones—and I might add, it made
my heart warm to hear Congressman Lungren refer to the constitu
ents and how you explain to them when they come before you op
posing increases in gas rates and telling you that they can’t find afford
to pay for the gas in their home—there is this problem that we must
face the consumers directly and explain why the purchased gas ad
justment clauses have to be raised.
It is true that we commissioners also felt very frustrated and help
less in this area because it was a congressional responsibility to pass
laws dealing with this issue.
And so that is why we entered into this and developed this kind
of bill. And its based upon the premise that the Natural Gas Policy
Act should not be scuttled, but rather, should be amended to make
it workable.
And that is because many of us recall a few years ago when we were
dealing with curtailment problems, when increasing the available supply of gas was very important. I can recall, as a matter of fact, in my
own State industrial companies coming before us to urge us not to
let anyone else come on the system because we had about a 7-year pro
jected future supply of gas and that was not even enough for them to
go into the capital expenditure of putting in gas furnaces.
244
And so in that kind of climate, the Natural Gas Policy Act was
enacted and it certainly did make a big change in the supply situation
of gas. And I suppose that if we had continued in inflation, we prob
ably wouldn’t have had the problems that we have today. But who
knows ?
In any event, the aspects of this bill which continue the old-gas
subsidy and regulation of old gas have value in our opinion, in that
it will continue to promote exploration and it will permit higher cost
gas, if it’s reasonably priced, to be brought into our projected supply.
It is, of course, based upon the original regulatory premise that prices
should be cost based, and that the owners of that old gas are receiving
an adequate return based upon their cost.
So they are not being hurt by continuing the old-gas regulation. I
would suspect that many Congressmen may have had the problem of
explaining back home why we should permit deregulation of old gas
and permit the price increases to take effect when they, the residents
who were buying the gas, would, in fact, be paying for larger profits
for some producers that had no cost-based justification, only marketbased justification.
And I think in this whole picture, we cannot lose sight of the fact
that gas is not like fuel oil. You cannot shift back and forth. It doesn’t
have a lot of different uses. And one of its main uses, probably about 50
percent, is the residential user in his home-heating plants. And those
people are not able to make the kinds of changes that industry can
make, nor do they have the options open that other industries have.
So we address in S. 823 the question of a national consensus for
something that would be practical, workable, would be nationally ac
ceptable, in States that have no wells, but also in States that might have
other interests in this area.
So the first step, of course, and I think there’s not been any disagree
ment here, is the contracts problems that ought to be correct. And
we felt that you shouldn’t throw the baby out with the bath, but just
get some clean water in there. And if take-or-pay contracts and indefi
nite escalators and these kinds of provisions were brought into con
trol, then the correction would be made and things could be improved.
And we also felt that FERC had been interpreting its authority
under the Natural Gas Policy Act too narrowly and that the definition
of abuse and fraud under the act should be improved so that the com
mission would exercise more authority in this direction.
Other things to make the law more acceptable, such as the require
ment that these contracts all be made public, were viewed as important
by State regulators. And I would like to add in regard to that, in
developing the position that the national association has in this, we
consulted with liberal groups, as well as conservative ones, and with the
AGA, as well as the AGD, as well with the Citizens/Labor Energy
Coalition people, and there were members from Kansas on our subcom
mittee, and there were all walks of life. And it was our judgment that
if we could come up with this kind of practical solution that addressed
the contract problems, making FERC itself more active in its over
sight of the pass through requests of pipeline companies, and provid
ing other alternatives that would help with the local distribution com
pany problems, that we would be overcoming and providing a kind of
245
correction to the Natural Gas Policy Act that would enable it to con
tinue as existing law.
And it does lead eventually toward total deregulation, but it moves
slowly and permits Congress, from time to time, as it is now, to take
another look to see if there should be corrections in this process.
And I ’m impressed by an article that I happened to note recently in
the New York Times by James Schlesinger, who said that, basically,
the situation in this area is such that the gas distribution companies
and the pipelines are not really equipped to move into total deregula
tion and that we should permit a slower movement in this direction, as
the Natural Gas Policy Act would contemplate, this being a more
appropriate direction to take.
My prepared statement goes into greater detail, but I thought I
should give some independent views here. Thank you.
[The prepared statement of Mr. Twilley follows:]
246
P repared St a t e m e n t
of
J o s h u a M. T
willey
Mr. Chairman and Distinguished Members of the Committee:
I.
Introduction
Good morning.
My name is Joshua M. Twilley, and I am a
Commissioner of the Delaware Public Service Commission, a position
I have held since 1975.
I am testifying today on behalf of the
National Association of Regulatory Utility C o m m issioners, commonly
referred to as the NARUC.
Accompanying me today are P a u l ‘
Rodgers,
NARUC Administrative Director and General Counsel; Rita A. Barmann,
NARUC Director of Congressional Relations; and Linda L. Kent,
NARUC Assistant Director of Congressional Relations.
The NARUC is a q u a s i-governmental, nonprofit organization
founded in 1889.
Within our membership are the governmental
agencies of the fifty States, the District of Columbia, Puerto
Rico and the Virgin Islands which are engaged in the regulation
of utilities and carriers.
Our chief objective is to serve the
public interest by seeking to improve the quality and effective
ness of government regulation in America.
The members of the NARUC appreciate this opportunity you
have afforded me today to make known their views on the economics
of natural gas deregulation.
As you know, all but one of the
State public utility commissions,-^ or State PUCs, are charged
with the responsibility for regulating retail natural gas sales
to residential, commercial and industrial ratepayers.
Federal natural gas
pricing is of vital concern to State regulators, since the major
cost components of retail gas rates--i.e.,
wellhead prices charged
by producers and wholesale or "city-gate" rates charged by pipeline
companies--are controlled only at the Federal level.
T7 The State of Nebraska does not regulate electric or gas
utilities, all of which are owned or regulated by public power
districts and municipal governments within its borders.
247
In 1978, Congress determined that it is in the public interest
to reduce Federal regulation of gas wellhead prices.
We are now
less than two years away from the partial deregulation date that
was thus established in the Natural Gas Policy Act of 1978 (NGPA ).U
We are also now engaged in an intensive national policy debate
concerning the extent to which NGPA revisions are needed to ensure
that natural gas prices do not exceed competitive levels.
Legis
lative proposals offered for this common purpose literally run
the gamut:
from total removal of wellhead price controls, to delay
of the 1985 partial decontrol date for two- or more years, with
various other remedies in between.
It is clear, then, that the subject of the Committee's hear
ing today could hardly be more timely, and on behalf of the State
regulatory community, I would like to commend you for placing the
impact of our Nation's current and future natural gas policies
among your top study priorities.
For our part, members of the NARUC have endeavored to reach
a consensus among State regulators as to the nature of our current
gas pricing problems and the most desirable means to resolve them.
Last November, I was appointed by the Association's Committee on
Gas, of which I serve as Vice Chairman, to head a special task
force on Federal legislation addressing natural gas policy.
Our
task force developed draft legislation proposing a range of NGPA
amendments, many of which are also included in various bills now
pending in the House and Senate.
Our draft legislation, the p r o
posed Natural Gas Fair Marketing Act of 1983, was subsequently
adopted by the NARUC's Gas Committee and the Association's policy
making arm, the Executive Committee.
Tj
15 U.S.C.
3301 et seq.
248
The NARUC-endorsed legislation has since been introduced in
the House (H.R. 2164), and in the Senate by the distinguished
Chairman of this Committee (S. 823),
Though some of us individually*
might advocate additional or different N G P A revisions, we think it
highly significant that so many of us, with our widely varying
perspectives on gas policy, have been able to agree on the need
for legislation of a relatively far-reaching nature.
This morning I would like to describe for the Committee the
underlying problems which have led us to this consensus position
regarding appropriate legislative remedies.
From our perspective,,
these problems can be generally characterized as follows:
• First, there is inadequate Federal oversight of the gas
purchasing practices of interstate pipelines companies;
• Second, pipeline-producer contracting practices are largely
insulating the producing segment of the gas industry from
market forces;
• Third, local distribution companies typically have no
competitive alternative from which to purchase gas supplies;
and
• Finally, certain Federal policies have been established that
thwart, rather than facilitate, effective State regulation
of retail gas rates.
II.
Pipeline Unaccountability
In retrospect, it seems clear to us that one of C o n g r e s s 1
major miscalculations in crafting the NGPA was its failure to
specify that interstate pipelines must be held responsible for
their gas purchasing decisions.
Section 601 of the law requires
that such p i p e l i n e s ’purchased gas costs be passed through a u t o
matically to the pipeline's wholesale customers, except where
there has been "fraud, abuse or similar grounds".— ^
-----
y
15'tJ.S.C."V7l31 (c).
The Federal
249
Energy Regulatory Commission (FERC) has interpreted the latter
exception quite n a r r o w l y , s u c h that "imprudent” pipeline p u r
chases of high priced gas when lower-cost supplies are available
are nevertheless granted automatic passthrough treatment
The adverse impact of dubious gas purchasing decisions is
not averted by such superficial regulatory review; it is merely
shifted to the pipeline's customers, most of whom are the local
gas utilities we regulate.
Both State commissions and utilities
have been active participants in recent FERC proceedings to con
sider interstate pipelines' purchased gas adjustment (PGA) re
quests.
However, unless the statutory standard of review is
broadened--by legislative action or by FERC reinterpretationeven the most insightful input in these proceedings will be of
limited effectiveness.
It should be noted that the groundwork for just such a re
interpretation on the FERC's part has already been laid.
In a
December 30, 1982 decision issued by FERC Administrative Law
Judge Michel Levant ,.§/ Columbia Gas Transmission Corp. was denied
the right to pass through certain of’its purchased gas costs
under Section 601, in part on the basis that the pipeline has
engaged in an "abusive" practice of cutting back on low-cost gas
supplies under take-or-pay contracts before reducing purchases of
higher cost supplies.
Judge Levant also found that Columbia's
practices in projecting future supply requirements and acquiring
gas supplies were "unjust, unreasonable, unduly discriminatory and
preferential" within the meaning of Section 5 of the Natural Gas
37 See the FERC's policy statement on this matter, published
at 47 Fed.Reg. 6253-63 (February 11, 1982).
5/
Docket Nos. TA81-1-21-000 and TA81-2-21-000.
250
Act ( N G A ) a n d
he ordered the pipeline to modify such practices
and to renegotiate inflexible contractual provisions to the maximum
extent feasible.
Judge L e v a n t ’
s decision reflects the effort to harmonize the
FERC's authority under NGPA Section 601(c) and NGA Sections 4 and 5
w hich FERC Commissioner
J,
David Hughes argued several months
earlier the Commission has thus far not met head on.
As Commissioner
Hughes noted in his partial dissent from a Commission order in a
Tennessee Gas Pipeline Co. PGA case,-^/ under the NGA interstate
pipelines are granted significant market power but are also vested
with responsibility to consider the economic consequences for
their captive customers of exercising this power.
He also points
out that "abuse" under Section 601(c) may be the disregard of a
duty or the improper use of a right or privilege.
Even assuming that the full Commission chooses to break new
ground and affirm Judge L e v a n t ’s decision, the NARUC believes
that Congress should explicitly codify a stricter standard of FERC
review for pipeline, purchasing practices.
The experience of the
last two years in particular shows that essential consumer p r o
tections should not be left to Federal agency discretion.
III.
Market-Insensitive Provisions In Producer-Pipeline Contracts
Virtually all parties to the natural gas policy debate agree
that inflexible, long-term contracts between producers and p i p e
lines have been a major contributing factor to gas price increases over
the last two years.
The existence and broad scope of the " c o n
tracts problem", as it has come to be called, are w e l l -document------57— 15"U7$ ."C:
717d (a),
7/ Docket Nos. TA82-2-9-000, RP81-54-000, RP82-12-001, and
TA82-T-9-001. The FERC's Order Denying Rehearing was issued on
October 1, 1982.
251
ed,.§/ and I will discuss it only briefly for this reason.
Take-
or-pay, indefinite price escalator, and most-favored-nation clauses
in such contracts provide producers an assured revenue stream, even
when the wellhead prices these revenues are based upon exceed the
actual market value of the purchased gas.
This problem is exacer
bated by the absence of renegotiation or ’
’
market-out” clauses in
many producer-pipeline contracts.
In our view, it makes no economic sense to permit the opera
tion of contract provisions which insulate the producing end of
the natural gas industry from the effects of overpricing gas.
This
is particularly so given the fact that the proportion of consumerderived revenues which goes to gas producers has doubled during
the last 11 years.— ^
There is an obvious link, of course, between FERC's regulatory
treatment of pipelines' gas acquisition costs and producer-pipeline contractual arrangements.
As long as a pipeline company's
management knows it will not be held accountable for its gas
purchase decisions, there exists no incentive to avoid onerous
terms in contracts with producers.
The recent news that Columbia
Gas plans to reduce certain of its ’
’
take” obligations to 50 percent
of contracted levels in an effort to hold down gas prices!®/ is
17 See generally, e. g . , Comptroller General of the United
States, Information on Contracts Between Natural Gas Producers and
Pipeline Companies (February 22, 1983); Energy Information Administration, U.S. Department of Energy, An Analysis of Post-NGPA InterState Pipeline Wellhead Purchases (September 1982); and Congressional
Research Service and National Regulatory Research Institute,
Natural Gas Regulation Study (July 1982).
9/
Analysis
10/
U.S. GAO, Natural Gas Price Increases:
(December 9, 1982) at 6.
A Preliminary
Reported in The Washington Pos t , April 6, 1983.
252
arguably a direct result of the previously mentioned PGA decision
by ALJ Levant.
But consumers nationwide need relief from rising gas prices n o w .
The NARUC therefore supports congressional action to outlaw c o n
tractual indefinite price escalators, to modify take-or-pay ob l i g a
tions in existing c o n t r a c t s , and to include Mmarket-out clauses”
in current contracts.
IV.
Distribution C o m p a n i e s 1 Lack of Competitive Supply Options
Currently, most local gas distribution companies have no
choice but to rely upon only one pipeline for their supply requ i r e
ments.
In much the same way, many producers complain of gas wells
being shut in because the only pipeline in the vicinity is unwilling
to buy their production.
Pipelines are thus accurately described
as possessing both monopsony and monopoly power within the natural
gas industry,
The NARUC believes that the time has come to begin serious
consideration of ways to restructure the role of pipelines in the industry in
order to encourage competition in the gas supply market.
A partial solution that
has received some support from the FEKC is greater pipeline freedom to engage in
off-system sales of natural gas.
Virtually all interstate pipelines have expressed
support for this approach, especially since it would assist
them in dealing with high take-or-pay requirements.
Pre
payments for natural gas under take-or-pay provisions are generally
included by the FERC in an interstate pipeline's rate base, whether
or not the gas can be sold.
If the pipeline is able to sell the
gas to off-system buyers, rate base treatment of the prepayment is
avoided, and the pipeline's on-system customers benefit.— ^
11/ See speech by FERC Commissioner J. David Hughes to the
Federal Energy Bar Association, January 13, 1983,
at 8-12.
253
The FERC recently approved a new off-system sales policy,i2/
and it remains to be seen whether the number of such transactions,
and the consequent level of supply competition, will increase as
a result.
Previous experience has been disappointing:
of the
1,090 Bcf of off-system gas sales authorized by the Commission as
of November 13, 1982, only about 227 Bcf have actually been s o l d . ü /
There are, of course, more radical approaches to revising
the role that pipelines play in the gas industry.
At least one
State commission is actively supporting Federal legislation to
impose common carrier status on all interstate pipelines.ii/
À
national coalition of producers and end-users— / advocates exten
sion of this to intrastate pipelines and distribution companies
as well.
Mandatory contract carriage of.gas owned by parties other
than the transporting pipeline is a variation on this theme.
The
thrust of such proposals--to enable producers and ultimate c o n
sumers to negotiate directly on gas sales--is quite attractive to
many State regulators, since this would surely encourage mar k e t sensitive producer pricing.
At this juncture, the NARUC believes that Congress should
direct the FERC to study
12/ The new policy
1983 meeting. A written
13/ Speech by FERC
all of the ramifications which may be
was approved at the Commission’
s March 10,
order has not been issued as of yet.
Commissioner Hughes at 8.
14/ Statement of Philip R. O'Connor, Chairman, Illinois
Commerce Commission, before the Senate Committee on Energy and
Natural Resources, March 12, 1983.
15/ The coalition is called the Association for Equal Access
to Natural Gas Markets and Supplies.
21-496
0
83
17
254
involved in restructuring existing relationships between d i stribu
tors and pipelines.
Unless the current situation is somehow
changed, the lack of competition between gas suppliers will c o n
tinue to cause unnecessarily high retail rates.
V.
Federal Impediments to Effective State Retail Rate Regulation
Incremental P r i c i n g .
The final set of problems I would like
to bring to your attention today concerns Federal policies that
have unnecessarily impeded effective State regulation of retail
gas rates.
State regulators would place the NGPA's Title II,i£/
containing mandatory incremental pricing provisions, among the
prime examples of such impediments.
The NARUC strongly opposed
inclusion of these provisions in the NGPA when the law was under
consideration in 1978, on the grounds that mandatory incremental
pricing would result in higher rates to residential users due to
consequent reduction of industrial gas use, and that it constituted
an unwarranted first-time intrusion of Federal control into this
aspect of retail ratemaking.
We are convinced that the passage
of time has only made these arguments more persuasive.
Title II of the NGPA provides that most large industrial
boiler consumers of gas which purchase supplies, either directly
or indirectly, from interstate pipelines are to be assigned the
incremental cost of new gas.
These industrial facilities are
required to,absorb this surcharge until their gas costs equal the
cost of alternative fuel, which the FERC has designated as No. 6
oil.
Title II also places specific restrictions on the S t a t e s ’
regulatory discretion with respect to the incremental pricing
TF7
IS U.S.C.' §§ 3341-3348.
255
surcharge on industrial users.
Under Section 205, State regulatory
commissions are required to pass through directly to incrementally
priced industrial users any surcharge paid by a local distribution
company for gas purchased from interstate pipelines.
In addition,
the States are forbidden from modifying rates for incrementally
priced industrial users
so
that the surcharge would be offset.
The troublesome nature of these restrictions on State regula
tory authority is especially apparent under today’
s natural gas
market conditions.
Automatic imposition of the incremental sur
charge on large, industrial users makes them extremely sensitive
to gas price increases.
Their fuel-switching capacity already
causes such users to place a lesser value on natural gas service;
mandatory incremental pricing only exaggerates this tendency,
making conversion to alternative fuels more attractive.
The impact of industrial load loss on a gas utility’
s remain
ing customers is direct and inevitable:
it increases the fixed
plant costs which must be shared by all ratepayers, thus causing
residential and commercial retail gas rates to rise.
Accord
ing to the F E R C ’
s Office of Regulatory Analysis, sales by
gas utilities to industrial customers during the last part of
1982 hit their lowest level in the last five years.— ^
Incremen
tal pricing as mandated by the NGPA unquestionably limits the
States’ability to respond to this reality, and thereby protect
the interests of all gas consumers.
Another flaw in the incremental pricing scheme relates to
the fact that the surcharge is imposed without regard to whether
the gas is contracted for on an interruptible basis.
Industrial
users are thus discouraged from entering into interruptible ser-
T77
FERC Monitor, March 21, 1983, at 8.
256
vice contracts, since the economic attractiveness of such arra n g e
ments is greatly reduced or eliminated.
Gas distribution companies
benefit from having interruptible customers; for example, this
allows them to meet peak demand during the heating season without
adding storage capacity.
Under Section 111 of the Public Utility
Regulatory Policies Act of 1978,— / electric utilities are required
to encourage customers to accept interruptible service.
Incremen
tal pricing serves to impede this same goal in natural gas markets.
In sum, the members of the NARUC firmly believe that experience
has shown incremental pricing to be a manifestly unwise Federal
policy that interferes with the S t a t e s ’ ability to ensure leastcost gas service to all consumers.
We have therefore requested
those congressional committees with legislative jurisdiction to
include repeal of Title II in any natural gas bill that is
reported.
Producer-pipeline contract fil i n g .
Turning to another Federal
barrier to effective State regulation, we feel strongly that the
FERC's failure to fully exercise its authority to require producerpipeline contracts to be filed with the Commission, and to make
material terms of those contracts publicly available, has made
the S t a t e s ’ task of evaluating the reasonableness of distribution
company purchasing practices unnecessarily difficult.
The NARUC’
believes that the Commission currently possesses ample statutory
authority to implement such filing requirements.
Section 315(c)— / of the NGPA permits the FERC to issue
regulations requiring the filing of all such contracts and ancillary
agreements.
Moreover, Section 501(a).?®/ grants the Commission
TS7
16
U.S.C. § 2621.
19/
15 U.S.C. § 3375(c),
20/
15 U.S.C. § 3411.
257
general rulemaking authority to issue regulations "as it may find
necessary or appropriate to carry out its functions under this
chapter" of the NGPA.
The NARUC has petitioned the FERC to implement producer-pipeline filing requirements, a request which the Commission has yet
to act upon —
'(
Without the opportunity to examine these c on
tracts, State commissions as well as the general public are p re
cluded from knowing how the major cost component in a retail gas
rate case is computed.
As with the pipeline accountability issue
I discussed earlier, we believe that although current law enables
the FERC to take the desired action and thereby subject pipeline
transactions to greater public and regulatory scrutiny, the
Commission’
s unwillingness to exercise its authority in this
regard demonstrates the need for a legislative remedy that compels
the FERC to act.
Preferential treatment of natural gas pipeline tax credits.
An additional concern shared by many State regulators involves
the FERC's regulatory treatment of investment tax credits claimed
by interstate natural gas pipelines.
Under a provision of the
22/
Internal Revenue Code that was added in 1971,—
the FERC is p er
mitted to set pipeline rates without regard to the tax forgiveness
obtained by the pipeline through investment tax credits.
The
Commission has routinely been granting this preferential treatment
since 1972, despite the fact that the statutory precondition for
such treatment--that the company’
s gas supply is "insufficient to
21/ The NARUC petition for rulemaking was filed in FERC
Docket No. RM-82-20. The Commission referenced the NARUC petition,
inter alia, in its April 28, 1982 Notice of Inquiry on Impact of
the NGPA on Natural Gas Markets (Docket No. RM82-26).
22/
Section 46(f)(1)[26 U.S.C. § 46 (f)(1)].
258
meet the present and future requirements of the domestic ec o n o m y " is clearly no longer applicable.
The Iowa State Commerce Commission recently petitioned the
FERC to revise its policy regarding treatment of pipeline tax
credits^?./
In a supporting statement filed by the N A R U C , it
was pointed out that the FERC policy "clearly results in a s u b
stantial direct subsidy from ratepayers to [the pipeline's] s t o c k
holders, which in turn causes natural gas rates to exceed those
which would be in effect if conventional normalization ratemaking
treatment were employed
," .— /
Seventeen States
have also joined in support of the Iowa petition.
The seriousness of this problem is substantial because of
the magnitude of the investment tax credits now being generated
by pipelines.
During the ten-year period between 1972-82, FERC
Class A and B pipeline companies claimed nearly $1.5 billion in
such tax credits.
Over $840 million of this sum was generated
in the past three years alone.— /
At a time when natural gas retail rates are rising p r e c i p i
tously throughout the Nation, we can ill afford to grant pipelines
a tax preference at the ultimate expense of gas utility r a t e
payers.
Accordingly, the NARUC has endorsed legislation pending
in the House (H.R. 570) which would repeal that Internal Revenue
Code provision permitting this preferential treatment,
Federal-State Joint B o a r d .
In order to foster future Federal-
State cooperation in natural gas regulatory matters, the NARUC
237 Docket No. RM83-8-000.
NovemFer 8, 1982.
The Iowa petition was filed on
24/ Statement of the NARUC In Support of Petition For Rulemaking, Docket No. 83-8-000 (December 1 4 3 1982) at 4.
25/
Id. at 6.
259
believes that a Joint Board mechanism should be established at
the FERC.
Federal-State Joint Boards have been a useful feature
of the telecommunications regulatory framework for many years,
providing the States with the opportunity for active input into
Federal Communications Commission deliberations which have a
special impact on State c o n c e r n s . S i m i l a r l y , a Joint Board on
natural gas matters would allow the States a meaningful voice in
recommended decisions of the FERC.
We believe the rationale for establishing a Joint Board
mechanism in the natural gas regulatory arena is a compelling one.
As mentioned earlier, the largest cost components in burner-tip
gas prices are controlled only at the Federal level,
Our experi
ence thus far in making the transition to partial deregulation of
wellhead prices shows that State regulators are forced to deal
with the consequences of a poorly fashioned transition in this
regard but are precluded from making the regulatory decisions
which are actually shaping it.
The Commission's proposed and
final rules concerning wellhead prices under Section 107 of the
NPGA— / are obvious examples of such decisions, but the list by
no means stops there.
Use of Joint Boards would ensure that State regulators are
permitted to do more than merely comment upon m a j o r •regulatory
proposals with respect to natural gas that are conceived by the
FERC staff.
Moreover, providing them with a more decisive role
in the promulgation of Federal regulations is in keeping with
State regulators' legal responsibility to see that retail gas
rates are just and reasonable.
7<[7
See 47 U.S.C. § 410(c),
27/
15 U.S.C. § 3317,
260
VI.
Conclusion
The problems I have touched upon this morning have contributed
in varying degrees to a gas pricing situation that is in the
interests of neither industry nor consumers.
Today's prevailing
prices for natural gas continue to increase even as demand is
dropping and gas supplies are growing more abundant.
In recent
testimony before a House subcommittee, FERC Chairman C.M. "Mike"
Butler III described an informal survey of gas distribution
companies undertaken by FERC staff.
This survey revealed that
significant fuel-switching is occurring around the country as a
result of gas prices which exceed market-clearing levels.1®/
State regulators can readily attest to the pervasiveness
of this market loss problem.
From our perspective as the o f f i
cials whose obligation it is to maintain adequate revenues for
the nation's gas utilities, we can also verify the existence of
the very real dilemma which this problem creates:
the only way
to assure recovery of the utility's fixed plant costs when i n
dustrial markets shrink is to raise prices for its captive c u s
tomers- -the residential and commercial ratepayers--even more.
Most assuredly, the smooth transition to a deregulated gas
market which the NGPA's authors intended the law to provide is
not occurring.
Demand-sensitive pricing of natural gas remains
largely an unrealized dream.
the complicated task
In our view, as Congress begins
of rethinking Federal gas policy, the
central focus must be how best to achieve that dream, consistent
with the public interest.
Thank you for your attention.
287 Statement of C.M. Butler IIIj Chairman, FERC, before
the Subcommittee on Fossil and Synthetic Fuels of the House
Committee on Energy and Commerce, February 10, 1983, at 3.
261
Senator J epsen . We appreciate that and I thank you. Mr. Cooper,
if Mr. MacAvoy is to keep his appointment, I think that, if we have
questions for him, we should ask them now.
Would you understand and please permit us to do that?
Mr. MacAvoy. Senator, to be courteous to my colleagues, my ap
pointment is a luncheon appointment with the Vice President. And
given the present powers of the Vice Presidency, I believe it could
wait 15 or 20 minutes longer. [Laughter.] So I would be perfectly
pleased to stay.
Senator J epsen . Y ou may proceed, Mr. Cooper. Thank you.
STATEMENT OF MARK COOPER, DIRECTOR OP RESEARCH, CON
SUMER ENERGY COUNCIL OF AMERICA
Mr. C ooper. I appreciate. Mr. MacAvoy’s, what I take to be some
what complimentary, remark. I ’m not sure that I can be more incisive,
but I will disagree. I ’ve become used to going last and I though I
would wait to see what Mr. Twilley would say. And, in fact, he said
a few things that I can agree with. Indeed, my hopes were met beyond
imagination when he mentioned cost-based pricing, which is a very
difficult thing to say in this town these days.
In my prepared statement, I ’ve tried to create a balance, to meet
the spirit of the committee’s request to deal with the issue in an
analytic framework, by blending about 50-percent conceptual state
ments, 25-percent empirical judgments, and 25-percent political
judgments. But given what’s gone before, I think I should stress
those aspects of my comments that reflect my political judgment, since
those are not frequently heard.
There are really two basic issues before Congress, this committee,
and the Nation. First, what should be done with the economic rents
of natural gas production ? Second, is there significant potential for
noncompetitive profits in the industry? In the current context, that
focuses a great deal of attention on the causes of the aberrant con
tract provisions that we find throughout the industry.
In my prepared statement, I distinguish two basic views of the
market, which, to try and depoliticize things, I call market hopefuls
and market protectors. The hopeful view believes that free competi
tion applied to American geology will yield a larger response of supply
to price increases, especially in old fields, than the available evidence
would suggest. In this view, the consumer would be protected by com
petition. Regulation distorts the supply curve in a number of ways. It
holds down low-cost-gas supply. It creates inequities in the endow
ments of low-cost supplies that create the possibility for the misallocation of resources to high-delete cost suppliers. And it creates nonprice
bidding practices that dampen the responsiveness of supply and price
to demand changes. I think I ’ve fairly represented both the adminis
tration’s position and Mr. MacAvoy’s comments.
The market protectors have a different view of things. They see three
first-order problems and one second-order problem.
First, an inelastic supply curve creates the potential for large eco
nomic rents.
262
Second, noncompetitive conditions between the wellhead and the city
gate create the potential for oligopoly problems. These noncompetitive
conditions include factors such as limited access to the field—and these
limitations are not imposed by regulation, but by real economic bar
riers—automatic passthrough clauses, affiliations and joint production
arrangements.
Third, captive consumers at the burner tip creates a potential for
even larger oligopoly or even monopoly profits.
With that view, market protectors believe that it is imperative for
Government to intervene to protect consumers because competition is
inadequate and wealth transfers are excessive. And analytically, they
seek a regulatory response that can capture economic rents and pre
vent the extraction of monopoly or oligopoly profits without destroy
ing the response of supply to price.
It is the preservation of that supply response that is the second
order of problem, which arises from the regulatory approach to the
first three problems. Mr. MacAvoy is right. There is an assumption of
prescience, the ability to look at the market and not distort it.
In theory, there is a set of regulatory categories that could simulate
closely the supply curve. Economic rents could be captured, while
supply responses could be elicited. That was the objective of the Natu
ral Gas Policy Act. The large number of categories that everyone com
plains about these days is nothing more or less than a rational at
tempt to move the regulatory scheme closer to the supply curve.
In practice, in spite of the mauling that the regulatory theory took
in the tortuous process of creating the Natural Gas Policy Act, and
in spite of the mauling that the Natural Gas Policy Act has taken at
the hands of the Federal Energy Regulatory Commission in imple
menting it, it seems clear that some of the rents have been passed
through to consumers and some have been captured by producers of
high-cost gas, while supply has, in fact, been stimulated.
It is absolutely critical to recognize that where you think we are
and where you want to go are separate considerations. You can believe
that we are in a situation of perverse regulation and want to move to
improved regulations. Or you can believe that we are in a position of
imperfect regulation and want to move to complete deregulation.
Where you think we are is an impirical question. Where you think
we should go is a morale, normative, and ultimately political, ques
tion. It is also obvious that how you think we got here will affect
where you want to go and how you think we can get there.
But there is a second point that is important. From the market pro
tector point of view, it is important to recognize the equity implica
tions of the economic reality of the fossil fuels market. The essence
of political choice in the pricing of a commodity such as natural gas
is the recognition that both supply and demand elasticities are low.
Therefore, the equity-efficiency tradeoff is very difficult. Even if one
does not assume oligopoly and monopoly, economic rents can be so
large and supply-demand responses to price so small, that equity
losses—that is, the transfer of wealth or surplus from consumers to
producers—may far outweigh efficiency gains, that is, the increase in
the national economic pie as a result of deregulation.
263
It is critical to recognize the possibility that the pie can get bigger,
but the redistribution of benefits may be so radical that there are large
groups, even a significant majority, that would end up with a smaller
piece. Distribution matters in philosophy, in practice, and in politics.
I believe that the evidence produced by the Department of Energy,
the Energy Information Administration, and the Government Ac
counting Office shows quite clearly for both natural gas and petroleum
that the low supply-demand elasticities create this very, very difficult
equity-efficiency tradeoff.
I am not a liberal who mistakes and overlooks efficiency. I just be
lieve that in the energy area the tradeoff is difficult and the sums at
stake are very large.
Given this conceptualization of the market, the Congress must read
the empirical record and decide between two competing interpreta
tions. And I rephrase the questions that you have asked in holding
these hearings. Does the recent loss of industrial load by natural gas
distributors reflect the temporary aberration of contracts or structural
forces which would indicate that natural gas producers will not com
pete in, nor will they attempt to clear, the No. 6 fuel oil market?
I f the latter, is that failure to compete simply a rationalization of
commodity values, what has been referred to in earlier testimony as
opportunity value or market value, or is it an exercise of oligopoly
power ?
The second major question—what is indicated by the fact that con
tracts were rewritten with incredible speed in the tight market of the
late 1970’s to include all those aberrant contract clauses we hear so
much about but the very slack markets of the early 1980’s have done
nothing at all to alter those clauses. In spite of what the administra
tion says about renegotiations, the responses to the questions posed by
Congressman Sharp on the House side clearly show that contract re
negotiations have gone nowhere.
Does this one-way street—up but not down, contract clauses that
push prices up, but never down, market pressures that put them in
but never remove those clauses—does this reflect perverse incentives
upon the Natural Gas Policy Act enshrined in inviolable contract? Or
does the fact that contracts are inviolable in some circumstances
but not others indicate the underlying distribution of market power is
structurally skewed to the advantage and in favor of producers at the
expense of pipelines and consumers ?
These are difficult questions to resolve empirically and they would
merit years of study. But as the chairman pointed out, politics and
price increases demand decisions faster than that. We must read the
record that we have as best we can.
I obviously believe that the record strongly suggests pervasive mar
ket imperfections that mandate consumer protection and regulatory
relief. The supply and demand curves that I have used in my prepared
statement are empirically based, having been derived, as I pointed out,
from the Department of Energy study, and I believe that they are
quite consistent with the ongoing work of the E l A.
The policy conclusions at which I arrive are quite different than
those you have heard earlier. I believe that in order to capture about
264
half of the economic rents that are likely to be available in the natural
gas market through the end of this decade, we must not decontrol old
gas.
Indefinite price escalators and most-favored-nation clauses which
refer to other prices must be abolished. This cross-referencing of
prices violates the very essence of competition at the wellhead and the
burner tip.
Take-or-pay clauses must be set at levels necessary to do what they
were intended to do—provide stable finance for the industry. They
must not be allowed to be used to bid for gas or insure producers very
high profits.
Automatic passthroughs must be permanently eliminated to re.move the insulation of pipelines from the consequences of their bid
ding practices.
The discretionary powers that FERC has used to raise prices and
the failure of FERC to police the industry by its interpretation of
fraud and abuse must not be permitted. We must go back to the just
and reasonable, or even stronger language, to guide pipeline behavior.
I like to call this a least-favored-nation clause, for any pipeline
that is not buying gas at the lowest price that FERC has before it,
should be forced to explain why it was unable to find the least cost
supply.
From this point of view, it is important to stress that a simple mar
ket solution, and certainly the one that is presented by the administra
tion, does not provide consumer protection. But it is even more im
portant to point out that it is not an economically efficient solution.
The transfer of economic rents to and the extraction of noncompetitive
profits by the producers will simply drain resources away from other
sectors of the economy that are in need of capital and consumer spend
ing. It will create a natural gas price drag on the economy at the
moment that the oil price drag of the second energy price shock is
finally working its way out.
Above all, if we give up any notion of setting prices for natural gas
by cost and accept the notion of market value or opportunity value,
we will tie natural gas prices irrevocably to the political manipulated
price of oil. And that is to give up all hope of allocating our economic
and energy resources in a manner that is consistent with the economic
forces, values, and needs of our domestic economy.
Therefore, we believe that it is necessary to design an institutional
regulatory structure that insures that gas prices will be driven by the
competitively determined cost of production, not by the opportunity
or market force of a politically dictated price of oil.
Thank you and I ’ll be glad to answer any questions.
[The prepared statement of Mr. Cooper, together with attachments,
follofws:j
265
P r e p a r ed S t a t e m e n t
of
M
ark
C ooper
Mr. C h a irman and Members of the Committee:
My name is Dr. Mark Cooper.
I am Director of Research at
the C o n sumer Energy Council of America (CECA).
CECA is a broad
based coalition of major national consumer, labor, farm, public
power, rural electric cooperative, senior citizen, urban and low
income o r g a nizations (see attached l i s t ) .
I enthusias t i c a l l y applaud the Committee for tackling the
difficult subject of natural gas pricing in a framework that asks
for analytic reflection on the differences of opinion about why
the natural gas market is not functioning well and how it might
be improved.
As one who spends a significant amount of time
dealing with politics, I appreciate the o pportunity to reflect.
In my remarks I will try to meet the spirit of the Committee's
request to deal with the issue in an analytic framework by
creating a blend of 50 percent conceptual statements, 25 percent
empirical assessment and 25 percent political judgments.
Basic Views of the Natural Gas M a r k e t
T here are two basic issues before this C o m m ittee and the
Congress:
production?
1) What should be done with the rents of natural gas
2) Is there significant potential for non-competi-
tive profits in the industry, which, in the current context,
focuses a great deal of attention on the causes of the aberrant
contract provisions that we find throughout the natural gas
industry?
Each of the proposals before the C ongress and the
nation takes a specific position on each of these issues.
266
Of course, the analysis that the proponents of the
various proposals conduct is much more complex than the simple
que s t i o n s suggest.
W hat I propose to do is to capture and
reconcile each aspect of the various proposals by ascertaining
w h a t they are saying about the nature of supply and demand for
n atural gas in this country.
For those who can stand to look at
supply and demand curves, I have provided a set of graphs which
d epict each step in my argument, although I hope my argument is
c o m p r e h e n s i b l e with o u t reference to the curves.
To defuse the political nature of the debate, I will
d epi c t the current differ e n c e of opinion as a difference between
those I call Market H o p efuls (MHs) and those I call Market
P ro t e c t o r s ( M Ps)•
[As depicted in Figure 1] M arket H opefuls believe that
the c u r r ently o bservable supply curve for natural gas is
distorted.
It has been rendered artificially inelastic by
partial regulation which gives strong incentives to produce high
cost gas and to withh ol d lower cost gas from the market in
antici p a t i o n of decontrol.
MHs believe that, given the chance,
the m arket would be extremely competitive and that free
com p e t i t i o n applied to A merican geo l o g y would produce a more
elastic supply curve, although it would still be relatively
inelastic.
That is, even with their hopeful view, they assume
that an increase in price of 1 percent would lead to increases in
s upply of cons i d e r a b l y less than 1 percent.
[As depicted in Figure 2] M arket Protectors do not see
such a rosy supply curve.
Not only do they not see a much more
267
FIGURE 1
MARKET PROTECTOR'S VIEW
OF THE NATURAL GAS MARKET
QUANTITY (Quadrillion Btu’s)
268
MARKET PROTECTOR'S VIEW
269
e l a s t i c s u p p l y c u r v e in the cards, b ut t h e y b e l i e v e th a t the r e
are n o n - c o m p e t i t i v e a s p e c t s of the m a r k e t w h i c h w o u l d d r i v e th e
p r i c e in a d e c o n t r o l l e d m a r k e t a b o v e the level
if c o m p e t i t i o n w e r e pe r f e c t .
it w o u l d s e t t l e at
T h e y b e l i e v e that a m a l d i s t r i b u t i o n
of b a r g a i n i n g p o wer, v a r i o u s a r r a n g e m e n t s b e t w e e n p r o d u c e r s and
pipelines
(affiliations, joint production arrangements)
and
s i m p l e m o n o p o l y or o l i g o p o l y c i r c u m s t a n c e s r e d u c e c o m p e t i t i v e
f o r c e s b e t w e e n the w e l l h e a d and c i t y g a t e
(the p o i n t at w h i c h ga s
is t r a n s f e r r e d to d i s t r i b u t i o n c o m p a n i e s ) •
T h i s w o u l d d r i v e the
p r i c e a b o v e the c o m p e t i t i v e e q u i l i b r i u m t o w a r d an o l i g o p o l y
l evel.
Moreover
[as d e p i c t e d
significant captive market —
in F i g u r e 3], the p r e s e n c e of a
a m a r k e t w i t h e i t h e r no real
a l t e r n a t i v e s or v e r y l a r g e c o s t s of c o n v e r s i o n to a l t e r n a t i v e s —
s h i f t s d e m a n d u p w a r d , l e a d i n g to an even h i g h e r price.
Basic Views of Regulation
[As d e p i c t e d in F i g u r e 4] t he M a r k e t P r o t e c t o r s see a
ne e d for r e g u l a t o r y r e l i e f b e c a u s e an i n e l a s t i c s u p p l y c u r v e
c r e a t e s l a r g e p o t e n t i a l e c o n o m i c rents,
in a d d i t i o n to the
p o s s i b i l i t y of o l i g o p o l y a n d / o r m o n o p o l y prof i t s .
They would
li k e to c a p t u r e the for m e r for c o n s u m e r s w h i l e p r e v e n t i n g the
latt e r .
curve.
T h e y w o u l d like to do so w i t h o u t d i s t o r t i n g the s u p p l y
In theo r y , t h e r e is a set of r e g u l a t o r y c a t e g o r i e s th a t
c o u l d s i m u l a t e c l o s e l y the s u p p l y curve.
of the N a t u r a l G a s P o l i c y A c t
(NGPA)
T h a t w as the o b j e c t i v e
T h e l a r g e n u m b e r of
c a t e g o r i e s th a t e v e r y o n e c o m p l a i n s a b o u t is n o t h i n g m o r e or less
tha n a r a t i o n a l a t t e m p t to m o v e the r e g u l a t o r y s c h e m e c l o s e r to
21-496
0
83
18
270
FIGURE 3
MARKET PROTECTOR'S VIEH
QUANTITY
(Q u a d rillion
B tu '* )
271
MARKET PROTECTOR'S VIEW
OF AN IDEAL REGULATORY SCHEME
QUANTITY
(Quadrillion Btu’s)
272
the supply curve.
Is it possible to shoot for such a regulatory scheme?
As
c o nvoluted as N G P A is and as badly as it has been implemented by
FERC, it h a s r in fact, achieved some of its goals,
A Government
Acco u n t i n g Office (GAO) report on N G P A concluded that:
throu g h o u t the period [1983-1990],
"In fact,
'NGPA* results in slightly
lower prices and higher production than in the 'Price Decontrol
in 1983' case,"
conclusion.
The De p a r t m e n t of Energy reached a similar
It is fairly certain that the conclusions these
reports project for the 1983-1990 period are exactly how N G P A has
o perated since its passage.
Some of the rents have been passed
through to consumers and some captured by producers and/or
pipelines.
As the Energy Information A d m i n i s t r a t i o n (EIA) has
concluded, "Binding price ceilings and average cost pricing have
the effect of transferring funds from the producers of lower
priced gas to the consumer in the form of lower prices, and to
the producers of new and especially high-cost gas in the form of
high e r prices."
T h e A d m i n i s t r a t i o n ' s V i e w of N G P A
T h e R e a g a n A d m i n i s t r a t i o n d o e s n ot a g r e e w i t h thi s
a s s e s s m e n t of N G P A .
[As depicted in Figure 5] the A d m i n i s t r a t i o n is not
simply Market Hopeful?
NG P A is perverse.
it believes that the regulatory scheme of
The ceilings on lower cost supply are too low,
w hich increases the q u a ntity of high cost gas necessary to clear
the market and drives up average prices.
In addition [as
273
FIGURE
5
ADMINISTRATION VIEW:
LOW PRICE CEILINGS ON
Which Would Be Produced
274
depicted in Figure 6], contract provisions, such as high
p e r c e n t a g e take-or-pay provisions, brought about by partial
regulation and perverse incentives to look for expensive gas,
further restrict low cost production.
This also drives up market
clearing and average prices.
Further [as depicted in Figure 7], partial controls
induce perverse contract clauses such as indefinite price
escala t o r s and most favored nation clauses which were used by
pipel i n e s to attract disc o v e r y of new supplies.
These created
the potential for a price fly up upon decontrol.
In summary, the Administ r a t i o n views the supply curve as
f undam e n t a l l y distorted by controls.
In the first instance, and
to an u nmeasureable degree, it is distorted by the very p resence
of controls.
At a more concrete level, it has been distorted by
specific contract provisions.
[As depicted in Figures 6 and 7],
the supply curve rotates to higher market clearing and average
prices on a fulcrum point which is defined by the q u a ntity of low
cost gas not produced.]
[As depicted in Figure 8] the Ad mi ni s tr at i on has, in
essence, a price ladder in mind in which Jan u a r y 1, 1985
wi t n e s s e s a sharp price run up, while current average prices have
been driven above the short term average price that would prevail
absent controls and their attendant aberrations.
I must say that any belief in a short term drop in prices
as a result of decontrol must be relying heavily on optimism
about the supply curve.
G iven the large q uantity and actual
p r ice of old gas that is flowing, it is impossible that prices
275
FIGURE
6
ADMINISTRATION VIEW:
CONTRACT PROVISIONS REDUCE
LOW COST SUPPLY
Low Cost Supplies Not Produced
Due to Take-Or-Pay Provisions
276
FIGURE 7
ADMINISTRATION VIEW:
POTENTIAL FLY UP
UPON DECONTROL
QUANTITY
(Q uadrillion
B t u ’s)
277
Price
ADMINISTRATION VIEW:
QUANTITY (Quadrillion Btu's)
278
will go down as a result of market forces, unless the market
clears at a much lower percentage of oil prices than the 70
percent figure the Admin i s t r a t i o n has asserted over the years.
However, the policy c o nclusions embodied in the
A d m i n i s t r a t i o n ' s recent proposals are consistent with their basic
a ssu m p t i o n s about the market.
If latent competition exists and
if the supply curve is relatively elastic, the Admin i s t r a t i o n
could be correct in its assertion that a period of intense
negotiations —
made more intense by d eadlines —
might exorcise
the contract provisions quickly enough to smooth the way toward a
c o m p l e t e l y deregulated market.
Moreover, competition would
prevent a reemergence of these aberrations in the long term.
N o n - c o m p e t i t i v e profits would not emerge, but rents would be
c ollected by producers.
A n A l t e r n a t i v e V i e w of N G P A
One of the interesting things about the current debate is
the significant agreement about the symptoms that are affecting
current prices and might affect future prices.
The Market
Protectors agree on the deleterious effects of take-or-pay
c lauses and escalators.
However, they do not accept the
Adm i ni s t r a t i o n ' s diagnosis of the disease.
They do not accept
the argument that these provisions are simply a response to
partial regulation or non-price c o mpetition for supplies.
Instead, they argue that these are caused by the basic imperfec
tions of the market (maldistributed b argaining power, a f f i l i a
tions, etc.).
[As depicted in Figure 9] they also argue that
279
FIGURE 3
MARKET PROTECTORS'S VIEW:
PRICE CEILINGS TOO HIGH
Economic
Rents not
Captured
QUANTITY
(Quadrillion Btu's)
280
many price ceilings for lower priced gas are too high, not too
low, thereby needlessly failing to c a pture rents.
[As depicted in Figure 10] the MPs^have a different price
ladder in mind.
Current prices are higher than they would be if
the c eilings could be readjusted and the contract and perverse
incentives could be eliminated.
Com p l e t e decontrol leads to a
price that embodies all market imperfections.
/
Indeed, with sixty
or seventy percent of gas decontrolled, they fear that the NGPA ' s
J a n u a r y 1, 1985 price fly up could push the average price close
to the complete decontrol level.
C o n tract provisions would
trigger and producers would have adequate market power to drive
mos t low cost gas out of the market (to a share of 20 percent,
for example).
Industrial load would plummet (loss of another 2.5
T C F , for e x a m p l e ) , but producers would be immune to the extent
that they maximize profits by clearing the market in the captive
sector.
It must be stressed that the MPs see the underlying
structural conditions in the industry, not the structure of NGPA,
as the main force that has driven prices up by eroding low cost
supply.
They blame FERC, by an error of omission (failure to
d efine abuse strictly e n o u g h ) , for failing to prevent these
c o ntracts and pricing practices and they blame FERC, by an error
of commis s i o n (through rate proceedings and rulemakings), for
p ushing up the cost of gas through a series of decisions.
Since
t hey see the problem as being lodged in the industry and in "do
nothing" regulators, they propose a restart of NGPA.
Emphasizing
the success of N G P A on the supply side, they would move the
281
f i 6ore
10
MARKET PROTECTOR'S VIEW:
PRICE LADDER
Price
Q U A N T IT Y
(Q u a d r illio n
B cu ’ s)
282
c urrent regulatory scheme back toward the underlying supply curve
to m a i ntain the supply response while recapturing rents and
preventing o l ig opoly profits.
If the Market Hopefuls' blind spot lies in the assumption
that the supply response will be better in the future, the Market
P r o t e c t o r s have difficulty d e m o nstrating the contribution of
non-c o m p e t i t i v e factors to the present situation.
There are a
few clear examples of these factors, including the recent
C olu m b i a T r a n s mission C o mpany ruling by an Administ r a t i v e Law
J u d g e at FERC that demonstrated the abusive effect of
a f f i l iations and contract provisions, as well as the very slow
pace of renegotiation of old contracts, which demonstrates the
m a l d i s t r i b u t i o n of bargaining power in the market.
On the other
hand, the arithmetic of sales between subsidiaries and other
types of affiliations is not overwhelming in their favor.
Nor
d oes the burgeoning independent production sector* which has
produced the supply side response under NGPA, and the expanding
potential for alternative supplies make the oligopol y / m o n o p o l y
case any easier to prove.
Empirics and Ethics
It is absolutely critical to recognize that where you
think we are and where you want to go are separate c o n s i d e r a
tions.
You can believe that we are in the situation of perverse
regulation and want to move to improved regulation.
Or, you can
b e lieve that we are in the position of imperfect regulation and
want to move to complete deregulation.
283
W here you think we are is an empirical question.
Where
you think we should go is a moral, normative and ultimately
political question.
In addition, it should be obvious that how
you think we got to where we are will dictate how you think we
should get to where you want us to be.
The Administ r a t i o n believes that we are in the position
typified by low ceilings, perverse regulation and potentially
elastic supply.
It wants to get to a completely free market.
The principles set out in S. 615 assume that we are in the
position typified by high ceilings, perverse contracts and
potential oligopoly or monopoly profits, in addition to very
large rents.
It aims at better regulation and a much longer
transition to a free market.
There are also many hybrid or mixed positions, d i s t i n
guishable p r imarily by a concern about rents or a moderate
concern about mar k e t imperfections.
D i stributors fall close to
the MPs* position (since they feel unable to influence the
pr o ducer/pipeline negotiations)
The A m e rican Gas A ssociation
(AGA), which represents distributors, for example, advocates
continuation of controls on old gas.
It may be concerned about
the rents and want to ensure that they are captured by consumers,
or it may be concerned about the market share of gas in total
energy demand and want to use low cost gas to keep its share of
the industrial market.
AGA also expresses some concerns about
non-competitive conditions between wellhead and city gate and
mumbles things about contract carriers, etc.
On the other hand, there are positions like that of the
284
N e w York T i m e s , which is closer to the Market H opefuls but
worries about the rents and calls for a windfall profits tax,
which, I would point out, is an inefficient way to capture rents.
The T i mes wants to capture half the rents (a 50 p e rcent tax)
A
tax incidence analysis will show that consumers would pay a large
part of the tax.
who pays.
It is not clear that the Times cares much about
But it is important to acknowledge that why you want
to c a pture the rents and how you go about it makes a great deal
of difference.
It is also critically important to recognize the equity
implications of the empirical reality of the fossil fuels market.
The essence of our political choice in the pricing of a commodity
such as natural gas is the recognition that both the supply and
demand elasticities are low and, therefore, that equity/
effi c i e n c y trade-offs are difficult.
Because rents are so large
and supply and demand responses to price changes are small,
equity losses (i.e., the transfer of surplus or wealth frpm
c o nsumers to producers)
tend to be much larger than efficiency
g ai n s (i.e., the increase in national economic output that would
result from a reallocation of resources)
It is absolutely
critical to recognize that even though the pie gets bigger, the
redistribution of benefits may be so radical that there are large
g roups —
actually a significant m a j o r i t y —
that would be worse
off.
Figure 11 shows this concept using the composite supply
and demand curves of Figure 10.
The figure assumes captive
285
FIGURE 11
THE EQUITY-EFFICIENCY TRADE OFF
WITH INELASTIC SUPPLY AND DEMAND
QUANTITY (Quadrillion Btu's)
21-496 0 - 83 - 19
286
c o n s umers and creates a composite demand curve.
assume oligopoly pricing.
It does not
It assumes a solution to the contract
p r oblem and the "true" supply curve as viewed by MPs, but not an
o ptimistic supply response as hoped for by MHs.
The classic supply and demand side inefficiencies of
price controls are identified as striped areas in the figure.
One can hypothesize a number of other inefficiencies including
those associated with curtailments or administrative allocation
of supplies, if or when either arises.
Further, there are
c ertain import inefficiencies one can hypothesize.
However, the
basic supply and demand side inefficiencies are the core of the
matter.
The point, as shown in the figure, is that the e x tremely
inelastic supply and demand responses yield small efficiency
gains, while the inelastic supply curve creates very large wealth
transfers.
This is the case with fossil fuel prices —
gas and petroleum.
both natural
As the Department of Energy's economic
analysis of a year ago showed, the decontrol of natural gas
increased the size of the national economic pie but reduced the
share of it received by labor and capital in non-gas industries.
C E C A did an analysis of that DOE study which examined the process
in detail, entitled "Natural Gas Decontrols
Economics," which I submit to the Committee.
A Case of Tric k l e - U p
In essence, we
found that for every one dollar of growth, there were two dollars
of wealth transfer«
And that was after ten years in which the
r ecessionary shocks of w e alth transfers had been allowed to work
their way out of the system.
The fascinating thing is that much
287
the s a m e relationship appears to hold for oil price increases —
for every one dollar of e f f iciency gain, there are two dollars of
w ealth transfer.
In short, even if you think the market works in
economic terms, you could well want to intervene because of the
equity impact.
Empirics and P olicy
Empirically, I read the evidence as strongly suggesting
that there are massive and pervasive imperfections in the market
that man d a t e consumer protection and regulatory relief.
I should
point out that the supply and demand curves I have used in my
g r aphs are not theoretical —
they are the supply and demand
curves implicit in the Department of Energy's Analysis of the
Natural G a s Policy Act.
They would be consistent with the GAO
analysis as well.
I drew those curves in February, 1982 in an A ppendix to a
report C ECA did on natural gas prices.
submit the analysis for the record.
With your permission, I
In the report, I estimated
that the olig o p o l y solution would cause the natural gas market to
reach a partially n o n -competitive equilibrium in which 6 percent
of total demand is lost.
If one assumes that the producers are
s ensitive only to demand in the captive m a rket and that they
therefore raise prices higher than they would if they were
concerned with demand in the total market, the estimate of
foregone demand would rise to 16 percent.
This demand would be
lost in the industrial market since the non-competitive rate of
profit is maximized by not competing against lower cost oil.
The
288
result is that the projected market clearing price would be
b et w e e n 7 and 15 percent higher than the c o mpetitive market
clearing price calculated by DOE.
The evidence that has accumulated with respect to the
b e h avior of the natural gas market, muc h of which has come to
light in the past year, contains nothing that would lead me to
abandon that view of the market.
The m a l d i s t r i bu t io n of market
power seems quite evident in the behavior of contracts and the
p r o gress of contract negotiations.
If one is willing to consider
this explanation of behavior, the empirical evidence is not
surprising at all.
It is not surprising to find, as a 1981 study by the
A m e r i c a n Gas A ssociation did, that 30 percent of all contracts on
p r e - 1 9 7 3 gas had been renegotiated in a very short period of time
to include escalator clauses.
It is not surprising to find, as EIA and G AO studies
have, that, for all intents and purposes, the entire industry has
indexed its prices to that of No. 2 oil, not the market in which
retail gas d i stributors c o mpete —
which is No. 6 oil —
but the
m a r k e t in which major integrated oil companies maximize their
profits.
It is not surprising that when a few pipelines have tried
to claim force majeure as their markets collapsed, p r oducers have
sued, saying, in essence, that they are immune to market forces
and will extract whatever they can from the highest price market
available.
Indeed, the almost lightening speed with which these
289
contract provisions worked -their way into every nook and cranny
of the industry and the snail's pace at which a very few of them
have been modified, testifies to the maldistr i b u t i o n of the chips
in the bargaining process.
Beyond the specifics, an even more powerful piece of
evidence lies in the response of natural gas prices to the
deepest recession since the G r eat Depression.
natural gas and oil has plummeted.
The demand for
In response to the
recession-induced decline in demand, crude oil prices have fallen
about 10 percent.
About 1.5 trillion cubic feet of industrial
demand for natural gas has been lost (.5 trillion cubic feet
permanently) and three trillion cubic feet of excess supply has
developed in the natural gas market.
Did the free negotiations
between producers and pipelines change the contract terms
which were propping up prices?
Did those immense downward
pressures have any effect on prices?
Not at all.
With oil
prices falling and inflation running at 4 percent, natural gas
prices have increased by over 20 percent.
The flaws that I see in the natural gas m a rket operate
at different levels of intensity in different regions of the
country and at different moments in time, but taken together they
constitute a fundamentally flawed market structure.
The fact
that FERC has failed to stop transactions at very high prices,
even though it has the power to do so, is important.
The fact
that these transactions occur in the first place is paramount,
and it is a direct result of the institutional and structural
imperfections in the gas market.
290
Clearly, I have a f u n d amentally d i f f erent view of the
m a r k e t p l a c e than that of the Administration.
The difference
embodies both an empirical and an ethical judgment.
The A d m i n i s t r a t i o n looks at the current situation and
sees the N G P A price ceilings pushing pipelines to engage in
non - p r i c e c o mpetition to attract supplies.
Thus, it identifies
these ceilings as the origin of the contracts problem.
I look at the fact that pipelines have Purchase Gas
Adjustment
(PGA) clauses which can be used to pass through price
increases directly to consumers and see absolutely no incentive
for them to bargain in the consumer's interest.
I look at the
close affiliation between producers and distributors and see a
serious lack of arms-length transactions leading to a strong
interest in price increases.
The A d m i n i s t r a t i o n looks at the supply side of the m a rket
and sees fierce c o m petition and rosy supply prospects.
Thus, it
predi c t s a fall in prices upon decontrol.
I look at the fact that the twenty largest producers of
natural gas produce more than half our gas and two-thirds of our
oil, and see an o ligopoly situation with little likelihood of
anything but price increases.
I look at the restricted access to
supplies in the field and see further possibilities of o l i g o p o l y
profits.
The A d m i n istration looks at the one third of the market
in which there is significant interfuel s u bstitutability and sees
compet i t i o n at the burner-tip.
Thus, it sees no need for
consumer protection through regulation.
291
I
look at the two-thirds of the gas market which is
captive and see a m o n opoly situation which creates the potential
for unjustified, inefficient mono p o l y profits.
The A d m i n i s t r a t i o n looks at tens of billions of dollars
in economic rents on natural gas production that results from an
inelastic supply curve and sees only the free market distribution
of wealth.
I
look at those rents and see an uneconomic allocation of
social resources and a powerful source of human despair as the
cost of a vital necessity rises beyond the means of millions of
Americans.
The Policy Conclusion
Obviously, a very d i fferent policy position emerges from
this reading of the empirical record and this statement of
principles:
1.
Old gas must not be decontrolled or it would capture
about half of the economic rents that are likely to
be available on natural gas production through the
end of this decade.
2.
Indefinite price escalators — which use other forms
of energy as a referent — and most-favored nation
clauses — w hich refer to other gas prices — must be
abolished.
This cross-referencing of prices violates
the very essence of competition at the wellhead and
the burner tip.
3.
Take-o r - p a y clauses must be set at levels necessary
to do what they were intended to do —
provide
stable finance for the industry. They must not be
allowed to be used to bid for gas or to ensure
producers unjustified profits.
4.
All automatic pass throughs must be permanently
eliminated to remove the insulation of pipelines from
the consequences of their bidding practices.
292
5.
The discret i o na r y powers that FERC has used to push
up the price of gas must be abolished and the damage
that it has done must be corrected.
Unless this is
done, the perverse incentives that FERC has created
will continue to distort the supply-response,
extracting rents from consumers.
6«
The rapid increase in inflation over the first
several years in which N G P A was in place have
d istorted the price increase formulae, in addition to
creating e xtremely large price increases. These must
be rolled back and only much smaller annual price
increases must be allowed.
7.
The d e f inition of fraud and abuse that FERC has been
allowed to apply under N G P A has proven totally
inadequate to protect consumers. Therefore, we must
return to the "just and reasonable" standards of the
N atural G as Act.
It is of paramount importance to stress the fact that the
Ad m i n i stration's package is not consumer protection.
It is not consumer protection to give a blank check to
the very same parties who created the problem in the first place
and who have been unable to solve it in more than two years when
downward pressures on price have been intense.
It is not consumer protection to decontrol old gas and
allow it to rise to the world-market oil price, when that gas has
been flowing for decades and costs nickles to produce.
It is not consumer protection to impose a three year
m o r a t o r i u m on abusive contract practices, without addressing any
of the underlying structural causes of those practices.
It is equally important to stress the fact that the
Adm i n i s t r a t i o n ' s solution is not an economically efficient
solution.
The transfer of economic rents to and the extraction of
n o n -competitive profits by the natural gas producers, especi a l l y
293
the maj o r s who own the maj o r i t y of the old gas, will simply drain
more resources away from other sectors of the economy that are in
de sperate need of capital and consumer spending.
It will create
a natural gas price drag on the economy, at the very moment that
the oil price drag of the second energy price shock has finally
begun to work its w ay out of the system.
To allow p o l i tically-manipulated oil prices to set the
price of natural gas, as the Administration's proposal would do,
is to give up all hope of allocating our economic and energy
resources in a manner that is consistent with the economic
forces, v alues and needs of our domestic economy.
Only through the measures we propose can we ensure that
the price of gas will be driven by the competitively determined
costs of production, thereby achieving both consumer protection
and national economic efficiency.
I
appreciate this o pportunity to testify before you today
and would be happy to work with the Committee as you grapple with
seeking equitable solutions to these problems.
294
N ATURAL GAS PRICE DEREGULATION:
A CASE OF TRICKLE
UP E C O N O M I C S
P r e p a r e d by:
C O N S U M E R E N ERGY COUN C I L OF A M E R I C A
RESEARCH FOUNDATION
J a n u a r y 28,
1982
295
TABLE OF C O N T E N T S
Chapter
I.
Page
GENERAL INTRODUCTION
A.
B.
II.
T h e D e p a r t m e n t o f E n e r g y ’s
Natural Gas Analysis
3
1,
D O E 's N a t u r a l G a s M a r k e t M o d e l
3
2.
DOE's Macroeconomic Analysis
4
a.
b.
4
5
Supply-Side Model
Demand-Side Models
The Basic Message:
Economics
.
T r i c k l e Up
THE I M P A C T OF D E C O N T R O L
A.
B.
.
.
.
6
8
. .
1.
Impact on Labor and Other S e c t o r s
2.
I m p a c t on P r o d u c t i v i t y and Gas
Production
.............
8
. .
11
........... 12
D O E 1s S l e i g h t o f H a n d .............
2.
C.
.
D e t a i l s of the A n a l y s i s
1.
III .
1
. .
14
Differential Treatments of
C h a n g e s in G N P
14
D enial of Income T r a n s f e r E f f e c t s
of D e r e g u l a t i o n
.
.
15
The Econometric Results
• .
1.
Similarities and Differences
2.
E x p l a n a t i o n of the D i f f e r e n c e s
. .
. .
. . . . . .
17
. 1 7
20
C O N C L U S I O N ..............................................
25
FOOTNOTES
26
296
L I S T OF T A B L E S
T a b l e 1:
S U M M A R Y OF THE M A C R O E C O N O M I C E F F E C T S OF
FUL L D E C O N T R O L IN 198 2 OF N A T U R A L GAS
PRI C E S
Ta b l e 2:
S U M M A R Y OF THE M A C R O E C O N O M I C E F F E C T S OF
P H A S E D D E C O N T R O L OF N A T U R A L GAS P R I C E S
T a b l e 3:
S U M M A R Y OF THE E F F E C T OF D E C O N T R O L ON
P R O D U C T I V I T Y A N D N A T U R A L GAS
PRODUCTION
T a b l e 4:
T H E M A C R O E C O N O M I C E F F E C T S OF F U L L
D E C O N T R O L D E P I C T E D IN T H R E E D I F F E R E N T
MODELS
T a b l e 5:
T H E M A C R O E C O N O M I C E F F E C T S OF P H A S E D
D E C O N T R O L IN T W O D I F F E R E N T M O D E L S
297
NATURAL GAS PRICE DEREGULATION:
A CA S E OF T R I C K L E UP E C O N O M I C S
I.
GENERAL INTRODUCTION
The d e c o n t r o l of n a t u r a l ga s p r i c e s m a y be the
s i n g l e m o s t i m p o r t a n t e n e r g y p o l i c y d e c i s i o n of the 1980s,
N a t u r a l gas is the d o m i n a n t h o u s e h o l d fuel,
With more
t han hal f the h o u s e h o l d s in A m e r i c a h e a ting, c o o k i n g and
h e a t i n g water w i t h n a t u r a l gas,
it a c c o u n t s for a l m o s t 55
p e r c e n t of all the e n e r g y u s e d in the home.'1' N a t u r a l ga s
is also a p r i m e i n d u s t r i a l fuel, a c c o u n t i n g for 31 p e r c e n t
of all the e n e r g y c o n s u m e d by industry.
2
S i n c e m a n y of the use s of n a t u r a l ga s are v i t a l to
b as i c d a i l y a c t i v i t i e s and e c o n o m i c p r o c e s s e s ,
trol of n a t u r a l gas p r i c e s c ould h a v e a g r e a t e r
the d e c o n
impa c t on
the n a t i o n ’s c o n s u m e r s and the e c o n o m y tha n an y ot h e r
e n e r g y p r i c i n g p o l i c y decision,
Thus, any d e c i s i o n to
d e c o n t r o l n a t u r a l gas s h o u l d be b a s e d on a c a r eful,
r i g o r o u s and o b j e c t i v e a n a l y s i s of the c o s t s and b e n e f i t s
t h a t w i l l flow from s uch a d ecision.
T h i s is no e a s y
matter
R e s p o n s i b l e a n a l y s i s of n a t u r a l g a s d e c o n t r o l is
an e x t r e m e l y c o m p l e x task,
The n a t u r a l g as m a r k e t itself,
as w e l l as the link b e t w e e n e n e r g y and the e c o n o m y ,
c o m p l i c a t e d and not w e l l un d e r s t o o d ,
is
B e y o n d that, the
298
- 2 -
im pact of r i sing p r i c e s on the d i s t r i b u t i o n of w e a l t h is
d i f f i c u l t to measure.
F i n ally,
the s p e c i a l i n t e r e s t s
i n v o l v e d in any d e c i s i o n to d e c o n t r o l are e x t r e m e l y
p o w e r f u l and p a s s i o n s run h i g h b e c a u s e so m u c h is at
stake,
A g r e a t dea l of i n f o r m a t i o n (and m i s i n f o r m a t i o n )
m u s t be sorted out, a n a l y z e d and e v a l u a t e d in order to
c o n d u c t a prop e r analysis.
Fortunately,
the a n a l y s i s of the d e c o n t r o l of
n a t u r a l gas need not be b a s e d on p u r e t h e o r y or guesswork,
O v e r the p a s t decade, b e c a u s e e n e r g y p o l i c y has b e e n such
a c r i t i c a l issue, the a n a l y t i c tools use d to e x a m i n e
p o l i c y d e c i s i o n s ha v e b e e n g r e a t l y improved,
Moreover,
in
the last five ye a r s the n a t i o n has e x p e r i e n c e d four m a j o r
d e c o n t r o l decisi o n s :
h e a t i n g oil
(August 1978), cr u d e oil
1981)
(May 1976), n a t u r a l gas
(June 1979)
and g a s o l i n e
(January
A track rec o r d has b e e n e s t a b l i s h e d w h i c h s h o u l d
shed c o n s i d e r a b l e l i g h t on h ow the e n e r g y m a r k e t s and the
e c o n o m y b e h a v e in the w a k e of decontrol,
It s h o u l d also
giv e cl u e s to w h i c h to o l s and a p p r o a c h e s b e s t p r e d i c t the
outcome.
W i t h this report,
the C o n s u m e r E n e r g y C o u n c i l of
A m e r i c a R e s e a r c h F o u n d a t i o n (CECA/RF)
initiates a series
of s t u d i e s w h i c h wi l l e x a m i n e the h i s t o r y of oil d e c o n t r o l
and p r e d i c t i o n s ab o u t n a t u r a l gas d e c ontrol,
C E C A / R F 1s
s e r i e s of st u d i e s w i l l r e v i e w the r e c o r d of p r i c e p r o j e c
ti o n s and p r i c e incr e a s e s ,
the s u p p l y and d e m a n d r e s p o n s e s
and the e c o n o m i c and e q u i t y i m p a c t s of c r u d e oil d e c o n t r o l
299
- 3 -
and c o n t r a s t them w i t h the v a r i o u s p r o j e c t i o n s for n a t u r a l
gas decontrol,
F u t u r e r e p o r t s w i l l also e x a m i n e the
p o t e n t i a l and actual e f f e c t s of w i n d f a l l p r o f i t s taxes.
Th i s initial report, h o w ever,
d i f f e r e n t approach.
takes a somewhat
It e x a m i n e s ba s i c p h i l o s o p h i c a l ,
t h e o r e t i c a l and t e c h n i c a l a s p e c t s of the D e p a r t m e n t of
E n e r g y ' s m o s t r e cent a n a l y s i s of n a t u r a l g as decontrol,
3
We b e l i e v e that there is a m e s s a g e of such s h o c k i n g
s i g n i f i c a n c e in the DOE a n a l y s i s —
that n a t u r a l gas
d e c o n t r o l isn't tr i c k l e d o w n e c o n o m i c s ,
economics —
that we will p o s t p o n e d i s c u s s i o n of a num b e r
of issues (such as p r i c e p r o j e c t i o n s ,
el a s t i c i t i e s ,
it is t r i c k l e up
s u p p l y and d e m a n d
etc,) w h i c h s h o u l d be d e a l t w i t h first, and
m o v e d i r e c t l y to the h e a r t of the matter,
A.
T h e D e p a r t m e n t of E n e r g y ' s
Natural Gas Analysis
1.
DOE *s N a t u r a l G a s M a r k e t Mo d e l
Th e D e p a r t m e n t of E n e r g y ' s s t u d y of n a t u r a l gas
d e c o n t r o l c o n s i s t s of two s e p a r a t e a n a l y t i c exercises,
The first e x e r c i s e i n v o l v e s an a t t e m p t to m o d e l the
n a t u r a l gas market.
4
T h a t is, u s i n g c e r t a i n a s s u m p t i o n s
a b o u t p r o d u c t i o n costs, the g e o l o g i c a l a v a i l a b i l i t y of gas
and the e c o n o m i c d e m a n d for gas, DOE p r e d i c t s the s u p p l y
of and d e m a n d for gas und e r v a r i o u s d e c o n t r o l scenarios.
300
- 4 -
2«
DOE's Macroeconomic Impact Analysis
In the second ex e r c i s e , DOE use s the supply,
d e m a n d and pr i c e p r e d i c t i o n s from its n a t u r a l gas m o d e l i n g
e x e r c i s e a bove as inputs into the a n a l y s i s of the m a c r o e c o n o m i c impact of d e c o n t r o l , ^
The o b j e c t i v e is to
p r e d i c t the impact of d e c o n t r o l on the G r o s s N a t i o n a l
Product
( G N P ) , inflation, e m p l o y m e n t and ot h e r m e a s u r e s of
the p e r f o r m a n c e of the economy,
For the p u r p o s e s of the m a c r o e c o n o m i c a n a l y s i s ,
D OE uses three d i f f e r e n t models,
one of w h i c h is c a l l e d a
s u p p l y - o r i e n t e d m o d e l and two of w h i c h are c a l l e d d e m a n d o r i e n t e d models,
D OE sees it,
a.
The d i f f e r e n c e b e t w e e n the m o d e l s ,
as
is as follows:
S u p p l y - S i d e Mo d e l
The s u p p l y - s i d e m o d e l
( s p e c i f i c a l l y the H u d s o n /
J o r g e n s o n D y n a m i c G e n e r a l E q u i l i b r i u m Model)
is d r i v e n by
s u p p l y c o n d i t i o n s -- the p r o d u c t i v i t y c o n d i t i o n s in the
e c o n o m y and c h a n g e s in the s u p p l y of inpu t s for p r o d u c t i o n
(i.e.,
the fact o r s of p r o d u c t i o n ,
s i m u l a t e the impact of d e c o n t r o l ,
by c h a n g e s in p o t e n t i a l G N P
c a p i t a l and labor)
tha t i m p a c t is m e a s u r e d
(the o u t p u t t h a t c o u l d be
a c h i e v e d if all fa c t o r s of p r o d u c t i o n w e r e f u l l y
u t i lized)
To
301
- 5 -
b.
Demand-Side Models
T h e d e m a n d - s i d e m o d e l s ( s p e c i f i c a l l y the W h a r t o n
A n n u a l and I n d u s t r y F o r e c a s t i n g M o del
Model)
[WAIFM]
and the DRI
are d r i v e n by d e m a n d c o n d i t i o n s -- the level of
aggregate demand —
to s i m u l a t e the imp a c t of d e c o n t r o l
T he impact is t y p i c a l l y m e a s u r e d by c h a n g e s in act u a l GNP,
c o n s u m p t i o n and employment,
D O E ' s p r e f e r e n c e for the s u p p l y - o r i e n t e d m o d e l is
q u i t e e v i d e n t in. its d i s c u s s i o n .
Thi s r e p o r t will d e m o n
s t r a t e that the d i f f e r e n c e s in the o u t p u t of the m o d e l s
are not as g r e a t as DOE s u g g e s t s and tha t t h e y are real l y
rela t e d to a rather d i f f e r e n t factor -- an a s s u m p t i o n
a b out the w a g e - p r i c e spiral,
E a c h of the a n a l y s e s ,
c o n n e c t i o n b e t w e e n them,
as w e l l as the i n t e r
is e x t r e m e l y complex.
H owever,
care f u l r e a d i n g of all of D O E ' s n a t u r a l ga s a n a l y s e s
a d d i t i o n to the s t u d y itself,
fin
th e r e are four a p p e n d i c e s as
w el l as s everal a t t a c h m e n t s and annexes)
reveals numerous
p o i n t s at w h i c h c r i t i c a l a s s u m p t i o n s are m a d e by DOE
w h i c h d i c t a t e the n a t u r e of the r e s u l t s .
points,
At e a c h of these
the a s s u m p t i o n c h o s e n by DOE is h i g h l y f a v o r a b l e
to decontrol,
We h a v e g r a v e d o u b t s ab o u t D O E ' s a s s u m p
tions in bo t h the n a t u r a l gas m a r k e t a n a l y s i s and in the
m a c r o e c o n o m i c a n a l y s i s and we b e l i e v e t hat th e s e
a s s u m p t i o n s call into q u e s t i o n the v a l u e of the e n t i r e
a n a l y s i s for d e c i s i o n m a k i n g .
21-496
0
83
20
302
-
6
-
It w o u l d be m o s t l o g i c a l to b e g i n C E C A / R F 1s s e r i e s
w i t h a c r i t i q u e of the g as m a r k e t m o d e l and then e x a m i n e
the m a c r o e c o n o m i c analysis.
H o w e v e r , we b e l i e v e that
there, is a m e s s a g e a b o u t s u p p l y - s i d e e c o n o m i c s in D O E ’s
s t u d y that is of such o v e r w h e l m i n g i m p o r t a n c e tha t we w i l l
d e v o t e our first r e p o r t to a d i s c u s s i o n of D O E ' s m a c r o e c o n o m i c analysis,
In o t her w ords,
for the m o m e n t , we
wi l l not q u e s t i o n D O E ' s a s s u m p t i o n s and p r o j e c t i o n s a b o u t
the gas m a r k e t and w i l l c o n c e n t r a t e i n s t e a d on the
i m p l i c a t i o n s of a s o - c a l l e d " s u p p l y - o r i e n t e d ” n a t u r a l gas
p o l i c y for the economy.
B.
T h e B a s i c Message;
Trickle Up Economics
S u p p l y - s i d e e c o n o m i c s is t y p i c a l l y p r e s e n t e d as a
s t r a t e g y for i n c r e a s i n g the n a t i o n a l e c o n o m i c pie,
c r e a t i n g i n c e n t i v e s to s ave and invest,
By
it is a r g u e d t h a t
all m e m b e r s of s o c i e t y ca n be m a d e b e t t e r off.
T h a t is,
the pie g e t s bigg e r and e v e r y o n e can b e n e f i t by t a k i n g a
big g e r piece.
Howe v e r ,
in o rder to e x p a n d the pie,
it is
n e c e s s a r y to tran s f e r r e s o u r c e s f r o m t h o s e w i t h a h i g h
p r o p e n s i t y to c o n s u m e
(low and m o d e r a t e i ncome groups)
to
th o s e w i t h a hig h p r o p e n s i t y to sav e (high i n c o m e
groups)
6
In the f i r s t i n s tance,
g r o u p that benefits.
then,
it is a small
It is o n l y at s ome later date,
if
o u t p u t e x p a n d s and if r e s o u r c e s " t r i c k l e d o w n , " as D a v i d
303
- 7 Stockman admitted
in the w i d e l y p u b l i c i z e d D e c e m b e r 1981
Atlantic Monthly article,
t h a t th e g r e a t m a j o r i t y of
citizens can benefit.
In fact, D O E ' s o w n a n a l y s i s of n a t u r a l g a s
decontrol
shows that supply-side economics
in th e n a t u r a l
g a s m a r k e t is no t t r i c k l e d o w n e c o n o m i c s at all —
t r i c k l e ujo e c o n o m i c s .
it is
W i t h a m a s s i v e t r a n s f e r of w e a l t h
to g a s p r o d u c e r s , D O E ' s a n a l y s i s s h o w s t h a t t h e p i e m i g h t
g e t a l i t t l e b i g g e r , b u t e v e n a f t e r 15 y e a r s o n l y t h o s e
who own gas related capital services
industry stocks)
(i.e., o w n e r s of g a s
w i l l be b e t t e r off.
E v e r y o n e e l s e , i.e.,
la b o r and o w n e r s of n o n - g a s r e l a t e d c a p i t a l s e r v i c e s ,
w o u l d s t i l l be w o r s e o f f e v e n a f t e r 15 years.
T h a t t h i s o u t c o m e is a b u n d a n t l y c l e a r ,
granting DOE's optimistic assumptions,
even
should be a cause
of c o n c e r n to b o t h the s u p p o r t e r s an d o p p o n e n t s of
s u p p l y - s i d e p o licy.
in detail.
L e t u s l o o k at t h i s t r o u b l i n g r e s u l t
304
-
II.
A.
Details
of
8
-
THE IM P A C T OF D E C O N T R O L
the An al y s i s
T a b l e 1 p r e s e n t s the r e s u l t s of D O E ' s a n a l y s i s of
t h e i m p a c t o f full d e c o n t r o l o n t h e a g g r e g a t e G N P a n d t h e
d i s t r i b u t i o n of i n c o m e b e t w e e n o w n e r s o f c a p i t a l and
labor.
P o t e n t i a l G N P is p r o j e c t e d to i n c r e a s e b y $41
billion —
or h a l f a p e r c e n t - - o v e r t h e 15 y e a r p e r i o d
(in c o n s t a n t 1 9 8 0 d o l l a r s )
projected
to d e c l i n e b y $53 b i l l i o n .
non-gas-related capital
billion,
Labor's gross
The
i n c o m e is
income of
is p r o j e c t e d to d e c l i n e b y $28
w h i l e t he i n c o m e of g a s - r e l a t e d c a p i t a l
is
p r o j e c t e d to r i s e b y $ 1 2 2 b i l l i o n .
T a b l e 2 p r e s e n t s the r e s u l t s of D O E ' s a n a l y s i s of
accelerated/phased decontrol
(a s c e n a r i o for d e c o n t r o l
t h a t c l o s e l y a p p r o x i m a t e s the p r o p o s a l s b e i n g d i s c u s s e d
for l e g i s l a t i o n in e a r l y 1 9 8 2 ) .
t e d to i n c r e a s e b y $ 38 b i l l i o n
year period.
P o t e n t i a l G N P is p r o j e c
( 1 980 d o l l a r s )
Labor's gross income
o v e r t h e 15
is p r o j e c t e d to d e c l i n e
b y $35 b i l l i o n , w h i l e t h a t o f n o n - g a s - r e l a t e d c a p i t a l
p r o j e c t e d to d e c l i n e b y $2 1 b i l l i o n .
related capital
The income of gas-
is p r o j e c t e d to r i s e b y $95 b i l l i o n .
To summarize this result simply,
d o l l a r of a d d i t i o n a l
c a pital gain,
for e v e r y o n e
income that h o l d e r s of g a s - r e l a t e d
labor l o s e s fifty cen t s and h o l d e r s of
non-gas-related capital
side magic
is
(i.e.,
lose t w e n t y - f i v e cents.
increasing
investment)
Supply-
c r e ates the
305
- 9
Table 1
SUMM A R Y OF THE M A C R O E C O N O M I C E FFECTS OF
FULL DECO N T R O L IN 1982 OF N A T U R A L GAS PRICES
(Billions of 1980 Dollars)
Chan g e s from the current p o l i c y situ a t i o n in:
Real GNP
G r o s s I ncome
Labor
Capital
G a s - R e l a t ed
Other
1982
- 8.5
-37,1
+33.4
- 4.8
1983
- 6,7
-33.0
+30.5
-
1984
- 5.5
-30.0
+29.3
- 4.8
1985
- 3.9
+ 0.9
+ 4.1
-
1986
+ 5.1
+ 2.3
+ 4.3
- 1.4
1987
+ 5.7
+ 3.7
+ 3.4
- 1.4
1988
+ 5.1
+ 3 r7
+ 2.7
-
1.2
1989
+ 5.7
+ 4.4
+ 2.7
-
1.2
1990
+ 6.0
+ 5.0
+ 2.3
-
1.2
1991
+ 5.3
+ 4.6
+ 2.0
-
1.2
1992
+ 6.0
+ 5.1
+ 2.1
-
1.2
1993
+ 6.6
+ 6.9
+ 0.9
-
1.2
1994
+ 6.0
+ 5.1
+ 2.3
- 1.4
1995
+ 6.0
+ 5.1
+ 2.1
-
C u m u lative
Effect
+40.7
-53.3
+ 1 22. 1
Source:
U.S. DOE, M a c r o e c o n o m i c C o n s e q u e n c e s , p. I-ii,
4,3
1. 1
1.2
-27.8
-
10
-
Table 2
S U M M A R Y OF TH E M A C R O E C O N O M I C E F F E C T S OF
P H A S E D D E C O N T R O L OF N A T U R A L GAS PRICES
( Billions of 1980 Dollars)
C h a n g e s f r o m t he c u r r e n t p o l i c y s i t u a t i o n in:
Real GNP
_____________G r o s s I n c o m e
Labor
___________ C a p i t a l
Gas-Related
Other
1982
- 3.4
14 c7
+ 13.1
00
1—
1
1
306
1983
- 6. 2
- 25.6
+ :2 2.4
- 3. 0
1984
- 6.7
30.3
+28.2
- 4.6
1985
+ 3. 9
0. 0
+ 4 .8
- 0. 9
1986
+ 5.3
+ 1.6
+ 5.1
- 1.4
19a?
+ 5.1
+ 2.8
+ 3,7
- 1. 4
1988
+ 4.6
+ .3.0
+ 2.7
- 1.1
1989
+ 5.1
+ 3. 5
+ 2,1
- 1.1
1990
+ 5.3
+ 4.1
+ 2.5
- 1. 2
1991
+ 4. 6
+ 3. 7
+ 2.0
- 1.1
1992
+ 5.3
+ 4.3
+ 2.0
- 1.1
1993
+ 4.3
+ 3. 5
+ 1.4
- 0.7
1994
+ 5.3
+ 4.3
+ 2.1
- 1.1
1995
+ 5.3
+ 4. 4
+ 2. 0
- 1. 1
Cumulative
Effect
+37.8
_
+94.7
-21.4
Source:
35.4
U.S. D O E , M a c r o e c o n o m i c C o n s e q u e n c e s # p. 1 - 4 3 .
307
- ll additional
t w e n t y - f i v e c e n t s t h a t o w n e r s of g a s - r e l a t e d
c a p i t a l gain.
T h a t is,
the p i e m a y g e t a l i t t l e b i g g e r as
a r e s u l t of d e c o n t r o l ,
s m a l l e r piece.
but just about everyone will get a
In f act,
the t r a n s f e r o f r e s o u r c e s
(the
losses
in i n c o m e of l a b o r and o w n e r s of n o n - g a s i n d u s t r y
stock)
is n e a r l y t w i c e as l a r g e as th e i n c r e a s e
total pie
(the i n c r e a s e
in G N P )
bottom line results after
Moreover,
in the
t h e s e a r e the
all c o s t s a n d b e n e f i t s o f
decontrol have been considered.
1.
I m p a c t on Labor and O t h e r Sec t o r s
A c c o r d i n g to D O E ' s s t u d y ,
th e m a g n i t u d e o f th e
g a i n s a nd l o s s e s is q u i t e s i m i l a r u n d e r e i t h e r
phased decontrol.
in b o t h cases,
T h e p a t t e r n o f l o s s e s is a l s o s i m i l a r
L a b o r l o s e s b i g in th e f i r s t t h r e e y e a r s ,
then recovers slightly,
loser.
Labor's losses
$100 b i l l i o n
f u l l or
b u t s t i l l r e m a i n s t he b i g g e s t
in t h e f i r s t t h r e e y e a r s t o t a l o v e r
(in c o n s t a n t 1 9 8 0 d o l l a r s )
for f u l l d e c o n t r o l
and $70 b i l l i o n for p h a s e d d e c o n t r o l .
H o l d e r s of n o n - g a s - r e l a t e d c a p i t a l a r e s m a l l b u t
steady losers.
Their
i n c o m e is r e d u c e d e v e r y y e a r for the
e n t i r e 15 y e a r p e r i o d .
concentrated
in i n d u s t r i e s w h i c h ar e p r e s e n t l y u n d e r the
greatest pressure —
agriculture.
years.^
T h e l o s s e s in i n c o m e a p p e a r to be
automobiles,
h o m e b u i l d i n g and
T h o s e l o s s e s a r e g r e a t e s t in th e e a r l y
308
-
2.
1 2
-
I m p a c t on P r o d u c t i v i t y an d G a s P r o d u c t i o n
It is a l s o i m p o r t a n t to r e c o g n i z e th a t ,
to D O E ' s a n a l y s i s ,
these e f f e c t s of d e c o n t r o l -- the small
i n c r e a s e in t he t o t a l p i e an d t h e m u c h l a r g e r
bution
according
in i n c o m e - - w o u l d o c c u r w i t h o u t
a m o u n t of n a t u r a l g a s p r o d u c e d
p r o d u c t i v i t y in th e e c o n o m y
redistri
i n c r e a s i n g t he
and w i t h o u t i n c r e a s i n g
(se e T a b l e 3)
In fact,
productivity would actually d e c l i n e .
T h e l o s s of G N P d u e to t h e r e d u c t i o n in p r o d u c
tivi t y that w o uld result from d e c o n t r o l would be b e t w e e n
,5 a n d 1 p e r c e n t o v e r
th e 15 y e a r p e r i o d .
The losses
w o u l d be c o n c e n t r a t e d
in t h e e a r l y y e a r s .
Further,
a l t h o u g h d e c o n t r o l w o u l d l e a d to g r e a t e r s u p p l i e s o f g a s
in t h e e a r l y y e a r s ,
supplies
these w o uld be o f f s e t by lower
in the l a t e r y e a r s a n d t o t a l s u p p l y o v e r
th e
p e r i o d w o u l d be a b o u t 1 p e r c e n t l o w e r t h a n u n d e r
c o n t i n u a t i o n of th e N a t u r a l G a s P o l i c y Act.
In sum,
there c o uld be no bett e r e x a m p l e of a
p o l i c y w h i c h is p u r e l y a r e d i s t r i b u t i v e s c h e m e t h a n
natural gas decontrol,
Unfortunately,
decidedly negative message
analysis,
is b u r i e d
it is n o t f u l l y r e f l e c t e d
o f th e p o l i c y a l t e r n a t i v e s .
Because
although this
in D O E ' s t e c h n i c a l
in D O E ' s p r e s e n t a t i o n
it is n ot,
the
p r e s e n t a t i o n of t h e p o l i c y a l t e r n a t i v e m a y m i s l e a d
decisionmakers.
was obscured.
The next sec t i o n ex a m i n e s how the m e s s a g e
309
13
Table 3
SUMMARY OF THE EFFECT OF DECONTROL
ON P R O DUCTIVITY AND N A TURAL GAS PRODUCTION
Changes in P r o d u c t i v i t y 1
(from base, in %)
Full
Decontrol
Accelerated/
Phased
Decontrol
D omestic Supply of Natural Gas
( in Billion Cubic Feet)
22
NGPA
Unmodified
Full
Decontrol
Accelerated/
Phased
Decontrol
(All New) ...
1982
,32
,13
18,147.6
18,426.9
18,243.9
1983
.34
,26
17,365.4
17,906.9
17,815.0
1984
.37
,34
16,881.8
17,611.5
17,544.2
1985
.08
.02
17,161.6
17,324.6
17,118.7
1986
.07
.02
17,431.2
17,289.8
17,167.7
1987
.03
.01
17,890.2
17,440.6
17,386.®
1988
.02
.01
17,884.3
17,539.2
17,524.6
1989
.01
+ .01
17,803.8
17,436.7
17,364.4
+ .03
17,649.7
17,144.5
17,185.2
1990
0
1991
.01
+ .01
17,487.9
17,108.5
17,161.6
1992
+ .02
+ .04
17,430.8
16,929.5
16,992.8
1993
+ .05
+ .01
17,266.3
16,926.2
16,996.8
1994
+ .04
+ .04
17,24 5.5
16,719.8
16,799.5
1995
+ .04
+ .04
17,164.7
16,655.8
16,734.8
^U.S. DOE, Macro e c o n o m i c C o n s e q u e n c e s , pp. 1-39, 1-45
2
U.S. DOE, Two Market A n a l y s i s , At t a c h m e n t 4.
310
- 14 B .
D O E ' s S l e i g h t of H a nd
The negative
submerged
and
by DOE because of
selective
c h o s e n as
behavior
i m p l i c a t i o n s of d e c o n t r o l
p r e s e n t a t i o n of
its c e n t r a l
for p o l i c y
in t h e l o n g
of actu a l G N P
1-
the e v i d e n c e p r e s e n t e d
billion
over
example,
(discounted
period
loss
as s m a l l
1980
rather
the
than
terms
Furthermore,
of C h a n g e s
$) p o t e n t i a l
as a m a j o r
in G N P o f $ 1 8
and
term,
or
it
in G N P
the D e p a r t m e n t of E n ergy
a 15 y e a r p e r i o d
a possible
evaluation
to t h i s p r e c o n c e p t i o n .
Differential Treatments
For
It h a s
in t h e s h o r t a n d m i d
the d i s t r i b u t i v e e f f e c t s of decontrol.
tailors
interpretation
its o w n e v idence.
criterion
of p o t e n t i a l G N P
the behavior
its s u b j e c t i v e
have been
treats
expansion
benefit,
billion over
while
a $10
in G N P
it t r e a t s
a three year
insignificant:
Full
decontrol
in
1982
creates
substantial
e f f i c i e n c y b e n e f i t s : $10 b i l l i o n (NPV) c o m p a r e d to
c u r r e n t p o l i c y and $41 b i l l i o n (NPV) w h e n c o m p a r e d
to c o n t i n u e d c o n t r o l s t o 1 9 9 5 .
These efficiency
g a i n s a r e s i g n i f i c a n t a n d p l a y a n i m p o r t a n t r o l e in
the a n a l y s i s of m a c r o e c o n o m i c e f f e c t s of full
decontrol.
The efficiency gains are robust with
respect
to v a r y i n g
assumptions
about
world
oil
p r ices and gas m a r k e t conditions. 8
Full decon t r o l of natural gas p r ices could also
have s h o r t-term impacts on m e a s u r e d inflation,
actual output, and unemployment.
Th ese effects are
n o t l i k e l y to be l a r g e a n d s h o u l d f a d e o v e r t i m e .
Immediate decontrol
is a l s o
estimated
to
reduce real GNP by
,2 t o
.6 p e r c e n t ($6 t o $ 1 8
b i l l i o n i n 1 9 8 0 $) a n d r a i s e t h e u n e m p l o y m e n t r a t e
by
,1 t o ,2 p o i n t s i n t h e f i r s t t h r e e y e a r s o f
decontrol. 9
311
-
In p o i n t of fact,
numbers
from a so-called
the opposite,
GNP costs
and
to b a s e
its a n a l y s i s
supply-oriented model)
First,
repeatedly points out
-
the ana l y s t s who g e n e r a t e d
upon which DOE opted
they come
quite
15
the
that both
report of
these
the p o t e n t i a l
benefits were quite
the
(because
stated
analysts
aggregate
small
N o n e of the c o n s e q u e n c e s of a c c e l e r a t e d d e c o n t r o l
is l a r g e ?
the costs
are r e l a t i v e l y small and
shortlived, w h i l e the b e n e f i t s are even smaller
b u t s u s t a i n e d . 10
Furthermore,
had
to g o
far o u t
the
in t h e
same
report noted
future
to r e v e r s e
that one really
the n e g a t i v e
effects:
It
is
important
to
note
however,
that
the
p r o j e c t i o n h o r i z o n m u s t be e x t e n d e d
to 1990
before the early losses are o f fset by s u bsequent
gains.
It t a k e s a b o u t n i n e y e a r s for t h e o v e r a l l
effects
to
become
positive
( in p r e s e n t
value
terms)
11
2.
Denial of Income Transfer
of D e r e g u l a t i o n
Even more misleading
that DOE
simply denied
the d i s t r i b u t i v e
uncertain
Effects
in D O E ' s
analysis
the e x i s t e n c e of
effects
of the policy.
is t h e
fact
the e v i d e n c e on
DOE claims
to b e
about those effects:
A l t h o u g h t h e n e t b e n e f i t s o f f u l l d e c o n t r o l in
198 2 are $10 b i l l i o n ( N P V ) , the d i s t r i b u t i o n of
t h e c o s t s a n d b e n e f i t s is l i k e l y t o b e u n e v e n .
I t is d i f f i c u l t to e s t i m a t e t h e m a g n i t u d e a n d t h e
d i s t r i b u t i o n of
these
effects
among
different
s e c t o r s of the economy, regions, and s oc i a l and
economic
groups,
The
macroeconomic
and
e f f i c i e n c y a n a l y s e s sh ow that all f a m i l i e s could
b e m a d e b e t t e r o f f a s a r e s u l t o f d e c o n t r o l . 12
312
16
-
-
The analysts who generated
emphatic
and
insistent
the numbers were
about the d i s t r i b u t i o n of costs
and
benefits:
Thus, accelerated decontrol involves a relative
s h i f t of real i n c o m e or p u r c h a s i n g p o w e r f r o m the
own e r s of labor services to the owners of capital
s e r v i c e s and, a m o n g the l a t t e r , f r o m the o w n e r s
o f o t h e r c a p i t a l a s s e t s to t h o s e h a v i n g c l a i m s o n
the
capital
associated
with
domestic
gas
s u p p l y . 13
Other
biases
differential
shifting
i n D O E ’s a n a l y s i s
of
of time
analysis
frames
in w h i c h
s u c h as
this,
the m o s t
tional models
criticized
assume
doubt
than
below,
(referred
exaggerated
time frame
policies)
to e r a s e
models,
later
are
models.
the
run over
between
the most
to let
initial
which begin
years
In
used
time
tradi
are
reason
as w i l l
to
subject
to
be shown
explained.
favorable model
compared
positive
factors.
to s h o w s m a l l
(for d e c o n t r o l
little
it
the models have been
small
negative
a shorter
to say,
is a n y l e s s
fact,
(for d e c o n t r o l
in o r d e r
little
The more
is r e a l l y
and can be e a s i l y
Furthermore,
the
are applied.
to a s d e m a n d - o r i e n t e d )
There
the differences
a long
Needless
the s u p p l y - s i d e m o d e l
the other
and
is p r e s e n t e d w i t h o u t d i s c u s s i o n
favorable results.
severely.
that
the m o d e l s
which has been
its l i m i t a t i o n s or c a v e a t s .
produces
in its
treatment of m a c r o e c o n o m i c m o d e l s
The supply-side model,
for
lie
frame.
to p r e s e n t
factors build up
The
negative
compared
is r u n o v e r
less
favorable
impacts
in
to p r e s e n t p o l i c i e s ) ,
There
are some very
313
-
good
reasons
to b e l i e v e
17
-
that decontrol would
negative
impacts
relative
policies
in t h e l a t e 1 9 8 0 s
and
in t h a t l a t e r p e r i o d .
present policies will
period
is r e a l .
after.
analysis
As n o t e d
the e c o n o m e t r i c
the m o d e l s
pt i o n s on w h i c h
t h e o r e t i c a l l y and
section will
clarifying,
to d e c o n t r o l
of t i m e
frames
the
to
that
in t h a t
in D O E ' s
and
important
it is d i f f i c u l t
A careful
employed
by DOE and
(2)
shows
that
technically explicable.
than obscuring,
and p i n p o i n t i n g
economics
the
the a s s u m
they are not
that exist
are
The next
the obj e c t i v e of
their
the m e s sage
review of
(1)
the d i f f e r e n c e s
analyze DOE's models with
to a s s e s s
important
they send
about
in t h e n a t u r a l g a s m a r k e t .
The Econometric Results
1.
Similarities
For
the
and
rather
supply-side
C.
the p o s s i b i l i t y
results.
they are based
that different
features
bring more gas
be a l e g i t i m a t e
this obfuscation
o u t p u t of all
all
above,
in t h e e s t i m a t i o n o f e f f e c t s .
Amid
properly
shifting
obscures what may
difference
Thus,
be p r e f e r a b l e
The
to
to c o n t i n u a t i o n o f p r e s e n t
c o n t i n u a t i o n of present poli c i e s would
market
lead
all
the fuss ma d e
supply-oriented
there
simply
sets of
and
about differences
the d e m a n d - o r i e n t e d
is n o t t h a t m u c h d i f f e r e n c e
results
comparable
and D i f f e r e n c e s
time
for
full d econtrol
frame
(9 y e a r s ) ,
between
approaches,
between
(see T a b l e
projected
the two
4).
changes
Over
a
in G N P
Table 4
THE MACROECONOMIC EFFECTS OF FULL DECONTROL
DEPICTED IN THREE DIFFERENT MODELS
(Change from Base Case) 1/
GNP
(Percent)
H/J
1982
.31
Inflation
(Percentge Points)
D
W
- .32
- .4
H/J
2.18
D
W
1.7
2.5
Labor
H/J2
.01
Investment
(Percent)
D3
W3
H/J
D
.1
.2
3.81
-1.1
3.28
-2.1
.5
3.35
-1.4
1.8
W
.1
1983
- .24
- .61
.4
- .33
,7
.4
.03
.2
1984
- .19
- .43
- .2
.24
.1
•2
.05
.2
1985
.13
.13
.4
-1.72
.9
-2.0
- .11
0.0
.41
.1
3.1
1986
.17
.37
- .3
- .06
- .9
- .5
.10
,1
.40
1.2
,3
1987
.18
- .08
.1
- .06
.2
- .3
- .08
.1
,31
1988
.16
.07
.1
0.0
.1
0.0
.09
.1
1989
.17
- .13
0.0
.02
.1
.2
.08
0.0
1990
.18
- .17
A
- .01
.1
0.0
.07
0.1
Cumulative
Impacts
Billions of
Constant 1980 $
-
-20.7
-39.7
■
-27.7
+1.61
9 yçar
+10.8
-40.5
--24.0
-.3
Explanatory Notes:
.21
1.2
.16
1.2
1.6
0
,1
].0
-0.2
o.n
Billions of
Constant 1980 $
+2.5
+3.1
100
500
300
46.10 -13.1
1.6
.8
.1
700
300
0
54.0
-19.5
44.7
1/ H/J « Hudson/Jorgenson; W = Wharton; D = DRI
Measured as percent decrease in labor supply.
Measured as percentage point increase in unemployment.
2/
3/
,3
Job Losses
(in thousands)
% Change
3 year
.1
0
315
- 19 range
from +10.8
billion
sound
billion
(constant
large,
percent
1980
of GNP.
impacts
largest
they present
less
in t h e
predicts
Again,
a small
the d i r e c t i o n of
$)
to - 4 0 „ 5
these numbers may
than one quarter
agree
on
fairly
first
three years.
a loss of
loss predicted
billion.
1980
Although
All models
supply-side model
$39c7
$)
they constitute
negative GNP
the
(constant
the numbers m a y
the p r e d i c t e d
The
billion,
while
side models
is
sound
f r a c t i o n of GNP.
large,
Further,
impact
a
substantial
$20,7
by the d e m a n d
of
is t h e
but
note
that
same —
negative,
The demand-oriented models
runs
of
models
increasing
predict
a sizable
models differ
year
somewhat
impact on
percentage
predictions
If t h e r e
occur
in the
model
shows
supply
and
decrease
in the
and
labor
and
supply
in i n v e s t m e n t
both
short and
and
long
is t r e a t e d
is o n
in t h e
to + .4).
The
longer
terms,
By
as e n e r g y
of
supply-side
term.
$50
and
The
person years
The
billion
implication,
saving
they
in l a b o r
100,000
the order
three
their
investment.
is a b o u t
three
in t h e m o d e l s ,
areas,
in
the
all
f r o m + 1„6
steady decrease
increase
The
of
points)
differences
term and 7 0 0 , 0 0 0
increase
in t h e m o d e l
percentage
investment
a continuous
in t h e
ranging
longer
But
inflation.
predictions
(increases
are major
labor
in
(-«2 p e r c e n t a g e p o i n t s
a continuous
short
the
in t h e i r
to + 3 . 1
slightly
in t h e e a r l y y e a r s ,
increase
inflation
points
nine year
inflation
produce
in
investment
labor
saving.
316
-
20
-
The demand-side models show somewhat different
p a t t e r n s of u n e m p l o y m e n t and i n v e s t m e n t .
increase
T h e r e is a n e t
in u n e m p l o y m e n t w h i c h p a r a l l e l s t he n e t d e c r e a s e
in l a b o r s u p p l y p r o j e c t e d by t h e s u p p l y - s i d e model,
However,
the p a t t e r n is s o m e w h a t d i f f e r e n t .
o r i e n t e d m o d e l s s how larger job losses
(300,000-500,000)
t h e l o n g ter m ,
in t h e s h o r t t e r m
t h a n in the l o n g t e r m
there
The demand-
(0-300,000)
In
is a s m a l l d e c r e a s e in i n v e s t m e n t in
one demand-oriented model
($13 b i l l i o n )
the other
T h e r e is a m a j o r d i f f e r e n c e
($45 b i l l i o n ) ,
a nd an i n c r e a s e in
in
t h e s h o r t t e r m e f f e c t s o f d e c o n t r o l o n i n v e s t m e n t in t h e
d e m a n d - s i d e m o d e l s w h e n c o m p a r e d to t h e s u p p l y - s i d e
models.
The supply-oriented model shows a large rapid
i n c r e a s e in i n v e s t m e n t ,
t h e d e m a n d - o r i e n t e d m o d e l s d o not.
One shows a very s light increase,
decrease.
T h e a n a l y s i s of a c c e l e r a t e d / p h a s e d d e c o n t r o l
exhibits similar patterns
2.
the other shows a la r g e
(see T a b l e 5),
E x p l a n a t i o n o f the D i f f e r e n c e s
It is e a s y to a t t r i b u t e t h e d i f f e r e n t b e h a v i o r of
l a b o r a nd i n v e s t m e n t to the b a s i c p h i l o s o p h y u n d e r l y i n g
the models.
The supp ly -s id e mo de l was p r e mi se d on a
t r a n s f e r of w e a l t h f r o m c o n s u m e r s
(labor)
to p r o d u c e r s
(investors)
w h i c h w a s a s s u m e d to b e p r o d u c t i v e .
differences
in r e s u l t s a re c o n s i s t e n t w i t h t h i s
philosophy.
In fact,
The
t h i s p h i l o s o p h i c a l d i f f e r e n c e is
e m b o d i e d in a s i m p l e t e c h n i c a l a s s u m p t i o n m a d e b y t h e
0
1
Table 5
THE MACROECONOMIC EFFECTS OF PHASED DECONTROL
DEPICTED IN TWO DIFFERENT MODELS 1/
(Change from Base)
GNP
(Percent)
H/J
Inflation
(Percentage Points)
_ D
H/J
Labor
Investment
(Percent)
H/J2
D3
H/J
.2
.01
0.0
1.53
D
1982
.12
.03
1983
.22
-.23
.8
.01
.1
2.40
1984
.23
.51
.8
.01
.2
3.22
1985
.13
.29
.9
.08
.2
.50
1986
.18
+ .19
.7
.07
0.0
.51
1987
.16
+ .22
.1
.07
,1
,34
1988
.14
.04
.1
.07
.1
.22
1989
.15
1990
.16
Cumulative
Impacts
Billions of
Constant 1980 $
0.0
.03
0.0
.07
0.0
,21
.1
.06
0.0
.17
% Change
Job Losses
(in thousands)
D
Billions of
Constant 1980 $
3 Year
-16.3
-22.5
na
1.8
10
300
31.6
na
9 Year
+13.1
-18.1
na
.1
430
300
41.4
na
Explanatory Notes:
1/ H/J = Hudson/Jorgenson; W = Wharton
2/ Measured as percent decrease in labor supply
T/ Measured as percentag^jgoint increase in unemployment
318
22
-
authors
does
-
of the e c o n o m e t r i c m o d e l s .
not allow a pric e- wa ge -p ri ce
The
supply-side model
spiral
to o c c u r :
F u r t h e r , n o p r i c e - w a g e - p r i c e s p i r a l m e c h a n i s m is
included.
This limits the p r o c e s s of a d j u s t m e n t
and,
hence,
the o v erall
price
impact
to t h a t
w h i c h is s o l e l y a t t r i b u t a b l e t o t h e c h a n g e i n g a s
p o l i c y . 14
The demand- o r i e n t e d m odels do permit pricewage-price
spirals:
In
WAIFM
[Wharton
Annual
and
Industry
F o r e c a s t i n g M o d e l ] , all c o s t c h a n g e s are p a s s e d
t h r o u g h to th e f i n a l p r o d u c t p r i c e s i m m e d i a t e l y .
Consumers must pay higher
gas bills and
face
higher prices
for o t her g o o d s and services,
These direct and indirect price effects are only
p a r t of the f inal p r i c e i nc rease.
Seeing their
real income fall, w o r k e r s d e m a n d higher wages.
W a g e i n c r e a s e s , in turn, i n c r e a s e t h e c o s t s o f
p r o d u c t i o n a n d p r o d u c t p r i c e s in f u t u r e p e r i o d s ,
g e n e r a t i n g a w a g e - p r i c e s p i r a l . 15
As
the
supply-side
price-wage-price
analysts
spiral dampens
impact.
In fact,
negative
impact of d e c o n t r o l
the
aggregate
would with
on GNP
will
suffer
a real
loss
n e c e s s a r y to p r e c l u d e
shift
resources
The
assume
That
in t h e
is w h y t h e
inflationary
It a l s o d a m p e n s
More
spiral
income;
the
(technically speaking,
it
importantly,
ensures
That
is,
the spiral m e c h a n i s m
that
the
labor
it is
in o r d e r
to
investors.
so-called demand-oriented models
that,
The models
to
in
the
not s h i f t as m u c h as
spiral m e c h a n i s m ) .
e x c l u s i o n of a p r i c e - w a g e - p r i c e
excluding
the pr o j e c t e d
it d o e s m u c h m o r e .
supply curve does
the
noted,
short
initial
also assume
term,
w a g e s d o n o t k e e p up.
reduction
that,
actually
in r e a l
in r e a l i t y ,
income occurs.
in t h e
long
run,
319
- 23 w a g e s do
t r y to k e e p u p w i t h p r i c e s .
between
the models
respond
to t h e
by attempting
increases
The
comes down
increase
to o f f s e t
The difference
to w h e t h e r
in p r i c e s
their
losses
assumes
unsuccessful,
even
models
that labor will
assume
very short
run,
but will
revenues)
through wage
be
that labor
in t h e l o n g
labor will
(and p r o d u c e r
and how e f f e c t i v e labor will
supply-side model
or n o t
run.
in s o d o i n g .
will
be
totally
The demand-side
not be s u c c e s s f u l
be l a r g e l y
in t h e
successful
in t h e l o n g
run.
There
between
for
are c er tainly other
the models,
but this one difference
the m a j o r i t y of the d i f f e r e n c e s
One can genuinely question
conducting
any analysis without
mechanisms.
omitting
world
Although
the
in f a c t
that does not exist.
The
sensit i v i t y case,
but
output.
the m e a n i n g f u l n e s s of
analysts
isolates
assert
the
analysis
excluding
at best,
it s h o u l d
that
impact of
impact of decontrol
price-wage-price mechanism would,
esting
account
some price-wage-price
spiral
it t e s t s t h e
should
in t h e i r
supply-side
a price-wage-price
decontrol,
case
p o i n t s of d i f f e r e n c e
in a
the
be an i n t e r
not be
the base
for d r a w i n g p o l i c y c o n c l u s i o n s .
What makes
that DOE does
this
not hesitate
demand-oriented models
not hesitate
approach even more
is
the so-called
for b ei n g u n r e a l i s t i c ,
to a l t e r b a s i c
them accord with
to c r i t i c i z e
troubling
and
it d i d
features of the m o d e l s to m a k e
its c o n c e p t i o n of reality.
To
some
320
24
-
extent,
the a l t e r a t i o n s w e r e
assumed,
incorrectly,
o p t i m u m use of gas?
rect responses
assumptions
that
-
called
industrial
the models,
to d e c o n t r o l .
and c h anges
for.
The models
users
therefore,
at t heir
predict
DOE properly
the d i r e c t i o n of
are
alters
incor
the
the m o d e l s 1
responses.
Shouldn't DOE
modified
have exercised
the s u p p l y - s i d e
no m o r e
realistic
than
demand-side models which DOE
other
words,
rectly,
doesn't
that there
therefore,
make
the a s s u m p t i o n s
criticized
assume,
spiral
is
in t h e
and changed.
is n o p r i c e - w a g e - p r i c e
In
incor
and,
incorrect predictions?
is t o r e n d e r
reached by DOE qui t e
positive
there
Such an a s s u m p t i o n
the s u p p l y - s i d e model
The net effect
sions
and
assumption which contends
is n o p r i c e - w a g e - p r i c e m e c h a n i s m ?
certainly
its j u d g m e n t
the over a l l
unrealistic.
effects of d e c o n t r o l
predicted
s u p p l y - s i d e m o d e l m u s t be ques ti on ed .
conclu
In p a r t i c u l a r
the
by the u n r e a l i s t i c
321
- 25 III.
Having
analyzed
CONCLUSION
and
D O E ’s e c o n o m e t r i c m o d e l s
differences
between
and
them,
input
Market Model,
will
be d i s c u s s e d
series.
important
unrealistic,
predicted
again
specification
the Gas
is i m p o s e d o n t h e e c o n o m e t r i c m o d e l s ,
above,
this output
the s i d e of e x t r e m e o p t i m i s m w i t h
of d e c o n t r o l .
to s t r e s s
The o utput of
in s u b s e q u e n t p a p e r s
As noted
some of the
agree with DOE's
to t h o s e m o d e l s .
which
the o u t p u t of
reconciled
it is
that we do not n e c e s s a r i l y
of thè
interpreted
If the o p t i m i s t i c
then the negative
in C E C A / R F ' s
re p e a t e d l y errs on
respect
to the e f f e c t s
assumptions prove
impact of d e control
by the m a c r o e c o n o m i c m o d e l s would
be e v en
larger.
Notwithstanding
of o v e r w h e l m i n g
with
importance
its o p t i m i s t i c
the s u p p l y - s i d e
overall
in g a s
economy,
in D O E ' s
assumptions,
analysis
the negative
approach are undeniable.
fers of w e a l t h will
increase
this note of caution,
occur,
supplies,
and
society that dwarf
with
little
the me ssage
is t h a t e v e n
i m pacts of
Massive
increase
declining productivity
losses
any gains
argument
is t r i c k l e d o w n
suggests
the p o l i c y w o u l d be
trans
in G N P ,
in t h e
in i n c o m e b y m o s t g r o u p s
in GNP.
in n a t u r e ;
The theoretical
the
trickle up
analytic work
in e f f e c t .
in
no
322
- 26 FOOTNOTES
^U.S. D e p a r t m e n t of Energy, R e s i d e n t i a l E n e r g y
C o n s u m p t i o n S u r v e y , P a r t I, N a t i o n a l D a t a , A p r i l 1 9 81,
T a b l e I.
2
U.S. D e p a r t m e n t of E n e r g y , M o n t h l y E n e r g y R e v i e w ,
O c t o b e r 1 9 8 1 , pp. 23, 25,
T h i s p e r c e n t a g e is b a s e d o n t h e
i n d u s t r i a l s e c t o r d i r e c t c o n s u m p t i o n for all e n e r g y e x c e p t
e l e c t r i c i t y plus the indir e c t c o n s u m p t i o n of n a t u r a l gas
for e l e c t r i c i t y g e ne ra ti on .
3U.S. D e p a r t m e n t of Energy, A S t u d y of A l t e r
n a t i v e s to the N a t u r a l G a s P o l i c y A c t of 1 9 7 7 , N o v e m b e r
1981; Two M a r k e t A n a l y s i s of N a t u r a l G a s Decontrol:
A p p e n d i x A , N o v e m b e r 1981; M a c r o e c o n o m i c C o n s e q u e n c e s of
N a t u r a l G a s D e c o n t r o l , A p p e n d i x C , N o v e m b e r 1981.
4
U.S. DOE, T w o M a r k e t A n a l y s i s .
5U.S.
DOE,
Macroeconomic Consequences
6H u d s o n / J o r g e n s o n A s s o c i a t e s , c o n t r a c t o r for D O E ' s
s u p p l y - o r i e n t e d study, s t a t e s the a r g u m e n t t e r s e l y for the
case of natural gas price decontrol.
In the n a t u r a l g a s
case, hou s e h o l d c o n s u m p t i o n goes down, w h i l e industry
i n c o m e ( t h e r e f o r e s a v i n g s a n d i n v e s t m e n t ) g o e s u p (U.S,
DOE, M a c r o e c o n o m i c C o n s e q u e n c e s , 1-24):
A c c e l e r a t e d d e c o n t r o l p r o m o t e s a n e x p a n s i o n in
the p r o d u c t i v e c a p a c i t y of the e c o n o m y as real
i n v e s t m e n t i n a l l y e a r s is h i g h e r t h a n i n t h e
R e f e r e n c e or p r e s e n t p o l i c y case.
. All
other
things
being
equal,
the
change
in
c a p ital supply inc r e a s e s the o u t p u t and real
income that the e c o n o m y can achieve.
Indeed,
this rise
in c a p i t a l
availability
is t h e
p r i n c i p a l m e c h a n i s m that r e duces the e a r l i e r
ec o n o m i c costs and s e c u r e s the c o n t i n u i n g
ec o n o m i c b e n e f i t of acc e l e r a t e d natural gas
price decontrol.
I n t h e 1 9 8 2 t o .1984 p e r i o d , p r i v a t e s a v i n g s
and i n v e s t m e n t increase s u b s t a n t i a l l y .
There
is a s u b s t a n t i a l r i s e in g a s - r e l a t e d c a p i t a l
i ncome, i.e., i n c o m e to g a s s u p p l i e r s .
That
is
reflected
in h i g h e r
dividends
from
and
r e t a i n e d e a r n i n g s in t h e s e i n d u s t r i e s .
The
u p w a r d m o v e m e n t in p r i c e s a l s o l e a d s t o s o m e
i n c r e a s e in o t h e r c a p i t a l i n c o m e a n d n o m i n a l
rates of return.
From each of these sources
t h e r e is a r i s e i n p r i v a t e i n c o m e .
Decontrol
l e a d s to h i g h e r e n e r g y p r i c e s , to h i g h e r c o s t s
and
to h i g h e r
output prices,
raising
the
323
A
-
2
7
-
average
price
of
consumption
goods
and
services.
Households
increase
their
c o n s u m p t i o n o u t l a y s b u t n o t by e n o u g h to
offset the higher prices
( t h e r e is a s m a l l
r e d u c t i o n in r e a l c o n s u m p t i o n )
7 I b i d ., p.
111-19.
Q
U.S.
D O E , A S t u d y o f A l t e r n a t i v e s , p.
9 I b i d „, p.
10U.S.
DOE,
^Ibid.,
p.
23,
27.
M a c r o e c o n o m i c C o n s e q u e n c e s , p.
I -15.
I-iii.
12tU . S .
DOE,
13r
* U.S.
D O E , M a c r o e c o n o m i c C o n s e q u e n c e s , p.
A S t u d y o f A l t e r n a t i v e s , p.
1 4 I b i d . , p. 1 - 1 8 .
1 5 I b i d . , p. 1 1 1 - 1 0 .
\
\
30.
I -iii.
324
THE P AST AS P R O L O G U E I
THE U N D E R E S T I M A T I O N OF P R ICE I N CREASES
IN T H E D E C O N T R O L D E B A T E :
A C o m p a r i s o n of Oil a n d N a t u r a l Gas
P r e p a r e d by:
C O N S U M E R E N E R G Y C O U N C I L OF A M E R I C A
RESEARCH FOUNDATION
F e b r u a r y 18,
198 2
325
CONTENTS
Introduction
1
T he Tr a c k R e c o r d of Oil D e c o n t r o l
2
Carter's Failure
3
Ford's Failure
6
R e a g a n 1s F a i l u r e
7
Natural Gas Price P ro jections
8
Price Increases and Economic Impacts
15
Summary and Conclusions
18
Footnotes
20
L I S T OF I L L U S T R A T I O N S
Figure 1
4
Figure 2
9
Figure 3
10
326
T H E P A S T AS P R O L O G U E I
T H E U N D E R E S T I M A T I O N OF P R I C E I N C R E A S E S
IN T H E D E C O N T R O L D E B A T E :
A C o m p a r i s o n of Oil and N a t u r a l G a s
Introduction
O n e of the m o s t c r i t i c a l
i s s u e s in e s t i m a t i n g the
i m p a c t of e n e r g y p r i c e d e c o n t r o l d e c i s i o n s
o f the m a g n i t u d e of the p r i c e
each p olicy alternative,
is the p r o j e c t i o n
increase that will f low fr o m
The s i z e of the p r i c e
increase
d e t e r m i n e s the i m p a c t of d e c o n t r o l on the e c o n o m y and on t he
d i s t r i b u t i o n of n a t i o n a l w e a l t h
(equity)
In o t h e r r e p o r t s ,
the C o n s u m e r E n e r g y C o u n c i l of A m e r i c a R e s e a r c h F o u n d a t i o n
(CECA/RF)
a n a l y z e s the e c o n o m i c a nd e q u i t y i m p a c t s of r i s i n g
e n e r g y pric e s .
This
r e p o r t f o c u s e s on the i s s u e of m a k i n g
realistic price projections.
T h i s m u s t be the s t a r t i n g p o i n t
f or a n y i m p a c t a n a l y s i s .
It s h o u l d be n o t e d at the o u t s e t t h a t p r e d i c t i n g
e n e r g y p r i c e c h a n g e s as a r e s u l t of d e c o n t r o l
business,
is an " i f f y "
D ue to the f a c t t h a t m a n y u n p r e d i c t a b l e v a r i a b l e s
affect energy prices,
m a r g i n of error.
projections typically have a wide
M o r e o v e r , m a t t e r s a re m a d e w o r s e b y t he
f a c t t h a t t h o s e - w h o s u p p o r t d e c o n t r o l of e n e r g y p r i c e s a re
l i k e l y to u n d e r e s t i m a t e p r i c e
increases;
b y the s a m e toke n ,
t h o s e w h o o p p o s e d e c o n t r o l are l i k e l y to o v e r e s t i m a t e them.
T h e c o m b i n a t i o n of g e n u i n e u n c e r t a i n t y in the e n e r g y m a r k e t
a n d s e l f - i n t e r e s t e d b i a s in m u c h of the d a t a m a k e s
it
327
-
2
-
e x t r e m e l y d i f f i c u l t to s o r t o u t the g o o d f r o m the bad p r i c e
projections.
Fortunately,
however,
we no l o n g e r h a v e to a p p r o a c h
e n e r g y p r i c e p r e d i c t i o n s in a v a c u u m .
Over the past decade
three different administ ra ti on s have made energy decontrol
decisions.
T h e r e is a r e c o r d of the p r e d i c t i o n s m a d e p r i o r
to t h o s e d e c o n t r o l d e c i s i o n s and the r e a l i t y of t he p r i c e
increases that resulted from decontrol.
B y c o m p a r i n g the
two, we c a n g l e a n at l e a s t s o m e idea of the m a g n i t u d e of
e r r o r in e a c h s e t of p r e d i c t i o n s .
Further,
if the e r r o r s c a n
be r e l a t e d to l o g i c a l or s y s t e m a t i c f a c t o r s , o u r a b i l i t y to
p r e d i c t f u t u r e p r i c e s w i l l be i m p r o v e d b y a n a l y z i n g a nd
s t u d y i n g them.
In p a r t i c u l a r ,
we c a n l e a r n w h i c h a s s u m p t i o n s
a p p e a r to be m o s t a p p r o p r i a t e for m a k i n g p r e d i c t i o n s .
In t h i s r e p o r t the C o n s u m e r E n e r g y C o u n c i l of A m e r i c a
R e s e a r c h F o u n d a t i o n e x a m i n e s t h e t r a c k r e c o r d of p r e v i o u s oil
d e c o n t r o l d e c i s i o n s and d r a w s s o m e i m p l i c a t i o n s for the
a n a l y s i s of n a t u r a l g a s d e c o n t r o l .
T he T r a c k R e c o r d of Oil D e c o n t r o l
In 1976,
oil p r i c e s .
the F o r d A d m i n i s t r a t i o n d e c o n t r o l l e d h e a t i n g
In 1979,
t he C a r t e r A d m i n i s t r a t i o n i n i t i a t e d the
p h a s e d d e c o n t r o l of c r u d e oil p r i c es .
In 1981,
the R e a g a n
A d m i n i s t r a t i o n f i n a l i z e d the d e c o n t r o l of g a s o l i n e p r i c e s .
(Ac t u a l l y,
t he R e a g a n A d m i n i s t r a t i o n f i n a l i z e d t he p h a s e - i n
of c r u d e oil p r i c e d e c o n t r o l , but,
s i n c e g a s o l i n e w a s the
328
- 3 o n l y c o n t r o l l e d p r o d u c t at t h a t time,
t r o l l e d g a s o l i n e prices,.)
m a d e a b o u t the p r i c e
that would ensue.
predictions
in e f f e c t it d e c o n
On e a c h o c c a s i o n a p r e d i c t i o n w a s
i n c r e a s e a n d / o r the i n f l a t i o n a r y i m p a c t
As F i g u r e 1 s h o w s ,
is u n i f o r m l y d i s m a l .
t he r e c o r d of t h o s e
Predicted price increases
w e r e a b o u t o n e - h a l f of t he a c t u a l
i n cr ea s e s ,
Below CECA/RF
e x a m i n e s the b a s i s for the p r e d i c t i o n s a n d / o r t h e i r e r r o r s
o r d e r to g a i n an i m p o r t a n t
in
i n s i g h t into e n e r g y p r i c i n g
behavior.
Carter's Failure
The Carter Admin i s t r a t i o n ' s
f a i l u r e to p r e d i c t the
i m p a c t of d e c o n t r o l c a n be p a r t l y a t t r i b u t e d to the e r r a t i c
b e h a v i o r of f o r e i g n o il p r i c e s ,
altho u g h one should not
d i s c o u n t the role of d o m e s t i c / m u l t i n a t i o n a l o il c o r p o r a t i o n s
in p a v i n g the w a y for the s u p p l y s h o r t a g e of 1 9 7 9 , ^
Nevertheless,
a g r e a t d e a l of the r h e t o r i c s u r r o u n d i n g c r u d e
o i l d e c o n t r o l w a s t h a t c o m p e t i t i v e p r e s s u r e s a nd the r e l e a s e
of m a r k e t f o r c e s w o u l d m o d e r a t e p r i c e i n c r e a s e s .
2
These
f o r c e s c e r t a i n l y d i d n o t p r o v i d e m u c h p r i c e p r o t e c t i o n and
one must q ue stion whether,
However,
in fact,
t h e y e x i s t at all,
b e c a u s e f o r e i g n oil p r i c e s w e r e r i s i n g
rapidly,
t he
d e c o n t r o l of c r u d e o il u n d e r P r e s i d e n t C a r t e r d o e s n o t s e r v e
as a g o o d t e s t of w h e t h e r m a r k e t f o r c e s c a n m o d e r a t e p r i c e
increases
in e n e r g y m a r k e t s .
oil decontrol,
however,
On the two o t h e r o c c a s i o n s of
the e r r o r s
in p r e d i c t i o n c a n n o t be
a t t r i b u t e d to f o r e i g n p r i c e i n c r e a s e s ,
FIGURE X
COMPARING PREDICTED AND AC T U A L PRICE INCREASES ASSOCIATED WITH
TritS"VARIOUS STAGES OF OIL DECONTROL
HEATING OIL PRICE INCREASES
APRIL 1976 to APRIL 1979
(Percent increase)
48.6
CRUDE OIL PRICE INCREASE
IMPACT ON THE CONSUMER
PRICE INDEX:
APRIL 1979 to JUNE 1980
(Percentage Points)
GASOLINE PRICE INCREASES:
JANUARY Ì9Ó1 fcpAMARCH 1981
(Percent increase)
25.8
9.4
75
SUPPORTER'S
rea
PREDICTION:
FORD
a/
ADMINISTRATION “
lity - /
SOURCES: See following page
3.9
1.8
n
d/
S U P P O R T E R 'S
R EALITY—
PREDICTION:
CARTER
ADMINISTRATION*-:'
n
SUPPORTER'S
REALITY—b/
PREDICTION:
REAGAN
ADMINISTRATION®/
330
- 5 N O T E S TO F I G U R E 1
a G o r m a n Smi t h , " H e a r i n g s , " C o m m i t t e e on I n t e r s t a t e and
F o r e i g n C o m m e r c e , H.R. Doc. No, 9 1 2 1 - 1 3 1 (June 22, 1976), p.
38.
^ M ER, v a r i o u s
issues.
c " T e s t i m o n y of C h a r l e s L. S h u l t z e , C h a i r m a n , C o u n c i l
of E c o n o m i c A d v i s o r s , b e f o r e t h e J o i n t E c o n o m i c C o m m i t t e e ,
S u b c o m m i t t e e on E n e r g y , U.S. C o n g r e s s , A p r i l 25, 1979.
^ C o n g r e s s i o n a l B u d g e t O f f i c e , l e t t e r f r o m A l i c e M.
R e i n l i n to S e n a t o r E d w a r d M. K e n n e d y , " I m p a c t of E n e r l g y
P r i c e s a n d I n f l a t i o n on A m e r i c a n F a m i l i e s , " h e a r i n g s b e f o r e
the S u b c o m m i t t e e on E n e r g y of the J o i n t E c o n o m i c C o m m i t t e e ,
C o n g r e s s of the U n i t e d S t a t e s , J u l y 8, 1980.
e W a l l S t r e e t J o u r n a l , " D e c o n t r o l of Oil P r i c e s
E x p e c t e d T o d a y , " J a n u a r y 28, 1981.
331
-
6
-
Ford's Failure
T h e Ford A d m i n i s t r a t i o n p r e d i c t e d t h a t h e a t i n g oil
p r i c e s w o u l d go up b y no m o r e t h a n the i n c r e a s e in the p r i c e
of c r u d e oil a f t e r t h e y w e r e d e c o n t r o l l e d
in M a y 1 9 7 6 . ^
That
is, w h a t e v e r h a p p e n d e d to c r u d e oil p r i c e s w o u l d h a p p e n to
h e a t i n g oil p r i c e s as well,
e x t e r n a l p r i c e shocks,
H e r e t h e r e c a n be no q u e s t i o n of
T h e a r g u m e n t p u t f o r w a r d at the t i m e
w a s t h a t c o m p e t i t i o n w o u l d p r e v e n t h e a t i n g oil p r o d u c e r s /
d i s t r i b u t o r s f r o m r a i s i n g p r i c e s h i g h e r t h a n the i n c r e a s e in
c r u d e oil costs.
The A d m i n i s t r a t i o n contended that
d i s t r i b u t o r s of h e a t i n g o i l w o u l d c o m p e t e b o t h w i t h o n e
a n o t h e r and w i t h a l t e r n a t i v e f u e l s to p r e s e r v e and e x p a n d
t h eir m a r k e t s .
Therefore,
they would put pressure on
p r o d u c e r s to h o l d the p r i c e of h e a t i n g oil down.
In fact,
the oil i n d u s t r y f o u n d s o m e w a y to c r e a t e p r i c e i n c r e a s e s
4
t w i c e as l a r g e as the c r u d e oil i n c r e a s e s .
A n a l y s e s of t he i n c r e a s e s in h e a t i n g oil p r i c e s in
e x c e s s of the i n c r e a s e in c r u d e p r i c e s s h o w t h a t b e t w e e n
o n e - f i f t h and t h r e e - q u a r t e r s of the i n c r e m e n t w a s d u e to
s o m e t h i n g o t h e r t h a n i n c r e a s e s in p r o d u c t i o n or o p e r a t i n g
costs.5
In o t h e r w o r d s ,
p rofit margins,
t h e r e a p p e a r e d to be i n c r e a s e s in
Thus, c o m p e t i t i v e press u r e s had once again
f a i l e d to k e e p p r i c e s down.
On the c o n t r a r y ,
decontrol
in
the a b s e n c e of c o m p e t i t i v e p r e s s u r e s s e e m s to h a v e e n a b l e d
p r o d u c e r s and r e f i n e r s to i n c r e a s e t h e i r p r o f i t s .
332
- 7 -
Reagan's Failure
In J a n u a r y 1981,
the R e a g a n A d m i n i s t r a t i o n f i n a l i z e d
the d e c o n t r o l of g a s o l i n e w i t h the a s s u r a n c e t h a t g a s o l i n e
prices would
rise, at m o s t ,
by f i v e c e n t s a g a l l o n .
(-
The
a d m i n i s t r a t i o n c o n t e n d e d t h a t c o m p e t i t i o n at the p u m p w o u l d
k e e p p r i c e s down.
actual price
Nothing
However,
w i t h i n les s t h a n two m o n t h s ,
the
i n c r e a s e wa s m o r e t h a n d o u b l e t h a t a m o u n t , 7
u n u s u a l w a s g o i n g on in the w o r l d oil m a r k e t at t h a t
moment —
in fact,
p r i c e s w e r e d e c l i n i n g s l i g h t l y and t h e r e
w e r e no r e g u l a t i o n s to b l a m e ,
decontrolled.
Yet,
s i n c e oil w a s n o w c o m p l e t e l y
p r i c e s w e n t up b y m o r e t h a n 12 c e n t s a
ga l l o n .
H e r e it is i m p o r t a n t to a d d r e s s a m y t h t h a t h a s g r o w n
up a r o u n d the R e a g a n g a s o l i n e d e c o n t r o l a c t i o n of J a n u a r y
1981.
The s u p p o r t e r s of d e c o n t r o l a re fon d of p o i n t i n g o u t
th a t a f t e r g a s o l i n e p r i c e s p e a k e d
in M a r c h 1981,
d e c l i n e d by 2.2 p e r c e n t t h r o u g h Oct o b e r .
decontrol
is claim e d ,
they
A g r e a t v i c t o r y for
The cl a i m does not stand even a m o d e s t
d e g r e e of s c r u t i n y ,
First,
b e t w e e n M a y 1979,
of c r u d e oil b e g a n ,
"peaked,"
the m o n t h b e f o r e d e c o n t r o l
and M a r c h 1981, w h e n g a s o l i n e p r i c e s
p r i c e s h a d r i s e n b y 60 c e n t s a g a l l o n
$ , 7 9 1 / g a l l o n to $ 1 . 3 8 8 / g a l l o n )
(from
It is h a r d l y a m a j o r v i c t o r y
if p r i c e s t h e n d r o p b y 3.5 c e n t s or a b o u t o n e t w e n t i e t h of
the i n c r e a s e of the p r e v i o u s
be v e r y s t r o n g
two years.
Market forces cannot
if it t a k e s a n e a r d o u b l i n g of p r i c e s to g e t
t h e m to m o v e d o w n w a r d a f r a c t i o n ,
333
-
Second,
the fall
8
-
in p r i c e s o b s e r v e d
h a v e b e e n t o t a l l y u n r e l a t e d to d e c o n t r o l
in 1 981 s e e m s to
The y e a r b e f o r e
R e a g a n ' s d e c o n t r o l a c t i o n , g a s o l i n e p r i c e s fell b y 2 p e r c e n t
from their peak
in J u l y 1980 to t h e i r f l o o r in N o v e m b e r
(see F i g u r e 2)
In fact, p r i c e s h a d b e e n q u i t e s t a b l e
1980
t h r o u g h o u t the l a t t e r p a r t of 1980, p r i o r to R e a g a n
decontrol,
T he R e a g a n d e c o n t r o l a c t i o n s e e m s to h a v e e n a b l e d
g a s o l i n e p r i c e s to j u m p 12 c e n t s ,
p a t t e r n of s e a s o n a l m o d e r a t i o n .
t h e n f o l l o w t h e i r usu a l
A careful
l ook at the
h i s t o r y of g a s o l i n e p r i c e s s h o w s tha t in 1975,
1980 and 1981 t h e r e w a s a d e c l i n e
r a n g i n g f r o m 1 to 3 p e r c e n t —
1976,
in g a s o l i n e p r i c e s --
b e t w e e n t h e i r p e a k in the
s u m m e r and t h e i r v a l l e y in the f o l l o w i n g w i n t e r .
p a t t e r n a p p e a r s to be s e a s o n a l
decontrol
Thus,
1977,
g
T he
r a t h e r t h a n b e i n g r e l a t e d to
the v i c t o r y t h a t is c l a i m e d for d e c o n t r o l
is an illusion,
It a p p e a r s t h a t b o t h R e p u b l i c a n and D e m o c r a t i c
a d m i n i s t r a t i o n s h a d s e r i o u s l y o v e r e s t i m a t e d the s t r e n g t h of
c o m p e t i t i v e and m a r k e t f o r c e s and s e r i o u s l y u n d e r e s t i m a t e d
the a b i l i t y of the d o m e s t i c e n e r g y i n d u s t r y to i m p o s e p r i c e
increases
in e x c e s s of w h a t a c o m p e t i t i v e s i t u a t i o n w o u l d
h a v e a llowed.
Natural Gas Price Projections
A g a i n s t thi s t r a c k record,
the c u r r e n t f l u r r y of
p r e d i c t i o n s a b o u t n a t u r a l gas d e c o n t r o l
is m o s t
i n t e re s ti ng ,
F i g u r e 3 p r e s e n t s a n u m b e r of r e c e n t p r o j e c t i o n s of the
21-496 0
83
22
334
-
9 -
FIGURE 2
GASOLINE PRICES
19 7 8 - 1 9 8 1
$/Gallon
January
1978
SOURCE:
U.S. D e p a r t m e n t of Energy,
January
1981
M o n t h l y E n e r g y R e v i e w , v a r i o u s issues.
FIGURE ]
PRICE INCREASES PROJECTED fcg ft RESULT OF NATURAL GAS DECONTROL
PEHCENTAGE REAL PRICE INCREASE IH THE FIRST VEAR AFTER DECONTROL
ACCELERATED DECONTROL
FULL DECONTROL
PERCENTAGE REAL PRICE INCREASE IH TtfE FIRST THREE ^ EARS AFTER DECONTROL
ACCELERATED DECONTROt.
FULL DECONTROL
I
CO
CO
C7Ì
SOURCESt
80a following page
336
-
li
-
N OTES TO FIGURE 3
^ G l e n n C. Lou r y , A n A n a l y s i s o f the E f f i c i e n c y and
I n f l a t i o n a r y I m p a c t of the D e c o n t r o l of N a t u r a l G a s P r i c e s ,
( N a t u r a l G a s S u p p l y A s s o c i a t i o n [ N G S A l , A p r i l 1981 ) .
Ful1
d e c o n t r o l is S c e n a r i o 4.
A c c e l e r a t e d d e c o n t r o l is S e n a r i o 6,
T h e l a t t e r is t a n t a m o u n t to a f o u r y e a r p h a s e - i n .
2
U.S. D e p a r t m e n t of E n e r g y , Tw o M a r k e t A n a l y s i s of
N a t u r a l G a s D e c o n t r o l , A t t a c h m e n t 3, N o v e m b e r 1981.
^ I n t e r s t a t e N a t u r a l G a s A s s o c i a t i o n of A m e r i c a ,
A n a l y s i s of N a t u r a l G a s D e c o n t r o l , D e c e m b e r 1, 1981.
C a s e J,
w h i c h is the s c e n a r i o p r e f e r r e d b y I N G A A (see S u p p l e m e n t a l
S t a t e m e n t on B e h a l f of the I n t e r s t a t e N a t u r a l G a s A s s o c i a t i o n
of A m e r i c a , S e n a t e C o m m i t t e e on E n e r g y and N a t u r a l R e s o u r c e s
o n the I m p l e m e n t a t i o n o f T i t l e I of the N a t u r a l G a s P o l i c y
A c t , D e c e m b e r 1, 1981)
4
U.S. D e p a r t m e n t of E n e r g y , .R e d u c i n g U.S. Oil
Vulnerability:
E n e r g y P o l i c y for the 1 9 8 0 ' s ( N o v e m b e r 10,
1 9 8 0 ) , C h a p t e r II.
5M a r y H. N o v a k , " N a t u r a l Gas :
S h o u l d t h e N G P A Be
R e o p e n e d , " D a t a R e s o u r c e s I n c . , S p r i n g 1981, D e c o n t r o l - 1 9 8 2
Scenario.
^Wharton Econometric Forcasting Associates,
D u n ' s B u s i n e s s M o n t h , N o v e m b e r 1981, p. 56.
c i t e d in
^Energy Action Educational Foundation, The Decontrol
of N a t u r a l Gas Prices:
A Price American's Can't Afford
( F e b r u a r y 19, 1981)
g
T h e A m e r i c a n G a s A s s o c i a t i o n , C o s t of I m m e d i a t e T o t a l
W e l l h e a d P r i c e D e c o n t r o l of N a t u r a l G a s to L o w I n c o m e and
D i s a d v a n t a g e d G r o u p s , A p r i l 9, 1981.
9
S ee A p p e n d i x A.
337
-
1 .2
-
i n c r e a s e in a v e r a g e w e l l h e a d p r i c e s in the f i r s t y e a r and the
f i r s t t h r e e y e a r s f o l l o w i n g b o t h a c c e l e r a t e d d e c o n t r o l and
full d e c o n t r o l ,
The r a n g e of e s t i m a t e s is e x t r e m e l y wide.
T he h i g h e s t e s t i m a t e for the f i r s t y e a r i n c r e a s e u n d e r an
accelerated decontrol scenario
l a r g e as the lowest,
is m o r e t h a n t e n t i m e s as
For full d e c o n t r o l ,
the h i g h e s t
e s t i m a t e of the f i r s t y e a r i n c r e a s e is six t i m e s as l a r g e as
the lowest,
E s t i m a t e s of the t h r e e y e a r i n c r e a s e s do not
v a r y as w i d e l y .
The h i g h e s t e s t i m a t e d i n c r e a s e for
accelerated decontrol
is 3,7 t i m e s t h a t of the l o w e s t , w h i l e
u n d e r full d e c o n t r o l the h i g h e s t e s t i m a t e is 3.6 t i m e s the
lowest.
F u l l d e c o n t r o l and the t h r e e y e a r a c c e l e r a t e d
d e c o n t r o l e s t i m a t e s a re p r o b a b l y b e t t e r g a u g e s of the
d i f f e r e n c e s of o p i n i o n a b o u t l i k e l y p r i c e
i n c r e a s e s t h a n the
e s t i m a t e s a f t e r j u s t o n e y e a r of a c c e l e r a t e d d e c o n t r o l ,
This
is the c a s e b e c a u s e the v a r i o u s a c c e l e r a t e d d e c o n t r o l
s c e n a r i o s w h i c h C E C A / R F h a s r e v i e w e d are b a s e d on s o m e w h a t
d i f f e r e n t a s s u m p t i o n s a b o u t w h i c h c a t e g o r i e s of g a s w i l l be
d e c o n t r o l l e d a n d w h a t the p a c e of d e c o n t r o l w i l l be,
However,
the a c c e l e r a t e d s c e n a r i o s b e g i n to c o n v e r g e in the
t h i r d y e a r in t e r m s of the q u a n t i t i e s of g a s d e c o n t r o l l e d and
the c e i l i n g p r i c e s a l l o w e d ,
so t h a t t h e s e p r i c e e s t i m a t e s are
b a s e d on r o u g h l y c o m p a r a b l e c o n d i t i o n s ,
As F i g u r e 3 s h o w s ,
example,
s u p p o r t e r s of d e c o n t r o l
the N a t u r a l Gas S u p p l y A s s o c i a t i o n
Reagan Administration)
project price
[NGSA]
(for
a nd the
i n c r e a s e s t h a t are
338
- 13 o n e - h a l f to o n e - t h i r d t h o s e of o p p o n e n t s of d e c o n t r o l
American Gas Association
Foundation
[EAEF])
[AGA]
(the
and E n e r g y A c t i o n E d u c a t i o n a l
H e r e the e x p e r i e n c e o f p r i o r oil and oil
product decontrol actions
is m o s t i n s t r u c t i v e .
Actual price
i n c r e a s e s g e n e r a l l y h a v e b e e n 2 to 2> t i m e s l a r g e r t h a n the
price
i n c r e a s e s p r e d i c t e d b y the v a r i o u s s u p p o r t e r s of
decontrol.
T h us, b a s e d o n r e c e n t h i s t o r y a n d the p a t t e r n of
projections,
it is a s a f e b e t to a s s u m e t h a t a c t u a l p r i c e
i n c r e a s e s w i l l fall m i d w a y b e t w e e n the h i g h a nd l o w
estimates.
S p l i t t i n g the d i f f e r e n c e
game.
is n o t s i m p l y a n u m b e r s
D i f f e r e n c e s in p r i c e p r o j e c t i o n s n e e d n o t s t e m f r o m
b l a t a n t b i a s e s or e r r o n e o u s c a l c u l a t i o n s .
In fact,
it is
e a s y to c o n s t r u c t t e c h n i c a l l y c o r r e c t e x p l a n a t i o n s for e a c h
se t of p r e d i c t i o n s ,
correct,
i.e., e x p l a n a t i o n s w h o s e r e a s o n i n g is
o n c e t h e i r a s s u m p t i o n s ar e g r a n t e d .
T h o s e w h o p r o j e c t l o w p r i c e e s t i m a t e s t e n d to a s s u m e
1) i n t e n s e c o m p e t i t i o n b e t w e e n s u p p l i e r s l e a d i n g to
r e l a t i v e l y e l a s t i c s u p p l y and 2) s i g n i f i c a n t d i s c r e t i o n a r y
u s e o f e n e r g y or e a s y s u b s t i t u t i o n of c a p i t a l for e n e r g y or
ea s y switc h i n g be t w e e n fuels,
demand.
In s h o r t ,
l e a d i n g to r e l a t i v e l y e l a s t i c
t h e r e is a n a s s u m p t i o n t h a t c o m p e t i t i v e
m a r k e t f o r c e s o n h o t h the s u p p l y a n d d e m a n d s i d e s w o u l d k e e p
prices down.
T h o s e w h o p r o j e c t h i g h p r i c e e s t i m a t e s t e n d to a s s u m e
1) m u c h l e s s c o m p e t i t i o n b e t w e e n s u p p l i e r s a n d 2) m u c h l e s s
e l a s t i c i t y of d e m a n d .
S i m p l y put,
t h e r e is an a s s u m p t i o n
339
- 14 t h a t c o m p e t i t i v e m a r k e t f o r c e s are w e a k a nd p r i c e s c o u l d run
up s h a r p l y a f t e r d e c o n t r o l
In A p p e n d i x A, C E C A / R F d e v e l o p s a d e t a i l e d e x a m p l e of
the b e h a v i o r of the n a t u r a l g a s m a r k e t u n d e r a s s u m p t i o n s of
r e s t r i c t e d c o m p e t i t i o n and i n e l a s t i c d e m a n d b a s e d on the m o s t
r e c e n t a n a l y s i s of the n a t u r a l g a s m a r k e t d e v e l o p e d b y the
D e p a r t m e n t of E n e r g y .
9
T h e C E C A / R F a n a l y s i s s h o w s t hat
a l t e r i n g D O E ' s a s s u m p t i o n s a b o u t c o m p e t i t i o n a nd d e m a n d
e l a s t i c i t y c an lead to a p r e d i c t e d p r i c e of g a s 15 p e r c e n t
h i g h e r t h a n D O E ' s e s t i m a t e s in F i g u r e
e s t i m a t e of p r i c e
3.
T h a t w o u l d pu t the
i n c r e a s e s c l o s e to t w i c e as h i g h as NGSA's.
For p r e s e n t p u r p o s e s ,
let it s u f f i c e to s a y t h a t one
a p p r o a c h to t a k e in r e s o l v i n g a d i f f e r e n c e of o p i n i o n a b o u t
t he s t a t e of c o m p e t i t i o n in t he m a r k e t w o u l d be to o b s e r v e
the m a r k e t
in o r d e r to a s c e r t a i n w h i c h set of a s s u m p t i o n s
b e s t f i t s rea l i t y .
E c o n o m i s t s a re fond of i d e n t i f y i n g t h o s e
c h a r a c t e r i s t i c s of the m a r k e t w h i c h t h e o r e t i c a l l y d e t e r m i n e
the l e v e l of c o m p e t i t i o n
(e.g., , c o n c e n t r a t i o n ratios)
t h e n c a l c u l a t i n g t h e m for e a c h e n e r g y m a r k e t .
and
However,
r e s e a r c h in thi s r e g a r d h a s n o t b e e n c o n c l u s i v e .
prior
Another,
m o r e d i r e c t and e m p i r i c a l a p p r o a c h is to look at the h i s t o r y
of p r i c e b e h a v i o r s u b s e q u e n t to r e c e n t d e c o n t r o l d e c i s i o n s ,
R a t h e r t h a n r e l y on s o m e t h e o r e t i c a l n o t i o n of w h a t the
m a r k e t s h o u l d d o , C E C A / R F c h a r t s w h a t it h a s a c t u a l l y d o n e in
t he r e c e n t past,
Past predictions, which assumed highly
c o m p e t i t i v e c o n d i t i o n s , h a v e b e e n off by a f a c t o r of two.
340
- 15 And
t h e y are l i k e l y to be off in the f u t u r e —
a l s o by a
f a c t o r of two,
Price Increases and Eco n o m i c Impacts
As m e n t i o n e d
in the i n t r o d u c t i o n ,
t he c o n c e r n o v e r
the m a g n i t u d e of p r i c e i n c r e a s e s h a s two p o i n t s of real
significance.
T h a t is, t h e r e are two m a j o r r e a s o n s w h y we
w o r r y so m u c h a b o u t p r i c e
increases,
e q u i t y of p r i c e i n c r e a s e s ,
O n e r e a s o n i n v o l v e s the
W h e n p r i c e s go up —
on d o m e s t i c a l l y pro d u c e d c o m m o d i t i e s —
a n d s o m e gain.
l oss e s .
some A m e r i c a n s lose
The h i g h e r the i n c r e a s e s ,
The s e c o n d
reason involves
especially
t he b i g g e r the
the i m p a c t of p r i c e
i n c reases on g eneral eco n o m i c activity.
e c o n o m i c a c t i v i t y t e n d s to be r e du ce d .
W h e n p r i c e s go up,
If p r i c e p r o j e c t i o n s
a r e o f f b y a f a c t o r of two,
the e s t i m a t i o n of i m p a c t s w i l l be
o f f as well,
i s s u e s w i l l be d e a l t w i t h
separate
E a c h of t h e s e
r e p o r t s b y C E C A / R F . 10
However,
in
in the c o n t e x t o f
t h e h i s t o r y of p r i c e p r o j e c t i o n s and p r i c e r e a l i t i e s o n e
i m p o r t a n t o b s e r v a t i o n c a n be o f f e r e d at t h i s p o i n t t h a t d e a l s
w i t h the l i n k a g e b e t w e e n p r i c e i n c r e a s e s and e c o n o m i c
impacts,
O n e of the a r g u m e n t s b e i n g m a d e in s u p p o r t of
a c c e l e r a t e d d e c o n t r o l of n a t u r a l g a s is t h a t it w i l l a v o i d a
"price shock"
r i s i n g p r ices.
and t h e r e f o r e m o d e r a t e the e c o n o m i c
i m p a c t of
T h e s e v e r e d i s r u p t i o n s a s s o c i a t e d w i t h the
o i l p r i c e s h o c k of 1 9 7 9 - 8 0 a r e f r e q u e n t l y the p o i n t of
reference.
T h a t is, t h o s e w h o s u p p o r t p h a s e d a c c e l e r a t e d
341
- 16 decontrol
t h i n k t h e y can a v o i d a p r i c e s h o c k s i m i l a r to t hat
of 1 9 7 9 - 8 0 ,
reference,
w h i c h o c c u r r e d for oil,
If t h a t is the f r a m e of
t h e n the a r g u m e n t t h a t a c c e l e r a t e d d e c o n t r o l of
n a t u r a l g a s w i l l c u s h i o n the e c o n o m i c b l o w is l a r g e l y
unfounded,
T h e p a t t e r n of p r i c e
increases that will occur under
a c c e l e r a t e d p h a s e d d e c o n t r o l of n a t u r a l g a s is v e r y s i m i l a r
to the p a t t e r n of p r i c e i n c r e a s e s t h a t a c t u a l l y o c c u r r e d
d u r i n g 1979-81,
increases
A l t h o u g h the c a u s e s of the c r u d e oil p r i c e
in 1 9 7 9 - 8 0 are d i f f e r e n t t h a n the c a u s e s of the
p r ojected natural gas price
increases,
the a c t u a l p a t t e r n s of
i n c r e a s e s and t h e i r l i k e l y e c o n o m i c e f f e c t s are s i m i l a r and
t h i s is a p o i n t of o v e r w h e l m i n g
importance.
e a c h p a t t e r n of p r i c e i n c r e a s e s
in turn.
Let us r e v i e w
The oil p r i c e s h o c k is c o m m o n l y a s s o c i a t e d w i t h an
event,
the I r a n i a n r e v o l u t i o n ,
increase
in c r u d e oil pric e s .
domestic economy,
wrong.
1979,
For six m o n t h s
o il began.
this concep t i o n
after
In J u n e 1979,
the
is c o m p l e t e l y
Ira n i a n s h u t d o w n of J a n u a r y
the p h a s e d d e c o n t r o l of d o m e s t i c
T h e n e t e f f e c t w as not t h a t c r u d e oil p r i c e s
instantaneously;
s t e a d y f a s hion.
rather,
t h e y ros e in a r a pid, b u t
T h e r e w as no s i n g l e p r i c e shoc k ;
p h a s e d r u n - u p in prices,
197 9 and O c t o b e r 1981,
o il
F r o m the p o i n t of v i e w of the
70 p e r c e n t of all d o m e s t i c c r u d e oil w a s u n d e r p r i c e
c o n t r o l s . 11
jumped
however,
and a s u b s e q u e n t r a p i d
12
Specifically,
there was a
between January
r e f i n e r a c q u i s i t i o n c o s t s for c r u d e
i n c r e a s e d f r o m a b o u t $ 2 . 2 6 p er m i l l i o n B tu
($13*1 1 / b b l )
342
- 17 to $ 6 . 0 2 p e r m i l l i o n Btu
increase
month
(compounded)
increases
increase was
changes
The av e r a g e m o n t h l y
3.3 p e r c e n t ,
The actual mo n t h by
was
in p r i c e s w e r e f a i r l y e v e n —
the a v e rage
3.7 p e r c e n t pe r m o n t h a n d 17 of the 29 m o n t h l y
represented
percent.
($34.93/bbl).
i n c r e a s e s of b e t w e e n 2.1 p e r c e n t and 7 . 2
T h i s is the p r i c e p a t t e r n t h a t p r o d u c e d the
n e g a t i v e e c o n o m i c i m p a c t s a s s o c i a t e d w i t h t he oil p r i c e
shock,
N o w let us c o n t r a s t t h a t h i s t o r i c a l
r e c o r d w i t h the
p r i c e t r a j e c t o r i e s p r o j e c t e d for a c c e l e r a t e d d e c o n t r o l of
n a t u r a l gas .
will
T h e p r i c e t r a j e c t o r y of n a t u r a l g a s d e c o n t r o l
r e f l e c t t wo f a c t o rs .
immediately
S o m e g a s w i l l be d e c o n t r o l l e d
(the m o s t f r e q u e n t l y d i s c u s s e d c a t e g o r i e s a r e all
g a s d i s c o v e r e d a f t e r J a n u a r y 1, 1 9 8 2
gas")
( r e f e r r e d to as " n e w - n e w
or all g a s d i s c o v e r e d a f t e r J a n u a r y 1, 197 7
to as "all n e w g a s " ) .
as " o l d gas")
T h e r e m a i n d e r of the g a s
w i l l be d e c o n t r o l l e d
in a p h a s e d
(referred
( r e f e r r e d to
fashion over a
p e r i o d of b e t w e e n 24 a n d 60 m o n t h s , d e p e n d i n g o n w h i c h
scenario
is c h o s e n and w h i c h c a t e g o r i e s a r e i n c l u d e d .
A c c o r d i n g to the h i g h and l o w e s t i m a t e s p r e s e n t e d in
F i g u r e 3, the p r i c e t r a j e c t o r y tha t w o u l d r e s u l t f r o m
decontrol
is as f o l l o w s :
n a t u r a l g a s p r i c e s w o u l d go f r o m
about $2.30 per million Btus
in J a n u a r y 1 9 8 2 to a p r i c e
b e t w e e n $ 7 . 0 0 a n d $ 8 . 5 0 p er m i l l i o n B t u s in J a n u a r y 1986.
The average monthly price
b e t w e e n 2 a n d 3.3 p e r c e n t ,
increases
( c om p o u n d e d )
w o u l d be
T h e r e w o u l d be a s u r g e
first year when monthly price
in t he
i n c r e a s e s w o u l d be b e t w e e n 3
343
-
an d 4.2 p e r c e n t
(compounded)
18
-
T he h i g h e s t p r i c e p r o j e c t i o n
l e a d s to a r a te of i n c r e a s e in g as p r i c e s t h a t is a b o u t 18
p e r c e n t f a s t e r t h a n t h a t w h i c h o c c u r r e d for oil.
The l o w
p r i c e p r o j e c t i o n l e a d s to a rate of i n c r e a s e t h a t is r o u g h l y
32 p e r c e n t s l o w e r t h a n the i n c r e a s e for oil.
If r e a l i t y
f a l l s b e t w e e n the two, one w o u l d e x p e c t a p a t t e r n of p r i c e
i n c r e a s e s t h a t is q u i t e c l o s e to t h a t w h i c h o c c u r r e d d u r i n g
t he oil p r i c e shock.
Su c h a p a t t e r n w o u l d m e a n t h a t p r i c e s
w o u l d i n c r e a s e at e x a c t l y the rate w h i c h o c c u r r e d d u r i n g the
oil p r i c e shock,
To the e x t e n t t h a t e n e r g y p r i c e
increases present
p r o b l e m s of s t r u c t u r a l a d j u s t m e n t in the e c o n o m y
(as o p p o s e d
to s i m p l e s u r p r i s e s for w h i c h the e c o n o m y is u n p r e p a r e d ) , not
m u c h r e l i e f c a n be e x p e c t e d f r o m a c c e l e r a t e d d e c o n t r o l ,
T h o s e s t r u c t u r a l p r o b l e m s and the m a g n i t u d e of the i m p a c t of
p r i c e i n c r e a s e w i l l be the t o p i c of a n o t h e r r e p o r t in t h i s
s e r i e s , b u t it is c l e a r t h a t the s u p p o r t e r s of d e c o n t r o l are
m i s t a k e n if t h e y b e l i e v e t h a t p h a s e d d e c o n t r o l w i l l c u s h i o n
the blow.
Su m m a r y and C o n c l u s i o n s
In t h i s r e p o r t we h a v e e x a m i n e d the h i s t o r y of p r i c e
p r o j e c t i o n s and the p r i c e r e a l i t i e s t h a t s u r r o u n d e n e r g y
price decontrol decisions,
of o i l - r e l a t e d d e c o n t r o l ,
W e h a v e f o u n d that,
in the cas e
the s u p p o r t e r s g r o s s l y u n d e r
e s t i m a t e d the i n c r e a s e in p r i c e s t h a t o c c u r r e d .
I n s o f a r as
they rep e a t e d l y argued that com p e t i t i o n would hold prices
344
- 19 down,
t h e i r d i s m a l r e c o r d of p r i c e p r o j e c t i o n s s u g g e s t s t h a t
c o m p e t i t i v e a nd m a r k e t f o r c e s a re weak,
T u r n i n g to the c u r r e n t p r o j e c t i o n s of the i m p a c t of
n a t u r a l g a s d e c o n t r o l , w e f i n d a w i d e d i f f e r e n c e of o p i n i o n .
T h e s u p p o r t e r s of d e c o n t r o l p r e d i c t p r i c e
t h a t of the o p p o n e n t s .
increases one-third
If h i s t o r y is a g u i d e , o n e c a n e x p e c t
t h a t the a c t u a l p r i c e i n c r e a s e s w i l l be t w i c e as l a r g e as
t h o s e p r e d i c t e d by the s u p p o r t e r s ,
F i n a l l y , we h a v e e x a m i n e d the p a t t e r n of p r i c e
i n c r e a s e s t h a t o c c u r r e d d u r i n g the "oil p r i c e s h o c k " of
1979-80.
W e fin d the a c c e l e r a t e d p h a s e d d e c o n t r o l of n a t u r a l
g a s w i l l c r e a t e a t r a j e c t o r y of p r i c e i n c r e a s e s t h a t is q u i t e
s i m i l a r to t h a t w h i c h o c c u r r e d d u r i n g the oil p r i c e shock.
This c l e a r l y suggests that p h a s i n g - i n d e c o ntrol will not
a v o i d the s e v e r e n e g a t i v e e c o n o m i c i m p a c t s of r i s i n g e n e r g y
p r i c e s t h a t o c c u r r e d d u r i n g the o il p r i c e shock.
345
-
20
-
FOOTNOTES
^ O f f i c i a l a c c o u n t s a b s o l v e the m a j o r oil c o m p a n i e s of
all r e s p o n s i b i l i t y (see, for e x a m p l e , T he R e p o r t of the
D e p a r t m e n t of J u s t i c e to the P r e s i d e n t C o v e r i n g the G a s
S h o r t a g e of 1 9 79 [ W a s h i n g t o n , DC:
G o v e r m e n t Printing Office,
J u l y 1980]) b u t t h e r e is a m p l e e v i d e n c e of t h e i r i n v o l v e m e n t
(see R o o t s , R e a l i t i e s , R e s p o n s i b i l i t i e s : H o w the M a j o r Oil
C o m p a n i e s , N o t OPEC, T i g h t e n e d Oil S u p p l i e s and I n i t i a t e d
P r i c e H i k e s in 1 9 78 and 1 9 7 9 [En e r g y A c t i o n E d u c a t i o n a l
Foundation, May 198 0 J )
2
See, for e x a m p l e , " T e s t i m o n y of C h a r l e s L. S h u l t z e ,
C h a i r m a n , C o u n c i l of E c o n o m i c A d v i s o r s , " b e f o r e th e J o i n t
E c o n o m i c C o m m i t t e e , S u b c o m m i t t e e on E n e r g y , U.S. C o n g r e s s ,
A p r i l 25, 1979.
3
See, for e x a m p l e , t e s t i m o n y of G o r m a n S m i t h , b e f o r e
the U.S. C o n g r e s s , C o m m i t t e e o n I n t e r s t a t e and F o r e i g n
C o m m e r c e , H.R. Doc. No. 9 1 4 - 1 3 1 (June 22, 29, 1976), p. 38.
4
U.S. D e p a r t m e n t of E n e r g y
R e v i e w , v a r i o u s issues,
(DOE), M o n t h l y E n e r g y
^The l o w e r e s t i m a t e c a n be d e r i v e d f r o m DOE,
Analysis
of R e f i n e r No. 2 D i s t i l l a t e C o s t s and R e v e n u e s ,
J u l y 1 9 7 6 - J u n e 1 9 7 9 , T a b l e s 9 a n d 19 ( S e p t e m b e r 1 979).
The
h i g h e r e s t i m a t e c a n be d e r i v e d f r o m the C o n s u m e r E n e r g y
C o u n c i l of A m e r i c a , " A n a l y s i s of No. 2 D i s t i l l a t e P r i c e s and
M a r g i n s , " p r e s e n t e d b e f o r e the U. S. C o n g r e s s , H o u s e ,
S u b c o m m i t t e e on E n v i r o n m e n t , E n e r g y and N a t u r a l R e s o u r c e s of
the G o v e r n m e n t O p e r a t i o n s C o m m i t t e e , F e b r u a r y 12, 1980.
6 See the c o m m e n t s of D a v i d S t o c k m a n , in " D e c o n t r o l of
Oil P r i c e s E x p e c t e d T o d a y , " W a l l S t r e e t J o u r n a l , J a n u a r y 28,
1981.
S o m e i n d u s t r y a n a l y s t s a s s e r t e d t h a t "we w o u l d be
h e s i t a n t to s o c k on a 1 0 - c e n t - a - g a l l o n i n c r e a s e at o n c e , t he
i n c r e a s e c o u l d c o m e in s t a g e s at a rate a c o u p l e of c e n t s a
month."
O t h e r s p r o f e s s e d to b e l i e v e t h a t " a l m o s t n o t h i n g "
w o u l d h a p p e n d ue to a m p l e s t o c k s w h i c h w o u l d f a c e r e f i n e r s '
m a r g i n s to shrink,
7MER, v a r i o u s i s sues.
g
9
Ibid., v a r i o u s issues,
U.S. D e p a r t m e n t of E n e r g y , T w o - M a r k e t A n a l y s i s of
N a t u r a l G a s D e c o n t r o l ( W a s h i n g t o n , DC: G o v e r n m e n t P r i n t i n g
O f f i c e , N o v e m b e r 1981)
346
-
21
-
^ C E C A / R F , "Natural Gas Price Deregulation:
T r i c k l e Up E c o n o m i c s " ( J a n u a r y 20, 1982)
A C a s e of
^ T h e C o n g r e s s i o n a l B u d g e t O f f i c e , T h e D e c o n t r o l of
D o m e s t i c Oil P r i c e s :
A n O v e r v i e w , M a y 1979, C h a p t e r II,
12
M ER, v a r i o u s issues.
347
Appendix A
COMPETITIVE VERSUS OLIGOPOLY PRICING
OF N A T U R A L GAS
or
H o w B i g D o e s t h e T a i l H a v e To B e
To W a g the Dog?
an a p p e n d i x to
The P a s t as P r o l o g u e I
The U n d erestimation of Price Increases
in the D e c o n t r o l D e b a t e
P r e p a r e d by:
CONSUMER ENERGY COUNCIL OF AMERICA
RESEARCH FOUNDATION
F e b r u a r y 18, 1 9 8 2
348
TABLE OF CONTENTS
Page
A.
I n t r o d u c t i o n .......... . ............................
1
B.
C o m p e t i t i o n vs. N o n C o m p e t i t i o n
................
3
C.
T h e D O E A s s u m p t i o n s ...............................
6
1.
2.
6
D.
T h e B a s i c A p p r o a c h .............................
The Theoretical Market Clearing
P r i c e ..........................................
7
A n E s t i m a t i o n of the Th eo re t i c a l M a r k e t
Clearing Price Under Competition . . . .
11
1.
2.
3.
11
13
23
T h e D e m a n d C u r v e ...............................
T h e S u p p l y C u r v e ...............................
T h e M a r k e t a t E q u i l i b r i u m ..................
E.
T h e O l i g o p o l y S o l u t i o n .............................
27
F.
Alternative Assumptions About
Residential/Commercial Sector Demand
32
G.
..........
S u m m a r y a n d C o n c l u s i o n .............................
FOOTNOTES
34
37
349
LIST OF TABLES
Page
Table A . 1
P e r c e n t a g e D i s t r i b u t i o n of N a t u r a l Gas
D e m a n d .................................................
9
Table A . 2
The Com pe tit ive We l l h e a d Price of Natural
Gas for Each User Category/Alternative
F u e l C o m b i n a t i o n ....................................
12
Table A . 3
Estimating Implicit Rates of Return
for Various Categories of Natural Gas
18
.
. .
Table A . 4
I mp l i c i t Supply Ela sti ci ti es in the
A g g r e g a t e N a t u r a l G a s M a r k e t .....................
24
Table A . 5
I m p l i c i t D e m a n d E l a s t i c i t i e s i n the
Aggregate Natural Gas Market .
26
21-496 0 - 83
23
. .
350
LIST OF ILLUSTRATIONS
Page
Figure A.l
Price and Supply Under Assumptions
o f C o m p e t i t i o n a n d M o n o p o l y .......................
4
Figure A . 2
P rice U n d e r A s s u m p t i o n s of Comp e t i t i v e
a n d O l i g o p o l y B e h a v i o r .............................
5
Figure A . 3
Maximum Potential Natural Gas Demand
Curve
.
.......................................
14
Figure A . 4
The D e p a r t m e n t of Energy's Con ce ptu al
D e m a n d C u r v e ..........................................
15
Figure A . 5
M a r g i n a l C o s t C u r v e for N a t u r a l Gas
.
16
Figure A . 6
A n E s t i m a t e d Supp l y F u n c t i o n for
Crude Oil
.
.
................
21
Figure A . 7
The D e p a r t m e n t of Ene rgy*s C o n c e p t u a l
..........................
Supply Curve . .
22
Figure A . 8
T h e O l i g o p o l y P r i c e C o m p a r e d to t h e
Competitive Market Price
................
28
Figure A . 9
The Oligopoly Price with Smoothed
Demand Curves
..................................
30
. . .
F i g u r e A . 10
The Oligopoly Price with High
M a r g i n a l C o s t s ............................... ..
.
F i g u r e A . 11
The Oligopoly Price w i t h Conversion
Costs in the Residen t i a l / C o m m e r c i a l
S e c t o r s ...............................................
31
35
351
APPENDIX A
COMPETITIVE VERSUS OLIGOPOLY PRICING
OF NATURAL GAS
or
H o w Bi g D o e s t h e T a i l H a v e To Be
To W a g t h e D o g ?
A.
Introduction
The r e v i e w of the recent h i s t o r y of the b e h a v i o r of
energy prices presented above has shown that history has been
e x t r e m e l y u n k i n d to t h o s e w h o a s s u m e t h a t e n e r g y m a r k e t s a r e
highly competitive.
A c t u a l p r i c e i n c r e a s e s h a v e f ar o u t
s t r i p p e d t h e i r p r e d i c t i o n s , c a l l i n g i n t o q u e s t i o n t he
s o u n d n e s s of the c o m p e t i t i o n assum p t i o n .
T h e r e v i e w of
n a t u r a l g a s d e c o n t r o l p r i c e p r o j e c t i o n s p r e s e n t e d in " P a s t as
Prologue I ” has shown wid e di ff er e n c e s and we ha ve suggested
t h a t t h e s e d i f f e r e n c e s in p r i c e p r o j e c t i o n s c a n b e e x p l a i n e d
l o g i c a l l y b y d i f f e r e n c e s in a s s u m p t i o n s w i t h r e s p e c t to t h e
e x t e n t of c o m p e t i t i o n in t h e m a r k e t .
In t h i s A p p e n d i x ,
we
d e m o n s t r a t e th a t d i f f e r e n c e s in a s s u m p t i o n s c a n b e t r a n s l a t e d
e m p i r i c a l l y i n t o d i f f e r e n c e s in p r i c e p r o j e c t i o n s .
Unfortunately,
few of those who a c t u al ly ma k e the
p r o j e c t i o n s b o t h e r to p r e s e n t a n d d e f e n d t h e i r a s s u m p t i o n s or
to a n a l y z e w h a t t h e i m p a c t o f a l t e r n a t i v e a s s u m p t i o n s w o u l d
be.
A b o v e all#
b e c a u s e p r i c e p r e d i c t i o n s t e n d to b e h i g h l y
p o l i t i c a l , m o s t o f t h o s e w h o m a k e t h e m a r e n o t a t all
352
- 2—
i n c l i n e d e v e n to c o n s i d e r a l t e r n a t i v e a s s u m p t i o n s t h a t t o u c h
o n m a t t e r s as b a s i c as c o m p e t i t i o n .
Moreover, most studies
do not c o n t a i n an a d e q u a t e b asis for u n d e r t a k i n g such
analyses.
Thus, mo st stud ie s s im pl y state their a s su mp ti on s
a n d d e r i v e t h e i r c o n c l u s i o n s w i t h o u t g a t h e r i n g e v i d e n c e or
d emonstrating that supply and demand
non-competitively)
( e i t h e r c o m p e t i t i v e l y or
w i l l reach e q u i l i b r i u m at the p a r t i c u l a r
p r i c e t h e y b e l i e v e is c o r r e c t .
The recent s t u d y by the D e p a r t m e n t of E n e r g y 1 does
h a v e t h e n e c e s s a r y e l e m e n t s for c o n s i d e r i n g a l t e r n a t i v e
assumptions about competition,
such an analysis.
a lthough DOE did not c onduct
In f a c t , D O E a s s u m e s a l e v e l o f c o m p e t i
t i o n t h a t is i d e n t i c a l to t h e a s s u m p t i o n s m a d e b y t h e g a s
producing
industry and never qu estions these assumptions.
B e c a u s e t h e D O E s t u d y is l i k e l y to be o f c o n s i d e r a b l e
i m p o r t a n c e in p r e s e n t a n d f u t u r e d e c o n t r o l d e b a t e s , b e c a u s e
it is o n e of t he f e w w i t h th e n e c e s s a r y a n a l y t i c e l e m e n t s ,
because DOE has blindly assumed competition, because recent
p r i c e h i s t o r y h a s s u g g e s t e d an a b s e n c e o f c o m p e t i t i o n ,
and
b e c a u s e w e b e l i e v e t h a t t h e r e is a c o n s i d e r a b l e b o d y o f
e v i d e n c e to j u s t i f y s o m e s k e p t i c i s m o f t he a s s u m p t i o n o f a
2
h i g h d e g r e e o f c o m p e t i t i o n in t h e n a t u r a l g a s m a r k e t ,
this
t e c h n i c a l a p p e n d i x c o m p a r e s t he e x p e c t e d p r i c e u n d e r t h e
a s s u m p t i o n s o f c o m p e t i t i o n to t he e x p e c t e d p r i c e u n d e r t h e
a s s s u m p t i o n of n o n - c o m p e t i t i o n in t h e m a r k e t ^
353
- 3 B.
C o m p e t i t i o n vs. N o n C o m p e t i t i o n
T h e b a s i c t o o l s n e e d e d to a n a l y z e p r i c i n g b e h a v i o r
u n d e r a s s u m p t i o n s o f a l a c k o f c o m p e t i t i o n c a n b e f o u n d in
the m os t e l e m e n t a r y of ec on om ic s texts.
Figures A.l and A . 2
p r o v i d e t wo s i m p l e d i s c u s s i o n s o f w h y m o n o p o l y o r o l i g o p o l y
m a r k e t c o n d i t i o n s l e a d to l o w e r q u a n t i t i e s s u p p l i e d a n d
higher prices than competitive conditions.
For those
un f a m i l i a r w i t h the b a sic concepts, a careful
r e a d i n g of the
e x p l a n a t i o n s a c c o m p a n y i n g the f igures will be helpful.
The e s s e n c e of the a r g u m e n t rests on the d e m a n d curve
w h i c h i n d i v i d u a l s u p p l i e r s face.
In a c o m p e t i t i v e s i t u a t i o n ,
each suppl i e r faces p e r f e c t l y ela s t i c d e m a n d and m a r g i n a l
revenue curves,
mar ke t price,
s i n c e if t h e s u p p l i e r r a i s e s p r i c e s a b o v e t he
the s u p p l i e r w o u l d l o s e h i s / h e r b u s i n e s s to
his/her competitors.
M o n o p o l i s t s o r o l i g o p o l i s t s do n o t f a c e
perfectly inelastic demand curves.
prices,
As t h e y r a i s e t h e i r
they lose o nly p art of their business;
competitors threaten their demand,
relatively small.
t h e i r l o s s of d e m a n d is
T h e y a r e w i l l i n g to l o s e d e m a n d ,
as t h e y i n c r e a s e p r o f i t s b y d o i n g so.
raising prices,
since fewer
as l o n g
T h a t is, t h e y k e e p
even though they are'losing business,
because
t h e y m a k e m o r e p r o f i t s b y s e l l i n g l e s s at h i g h e r p r i c e s .
In
fact, all s u p p l i e r s m a x i m i z e p r o f i t s at the p o i n t w h e r e
m a r g i n a l reve n u e e q u a l s m a r g i n a l cost; but o l i g o p o l i s t s
m a x i m i z e p r o f i t s at h i g h e r p r i c e s a n d l o w e r q u a n t i t i e s
s upplied than those who face c o m pet it io n be ca us e they face a
less than perfectly elastic
(i.e., d o w n w a r d l y s l o p i n g )
demand
F I G U R E A. 1
P RICE A ND SUPPLY UND ER ASSUMPTIONS OF C O M E T I T I O N A N D M O N OP OL Y
s
CO
Aft tha aarkat prica of I,, tba firm cboosaa a laval of output, c , « h u t HR • MC. tine« »
la above AC, profits irt Nni*4. Entry occurs, pushing tba aarkal supply curva out to tha
right, and aarkat prloa daaraaaaa. Khan aarkat prica falls to
antry will eaaaa. For tha
fin, n « K at C (so profits ara 'aaxlaitad,* tha f i n doaa tha bast it caa givan tha
cireuaatancas)r ana thara ara ao profits, sinca *C*f! Tha cost par unit producad la equal to
tha prloa tha fira gats par unit sold. Raranuaa just corar coats. Hovavsr, raaaabar that
costs include opportunity costs for tha fln( I n n though no aconaalc profits ara aarnad
at this level of output, tha fira still gats enough revenue to covar its opportunity costs
(noraal profits). So tha fira will rasa in la buainaae. But nota what haa happanad. Dua to
ooMpatltion and fraa antry, tha fira hss baaa forcad to produca at that level of output that
alniaisas average coat!
Souroet Toa Rldall, Itava Stsaes and Jean Shacklaford, goonoalca« A Tool for Pndaratandlnq
Soclaty (Heading Haea.t Addiaon Weisley, 1*7») pp. lit, 17^-i^».
'
Mhat laval of outsat will tha aonopoly chooaa to produoa? It will produoa Q , where NC « M L
bacausa that lava! of output aaxialsee its profits. St will eharga a prloa of p for that
aaaunt of output, bacausa that is tha prica tha aarkat la willing to pay for thlt quantity.
Ttie aonopolyia earning profits since F is wall above AC. And tha aonopoly la producing at
a rata of output that doaa
loea nob
not alnintse average costa
cot
(Q is whara AC is at a ainlaua).
■owever, in a aonopoly,, whan profits ara being> »iraed,
at
"there is no antry into tha aarkat,
bacauaa thara ara no c<«petitors.
.
Ma can axaaina tba thaoratical rasults of this by focuslay
on the (aggragata aarkat). If thara wara ooapatitioa in tha irket, naw f i n s would
aarkat supply would lncraaaa
— * aarkat
---— prica
— * would dacraaaa to
eaee to SS. , and
91ms, Ktnopoly
raatriota---output,
sinca
.— --a « o . a m aonopoly chargaa highar pricas, alnSe Í.» » . rinally,
aonopolies aarn aonopoly profits. An iaportant conclusion that can ba drawn Iroathe aonopoly
aodal is that tha existence of aarkat powar (ability to control supply and prica) tands to
prevent the occurrence of oonauaar sovereignty, tha attalnaant of aconaalc afficlancy, and tha
oparaticn of tha invisible hand, tha aonopoly banaflts at tha expense of tha soclaty.
355
- 5 -
FIGURE A. 2
PRICE UNDER ASSUMPTIONS OF COMPETITIVE AMD OLIGOPOLY BEHAVIOR
PERFECT COMPETITION
OLIGOPOLIST*S EQUILIBRIUM
SAKUELSON OFFERS THE FOLLOWING DISCUSSION OF THE TWO SITUATIONS:'
This typical perfect competitor is on* of
so many producers of an identical good that
he/she faces a practically horizontal
(infinitely elastic) demand (dd) curve,
even though the industry's very much larger
DD curve can be much more inelastic. If there
is free entry and exit of well-informed firms
who can replicate the cost conditions gf
any other firm, long-run equilibrium at E
will involve no excess of profit over
competitive costs (including properly
computed implicit opportunity cost retu rn s),
Society is getting its total output most
efficiently, in recognition of the P«MC
condition, both in long and short runs. I t is
not forcing out of existing firms any output
that could be obtained more cheaply by
adding new firms.
After experience with disastrous
price wars, each of the few rivals that
dominate a given market is almost sure
to recognize that price Cutting begets
cancelling-out price cutting. So the
typical oligopolist will estimate his/her
demand curve DD by assuming others will
be charging similar prices (and by taking
into account the potential entry of
other oligopolists). Since he/she gains
little from extreme cutting of P, he/she
will settle for sizable markup of P over
MC.
aPaul Samuelson, Economics (New York: McGraw Hill, 1980), pp. 482, 485.
356
-
curve.
6
-
This b a sic c o n c e p t u n d e r l i e s all d i s c u s s i o n s of
pricing under non-competitive conditions.
Thus,
in o r d e r to e s t i m a t e n a t u r a l g a s p r i c e s u n d e r
e i t h e r c o m p e t i t i v e or n o n - c o m p e t i t i v e a s s u m p t i o n s , w e m u s t
e s t i m a t e the supply, m a r g i n a l cost, demand,
and m ar gi na l
revenue curves.
C.
The DOE Assumptions
1.
The Basic Approach
T h e D e p a r t m e n t of E n e r g y a n d t h e g a s p r o d u c i n g i n d u s
try assume a partially competitive market.
They assume that
a p r i c e c e i l i n g o n n a t u r a l g a s is s e t b y s o m e a l t e r n a t i v e
fue l .
T h a t is, t h e y a s s u m e t h e r e e x i s t s a p r i c e a b o v e w h i c h
s u p p l i e r s of a l t e r n a t i v e f o r m s o f e n e r g y
(e.g., oil)
a b l e to s t e a l b u s i n e s s f r o m g a s p r o d u c e r s .
w i l l be
Therefore,
c o m p e t i t i o n b e t w e e n f u e l s r e s t r a i n s t h e p r i c e i n c r e a s e s of
na t u r a l gas and sets the m a r k e t c l e a r i n g price.
If w e a s s u m e a c e i l i n g p r i c e o n g a s w h i c h is s e t b y
c o m p e t i t i o n with oil we can e s t a b l i s h a d e m a n d curve for gas.
W h e n t h e d e m a n d c u r v e is c o u p l e d w i t h a s u p p l y c u r v e , w e c a n
a n a l y z e w h a t t he m a r k e t p r i c e o f g a s w o u l d be u n d e r d i f f e r e n t
a s s u m p t i o n s about the p r i c i n g b e h a v i o r of s uppliers.
However,
it s h o u l d be n o t e d t h a t t h e m a r k e t a s s u m e d
b y D O E is n o t a p e r f e c t l y c o m p e t i t i v e m a r k e t in t h e c l a s s i c
sense.
DOE does not as s u m e that s u p p l i e r s of gas can ex e r t
s i g n i f i c a n t d o w n w a r d p r e s s u r e on the pr i c e of a l t e r n a t i v e
fuels.
T h a t is, g a s p r o d u c e r s d o n o t s t e a l s u f f i c i e n t o i l
357
- 7 b u s i n e s s b y p r o d u c i n g m o r e g a s at l o w e r p r i c e s to f o r c e the
o i l s u p p l i e r s to l o w e r t h e i r p r i c e s .
The fact that gas
s u p p l i e r s do n o t t r y to e x e r t d o w n w a r d p r e s s u r e o n o i l p r i c e s
s u g g e s t s t h a t p e r f e c t c o m p e t i t i o n is n o t p r e s e n t .
This
c r e a t e s the p o s s i b i l i t y of e x t r e m e l y h i g h pr o f i t s on n atural
gas production because natural gas prices need not bear any
r e l a t i o n s h i p to t h e c o s t s of p r o d u c i n g n a t u r a l g a s .
T h a t is,
e n t r y int o t h e e n e r g y i n d u s t r y d o e s n o t o c c u r to w i p e o u t
abnormal profits
(see F i g u r e A . l a b o v e ) .
I n s t e a d o f the
a v e r a g e p r i c e o f a l l f o r m s o f e n e r g y b e i n g d r i v e n d o w n to a
p o i n t w h e r e o n l y n o r m a l p r o f i t s e x i s t , D O E a s s u m e s t h a t the
p r i c e of g a s r i s e s a n d y i e l d s a b n o r m a l p r o f i t s .
In f act, as
w i l l be d i s c u s s e d b e l o w , D O E ' s a n a l y s i s s u g g e s t s thate x t r e m e l y h i g h r a t e s of p r o f i t e x i s t o n g a s p r o d u c t i o n .
T h e s e r a t e s of p r o f i t w o u l d n o t e x i s t in a p e r f e c t l y
competitive world.
2.
The Theoretical Market Clearing Price
The D e p a r t m e n t of En e r g y and the gas p r o d u c t i o n
i n d u s t r y b o t h a s s u m e a p a r t i a l l y c o m p e t i t i v e e n v i r o n m e n t in
w h i c h the p r i c e o f g a s at the w e l l h e a d is s e t b y t h e c h e a p e s t
c o m p e t i n g fuel.
T h e c h e a p e s t c o m p e t i n g f u e l is a s s u m e d to be
high sulfur
r e s i d u a l f u e l o i l u s e d p r i m a r i l y in i n d u s
(#6)
trial boilers
(including electric utility power plants).
C o n s u m e r s o f #6 oil a r e a s s u m e d to s e t t h e m a r g i n a l p r i c e
b o t h b e c a u s e t h a t f u e l is c h e a p e s t a n d b e c a u s e t h e s e i n d u s
t r i a l c o n s u m e r s t e n d to h a v e the c a p a c i t y to s h i f t b e t w e e n
358
-
f u e l s in t h e s h o r t term.
8
-
At a minimum,
i n c e n t i v e to a c q u i r e t h a t c a p a c i t y ,
they have adequate
t h e r e b y t h r e a t e n i n g to
s w i t c h f u e l s if t h e g i v e n p r i c e is n o t c o m p e t i t i v e .
T h a t is,
t h e y c a n o r a r e w i l l i n g to a c q u i r e t h e a b i l i t y to b u r n e i t h e r
f u e l at a n y m o m e n t .
Therefore,
th e y "play" the e n e r g y m a r k e t
to m i n i m i z e c o s t s .
They install dual fuel-burning capacity partly
b e c a u s e t h e y h a v e b e e n l o w p r i o r i t y " i n t e r r u p t i b l e " u s e r s in
the pa st
(and h a v e n e e d e d d u a l c a p a c i t y in o r d e r to m a i n t a i n
production operations)
and p a r t l y b e c a u s e t h e y c o n s u m e enou g h
e n e r g y to m a k e p l a y i n g th e e n e r g y m a r k e t e c o n o m i c a l l y j u s t i
fiable.
T h a t is, t h e v o l u m e s of e n e r g y t h e y c o n s u m e a r e so
l a rge that they can c o ver the costs
profits)
(including normal
of installing dual f u e l - b u r n i n g equipment.
DOE a s s umes that the w e l l h e a d p rice of n atural gas
w i l l be e q u a l to t h e b u r n e r t i p p r i c e o f
g as t r a n s m i s s i o n and d i s t r i b u t i o n costs.
#6
f uel o i l m i n u s
T h a t is, t h e p r i c e
o f g a s at the w e l l h e a d c a n be no h i g h e r t h a n t h e p r i c e o f t h e
a l t e r n a t i v e at t he b u r n e r t i p n e t of t h e t r a n s m i s s i o n a n d
d i s t r i b u t i o n costs,
i.e.,
t h e c o s t s of g e t t i n g t h e g a s f r o m
t h e w e l l h e a d to the b u r n e r tip.
Recent estimates by DOE show
t h a t c o n s u m e r s of h i g h s u l f u r #6 o i l w h o a r e p o t e n t i a l g a s
c o n s u m e r s a c c o u n t f or l e s s t h a n 4 p e r c e n t o f t h e a g g r e g a t e
d e m a n d for g a s
( R e s i d u a l D in T a b l e A . l ) .
However, because
t h e y a r e the m a r g i n a l u s e r s in a c o m p e t i t i v e f r a m e w o r k ,
set the w e l l h e a d price.
they
Table A.l
PERCENTAGE DISTRUBTION OF NATURAL GAS DEMAND
Category and Alternative Fuel Type
Alternative
Fuel
Residential
Commercial
Industrial
Non-Boiler
Electric
Utilities
Industrial
Boiler
TOTAL1
Interstate
Intra
state
Distillate
25.9
3.4
7.3
1.4
3.3
1.5
2.4
.8
.2
1.3
46.5
Residual A
0
0
3.3
.7
10.1
4.9
.7
.2
1.4
2.0
23.3
Residual B
0
0
3.3
.7
1.5
2.6
.9
8.4
.6
1.2
19.2
Residual C
0
0
0
0
1.0
.7
1.3
.2
1.0
1.4
5.6
Residual D
0
0
0
0
.3
.1
.6
.1
1.1
1.4
3.6
Residential
($2. 00)
0
0
0
0
.3
.2
.6
.1
.4
Interstate
Intra
state
^Numbers may not add due to rounding.
Source:
DOE, Two Market Analysis, p. A-88.
Interstate
Intra
state
Interstate
Intra
state
Interstate
Intra
state
.6
2.2
360
- 10 A c c o r d i n g to D O E , o n c e t h e w e l l h e a d p r i c e is s e t a t
the m a r g i n b y these c o n sumers,
then the burn e r tip price can
be c a l c u l a t e d for a l l o t h e r c o n s u m e r s .
T h i s is a c c o m p l i s h e d
b y t a k i n g t h e w e l l h e a d p r i c e a n d a d d i n g to it t h e t r a n s m i s
s i o n a n d d i s t r i b u t i o n c o s t s t h a t a p p l y to e a c h u s e r .
other words,
In
t h e e n t i r e m a r k e t is d r i v e n b y c o m p e t i t i o n a t
the m a r g i n for h i g h sul f u r fuel oil users.
If o n e q u e s t i o n s t h e a s s u m p t i o n t h a t s u p p l i e r s b e h a v e
a s t h o u g h t h e y w e r e d r i v e n b y c o m p e t i t i o n to s e l l e v e r y c u b i c
foot of gas that t hey can, then one m u s t q u e s t i o n w h e t h e r
h i g h s u l f u r residual fuel oil should dr i v e the w e l l h e a d
price.
S u c h a s m a l l p e r c e n t a g e of d e m a n d m a y l o o k l i k e a
v e r y s m a l l t a i l to b e w a g g i n g a b i g dog.
Wouldn't producers
b e w i l l i n g to l o s e 4 p e r c e n t of t h e i r d e m a n d b y r a i s i n g t h e i r
price,
if t he i n c r e a s e d p r i c e w o u l d l e a d to an i n c r e a s e in
total profits?
A s w e s h a l l see, D O E ' s e v i d e n c e s u g g e s t s t h at,
p r o d u c e r s b e h a v e in a n o n - c o m p e t i t i v e f a s h i o n ,
if
they can
m a x i m i z e profits by raising prices well above DOE's t h e o r e t i
c al c o m p e t i t i v e m a r k e t c l e a r i n g p r i c e a n d s a c r i f i c i n g as m u c h
as 30 p e r c e n t of t h e t o t a l d e m a n d .
T h e f o l l o w i n g a n a l y s i s e s t i m a t e s t he d e m a n d , m a r g i n a l
r e v e n u e and m a r g i n a l c ost cu r v e s p r o j e c t e d for 1985 ba s e d on
D OE's recent analysis of a c c e l e r a t e d / p h a s e d decontrol.
B e c a u s e t he d a t a a r e t a k e n d i r e c t l y f r o m p u b l i s h e d D O E
materials,
t he a n a l y s i s e m b o d i e s D O E ' s a s s u m p t i o n s a n d r e l i e s
361
-
1 1
-
on c o n s i d e r a b l e i n t e r p o l a t i o n of D OE's results.
theless,
D*
Never
it m a k e s t h e p o i n t q u i t e c l e a r l y .
An E s t i m a t i o n of the T h e o r e t i c a l M a r k e t
Clearing Price under Competition
1.
The Demand Curve
In o r d e r t o . c r e a t e t h e d e m a n d c u r v e f o r n a t u r a l g a s ,
we b e g i n b y i d e n t i f y i n g t h e q u a n t i t y o f g a s d e m a n d e d b y a
s e r i e s o f s p e c i f i c c a t e g o r i e s of u s e r s
User c a t e g o r i e s are ident i f i e d by
the f u e l is p u t
boiler,
(see T a b l e A . l a b o v e ) .
(1) t h e e n d u s e to w h i c h
(residential, commercial,
industrial non
i n d u s t r i a l b o i l e r a n d e l e c t r i c u t i l i t y ) , (2) t he
pipeline market
(interstate v ersus intrastate)
al t e r n a t i v e fuel
(distillate,
the l o w e s t g r a d e
[highest sulfur]
and
(3) t h e
4 g r a d e s o f r e s i d u a l o i l a nd
residual min us $2.00).
T h e r e a r e 44 c o m b i n a t i o n s of e n d u s e s / p i p e l i n e m a r k e t s /
a l t e r n a t i v e f u e l s a n d t h e s e a r e u s e d as d a t a p o i n t s for the
e s t i m a t i o n of the demand curve.
E nd u s e typ e , p i p e l i n e
m a r k e t a n d a l t e r n a t i v e f u e l a r e c h o s e n to d e f i n e t h e
c a t e g o r i e s of users b e c ause they are the m o s t cri t i c a l
d e t e r m i n a n t s o f t he w e l l h e a d p r i c e o f n a t u r a l g a s t h a t w o u l d
c o m p e t e w i t h a l t e r n a t i v e s at t h e b u r n e r tip.
In t h e n e x t s t e p , w e c a l c u l a t e t h e w e l l h e a d n a t u r a l
gas price that wo u l d just c a p t u r e the b u s i n e s s of each user
category.
T h a t is, w e c r e a t e a s e c o n d m a t r i x b y c a l c u l a t i n g
the b u r n e r t i p p r i c e o f t h e a l t e r n a t i v e f u e l m i n u s t h e
t r a n s m i s s i o n a n d d i s t r i b u t i o n c o s t s i m p l i c i t in D O E ' s
a n a l y s i s for e a c h s p e c i f i c u s e r c a t e g o r y
(see T a b l e A . 2).
Table A.2
Hie Competitive Wellhead Price of Natural Gas
for Each User Category/Alternative Fuel Combination
Alternative Transmission
Fuel
& Distribution
Costs
Residential
InterState
Distillate
7.13
Residual A
6.17
na
Residual B
5.71
Residual C
5.79
InterState
IntraState
Industrial
Non-Boiler
InterState
IntraState
Electric
Utilities
InterState
Intra
stat e
Industrial
Boilers
InterState
IntraState
5.36
6.10
6.00
6.69
5.95
6.77
6.16
6.16
na
4.40
6.14
5.04
5.73
4.99
5.81
5.20
5.20
na
na
3.94
4.68
4.58
5.27
4.53
5.35
4.74
4.74
5.55
na
na
na
na
4.42
5.11
4.37
5.19
4.58
4.58
Residual D
5.36
na
na
na
na
4.23
4.92
4.18
5.00
4.39
4.39
Residual D
minus $2.00
3.36
na
na
na
na
2.25
2.92
2.18
2.00
2.39
2.39
Source:
5.08
IntraState
Commercial
DOE, Tv*> Market Analysis, Attachment IV.
363
- 13 T h e b u r n e r t i p p r i c e o f t he a l t e r n a t i v e f u e l m i n u s t r a n s
m i s s i o n and d i s t r i b u t i o n costs equals the w e l l h e a d pr i c e that
w o u l d be j u s t c o m p e t i t i v e w i t h t h e a l t e r n a t i v e .
The demand curve that results
(see F i g u r e A , 3)
e x h i b i t s a s h a p e t h a t is q u i t e f a m i l i a r .
In f act,
it is n o t
u n l i k e t he d e m a n d c u r v e d e p i c t e d b y D O E in its c o n c e p t u a l
d i s c u s s i o n s of the n a t u r a l g a s m a r k e t
However,
(see F i g u r e A . 4).
t h e p o i n t at w h i c h d e m a n d b e c o m e s i n e l a s t i c for t he
s e c o n d t ime,
t h e p o i n t at w h i c h the c u r v e t u r n s d o w n for the
s e c o n d tim e , o c c u r s at a h i g h e r p r i c e t h a n in D O E ' s c o n c e p
tual curve.
T h e d i f f e r e n c e in s h a p e is s i g n i f i c a n t f or two
r e a s o n s w h i c h w i l l be e l a b o r a t e d b e l o w .
b e n e f i t s of o l i g o p o l y p r i c i n g s e c u r e .
a r e i m p e r v i o u s to
First,
it m a k e s t he
T h a t is, t h e b e n e f i t s
(or " r o b u s t " wi.th r e s p e c t to)
the a s s u m p
t i o n s m a d e a b o u t t h e s h a p e of the m a r g i n a l c o s t c u r v e .
S e c o nd ,
it a l s o h a s m a j o r i m p l i c a t i o n s for t h e b e h a v i o r of
the m a r k e t ,
e v e n if c o m p e t i t i o n is a s s u m e d .
T h e s t e e p n e s s of
the d e m a n d c u r v e at p r i c e s b e l o w $ 5 . 0 0 m e a n s t h a t t h e m a r k e t
w i l l n o t be v e r y r e s p o n s i v e to p r i c e c h a n g e s .
2-
The Supply Curve
T h e s e c o n d c u r v e n e c e s s a r y to c a l c u l a t e t h e m a r k e t
e q u i l i b r i u m a n d / o r t h e p o i n t o f m a x i m u m p r o f i t f or o l i g o
p o l i s t s is the m a r g i n a l c o s t
(supply)
curve
(see F i g u r e A . 5).
D O E g i v e s 1 9 8 0 m a r g i n a l c o s t s in 1 9 8 0 $ / m c f for f o u r
c a t e g o r i e s of d o m e s t i c a l l y p r o d u c e d g a s —
associated
("no
7.00h
1980$ PER MILLION CUBIC FEET
5.GO -
S o u rce :
FIGURE A . 3
MAXIMUM POTENTIAL NATURAL GAS DEMAND CURVE
---------------------------1------------------------
50
PERCENT OP TOTAL POTENTIAL DEMAND
Tables A . 1 and A . 2
"T
80
365
-
15 -
FIGURE A . 4
THE DEPARTMENT OF ENERGY*S CONCEPTUAL DEMAND CURVE
FINAL CONSUMPTION
Sources
21-496
DOE,
0
83
T w o M a r k e t A n a l y s i s , p. A - 9 7
1910$
PEU MILLION
CUBIC
FEET
FIGURE ...5
MARGINAL COST CURVE FOR NATURAL GAS
PERCENT OF TOTAL POTENTIAL DEHAND
Source: See text
367
- 17 cost"),
deep gas
shallow conventional
($1.24), t i g h t g a s
($1.50)
and
( $2.15).
S i n c e all p r i c e s u s e d to p l o t t h e d e m a n d c u r v e a r e
1985 prices
stated
in 1 9 8 0 $ / m c f ,
t he c o s t s a r e s t a t e d o n
the same b a sis for both d e mand and supply.
However,
s u p p l y c o s t s a r e e s t i m a t e d for 1980, n o t 1985.
the
Therefore,
it
is n e c e s s a r y to c a l c u l a t e m a r g i n a l c o s t s f or 1985.
Mar g i n a l costs will rise over time and DOE a ssumes
t h e y w i l l r i s e as a f u n c t i o n of t h e d e c l i n i n g s u c c e s s r a t e of
natural gas exploration.
If s u c c e s s r a t e s c h a n g e d i f f e r e n t l y
for e a c h c a t e g o r y of g a s e x p l o r a t i o n ,
marginal cost curve could change.
t h e n t h e s h a p e of the
However,
for t h e b a s e
c a s e , D O E a s s u m e d a real 2 .5 p e r c e n t i n c r e a s e in m a r g i n a l
c o s t s p er y e a r .
unaffected.
future,
T h i s l e a v e s t he s h a p e o f t h e c u r v e l a r g e l y
F o r the p u r p o s e s of m o v i n g f i v e y e a r s int o the
t h i s w o u l d a p p e a r to be a r e a s o n a b l e a s s u m p t i o n .
The
m a r g i n a l c o s t c u r v e s h o w n in F i g u r e A . 5 i n c l u d e s t h i s 2.5
p e r c e n t p e r y e a r rea l p r i c e i n c r e a s e for the f i v e y e a r s
b e t w e e n 1 9 8 0 a n d 1985.
H e r e it s h o u l d b e n o t e d t h a t D O E ' s i n i t i a l m a r g i n a l
c o s t s for 1 9 80 i n c l u d e a n 8 p e r c e n t r e a l r a t e o f r e t u r n
(normal p r o f i t s ) .
However,
if w e c o m p a r e t he i n i t i a l
m a r g i n a l c o s t to t h e a c t u a l p r i c e s b e i n g a l l o w e d o r p a i d in
t h e m a r k e t in 1980, we d i s c o v e r t h a t t h e r a t e of r e t u r n is
much higher than 8 percent
(see T a b l e A . 3).
marginal cost estimates imply actual costs
p r o f i t s a r e a dded)
The initial
( costs b e f o r e
o f $ 1 . 1 4 / m c f f or c o n v e n t i o n a l s h a l l o w gas ,
Table A.3
ESTIMATING IMPLICIT RATES OF RETURN FOR VARIOUS
CATEGORIES OF NATURAL GAS
(1)
Initial
Marginal
(1980$ rocf)
(2)
Profit
(8% real)
(3)__________ (4) ,
Cost________ Ceiling
[(3)=(X)— (2)]
Price
___________ __ (1980$ mcf)
(5)
Production
Taxes
(7%)
(6)
d
Additional0
Costs
(7)
Net Producer
Revenues
t(7)«(4)-
(5)-(6)]
(8)
Implicit
Rule of
r(8)«(7)-
(3)/(3)1
Shallow
Conventional
1.24
.10
1.14
2.47
.16
.03
2.28
100
Tight Sands*3
1.50
.11
1.39
4.92
.32
.03
4.57
229
Deep Gas0
2.15
.16
1.99
6.80
.48
.03
6.29
Source: DOE, Two Market Analysis, as follows:
W e i g h t e d average of regional marginal costs in Figure III-6, p. A-20.
bP. A-54.
CP. A-53.
^Attachment 2,p. 2-2.
00
1
369
- 19 $ 1 . 3 9 / m c f f or t i g h t s a n d s g a s a n d $ 1 . 9 9 / m c f f o r d e e p g a s .
The cei l i n g pr i c e s a llowed for these types of gas imply
r e v e n u e s to p r o d u c e r s
(i.e., t h e m a r k e t p r i c e of g a s n e t of
s e v e r a n c e a n d o t h e r p r o d u c t i o n t a x e s as w e l l as c o s t a d d - o n s )
of $ 2 . 2 8 / m c f f o r s h a l l o w g a s , $ 4 . 5 7 / m c f for t i g h t s a n d s g a s
a n d $ 6 . 2 9 / m c f for d e e p g a s
( a s s u m i n g d e e p g a s c a n g e t the
i n t e r s t a t e m a r g i n a l p r i c e t h a t D O E a s s u m e s f or 1981 ) .
The
implicit rates of return
( b e f o r e i n c o m e taxes)
a r e 100
p e r c e n t for s h a l l o w gas ,
229 p e r c e n t for t i g h t g a s a n d 216
p e r c e n t for d e e p gas.
T hese e x t r e m e l y h igh rates of return are the result
of the a b s e n c e o f p r e s s u r e to d r i v e p r i c e s b e l o w t he
eff e c t i v e c e i l i n g s wh i c h oil pr i c e s
d i s c u s s e d above,
(and NGP A )
allow.
As
the f u n d a m e n t a l m a r k e t p r o c e s s w h i c h s h o u l d
d r i v e p r i c e s d o w n in a c o m p e t i t i v e e c o n o m y —
the free entry
of f i r m s w i l l i n g a n d a b l e to p r o d u c e g a s at t h e a v e r a g e rat e
of r e t u r n in t h e e c o n o m y ,
rate of p r o f i t —
In fact,
t h e r e b y l o w e r i n g t he p r i c e and the
is o b v i o u s l y n o t w o r k i n g .
in D O E ' s m o d e l ,
d o m e s t i c p r o d u c t i o n n e v e r is
a b l e to m e e t d o m e s t i c d e m a n d and, t h e r e f o r e ,
the m a r k e t .
However,
imports enter
t h o s e w h o e x p o r t g a s to t h e U n i t e d
S t a t e s b e h a v e at l e a s t as s i l e n t p a r t n e r s in t h e o l i g o p o l y
an d do n o t t r y to s t e a l m o r e b u s i n e s s b y m o v i n g t h e i r p r i c e s
d o w n to u n d e r c u t the a b n o r m a l p r o f i t s of A m e r i c a n p r o d u c e r s .
Indeed,
price —
t h e y s e t t h e i r p r i c e a t th e t h e o r e t i c a l m a r g i n a l
the a l t e r n a t i v e fuel price.
is $ 4 . 6 9 / m c f
(1980 $).
In D O E ' s a n a l y s i s ,
thi s
370
- 20 The marginal costs cited above generate a curve with
a v e r y s h a l l o w s l o p e u n t i l c o n v e n t i o n a l p r o d u c t i o n is
exhausted
(on a n a n n u a l b a s i s )
thereafter.
and a ve r y ste ep slope
Interestingly, economist William Nordhaus has
re ce nt ly dra wn a s up pl y curve for the oil m a r k e t w it h a
similar shape
(see F i g u r e A . 6)•
T h i s c u r v e is n o t u n l i k e t h e
c u r v e D O E u s e s in its c o n c e p t u a l d i s c u s s i o n
However,
(see F i g u r e A . 7) .
n o t e t h a t t h e s l o p e of t h e a c t u a l c u r v e d e r i v e d f r o m
D O E ' s d a t a is m u c h m o r e i n e l a s t i c
"inflection."
Again,
(steep)
after the p o i n t of
t h i s d i f f e r e n c e in s h a p e h a s t w o p o i n t s
o f s i g n i f i c a n c e w h i c h w i l l be e l a b o r a t e d b e l o w .
First,
it
ma ke s the potential ben ef it s of o l i g o p o l y rela ti ve ly secure.
T h a t is, the b e n e f i t s a r e i m p e r v i o u s to
r e s p e c t to)
(or r o b u s t w i t h
t h e a s s u m p t i o n s m a d e a b o u t t h e s h a p e o f t he
de ma nd curve.
Second,
it h a s i m p o r t a n t i m p l i c a t i o n s f o r
ma r k e t behav io r even under the as su mp t i o n of c o mpe tition.
It
m e a n s t h a t t he m a r k e t w i l l n o t be v e r y r e s p o n s i v e to p r i c e
changes.
D O E ' s m o d e l is " s o l v e d " at $ 4 . 6 9 / m c f —
lent of the lowest pr i c e d a l t e r n a t i v e
and d i s t r i b u t i o n c o s t s ) .
the e q u i v a
(net o f t r a n s m i s s i o n
T h e market' s e t t l e s a t a p o i n t at
w h i c h a b o u t 16 p e r c e n t o f t h e m a x i m u m p o t e n t i a l d e m a n d is n o t
captured by gas producers.
T h a t is,
16 p e r c e n t o f t h e
p o t e n t i a l d e m a n d is a l l o w e d to s l i p a w a y to a l t e r n a t i v e
fuels.
371
- 21 FIGURE A.6
AN ESTIMATED SUPPLY FUNCTION FOR
CRUDE OIL
Ratio of spot price to official price
S o u r c e : W i l l i a m N o r d h a u s , " O i l a n d E c o n o m i c P e r f o r m a n c e in
Industrial Countries,* Brookings Papers on Economic
A c t i v i t y , 2, 1980, p. 369.
372
- 22 FIGURE A . 7
THE DEPARTMENT OF ENERGY'S
CONCEPTUAL SUPPLY CURVE
S o u r c e : DOE ,
T w o M a r k e t A n a l y s i s , p. A . 99
373
- 23 3*
Th e Mar k e t at E q u i l i b r i u m
As n oted above,
t h e s h a p e s o f t h e s u p p l y a nd d e m a n d
c u r v e s h a v e i m p o r t a n t i m p l i c a t i o n s for t h e b e h a v i o r o f t h e
natural gas market, even under assumptions of c o m p e t i t i o n .
B e c a u s e t he c u r v e s a r e so s t e e p ,
i.e.,
inelastic, the market
w i l l n o t be v e r y r e s p o n s i v e to p r i c e c h a n g e s .
Neither demand
n o r s u p p l y w i l l be c h a n g e d m u c h , e v e n in t he f a c e of
relatively large price increases.
T h i s i n s e n s i t i v i t y to
p r i c e c h a n g e s , e v e n u n d e r t h e a s s u m p t i o n s of c o m p e t i t i o n ,
deserves further empirical analysis.
E v e n in D O E ' s a n a l y s i s ,
e l a s t i c i t y is v e r y smal l .
in t h e l o n g run, t h e s u p p l y
E v e r y d e c o n t r o l s c e n a r i o l e a d s to
a l o w e r t o t a l s u p p l y t h a n a c o n t i n u a t i o n of N G P A .
more,
Further
in the s h o r t run, D O E ' s a n a l y s i s s h o w s v e r y s m a l l
s u p p l y r e s p o n s e s to p r i c e i n c r e a s e s .
T a b l e A . 4 s h o w s t he
c a l c u l a t i o n of the a g g r e g a t e m a r k e t e l a s t i c i t y that DOE
p r o j e c t s for a c c e l e r a t e d p h a s e d d e c o n t r o l , w h e n c o m p a r e d to a
c o n t i n u a t i o n of N G P A .
It c a n be s e e n t h a t t h e p r i c e
e l a s t i c i t y of s u p p l y is l e s s t h a n .07 in all y e a r s a n d the
a v e r a g e is o n l y .04.
T h a t is e x t r e m e l y s m a l l .
D O E ' s d a t a is
i n t e n d e d to t e s t c o m p a r i s o n s b e t w e e n s c e n a r i o s w i t h i n y e a r s
(e.g., N G P A c o m p a r e d to a c c e l e r a t e d d e c o n t r o l
However,
in 1983)
the c o n c l u s i o n a b out s u p p l y e l a s t i c i t y s t ands up
w h e n the d a t a is l o o k e d at in a n o t h e r w a y .
For example, note
t h a t the s u p p l y e l a s t i c i t y b e t w e e n t h e y e a r b e f o r e d e c o n t r o l
a n d the y e a r a f t e r d e c o n t r o l u n d e r N G P A
1985)
is o n l y
.039 p e r c e n t .
( c o m p a r e 1 9 8 4 to
Table A.4
IMPLICIT SUPPLY ELASTICITIES
IN THE AGGREGATE NATURAL GAS MARKET
NGPA Base Case
___ ______________ ______ _
_
(1)
Wellhead
Price
(1980$/mcf)
(2)
Domestic
Demand
(BCF)
(3)
Wellhead
Price
(1980$/mcf)
(4)
Domestic
Demand
(BCF)
1982
2.27
17737.6
3.05
18033.9
1983
2.42
17155.0
3.81
1984
2.61
16671.7
1985
4.45
17131.6
Source:
Accelerated/Phased Decontrol
_______ (All New Scenario)______
(6)
% Demand
Difference
(6) = f (2)-(4) ]/(4)
(7)
Implicit
Elasticity
(7) = (6)/(5)
34.3
.5
.015
,
17605.0
57.4
2.6
.045
£
4.42
17440.5
69.4
4.6
.066
'
4.69
17088.7
-
DOE, Two Market Analysis, Attachment IV.
(5)
% Price
Difference
(5)=t(3)-(l)]/(l)
375
- 25 C a l c u l a t i o n of t he d e m a n d e l a s t i c i t y is m o r e c o m p l e x
s i n c e t h e r e is a g r e a t d e a l of fue l s w i t c h i n g t h a t g o e s o n in
the g a s m a r k e t .
I n d u s t r i a l u s e r s o f o i l s w i t c h to g a s as do
some residential consumers.
Table A . 5 presents a calculation
of the i m p l i c i t d e m a n d e l a s t i c i t i e s in t he a g g r e g a t e g a s
m a r k e t that DOE p r o j e c t s for a c c e l e r a t e d d e c ontrol.
to t a k e a c c o u n t of f u e l s w i t c h i n g ,
In o r d e r
t h e d e m a n d u t i l i z e d as the
b a s i s f or t h e c a l c u l a t i o n s is t h e m a x i m u m p o t e n t i a l g a s
demand,
i.e., t h e t o t a l e n e r g y c o n s u m e d b y all p o t e n t i a l g a s
users.
S i n c e t h e o i l p r i c e is i d e n t i c a l for a ll s c e n a r i o s ,
a n y c h a n g e in d e m a n d m u s t be d u e to c h a n g e s in t h e n a t u r a l
g a s p r i c e and c h a n g e s in th e m i x of o i l a n d g a s u s e d b y the
a g g r e g a t e of c o n s u m e r s .
T h a t is, if s o m e oil c o n s u m e r s
s w i t c h to g as, t h e y m a y p a y a p r i c e t h a t is l o w e r t h a n t h e y
w o u l d h a v e p a i d f or oil.
T h e i r e f f e c t i v e p r i c e is l o w e r and
t h e i r d e m a n d w i l l be h i g h e r .
T h e a g g r e g a t e p r i c e p a i d b y all
c o n s u m e r s w o u l d a l s o be l o w e r .
To c o m p e n s a t e for t h i s s h i f t
in the m i x o f f u e l s , we h a v e c a l c u l a t e d an " e f f e c t i v e "
a v e r a g e e n e r g y p r i c e for a l l p o t e n t i a l g a s c o n s u m e r s u n d e r
N G P A a nd u s e d it as t he b a s i s for c a l c u l a t i n g d e m a n d
elasticities.
It w i l l be n o t e d t h a t d e m a n d e l a s t i c i t i e s a r e s o m e
w h a t h i g h e r t h a n the s u p p l y e l a s t i c i t i e s ,
to .184 a n d a v e r a g i n g a b o u t
.14.
r a n g i n g f r o m .088
T h e i m p l i c i t e l a s t i c i t y for
the y e a r in w h i c h d e c o n t r o l b e g i n s u n d e r N G P A is .18.
e l a s t i c i t i e s are c o n s i s t e n t w i t h o t h e r e s t i m a t e s . 3
a l s o q u i t e l o w c o m p a r e d to o t h e r c o m m o d i t i e s .
These
T h e y a re
Table A.5
IMPLICIT DEMAND ELASTICITIES
IN THE AGGREGATE NATURAL GAS MARKET
NGPA Base Case
(1)
(2)
(3)
Wellhead
Effective
Domestic
Price Wellhead
Demand
(1980$/mcf)Price
(BCF)
Accelerated/Phased Decontrol
(All New Scenario)
(4)
Wellhead
Price
(1980$/mcf)
(5)
Domestic
Demand
(BCF)
Estimating the Elasticity
(6)
% Price
Difference
(6) = (4) —
(2)/(2)xl00]
(7)
% Demand
Difference
[ (7)*(3)(5)/(2)xl001
(8)
Implicit
Elasticity
(8=7/6)
1982
2.27
2.44
22908.7
3.05
22495.1
25.0
-2.2
-.088
1983
2.42
2.54
22659.1
3.81
20754.1
50.0
-9.2
-.184
1984
2.61 2.72
4.42
20461.6
-9.3
-.149
1985
4.45
Source:
DOE, Two Market Analysis, Attachment IV.
2268.6
4.02
20438.0
4.69
62.5
377
- 27 Thus,
t h e s h a p e s o f t h e s u p p l y an d d e m a n d c u r v e s do
n o t r e s e m b l e t he c l a s s i c a l , m o d e r a t e l y e l a s t i c s t r a i g h t l i n e s
t y p i c a l l y u s e d to d e p i c t " c o m p e t i t i v e " s i t u a t i o n s .
Any
theoretical conclusions drawn about typical competitive
s i t u a t i o n s o n t h e b a s i s o f t h o s e t y p i c a l c u r v e s s h o u l d n o t be
e x t r a p o l a t e d to t h e n a t u r a l g a s m a r k e t .
A b o v e all, o n e m u s t
n o t a s s u m e a g r e a t d e a l of p r i c e s e n s i t i v i t y e v e n w h e r e
c o m p e t i t i o n is a s s u m e d .
T h e i m p l i c a t i o n s of t h e s e s t e e p l y
s l o p i n g s u p p l y and de m a n d cu r v e s
(when c o m p a r e d to the
cla s s i c a l c u rves of c o m p e t i t i v e s u pply and d e m a n d ) , wh i c h are
e x p l o r e d in o t h e r r e p o r t s in t h i s s e r i e s , are:
1.
T o t a l s u p p l y u n d e r d e c o n t r o l is n o t g r e a t e r t h a n
u n d e r a c o n t i n u a t i o n o f N G P A , e v e n t h o u g h p r i c e s are
higher, b e c a u s e s u p p l y responses are small.
2.
T h e e q u i t y l o s e s t h a t o n e m i g h t p r e d i c t for d e c o n t r o l
are larger than ex p e c t e d be c a u s e demand responses are
s m a l l a n d c o n s u m e r s b e a r m o r e of t he b u r d e n t h a n
expected.
3.
T h e e f f i c i e n c y g a i n s t h a t o n e m i g h t p r e d i c t for
decontrol are smaller than expected because supply
and demand responses are smaller than expected.
H a v i n g e x a m i n e d t he i m p l i c a t i o n s of t h e s h a p e of the
s u p p l y a n d d e m a n d c u r v e s f o r the a n a l y s i s w h e n c o m p e t i t i v e
b e h a v i o r is a s s u m e d , we t u r n n e x t to t h e a n a l y s i s o f
s i t u a t i o n s in w h i c h n o n - c o m p e t i t i v e b e h a v i o r s a r e a s s u m e d .
E.
The O l i g o po ly Solution
If p r o d u c e r s b e h a v e r a t i o n a l l y ,
they will examine
t h e i r m a r g i n a l c o s t a n d m a r g i n a l r e v e n u e c u r v e s in o r d e r to
c h o o s e the p r i c e / q u a n t i t y c o m b i n a t i o n w h ich will m a x i m i z e
profits.
If t h e y a r e o l i g o p o l i s t s o r m o n o p o l i s t s ,
each
FIGURE A. 8
THE OLIGOPOLY PRICE COMPARED TO THE COMPETITIVE MARKET PRICE
Source: Table A.l and A.2.
379
- 29 p ro du ce r will not face a p er fe ct ly elastic demand curve.
In
fact, e a c h o l i g o p o l i s t w i l l f a c e a d e m a n d c u r v e t h a t h a s a
s l o p e some place b e t w e e n the m a r k e t de m a n d curve and a
perfectly flat demand curve.
For p u r p o s e s of t h i s a n a l y s i s ,
we will assume that each producer faces a demand curve with
the s l o p e o f t he m a r k e t d e m a n d c u r v e .
This w ould fit a
s t r i c t m o n o p o l y or a n u m b e r of o l i g o p o l y a r r a n g e m e n t s .
In o r d e r to a r r i v e a t t h e m o n o p o l y
(oligopoly)
w e m u s t c a l c u l a t e t he m a r g i n a l r e v e n u e c u r v e
A . 8).
B e c a u s e t h e a c t u a l d a t a is n o t s m o o t h ,
price,
(see F i g u r e
the m a r g i n a l
r e v e n u e c a l c u l a t i o n s a r e s o m e w h a t e r r a t i c , b u t an a c t u a l p l o t
o f the c u r v e s h o w s t h a t the p o i n t w h e r e m a r g i n a l c o s t s e q u a l
marginal
r e v e n u e s is a r o u n d t h e $ 5 . 0 0 p o i n t .
curves yield almost identical results
Several smooth
(see F i g u r e A . 9).
B e c a u s e b o t h t he m a r g i n a l c o s t a n d m a r g i n a l
revenue
c u r v e s a r e so s t e e p , t h i s p o i n t of m a r k e t e q u i l i b r i u m u n d e r
o l i g o p o l y b e h a v i o r is q u i t e r o b u s t .
T h a t is,
if w e w e r e to
a s s u m e t h a t t h e s h a p e of o n e o f t h e c u r v e s w a s d i f f e r e n t , or
w e w e r e to s h i f t e i t h e r c u r v e up or d o w n ,
largely unaffected.
F or e x a m p l e ,
t he r e s u l t w o u l d be
F i g u r e A . 10 s h o w s t h e
a n a l y s i s w i t h the m a r g i n a l c o s t c u r v e c a l c u l a t e d a s s u m i n g
m a r g i n a l c o s t s e s c a l a t e d at 15 p e r c e n t
holding import prices c o n s t a n t ) .
be a l t e r e d l i t t l e ,
(real) p e r y e a r
(but
The oligopoly price would
r a n g i n g f r o m $ 5 . 0 0 to $ 5 . 1 0 , d e p e n d i n g o n
w h i c h s p e c i f i c a t i o n of the m a r g i n a l
r e v e n u e c u r v e is used.
If i m p o r t p r i c e s e s c a l a t e a t 15 p e r c e n t p e r y e a r ,
s t i l l a r e a b o u t t he sam e .
the results
FIGURE A.9
THE OLIGOPOLY PRICE WITH SMOOTHED DEMAND CURVES
Source: Tables A.l and A,2
1980$ PER MILLION CUBIC FEET
Source: See text
FIGURE A.10
THE OLIGOPOLY PRICE WITH HIGH MARGINAL COSTS
PERCENT OF TOTAL POTENTIAL DEMAND
382
- 32 It s h o u l d b e n o t e d t h a t t h e o l i g o p o l y p r i c e w o u l d
reduce s up pl y by ab o u t 6 p e r ce nt ag e points b e l o w the c o m p e
titive market solution.
Assuming a higher cost curve,
the
r e d u c t i o n in s u p p l y m i g h t b e a s l a r g e a s 13 a d d i t i o n a l
percentage points.
Thus, an o l i g o p o l y a s s um pt io n will
lead
to a m a r k e t p r i c e a b o u t 10 p e r c e n t h i g h e r t h a n t h e c o m p e t i
t ive a s s u m p t i o n w i t h the q u a n t i t y s u p p l i e d r e d uced by at
least 6 percentage points.
A m e s s a g e o f e q u a l s i g n i f i c a n c e to b e d r a w n f r o m t h e
a n a l y s i s is t h a t t h e o l i g o p o l y p r i c e w i l l b e s e n s i t i v e to t h e
re s i d ential, not the industrial, ma r k e t .
T h a t is, o v e r
o n e - q u a r t e r of a l l t h e d e m a n d o c c u r s a s i n t e r s t a t e r e s i d e n
t i a l d e m a n d at $ 5 . 0 8 a n d t h i s a p p e a r s to b e t h e c r i t i c a l
p o i n t on the d e m a n d c u r v e . 4
The hi g h sulfur residual oil
m a r k e t is n o t i m p o r t a n t to t h e o l i g o p o l i s t a n d h e f o r e g o e s
m o s t o f it.
T h e r e s i d e n t i a l d e m a n d is t h e m o s t i m p o r t a n t p o i n t o n
t h e d e m a n d c u r v e a n d it is a p o i n t a b o u t w h i c h t h e r e a r e
s i g n i f i c a n t d i f f e r e n c e s o f o p i n i o n in r e g a r d to t h e t r u e
e l a s t i c i t y of demand.
In t h e n e x t s e c t i o n , w e e x a m i n e a n
al t e r n a t i v e as su m p t i o n about r es id ential and c om me rc ial
demand.
T h i s l e a d s us to r e d r a w t h e d e m a n d c u r v e a n d e x a m i n e
t h e i m p l i c a t i o n s of a d i f f e r e n t l y s h a p e d d e m a n d c u r v e f o r t he
market price set by oligopolistic behavior.
F.
Alternative Assumptions About Residential/
Commercial Sector Demand
In c a l c u l a t i n g t h e a l t e r n a t i v e f u e l p r i c e s f o r
industrial and e le ct ri c u t i l i t y demand, DOE included fuel
383
- 33 conversion costs
(i.e., t h e c o s t of s w i t c h i n g to gas)
s u c h c o s t s a r e a s s u m e d to e x i s t .
where
Moreover, at the margin,
d u a l f u e l b u r n i n g c a p a c i t y w a s a s s u m e d to e x i s t so t h a t t h e r e
a r e no c o n v e r s i o n c o s t s .
D O E did not factor c o n v e r s i o n costs
into the a l t e r n a t i v e fuel pr i c e for the res i d e n t i a l and
co m m e r c i a l m a r k e t s since t hese m a r k e t s w ere not n e a r the
theoretical margin.
However,
if r e s i d e n t i a l a n d c o m m e r c i a l d e m a n d is
g o i n g to p l a y a c r i t i c a l r o l e in s e t t i n g t h e o l i g o p o l y p r i c e ,
t h e n t h e r a t i o n a l o l i g o p o l i s t w o u l d d e f i n i t e l y w a n t to t a k e
c o n v e r s i o n c o s t s in t h o s e s e c t o r s i n t o a c c o u n t .
T h a t is, if
residential and commerc ia l c o n su me rs mu s t incur a dditional
c o s t s to c o n v e r t f r o m n a t u r a l g a s to s o m e a l t e r n a t i v e , t h i s
r a i s e s t he e f f e c t i v e c o s t of t h e a l t e r n a t i v e fuel.
Oligopo
l i s t s c a n c a p t u r e s o m e o f t h i s in t h e i r p r i c e w i t h o u t f e a r o f
losing that demand.
In fact, t h e r e is v e r y l i t t l e d u a l fuel
b u r n i n g c a p a c i t y in t h e r e s i d e n t i a l a n d c o m m e r c i a l s e c t o r s
a n d v e r y s i g n i f i c a n t c o n v e r s i o n c o s t s in t h o s e s e c t o r s .
L e t us t a k e a s i m p l e e x a m p l e .
First, we assume
c o n v e r s i o n c o s t s of $ 1 4 0 0 to b e a m o r t i z e d
over seven years.^
(simple payback)
Spread over an a verage annual c o n su mp ti on
o f 100 m i l l i o n B T U s p e r y e a r ,
t h i s w o u l d a d d $ 2 . 0 0 / m c f to the
e f f e c t i v e a l t e r n a t i v e fuel p r i c e . 6
The commercial sector
w o u l d h a v e l a r g e r v o l u m e s of g a s c o n s u m e d b u t h i g h e r c o n v e r
s i o n c o s t s , so t h a t $ 2 . 0 0 / m c f is a r e a s o n a b l e e s t i m a t e for
t h i s s e c t o r as w e l l .
Finally, we a s s u m e that all r e s i dential
and commercial users must incur these costs.
384
- 34 The resulting demand curve
(see F i g u r e A . 11) b e c o m e s
m u c h smoother than the earlier curve and less elastic,
steeper*
i.e . ,
A stra ig ht line m a r gi na l revenue curve n ow cuts the
m a r g i n a l c o s t c u r v e a t a l o w e r q u a n t i t y l e a d i n g to a h i g h e r
price.
T h e o l i g o p o l i s t w o u l d o p t i m i z e p r o f i t s in t h e
$ 5 . 40/M CF range and s up p l y would be reduced by an ad di ti o n a l
10 p e r c e n t a g e p o i n t s .
T h i s m o d i f i c a t i o n o f t h e d e m a n d c u r v e l e a d s to r a t h e r
robust results.
If w e a s s u m e o n l y $ 1 . 0 0 / m c f in c o n v e r s i o n
c o sts, the o l i g o p o l y p r ice w o u l d be b e t w e e n $5.30 and $5.40.
Obviously, different assumptions about c o nversion
c o s t s a n d / o r m o r e d e t a i l e d a n a l y s i s o f t h e c a p a c i t y to s w i t c h
f u e l s in t h e s h o r t a n d l o n g t e r m m i g h t a l t e r t h e s e o u t c o m e s .
However,
s o m e c o n v e r s i o n c o s t s m u s t be f a c t o r e d in a n d a
p r i c e r a n g e o f $ 5 . 3 0 - $ 5 . 4 0 f or t h e o l i g o p o l y w e l l h e a d p r i c e
s e e m s to be a g o o d e s t i m a t e .
T h i s is a p r i c e t h a t is a b o u t
15 p e r c e n t h i g h e r t h a n D O E ' s a s s u m e d m a r k e t c l e a r i n g p r i c e
a n d a b o u t t w i c e as h i g h as t h e i n d u s t r y e s t i m a t e s .
The
q u a n t i t y s u p p l i e d w o u l d b e a b o u t 15 p e r c e n t b e l o w t h e
c o m p e t i t i v e m a r k e t s o l u t i o n w h i c h m e a n s t h a t 30 p e r c e n t of
t h e t o t a l d e m a n d is f o r e g o n e .
G.
Su m m a r y and C o n c l u s i o n
In t h i s A p p e n d i x ,
the p o s si bl e impact of o l i g o p o
l i s t i c , as o p p o s e d to c o m p e t i t i v e , b e h a v i o r o n t h e m a r k e t
pr i c e of na t u r a l gas h a s b e e n examined.
FBI
CUBIC
HXLLXOW
1980$ m
Source: S«« text
FICU»E A.11
THE OLIGOPOLY /RICE WITH
CONVERSION COSTS IN THE RESIDENTIAL/COMMERCIAL SECTORS
■-■
■
■
■—
1
,
11
SO
PERCENT OP TOTAL POTENTIAL DEMAND
~T
80
386
- 36 It h a s b e e n s h o w n t h a t t h e c o n f i g u r a t i o n o f t h e
s u p p l y a n d d e m a n d c u r v e s is s u c h t h a t o l i g o p o l i s t s c o u l d
administer prices with considerable security.
In c o n t r a s t to
the m a r k e t c l e a r i n g p r ice e s t i m a t e d b y DOE of $ 4 . 69/mcf, an
o l i g o p o l y s i t u a t i o n c o u l d r e s u l t in a m a r k e t p r i c e in e x c e s s
o f $ 5 . 4 0 , a l t h o u g h a r a n g e of $ 5 . 3 0 to $ 5 . 4 0 m a y b e m o r e
likely.
The e s t i m a t i o n of the su pp ly curve also reveals that
t h e r a t e o f r e t u r n o n n a t u r a l g a s p r o d u c t i o n is e x t r e m e l y
high —
b e t w e e n 100 a n d 300 p e r c e n t .
The se rates of prof it
c a n b e p r e s u m e d to r e f l e c t a n a b s e n c e o f c o m p e t i t i v e
c o n d i t i o n s on the s u p p l y side of the market.
From a more general perspective,
t h e . s h a p e of the
d e m a n d and sup p l y cur ves that h ave b een calc ul a t e d should
c a u t i o n a g a i n s t s i m p l i s t i c a n a l y s e s of the g a s m a r k e t ev e n
w h e r e c o m p e t i t i o n is a s s u m e d .
(i.e.,
inelastic)
Both c urves are quite s te ep
at t h e p o i n t o f e q u i l i b r i u m , m e a n i n g t h a t
t h e y a r e i n s e n s i t i v e to p r i c e c h a n g e s .
387
- 37 -
FOOTNOTES
^DOE, Two M a r k e t A n a l y s i s of N a t u r a l Ga s D e c o n t r o l
( W a s h i n g t o n , DC: G o v e r n m e n t P r i n t i n g O f f i c e , N o v e m b e r 1 9 8 1 ) .
2
A brief d e sc r i p t i o n of the basic s tr uctural
c h a r a c t e r i s t i c s o f t h e n a t u r a l g a s m a r k e t t h a t l e a d u s to
t h i s .co n cl u s i o n c a n b e f o u n d in Dr. M a r k C o o p e r , D i r e c t o r o f
Research, Cons um er E nergy Council of America, "The Im ple
m e n t a t i o n of T itle I of the Na t u r a l Gas P o l i c y Act of 1978,"
t e s t i m o n y b e f o r e the C o m m i t t e e on Ene r g y and N a t u r a l
R e s o u r c e s , U n i t e d S t a t e s S e n a t e ( N o v e m b e r 5, 1 9 8 1 ) .
^ R o b e r t S. P i n d y c k , T h e S t r u c t u r e o f W o r l d E n e r g y
(Cambridge, M IT Press, 1 & 7 9 ) .
4
T h e s l o p e o f t h e d e m a n d c u r v e c a n b e d e s c r i b e d as
follows:
T h e r e is a s e c t i o n o f t h e c u r v e ( a b o u t 20 p e r c e n t of
t h e t o t a l d e m a n d ) t h a t is r e l a t i v e l y i n e l a s t i c (steep) at
h i g h w e l l h e a d p r i c e s ( b e t w e e n $ 5 . 7 0 a n d S 6 . 7 0 / M C F in 1 9 8 0 $).
T h i s d e m a n d o c c u r s in t h e i n t r a s t a t e m a r k e t .
This block
combines high priced alternative fuels with low transmission
costs.
T h a t is, t h e w e l l h e a d g a s p r i c e c o u l d be q u i t e h i g h
b e c a u s e t he a l t e r n a t i v e is e x p e n s i v e a n d t r a n s m i s s i o n and
d i s t r i b u t i o n c o s t s a r e low.
T h e r e is t h e n a s e c o n d s e c t i o n of t h e c u r v e ( about 60
p e r c e n t of total demand) that a p p e a r s quite e l a s t i c (between
$ 5 . 0 0 a n d $ 5 . 6 0 / M C F in 1 9 8 0 $).
M o s t of t h i s b l o c k (43
p e r c e n t a g e p o i n t s o f t h e 60 p e r c e n t a g e p o i n t s ) is m a d e u p of
the int e r s t a t e residential, c o m m e r c i a l and i ndustrial
nonboiler demand.
This block combines high priced alter
natives with high transmission costs.
N e x t , t h e r e is a b l o c k (ab o u t 18 p e r c e n t o f t o t a l
d e m a n d ) w h i c h is r e l a t i v e l y i n e l a s t i c at p r i c e s b e t w e e n $ 3 . 9 0
a n d $ 5 . 0 0 / M C F in 1 9 8 0 $.
T h i s is p r i m a r i l y i n d u s t r i a l d e m a n d
— plus some commercial demand.
This includes the ca te go ry
of h i g h s u l f u r r e s i d u a l .
F i n a l l y , t h e r e is a s m a l l b l o c k o f d e m a n d (ab o u t 3
p e r c e n t ) t h a t is v e r y i n e l a s t i c a t l o w p r i c e s .
T h i s b l o c k is
intrastate boiler demand.
In D O E ' s a n a l y s i s , t h e i n d u s t r i a l d e m a n d b e t w e e n
$ 3 9 . 0 a n d $ 5 . 0 0 is t h e c r i t i c a l m a r g i n a l d e m a n d .
In t h e
o l i g o p o l y s i t uation, the r e s i d e n t i a l d e mand a b o v e $5.00
a p p e a r s to be t h e c r i t i c a l m a r g i n a l d e m a n d .
Demand
^ S e e , C o n s u m e r E n e r g y C o u n c i l o f A m e r i c a , "An
A n a l y s i s of the E c o n o m i c s of Fuel S w i t c h i n g V e r s u s
C o n s e r v a t i o n f or t h e R e s i d e n t i a l H e a t i n g O il C o n s u m e r "
( W a s h i n g t o n , DC, O c t o b e r 5, 1980) for a d i s c u s s i o n o f
c o n s e r v a t i o n costs.
388
T H E P A S T AS P R O L O G U E II
THE ECO N O M I C EF F E C T S OF RI S I N G E N E R G Y PRICES:
A C o m p a r i s o n of t h e O il P r i c e S h o c k
and Natural Gas Decontrol
A.
Introduction
O n e of t he c e n t r a l q u e s t i o n s t h a t m u s t be a n s w e r e d
in e v e r y p o l i c y d e c i s i o n a f f e c t i n g e n e r g y p r i c e s is " W h a t
will the e c onomic
impact be?"
E n e r g y is of s u c h c e n t r a l
i m p o r t a n c e to the c o n d u c t of m o s t e c o n o m i c a c t i v i t i e s t h a t
pricing decisions can have a major
impact on the level and
type of output that our e conomy produces.
In t h i s r e p o r t t he C o n s u m e r E n e r g y C o u n c i l o f
America Research Foundation
n u m b e r of p e r s p e c t i v e s ,
(CECA / R F )
analyzes,
from a
t h e r e l a t i o n s h i p b e t w e e n c h a n g e s in
t h e p r i c e of e n e r g y a n d c h a n g e s in e c o n o m i c a c t i v i t y .
First, we ma k e a br i e f s t a t e m e n t of the g e n e r a l t h e o r e t i c a l
r e l a t i o n s h i p b e t w e e n c h a n g e s in e n e r g y p r i c e s a n d e c o n o m i c
activity.
S e c o n d , we r e v i e w t h e r e c o r d o f t h e i m p a c t of
t h e "oi l p r i c e s h o c k " a n the e c o n o m y .
Third, we examine
r e c e n t p r o j e c t i o n s o f the i m p a c t of n a t u r a l g a s d e c o n t r o l .
T h e c e n t r a l c o n c l u s i o n t h a t t h e r e p o r t r e a c h e s is
that energy price increases have a massive, negative impact
o n t h e e c o n o m y , an i m p a c t t h a t p e r s i s t s for a c o n s i d e r a b l e
l e n g t h of time —
at least a decade.
mitig a t e that impact —
Further,
p o l i c i e s to
a t t h e l e v e l o f i n d i v i d u a l s a n d at
t h e l e v e l of t he g e n e r a l e c o n o m y —
have either not been
389
e f f e c t i v e in t h e p a s t or h a v e s i m p l y n e v e r b e e n d e v e l o p e d
an d i m p l e m e n t e d .
T h e p r o s p e c t s for n a t u r a l g a s d e c o n t r o l
a p p e a r to be e q u a l l y bleak.
E n e r g y and t he E c o n o m y :
A General Conceptualization
T h e n e g a t i v e e c o n o m i c i m p a c t of r i s i n g e n e r g y p r i c e s
o c c u r s in two i n t e r c o n n e c t e d w a y s .
T h e r e t e n d s to be a
r e d u c t i o n in t he l e v e l of o u t p u t a nd a l s o a l o s s in
productivity.
1.
Economic Activity
T h e r e d u c t i o n in o u t p u t t h a t r i s i n g e n e r g y p r i c e s
m a y c a u s e s t e m s f r o m the f a c t that,
in t he s h o r t run,
it is
d i f f i c u l t to f i n d s u b s t i t u t e s for e n e r g y in m a n y e c o n o m i c
activities
(i.e.,
it is p r i c e i n e l a s t i c ) , 1
When prices
rise, a l a r g e r s h a r e of i n c o m e m u s t be d e v o t e d to e n e r g y
b e c a u s e c o n s u m p t i o n c a n n o t be r e d u c e d in the s h o r t run.
The
i n c r e a s e in i n c o m e d e v o t e d to e n e r g y p r i c e s m a y a p p e a r in
two ways.
First,
t he i n c o m e s p e n t d i r e c t l y for e n e r g y ,
e .g., h o u s e h o l d h e a t i n g fue l s , etc., w i l l rise.
Second,
the
e n e r g y c o s t s r e l a t e d to p r o d u c i n g all g o o d s a nd s e r v i c e s
w i l l rise.
If t h e p r o d u c e r s of t h e s e g o o d s and s e r v i c e s are
a b l e to p a s s t h r o u g h the i n c r e a s e in e n e r g y c o s t s to c o n
sumers,
t h e n t h e r e w i l l be a g e n e r a l
l e v e l of t h o s e g o o d s .
increase through,
i n c r e a s e in t h e p r i c e
If t h e y are n o t a b l e to p a s s the
t h e r e w i l l be a r e d u c t i o n in p r o f i t s in
non-energy sectors.
390
G i v e n t he g e n e r a l t e n d e n c y o f p r i c e s in o u r e c o n o m y
no t to d e c l i n e ,
t he r e s p o n s e to a r i s e in e n e r g y p r i c e s
t e n d s to be an i n c r e a s e in t he g e n e r a l p r i c e leve l .
is,
rising e n e r g y co s t s will be p a s s e d through.
That
If the
m o n e y s u p p l y d o e s n o t e x p a n d to a c c o m m o d a t e t h e p r i c e
increase
a n d w a g e s do n o t
r i s e as f a s t as p r i c e s
t h e n the p r i c e i n c r e a s e r e d u c e s rea l i n c o m e
increase,
(i.e.,
the same
2
n u m b e r of d o l l a r s p u r c h a s e s f e w e r g o o d s a n d s e r v i c e s ) .
R e d u c e d real i n c o m e m e a n s l o w e r c o n s u m p t i o n o u t l a y s a n d
l o w e r real GNP.
T h i s e f f e c t c a n be c o m p o u n d e d b y an i n c r e a s e in
interest rates.3
R i s i n g p r i c e s l e a d to a n i n c r e a s e d d e m a n d
fo r c r e d i t to f i n a n c e h i g h e r l e v e l s of s p e n d i n g or i n v e s t
ment.
Again,
if m o n e t a r y p o l i c y is n o t a c c o m m o d a t i v e ,
interest rates rise
supply)
as
(due to i n c r e a s e d d e m a n d a n d t i g h t m o n e y
t he c o s t s o f f i n a n c i n g c o n s u m p t i o n o r i n v e s t m e n t
i n c r e a s e a n d t h e l e v e l of r e a l s p e n d i n g d e c l i n e s .
In r e a l i t y ,
t h e r e s p o n s e o f t he e c o n o m y to p r i c e
i n c r e a s e s t e n d s to b e a m i x t u r e of t h e s e p o s s i b i l i t i e s .
M o s t of t h e p r i c e i n c r e a s e s a r e p a s s e d t h r o u g h
(with a lag)
a n d w a g e s t r y to k e e p u p (wi t h a l o n g e r l a g ) .
The general
c o n s e n s u s is, h o w e v e r ,
unavoidable
income,
(1)
t h a t in the s h o r t run, t h e r e is a n
i n c r e a s e in p r i c e s ,
(2) r e d u c t i o n in rea l
(3) r e d u c t i o n in real o u t p u t and, as a c o n s e q u e n c e ,
(4) a n i n c r e a s e in u n e m p l o y m e n t .
conse ns us that accommod at iv e,
T h e r e is a l s o an e m e r g i n g
rather than tight, m o n e t a r y
391
and fiscal p o l i c y can reduce these impacts, but not
e l i m i n a t e them.
W h i l e t h e r e is a g e n e r a l c o n s e n s u s t h a t s h o r t run
negative
impacts occur wh e n e n ergy prices are increased,
t h e r e is no c o n s e n s u s a b o u t j u s t h o w l o n g the s h o r t r un is
or h o w l a r g e the i m p a c t s w i l l be.
4
S o m e a r g u e t h a t the
a d j u s t m e n t p e r i o d c a n be q u i t e lon g —
well over a decade;
o t h e r s e n v i s i o n s h o r t e r p e r i o d s of a d j u s t m e n t ,
u p to a
decade.
2.
Productivity
Rising energy prices can also have a negative impact
o n p r o d u c t i v i t y for a n u m b e r of r e a s o n s . 5
1.
B e c a u s e t he u t i l i z a t i o n of l a b o r a n d c a p i t a l
d e c l i n e s m o r e s l o w l y t h a n the d e c l i n e o f o u t p u t ,
tivity declines
produc
(i.e., l a b o r is " h o a r d e d " a nd c a p i t a l
is not
s c r a p p e d at a s u f f i c i e n t l y r a p i d p a c e to k e e p p r o d u c t i v i t y
up) .
2.
As e c o n o m i c a c t i v i t y d e c l i n e s ,
the g e n e r a l
r ate
of i n v e s t m e n t d r o p s off, s l o w i n g p r o d u c t i v i t y g r o w t h .
3.
A s e n e r g y p r i c e s rise, c a p i t a l a n d l a b o r a r e
s u b s t i t u t e d for e n e r g y in the p r o d u c t i o n p r o c e s s a n d t h a t
m e a n s l e s s o u t p u t p e r u n i t of c a p i t a l a n d l a b o r i nput.
4.
I n s o f a r as c a p i t a l a n d l a b o r a r e n o t p e r f e c t
s u b s t i t u t e s f or e n e r g y , an a d d i t i o n a l lo s s in p r o d u c t i v i t y
occurs^
392
5.
T h e n e e d to i n v e s t in e n e r g y s a v i n g s d e l a y s the
i n v e s t m e n t in e q u i p m e n t d e s i g n e d to e n h a n c e l a b o r p r o d u c
tivity.
This reduces the gro w t h
in t h e p r o d u c t i v i t y of
labor.
T h e f i r s t a nd s e c o n d e f f e c t s a r e p r i n c i p a l l y s h o r t
term effects;
the t h i r d ,
f o u r t h a nd f i f t h e f f e c t s m a y be
s o m e w h a t l o n g e r t e r m in n a t u r e .
Once again,
t h e r e t e n d s to
be g e n e r a l a g r e e m e n t t h a t t h e s e e f f e c t s o c c u r ; b u t t h e r e is
r a t h e r w i d e d i s a g r e e m e n t a b o u t h o w l a r g e t h e y a r e and h o w
long they l ast.6
3-
Potential Benefits
It s h o u l d b e n o t e d h e r e t h a t t h e r e a r e p o t e n t i a l
e f f i c i e n c y bene fi ts of decontrol.
7
be noted.
1.
Three such benefits can
It is p o s s i b l e t h a t m o r e a g g r e g a t e o u t p u t c a n b e
a c h i e v e d f or e a c h u n i t of d o m e s t i c r e s o u r c e s e x p e n d e d in
a c q u i r i n g a g i v e n l e v e l of e n e r g y s u p p l y .
T h a t is, if
r e s o u r c e s a r e d i v e r t e d f r o m t h e s e a r c h for h a r d - t o - f i n d
e n e r g y s o u r c e s to m o r e e a s i l y l o c a t e d a n d / o r p r o d u c e d
sources,
t h e n l e s s r eal r e s o u r c e s w i l l be u s e d to p r o d u c e
t h e s a m e a m o u n t o f avai l a b l e ^ e n e r g y .
F or e x a m p l e ,
if i n c e n t i v e s h a v e b e e n s t r u c t u r e d b y
p a r t i a l d e c o n t r o l to d i r e c t e x p l o r a t i o n t o w a r d m o r e e x p e n
s i v e d e e p g a s , t h e n f u l l d e c o n t r o l m i g h t c a u s e p r o d u c e r s to
sh i f t their e x p l o r a t i o n toward less e x p e n s i v e s h a l l o w gas.
393
P r o d u c e r s c o u l d c o n s u m e f e w e r r e s o u r c e s in f i n d i n g the s a m e
a m o u n t of 'gas,
T h e s e s a v e d r e s o u r c e s c a n t h e n be p u t to a l t e r n a t i v e
u s e s in s o c i e t y .
reflected
If the r e d u c t i o n in real r e s o u r c e c o s t s is
in l o w e r e n e r g y p r i c e s ,
additional
real r e s o u r c e s at t h e i r d i s p o s a l ,
p r i c e s do n o t fall,
additional
2.
c o n s u m e r s w i l l h a v e the
If e n e r g y
t h e n e n e r g y p r o d u c e r s w i l l h a v e the
real r e s o u r c e s at t h e i r d i s p o s a l ,
If d o m e s t i c s u p p l i e s r e p l a c e i m p o r t s a n d r e d u c e
the a g g r e g a t e
import bill,
then domestic economic activity
w i l l be s t i m u l a t e d to the e x t e n t t h a t r e s o u r c e s k e p t in the
d o m e s t i c e c o n o m y r e c y c l e t h r o u g h the e c o n o m y m o r e e f f i c i
ently than exported dollars.
3.
C o n t r o l l e d e n e r g y p r i c e s m a y r e s u l t in too m u c h
e n e r g y b e i n g c o n s u m e d b y c e r t a i n c o n s u m e r s and,
of e n e r g y r a t i o n i n g r e s u l t s ,
others.
if s o m e f o r m
too l i t t l e b e i n g c o n s u m e d by
This i n e f ficient a l l o c a t i o n ma y reduce the m a g n i
t u d e of t o t a l o u t p u t .
T h e f i r s t se t of b e n e f i t s t e n d s to b e l o n g t e r m in
nature.
Again,
T h e s e c o n d a n d t h i r d a r e b o t h s h o r t a n d l o n g term.
c o n s i d e r a b l e d i f f e r e n c e of o p i n i o n e x i s t s o v e r the
ma gn it ud e of these p ot en ti al ly positive impacts b ecause they
are c r i t i c a l l y d e p e n d e n t on w h e t h e r resou r c e s are a c t u a l l y
m a d e a v a i l a b l e , on w h o m h a s a c c e s s to t h e m a n d o n t h e u s e s
to w h i c h t h e y a r e put.
394
4.
Conclusion
E c o n o m i c t h e o r y d o e s n o t l e a d to c l e a r c o n c l u s i o n s
a b o u t the u l t i m a t e
i m p a c t of t he d e c o n t r o l of e n e r g y prices,
T h a t is, t h e r e is a s o u n d t h e o r e t i c a l b a s i s to e x p e c t s i g
n i f i c a n t econo m i c and p r o d u c t i v i t y losses and a sound
t h e o r e t i c a l b a s i s to e x p e c t s o m e r e s o u r c e g a i n s , b u t t h e r e
is no t h e o r e t i c a l b a s i s for d e c i d i n g w h i c h w i l l b e l a r g e r .
T h e b o t t o m l i n e is a n e m p i r i c a l
on e .
T h a t is, the u l t i m a t e
shape
(elasticity)
energy
iss u e ,
not a theoretical
i m p a c t is d e t e r m i n e d b y t he
of t he d e m a n d a n d s u p p l y c u r v e s for
( which d e t e r m i n e s the b e n e f i t s )
a n d the e l a s t i c i t y of
s u b s t i t u t i o n b e t ween e n e r g y and o ther f actors of p r o d u c t i o n
( w h i c h d e t e r m i n e s t he c o s t s ) .
Appendix A presents a brief
c o n c e p t u a l i z a t i o n of t h i s i s sue.
e m p h a t i c a l l y n o t e d tha t ,
However,
it s h o u l d be m o s t
as the f o l l o w i n g d i s c u s s i o n s h o w s ,
t h e e m p i r i c a l e v i d e n c e s t r o n g l y s u g g e s t s t h a t the p o t e n t i a l
e f f i c i e n c y b e n e f i t s do n o t o u t w e i g h th e c o s t s .
The e m p i r i
c a l a n s w e r s e e m s to be n e g a t i v e .
T h e d i s a g r e e m e n t o v e r th e m a g n i t u d e a nd d u r a t i o n o f
t he i m p a c t o f d e c o n t r o l
is m o s t f r e q u e n t l y e x p r e s s e d
in the
r e s u l t s of the e c o n o m e t r i c m o d e l s w h i c h a r e u s e d to s i m u l a t e
t h e b e h a v i o r of t he e c o n o m y .
T h e n e x t s e c t i o n r e v i e w s the
i m p a c t o f the o i l p r i c e s h o c k o n t h e e c o n o m y as s e e n t h r o u g h
t he e y e s of a n u m b e r of e c o n o m e t r i c m o d e l s .
A l l o f the
m o d e l s t e n d to c o n f i r m the g e n e r a l c o n c e p t u a l i z a t i o n p r e s e n
t ed a b o v e ,
although they differ
in d e t a i l s ,
395
C.
T h e Oil P r i c e S h o c k
1,
Prices and I n flation
The first,
critical macroeconomic
i s s u e r e l a t i n g to
d e c i s i o n s a f f e c t i n g e n e r g y p r i c e s is t he m a g n i t u d e and s p e e d
of the p r i c e i n c r ea s e .
The gre a t e r and more rapid the orice
increase,
the g r e a t e r the i m p a c t w i l l be t h r o u g h o u t t h e
economy.
For two m a j o r r e a s o n s , p r i c e i n c r e a s e s s h o u l d be
s t u died first and s e p a r a t e l y from other m a c r o e c o n o m i c
i m p a c t s s u c h as the i m p a c t on u n e m p l o y m e n t , c h a n g e s
output,
in
etc.
First,
as n o t e d a b o v e ,
t he p r i c e i n c r e a s e s a r e the
t r i g g e r to t he t r a n s f e r of r e s o u r c e s on t he d e m a n d s i d e and
t h e e s c a l a t i o n of c o s t s o n t he s u p p l y side.
Second,
to a c o n s i d e r a b l e e x t e n t , p r i c e a n d i n f l a
t i o n a r y i m p a c t s c a n be s t u d i e d in a s i m p l e f a s h i o n w i t h o u t
complicating assumptions,
p r o j e c t i o n s or e c o n o m e t r i c m o d e l s .
O t h e r e c o n o m i c i m p a c t s c a n n o t be s t u d i e d in s u c h a f o r m a t .
T h e m a g n i t u d e of p r i c e
i n c r e a s e s in c r u d e o il a nd
pe tr ol eu m products resulting from decontrol
T a b l e 1.
is d e s c r i b e d
in
P r i c e i n c r e a s e s in c r u d e o i l at the w e l l h e a d ,
r e f i n e r a c q u i s i t i o n c o s t s , and p r o d u c t p r i c e s w e r e all w e l l
in e x c e s s of 64 p e r c e n t b e t w e e n J u n e 19 7 9 a n d N o v e m b e r 1981.
T h e s e p r i c e i n c r e a s e s in p e t r o l e u m p r o d u c t s far
e x c e e d e d the i n c r e a s e s in the C o n s u m e r P r i c e I n d e x
(CPI)
A l l i t e m s in the CPI i n c r e a s e d b y 31 p e r c e n t in t h a t two
year period.
Of c o u r s e ,
e n e r g y prices are one impor t a n t
c o m p o n e n t of the C P I i t s e l f , so t h a t n o n - e n e r g y i t e m s in the
396
Table 1
RISING PRICES SINCE DECONTROL
May
1979
November
1981
Percentage
Increase
Refiner Acquisition Costs3
Domestic Crude ($/bbl)
Importedd Crude ($/bbl)
12.41
19.00
33.49
36.21
169.9
90.5
Consumer Prices*3
Heating Oil ($/gallon)
Gasoline ($/gallon)
Energy (index, 1967=100)
.656
.823
260.8
Consumer Price Indexc
All Items
(index, 1967=100)
All Non-energy Items
(index, 1967=100)
Source:
1.209
1.351
417.6
84.2
64.2
60.2
214.1
280.7
21
210.7
270.4
28
U.S. Department of Energy
aMonthly Energy Review, various issues
bU.S. Bureau of Labor Statistics, Consumer Price Index
cConsumer Price Index, various issues
397
I n d e x i n c r e a s e d m o r e s l o w l y t h a n the o v e r a l l
index.
An
in d e x c o m p o s e d of all n o n - e n e r g y i t e m s w o u l d h a v e i n c r e a s e d
o n l y 28 p e r c e n t in t h a t period.
Moreover,
rising petroleum prices have an indirect
i m p a c t o n all n o n - e n e r g y items in the index.
rising energy prices
noted above.
T h a t is,
i n c r e a s e the c o s t of o t h e r
items, as
It is p o s s i b l e to e s t i m a t e w h a t the C P I w o u l d
h a v e b e e n if e n e r g y p r i c e s h a d n o t b e e n r i s i n g so rapi d l y .
S u c h e s t i m a t e s v a r y d e p e n d i n g o n the e c o n o m e t r i c m o d e l s u sed
a nd the a s s u m p t i o n s m a d e a b o u t w h a t p r i c e s w o u l d h a v e b e e n
in the a b s e n c e of d e c o n t r o l .
H o w e v e r , a r e v i e w of a n u m b e r
o f e c o n o m e t r i c a n a l y s e s s h o w s t h a t the i m p a c t o f r i s i n g oil
p r i c e s o n the G N P d e f l a t o r w a s e s t i m a t e d to be in the r a n g e
of a 2.7 to 3.0 p e r c e n t c u m u l a t i v e i n c r e a s e b e t w e e n 1979 and
1981
(see T a b l e 2).
higher,
T h e i m p a c t o n t he C PI w a s s o m e w h a t
in the r a n g e of 3.9 to 4.9 p e r c e n t .
B e c a u s e t h e s e m o d e l s w e r e run in l a t e 1 9 7 9 a nd e a r l y
1980
they are p a r t l y r e t r o s p e c t i v e and pa r t l y p r o s p e c t i v e
w i t h r e g a r d to the e n e r g y p r i c e s h o c k of 1 9 7 9 - 8 0 .
T h us,
it
is i m p o r t a n t to n o t e t h a t m o s t of t he e s t i m a t e s c o n t a i n e d in
Table 2 we r e based on estim a t e d oil pric e s that w e r e u n d e r
s t a t e d b y a b o u t 30 p e r c e n t b e c a u s e the a n a l y s e s w e r e p e r f o r
m e d b e f o r e t h e s p a t e of i n c r e a s i n g p r i c e s h a d r un its
course.
Therefore,
t he e s t i m a t e d i m p a c t of o i l p r i c e
i n c r e a s e s o n t h e G N P d e f l a t o r s h o u l d p r o b a b l y b e in the 3.9
to 4.3 p e r c e n t a g e p o i n t range, w h i l e
i n c r e a s e s in the CPI
s h o u l d p r o b a b l y be in t he 5.6 to 7.0 p e r c e n t a g e p o i n t range.
2 1-496 0
83
26
398
Table 2
ANNUAL CHANGES IN INFLATION DUE TO
OIL PRICE INCREASES
(in percent)
Source
Congressioinal Budget Office
May 1979: Decontrol only,
June 1979: Decontrol only,
June 1980: Decontrol only,
June 1980: Decontrol only,
GNP deflator.
GNP deflator
<2*P deflator
CPI-W
Wharton (June 1980)d
Second half of decontrol only: CPI
(gasoline tax assumed)
1979
1980
1981
1982
1983
19S4
+ ,1
0
+ .2
+ .3
+1.1
+1.5
+ .3
+ .1
+1.7
+2.1
0
+ .4
+ .6
+ .7
0
+ .5
na
na
0
na
na
na
+2.01
na
na
na
na
na
.92 +1.01
Mork and Hall6 (Nov. 1979)
Total energy shock:
+1.8
+1.3
+ .1
na
Eckstein (DRI)f (Nov. 1979)
Total energy shock: GNP
Total energy shock: Personal consump
tion deflator (CPI)
+ .9
+1.5
+ .4
- .2
0
+
+1.1
+2.3
+1.5
+ .9
+ .6
+
^Thurman and Berner (MPS)g (Nov. 1979)
Total energy shock: GNP deflator
Total energy shock: Personal consump
tion deflator (CPI)
+ .1
+1.1
+1.5
+ .5
- .3
na
+ ,7
+1.6
+1.4
+ .5
- .2
na
aCongressional Budget Office, The Decontrol of Domestic Oil Prices:
(Washington, DC, May 1979), p. 45.
A
An Overview
^Congressional Budget Office, Memorandum from Roy Scheppach to Jim Cubie (Wàshington, DC,
July 12, 1979).
°Hearing before the Subcommittee on Energy of the Joint Economic Committee, Congress of the
United States, Impact of Energy Prices and Inflation on American Families, July 8, 1980
(Washington, DC 1981), p. 72.
dIbid., p. 65.
eKurt Anton Mork and Robert E. Hall, "Macroeconomic Analysis of Energy Price Shocks and
Offsetting Policies in Kurt Anton Mork, ed., Energy Prices, Inflation, and Economic
Activity (Cambridge, Ballenger, 1981).
fOtto Eckstein, "Shock Inflation, Core Inflation and Energy Disturbances in the DRI Model,"
in Mork, Energy Prices.
^Stephan Thurman and Richard Berner, "Analysis of Oil Prrice Shocks in the MPS Model," in
Mork, Energy Prices.
399
This
r a n g e of e s t i m a t e s
is c o n s i s t e n t w i t h a r u l e of
t h u m b t h a t is f r e q u e n t l y u s e d to e s t i m a t e the i m p a c t of
0
r i s i n g e n e r g y p r i c e s on c o n s u m e r p r i c e s .
For e v e r y o n e
p e r c e n t a g e p o i n t t h a t e n e r g y p r i c e s r a i s e the C P I d i r e c t l y ,
it is a s s u m e d t h a t i n d i r e c t i m p a c t s w i l l a d d an a d d i t i o n a l
,5 to 1 p e r c e n t a g e poi n t s .
In T a b l e
1, it w a s s h o w n t h a t
the d i r e c t c o n t r i b u t i o n of e n e r g y p r i c e s to the C P I w a s
a b o u t 3 p e r c e n t a g e points.
indicated a total
The rule of thumb w o u l d have
i m p a c t of 5 to 6.6 p e r c e n t a g e p o i n t s ,
A r e c e n t e s t i m a t e b y t he U.S.
D e p a r t m e n t of E n e r g y
u s i n g a m o d i f i e d v e r s i o n of two of t h e m o d e l s i n c l u d e d
in
T a b l e 2 ( W h a r t o n a n d DRI)
a n d d a t a w h i c h r e f l e c t s the full
g
i m p a c t of r i s i n g p r i c e s c o n f i r m s t h e s e e s t i m a t e s .
Accor
d i n g to DOE,
price
increases
in all e n e r g y s o u r c e s a r e f o u n d
to h a v e c o n t r i b u t e d b e t w e e n 4 .1 a n d 5 . 5 p e r c e n t a g e p o i n t s to
the G N P d e f l a t o r a n d b e t w e e n 5.7 a n d 7.3 p e r c e n t a g e p o i n t s
to the C PI in 1 9 7 9 a n d 1 9 8 0 c o m b i n e d .
Thus,
it s e e m s s a f e to s a y t h a t o i l p r i c e i n c r e a s e s
a c c o u n t e d for b e t w e e n 20 a nd 25 p e r c e n t o f the t o t a l
t i o n f e l t in the 1 9 7 9 - 1 9 8 1 p e r i o d .
tedly had major
infla
S u c h an i m p a c t u n d o u b
i m p l i c a t i o n s for t he e c o n o m y .
It a l s o
c e r t a i n l y h a d a n i m p a c t o n the r e s t r i c t i v e m o n e t a r y a n d
fiscal pol ic ie s that were p ur sued du ring this period
e f f o r t to l o w e r t he r a t e o f i n f l a t i o n .
in an
400
2•
The Impact on Econom ic A c t i v i t y
With price
i n c r e a s e s g r e a t e n o u g h to a f f e c t the G N P
d e f l a t o r a n d C P I so d r a m a t i c a l l y ,
o n e m u s t e x p e c t to o b s e r v e
r a t h e r l a r g e d e c r e a s e s in e c o n o m i c a c t i v i t y .
Estimating
th e s e impacts relies a l m o s t e n t i r e l y on e c o n o m e t r i c
modeling,
As n o t e d a b o v e ,
h i g h d e g r e e of u n c e r t a i n t y .
such m o d e l i n g
is s u b j e c t to a
The d i f f e r e n c e s that exist
between econometric models result from differences
w a y t h e y t r y to s i m u l a t e th e e c o n o m y .
th e m o d e l i n g s t e m s f r o m d i f f e r e n c e s
econometric models
in t h e
T h e u n c e r t a i n t y of
in t he s t r u c t u r e o f t h e
( a s s u mptions and parameters)
e n c e s in e s t i m a t e s o f i n p u t v a r i a b l e s
and d i f f e r
(energy p r i c e s ) .
M a j o r d i f f e r e n c e s c e n t e r o n t he a s s u m p t i o n s a b o u t a n d t h e
d e t a i l w i t h w h i c h t h e m o d e l s h a n d l e t h e r e s p o n s e to r i s i n g
e n e r g y p r i c e s of l a b o r
(in its w a g e d e m a n d s )
(in c h a n g i n g t he a m o u n t o f e n e r g y ,
and indus tr y
l a b o r a n d c a p i t a l u s e d in
production).
In s p i t e of t h e d i f f e r e n c e s b e t w e e n t he m o d e l s ,
a
n u m b e r of t h e m p r o d u c e d f a i r l y c o n s i s t e n t e s t i m a t e s of t h e
im p a c t of rising e n e r g y p r ices
(see T a b l e 3).
i n c l i n e d to s t r e s s t h e i r s i m i l a r i t i e s ,
differences.
We are
rather than their
A s i d e f rom the C B O an a l y s i s , w h i c h was ba s e d
o n v e r y l o w p r i c e e s t i m a t e s b e c a u s e it w a s d o n e v e r y e a r l y ,
a n d W h a r t o n , w h i c h t o o k o n l y t he l a t e r s t a g e s o f p r i c e
i n c r e a s e s int o a c c o u n t ,
t he o t h e r a n a l y s e s s h o w t h a t t h e
l o s s of G N P is in t h e r a n g e o f 2 .5 to 4.3 p e r c e n t a g e p o i n t s
in t h e 1 9 7 9 - 1 9 8 1 p e r i o d .
T h e i n c r e a s e in u n e m p l o y m e n t f a l l s
401
Taole j
CHANGES IN ECONOMIC ACTIVITY AS A
RESULT OF RISING OIL PRICES
1979
1980
1981
1982
1983
1984
GNP Changes
CBO, May 1979: Decontrol only
■v---.0 to -.1
CBO, June 1979: Decontrol only
.0 to -.2
—
.fi to ,2
'V''“
.2 to *•,4
V
Total Energy Price Shock
Wharton
na
Mork and Hall
Employment Changes
CBO, May 1979
Eckstein
Thurman and Berner
Sources:
See Table 2.
na
na
+ .4
na
na
na
-2.0
+ .5
+ .6
+ .9
- .5 - .9
-1.4
-1.2
-1.0
na
/
j
V
0
V
/
0 to + .2
V
S
+ ,1 to + .3
+V .l
.14
.36
.76
na
na
+ .4
+1.2
+ .9
na
na
na
0
+ .4
+1.3
+1.2
+ .7
+ ,7
+ .1
+1.3
+1.4
+ .5
+ .1
.1
-
Mork and Hall
.6
-2.8
CBO, June 1979
Wharton
.3
-.1 -2.2
-1.1
Eckstein
Thurman and Berner
.3
402
in the 1.5 to 2.8 p e r c e n t a g e p o i n t range.
Once again,
these
e s t i m a t e s are based on e n e r g y p r ice p r o j e c t i o n s that w ere
a b o u t 30 p e r c e n t too l o w b e c a u s e t h e y w e r e d o n e b e f o r e t he
r i s e in e n e r g y p r i c e s h a d run its c o u r s e ,
Therefore,
the
n e g a t i v e e c o n o m i c i m p a c t w a s in f a c t g r e a t e r t h a n the m o d e l s
predict.
Considering actual energy prices,
it w o u l d be
r e a s o n a b l e to a s s u m e t h a t the l o s s in G N P w a s o n the o r d e r
o f 3.5 to 6.1 p e r c e n t a n d t h e i n c r e a s e in u n e m p l o y m e n t w a s
b e t w e e n 2.1 a nd 4 p e r c e n t a g e p o i n t s .
Again,
t he r e c e n t e c o n o m e t r i c a n a l y s e s c o n d u c t e d b y
D O E t e n d to c o n f i r m t h e s e r e s u l t s . 1 **
I n c o r p o r a t i n g t h e f ull
m a g n i t u d e of p r i c e i n c r e a s e s , D O E e s t i m a t e s t h a t a l o s s in
G N P in 1 9 7 8 - 8 0 o f b e t w e e n 5.1 a n d 5 . 9 p e r c e n t a n d an
i n c r e a s e in u n e m p l o y m e n t of b e t w e e n 1.4 a n d 3.8 p e r c e n t a g e
p o i n t s c a n b e a t t r i b u t e d to r i s i n g e n e r g y p r i c e s .
T h e b e h a v i o r o f s p e c i f i c e l e m e n t s of t h e e c o n o m y
a l s o c o n f o r m s to the p r e d i c t i o n s o f m a c r o e c o n o m i c t h e o r y
described above).
In 1 9 7 9 a n d 1980,
investment suffered a
m a j o r s e t b a c k as a r e s u l t of t h e o i l p r i c e s h o c k —
r e d u c t i o n o f as m u c h as 12 p e r c e n t . 11
(as
a
Productivity was
r e d u c e d as w e l l , b y as m u c h as 3 p e r c e n t .
12
Some estimates
s h o w t h a t as m u c h as o n e - t h i r d to o n e - h a l f of t h e s l o w - d o w n
in p r o d u c t i v i t y g r o w t h m a y h a v e b e e n d u e to e n e r g y p r i c e
increases.
13
E xp enditures on cons um er d ur ables were also
p a r t i c u l a r l y h a r d h it.
14
I n v e s t m e n t in r e s i d e n t i a l h o u s i n g
s t r u c t u r e s m a y h a v e b e e n r e d u c e d b y as m u c h as 1 5 - 2 0 p e r c e n t
403
w h i l e s a l e s of A m e r i c a n a u t o m o b i l i e s m a y h a v e b e e n r e d u c e d
b y as m u c h as 40 p e r c e n t . 15
3.
A s s e s s i n g the I m p a c t
J u d g i n g the a c t u a l s i g n i f i c a n c e of the n e g a t i v e
e c o n o m i c i m p a c t s c a n be a m a t t e r of p e r s p e c t i v e .
It h a s
b e c o m e c o m m o n a m o n g t h o s e i n c l i n e d to d o w n p l a y the i m p o r
t a n c e of e n e r g y to f o c u s o n the e n t i r e p e r i o d a f t e r the O P E C
oil e m b a r g o
(1973)
in o r d e r to p l a c e the 1 9 7 9 - 8 0 o i l p r i c e
s h o c k in the c o n t e x t of a g e n e r a l l y b a d e c o n o m i c p e r i o d . 16
T a b l e 4 s h o w s t h a t the e c o n o m y t o o k a d e c i d e d t u r n for the
w o r s e in 1 9 7 3 - 8 0 , c o m p a r e d to t he p r e v i o u s e i g h t y e a r s .
r a t e of g r o w t h of real GNP,
real d i s p o s a b l e i n c o m e ,
T he
invest
me n t and p r o d u c t i v i t y slowed dra m a t i c a l l y , w h ile inflation
and u n e m p l o y m e n t i n c r e a s e d .
P a r t of the d o w n t u r n —
least o n e - t h i r d and p r o b a b l y o n e - h a l f —
at
c a n d e f i n i t e l y be
a t t r i b u t e d to the e n e r g y p r i c e s h o c k .
S o m e a n a l y s t s f o c u s o n t h a t p a r t of t h e d o w n t u r n
w h i c h e n e r g y p r i c e s d i d n o t c a u s e a n d l o o k for a b i g g e r
" p i c t u r e , " t h e r e b y d o w n p l a y i n g t he i m p o r t a n c e of e n e r g y
price increases.
C E C A / R F is i n c l i n e d to t a k e t he o p p o s i t e
vi ew.
W e a r e s t r u c k b y the f a c t t h a t so m u c h o f the
d o w n t u r n c a n be a t t r i b u t e d to t h i s o n e f a c t o r .
E n e r g y is
o b v i o u s l y a v e r y ma j o r influence on econo m i c activity.
One
w i l l l o o k in v a i n to f i n d a n y o t h e r s i n g l e f a c t o r t h a t is as
important.
Moreover,
t h e r e a r e e v e n w a y s in w h i c h t h e s e
Table 4
THE IMPORTANCE OF RISING ENERGY PRICRES
IN DETERMINING ECONOMIC PERFORMANCE
Actual
Hypothetical
Assuming no
Energy Price
Increase
(4)
Change
Attributable
to Energy
Prices
(5=2-4)
% of Change
Attributable
to Energy
Prices
(6=5/3)
1965-1972
1973-1980
Change
(1)
(2)
(3=1-2)
Real Growth of GNP
(% per year)
3.5
2.4
-1.1
2.8
.4
36
Real Disposable Imcome
(% per year)
4.0
2.4
-1.6
3.3
T- .9
56
Growth of Real Fixed
Investment
4.0
.4
-3.6
2.0
-
1.6
44
Rate of Change in CPI
(Percentage points)
+4.1
+9.2
45
Rate of Growth of
Productivity
(% change/year of output
per person hour)
2.0
.2
Unemployment Rate
(Average annual)
4.5
6.6
+5.1a
+6.9
+2.3b
-1.8
1.6
.4
77
+2.1a
5.4
+1.2
57
a/ Column 2 minus column 1.
E/ Column 4 minus column 2.
Source:
DOE, The Interralationship of Energy and the Economy, 1981, Chapter 2.
405
a n a l y s e s u n d e r e s t i m a t e the i m p a c t t h a t r i s i n g e n e r g y p r i c e s
c a n hav e .
F i r s t , w h e n the e c o n o m e t r i c a n a l y s e s a r e c o n d u c t e d ,
o n l y e n e r g y p r i c e s are c h a n g e d
would have happened
prices.
in o r d e r to s i m u l a t e w h a t
in t he e c o n o m y w i t h o u t a c h a n g e
T h i s o v e r l o o k s the f a c t that,
in
as e n e r g y p r i c e s
rose, m a n y p o l i c y d e c i s i o n s w e r e m a d e in r e s p o n s e to t h o s e
rising prices.
Is it r e a l l y p o s s i b l e to s e p a r a t e e n e r g y
p r i c e i n c r e a s e s f r o m the p o l i c y d e c i s i o n s w h i c h t h e y
d i r e c t l y c a u s e d a n d to w h i c h t h e y w e r e i n s e p a r a b l y
connected?
T h e m o s t i m p o r t a n t p o l i c i e s in t h i s r e g a r d a r e
fiscal and m o n e t a r y policies.
As rising e n e r g y p r ices
i n c r e a s e d the r a t e of i n f l a t i o n ,
p o l i c y - m a k e r s r e s p o n d e d by
t i g h t e n i n g t h e m o n e y s u p p l y a n d r e d u c i n g f i s c a l d e f i c i t s in
a n e f f o r t to s l o w i n f l a t i o n d o w n . 17
Of c o u r s e ,
p o l i c i e s h a v e r e c e s s i o n a r y i m p a c t s o f t h e i r own,
these
impacts
w h i c h r e i n f o r c e t h e i m p a c t of r i s i n g e n e r g y p r i c e s .
Most
a n a l y s e s sh o w that the r e s t r i c t i v e m o n e t a r y and fiscal
r e s p o n s e s to r i s i n g e n e r g y p r i c e s d o u b l e d t he r e c e s s i o n a r y
impact.
18
In t h i s s e n s e ,
energy prices caused about one-
t h i r d of t h e e c o n o m i c p r o b l e m d i r e c t l y a n d a n o t h e r o n e - t h i r d
o f t h e p r o b l e m i n d i r e c t l y t h r o u g h t h e i m p a c t of e n e r g y p r i c e
i n c r eases on m o n e t a r y and fiscal policy.
Thus,
if o n e
a s s u m e s a d i f f e r e n t p a t h of e n e r g y p r i c e s , o n e s h o u l d
p r o b a b l y a s s u m e d i f f e r e n t f i s c a l a n d m o n e t a r y p o l i c i e s as
w e l l . 19
406
A s e c o n d w a y in w h i c h the e c o n o m e t r i c a n a l y s e s
u n d e r e s t i m a t e the i m p a c t o f r i s i n g e n e r g y p r i c e s is n o t
easily quantifiable,
b u t it is n o n e t h e l e s s real.
Rising
e n e r g y p r i c e s h a d a m a j o r i m p a c t o n the m o o d o f t h e p u b l i c
and on policy-makers.
T h e e c o n o m e t r i c a n a l y s e s s h o w t h a t in
t h e a b s e n c e of r i s i n g e n e r g y p r i c e s ,
there would have been
a l m o s t no r e c e s s i o n in 1 9 7 4 - 7 5 a n d no r e c e s s i o n in 1980.
20
T h e r e w o u l d h a v e b e e n no " d o u b l e d i g i t i n f l a t i o n " a t a n y
t i m e in t h e d e c a d e .
21
In t h i s r e g a r d , e n e r g y p u s h e d t h e
economy past several major psychological thresholds
i n t o a r e c e s s i o n a n d o v e r the
double
(i.e.,
d i g i t m a r k in
inflation).
In 1 9 8 0 a l o n e , h a d e n e r g y p r i c e s n o t i n c r e a s e d so
r a p i d l y # as m a n y as t h r e e m i l l i o n f e w e r p e o p l e w o u l d h a v e
been unemployed.
22
As m a n y as two m i l l i o n m o r e A m e r i c a n
a u t o m o b i l e s w o u l d h a v e b e e n s o l d a n d an a d d i t i o n a l 2 5 0 , 0 0 0
housing starts would have been undertaken.
23
Here,
too,
critical psychological thresholds would have been avoided,
e s p e c i a l l y r a t e s of u n e m p l o y m e n t t h a t r i v a l e d t h o s e o f t h e
g r e a t d e p r e s s i o n in t w o of A m e r i c a ' s l a r g e s t i n d u s t r i e s .
In s h o r t ,
been different.
pessimistic,
th e e n t i r e e c o n o m i c e n v i r o n m e n t w o u l d h a v e
The public mood would have been much less
a n d c e r t a i n l y c o u l d h a v e led to d i f f e r e n t
consumption and saving patterns.
Policy-makers would not
h a v e b e e n t h r a s h i n g a b o u t in s e a r c h of e c o n o m i c q u i c k f i x e s .
T h e e c o n o m y w o u l d h a v e r e m a i n e d m u c h c l o s e r to its h i s t o r i
c al p a t h of r e l a t i v e l y r a p i d a n d r e l a t i v e l y s t a b l e
expansion.
407
In t h i s s e n s e ,
energy may have been more than two-
t h i r d s of the p r o b l e m —
o n e - t h i r d d u e to the d i r e c t
impact
of r i s i n g p r i c e s , o n e - t h i r d d u e to the i n d i r e c t i m p a c t
through m o n e t a r y and fiscal policy,
a n d an a d d i t i o n a l ,
u n m e a s u r a b l e a m o u n t d u e to t he q u a l i t a t i v e i m p a c t of h a v i n g
the e c o n o m y a p p e a r to be in a s t a t e of u t t e r c h a o s and o n
t he b r i n k of c o l l a p s e .
In the c o n t e x t of e n e r g y - p r i c e -
p o l i c y - d e c i s i o n m a k i n g , it is i m p o r t a n t to r e c o g n i z e t h a t in
t he 1 9 7 0 s a nd e s p e c i a l l y the 1 9 7 9 - 3 0 p e r i o d ,
not collapsing —
rather,
the e c o n o m y w a s
to a v e r y c o n s i d e r a b l e d e g r e e ,
was being crushed by energy prices.
it
Had this been r e c o g
nized, very d if fe re nt economic and energ y poli cy decisions
m i g h t h a v e b e e n made.
T wo o t h e r g e n e r a l o b s e r v a t i o n s o n t h e s e e c o n o m i c
i m p a c t s a r e in o r d e r b e f o r e w e t u r n to the d i s c u s s i o n of
natural gas decontrol.
First,
the general pri n c i p l e that lost purch a s i n g
p o w e r r e s u l t i n g f r o m r i s i n g e n e r g y p r i c e s c a n n o t be r e c o u p e d
in t he s h o r t or m i d - t e r m s c a n be d e m o n s t r a t e d o n the b a s i s
of t h e s e e s t i m a t e s .
In an e a r l i e r w o r k , C E C A / R F e s t i m a t e d
t h a t d u e to r i s i n g oil p r i c e s a b o u t $ 1 6 0 b i l l i o n in real
p u r c h a s i n g p o w e r w a s l o s t in the 1 9 7 9 - 1 9 8 1 p e r i o d
dollars).
24
if w e u s e an e s t i m a t e of 5 p e r c e n t of G N P l o s t
d u e to t h e o i l p r i c e s h o c k ,
b i l l i o n w a s l o s t in real G N P
o f 1981.
(in 1978
t h e n w e c o n c l u d e t h a t a b o u t $13 0
(1978 d o l l a r s )
t h r o u g h t he e nd
Thu s , a b o u t 80 p e r c e n t o f t h e l o s s in p u r c h a s i n g
p o w e r is t r a n s l a t e d into a l o s s in G N P in the s h o r t run.
408
Second,
it is i m p o r t a n t to n o t e t h a t the e c o n o m i c
i m p a c t s p e r s i s t o v e r a l o n g term.
T h e h e a d l i n e s d e v o t e d to
r i s i n g e n e r g y p r i c e s m a y p a s s q u i c k l y o n c e the s h o c k is
o v e r , b u t t he n e g a t i v e e c o n o m i c
i m p a c t s of t h o s e p r i c e s w i l l
k e e p w o r k i n g t h e i r w a y t h r o u g h t he e c o n o m y .
models project a cumulating negative
10 y e a r s .
M o s t of the
i m p a c t t h a t l a s t s 5 to
T h e r e t h e n e n s u e s a p e r i o d in w h i c h p a r t of the
e c o n o m i c l o s s e s m a y be r e c o v e r e d .
In t he l o n g run, t h e r e
r e m a i n s an a p p r e c i a b l e l o s s in t o t a l GNP.
D*
Natural Gas Decontrol
1.
Introduction
H a v i n g r e v i e w e d the t h e o r e t i c a l e x p l a n a t i o n s o f w h y
r i s i n g e n e r g y p r i c e s s h o u l d be e x p e c t e d to h a v e a n e g a t i v e
i m p a c t o n the e c o n o m y a n d t he e m p i r i c a l e v i d e n c e w h i c h s h o w s
t h a t o i l p r i c e i n c r e a s e s d i d a f f e c t t h e e c o n o m y as p r e d i c
ted, w e t u r n to t h e p r o j e c t i o n s o f the i m p a c t o f r i s i n g
natural gas prices on the economy.
There are a number of
r e a s o n s t h a t we s h o u l d e x p e c t r i s i n g n a t u r a l g a s p r i c e s to
have significant negative economic
2.
impacts.
T h e E x p e c t e d I m p a c t of N a t u r a l
Gas Decontrol
a.
Prices
In a s e p a r a t e r e p o r t ,
" P a s t as P r o l o g u e Is
The
U n d e r e s t i m a t i o n o f P r i c e I n c r e a s e s in t h e D e c o n t r o l D e b a t e , "
C E C A / R F h a s a n a l y z e d in d e t a i l t h e q u e s t i o n of the p r i c e
i n c r e a s e s l i k e l y to f o l l o w f r o m a c c e l e r a t e d / p h a s e d d e c o n t r o l
409
of n a t u r a l g a s .
25
W e h a v e d e m o n s t r a t e d t h a t the p r i c e
i n c r e a s e s t h a t w i l l o c c u r u n d e r a c c e l e r a t e d d e c o n t r o l of
n a t u r a l g a s are q u i t e s i m i l a r to the p r i c e p a t h t h a t oil
too k d u r i n g the o i l p r i c e s h o c k of 1 9 7 9 - 8 0 .
T h i s is o n e
r e a s o n we w o u l d e x p e c t the e c o n o m i c i m p a c t f o l l o w i n g n a t u r a l
gas decontrol
to be s i m i l a r to the e c o n o m i c
oil p r i c e shock.
i m p a c t o f the
B e l o w , w e w i l l s h o w t h a t the r e l a t i o n s h i p
b e t w e e n n a t u r a l g a s p r i c e i n c r e a s e s a n d c h a n g e s in t h e G N P
deflator
is v e r y s i m i l a r to the r e l a t i o n s h i p b e t w e e n oil
p r i c e i n c r e a s e s a n d c h a n g e s in the G N P d e f l a t o r .
b.
Fue l U s e s
Second,
the g e n e r a l a r g u m e n t s m a d e a b o v e a b o u t the
mechan is ms by which e nergy price increases are translated
into e c o n o m i c s l o w d o w n s c e r t a i n l y h o l d for n a t u r a l gas.
T h a t is, the c o n c e p t u a l r e l a t i o n s h i p b e t w e e n e n e r g y a nd the
e c o n o m y h o l d s for gas.
In fact,
t h e r e a r e r e a s o n s to e x p e c t
t h a t the n a t u r a l g a s p r i c e i n c r e a s e s m i g h t h a v e e v e n l a r g e r
n egat i v e e ffects than oil price increases.
the p r i c e e l a s t i c i t y of e n e r g y —
T h e s e r e l a t e to
t he k e y l i n k b e t w e e n
e n e r g y p r i c e i n c r e a s e s a nd m a c r o e c o n o m i c a c t i v i t y .
T h a t is,
the a b i l i t y to s u b s t i t u t e f or e n e r g y in the s h o r t a n d lon g
t e r m as a r e s p o n s e to p r i c e i n c r e a s e s d i c t a t e s t h e i m p a c t of
t h o s e p r i c e i n c r e a s e s on t he e c o n o m y .
A l t h o u g h the a g g r e g a t e p r i c e e l a s t i c i t y of n a t u r a l
g a s a p p e a r s to be s i m i l a r to t h a t o f c r u d e o i l ,
e l a s t i c i t y in i n d u s t r i a l u s e s is m u c h l ower.
26
the price
Most studies
410
s u g g e s t t h a t t he p r i c e e l a s t i c i t y o f n a t u r a l g a s in
i n d u s t r i a l u s e s is o n l y a b o u t o n e - h a l f as l a r g e as the p r i c e
e l a s t i c i t y of p e t r o l e u m in i n d u s t r i a l use s .
Thus,
natural
g a s p r i c e i n c r e a s e s p o s e a g r e a t e r p r o b l e m of s t r u c t u r a l
adjustment
in the e c o n o m y .
This
is e s p e c i a l l y t r u e of the
long e r term p r o d u c t i v i t y and e c o n o m i c
impacts discussed
above.
T h e a n a l o g y b e t w e e n the i m p a c t of o il a n d g a s p r i c e s
o n t h e e c o n o m y s h o u l d n o t be t a k e n t oo l i t e r a l l y .
o b v i o u s d i f f e r e n c e s b e t w e e n t he two f u e l s .
consume much more petroleum.
Second,
Th e r e are
First, we
a much larger p e r c e n
t a g e of t he p e t r o l e u m w e c o n s u m e is i m p o r t e d f r o m a b r o a d .
If o n e w i s h e s to e x t r a p o l a t e f r o m t h e a n a l y s i s of t h e o i l
p r i c e s h o c k to t h e i m p a c t of n a t u r a l g a s d e c o n t r o l ,
great
c a r e m u s t be t a k e n .
A p p e n d i x B p r e s e n t s a n u m b e r of s t e p s t h a t m u s t be
t a k e n in o r d e r to m a k e t h e c o m p a r i s o n .
It s h o w s t h a t t h e
e c o n o m e t r i c a n a l y s e s of t h e o i l p r i c e s h o c k , w h e n u s e d to
p r e d i c t t he i m p a c t o f n a t u r a l g a s d e c o n t r o l ,
l e a d to
r e a s o n a b l e e s t i m a t e s if t h e y a r e t r e a t e d p r o p e r l y .
c.
Production
It s h o u l d be n o t e d ,
d o m e s t i c s u p p l y of e n e r g y ,
f r o m t h e p o i n t o f v i e w o f t he
that oil and gas are p r o d u c e d
in
r o u g h l y t h e s a m e g e o g r a p h i c a r e a s w i t h r o u g h l y t he s a m e
technology.
The lar g e s t d o m e s t i c p r o d u c e r s of oil are also
b y far t h e l a r g e s t d o m e s t i c p r o d u c e r s of g as.
27
Clearly,
t h e r e is g o o d c a u s e to d r a w p a r a l l e l s b e t w e e n t h e t w o f u e l s .
411
3.
C o n s i d e r a t i o n s in D e r i v i n g a B e s t E s t i m a t e
o f the I m p a c t of N a t u r a l G a s D e c o n t r o l
Having seen that both t h e o r y and recent e n e r g y price
history suggest significant economic
impacts of n atural gas
d e c o n t r o l , we r e v i e w in t h i s s e c t i o n a n u m b e r of e c o n o m e t r i c
e s t i m a t e s o f t he i m p a c t of n a t u r a l g a s d e c o n t r o l o n i n f l a
tion, o u t p u t a nd u n e m p l o y m e n t .
T h e o b j e c t i v e is to a r r i v e
at a b e s t o r a m o s t r e a s o n a b l e e s t i m a t e of t h o s e i m p a c t s .
In o r d e r to do so,
it is n e c e s s a r y to f o l l o w a v e r y c a r e
f u l l y c o n c e i v e d a p p r o a c h to t h e a n a l y s i s .
The following
s t e p s h a v e b e e n t aken.
a.
The Time Frame
B e c a u s e t he v a r i o u s d e c o n t r o l s c e n a r i o s do n o t a g r e e
on t he q u a n t i t y a n d p r i c e o f g a s t h a t w i l l b e d e c o n t r o l l e d ,
or the t i m e p e r i o d o v e r w h i c h d e c o n t r o l w i l l o c c u r ,
it is
o f t e n d i f f i c u l t to c o m p a r e e c o n o m e t r i c r e s u l t s o n a y e a r b y
year basis.
H o w e v e r , m o s t s c e n a r i o s b e g i n to c o n v e r g e b y
th e t h i r d y e a r a f t e r d e c o n t r o l b e g i n s .
Moreover,
e c o n o m i c i m p a c t s do n o t o c c u r i n s t a n t a n e o u s l y .
short term
It t a k e s
s e v e r a l y e a r s for the i n i t i a l r e c e s s i o n a r y s h o c k o f the
p r i c e i n c r e a s e to be f u l l y r e g i s t e r e d .
Therefore,
the
i m p a c t o f d e c o n t r o l w i l l be c a l c u l a t e d in t e r m s o f t h r e e
y e a r i n c r e m e n t s a n d we h a v e e s t i m a t e d 3, 6 a n d 9 y e a r
impacts.
412
b.
S t a n d a r d i z e d I m p a c t s for P r i c e
Increases
B e c a u s e p r i c e i n c r e a s e s a r e t he k e y to t r i g g e r i n g
the eco n o m i c
impact and b e c a u s e d e c o n t r o l s c e n a r i o s d i f f e r
d r a m a t i c a l l y in th-? m a g n i t u d e of the i n c r e a s e t h a t t h e y
p r o j e c t , w e h a v e a l s o c a l c u l a t e d t he i m p a c t s on a s t a n d a r
dized
basis.
W e h a v e c h o s e n to e x a m i n e the
impacts a s s o c i
a t e d w i t h a s p e c i f i c p e r c e n t i n c r e a s e in p r i c e s .
In s t a t i n g t he i m p a c t s in t h e f i r s t t h r e e y e a r
p e r i o d , we u s e e s t i m a t e s of the i m p a c t t h a t w o u l d o c c u r f or
a 100 p e r c e n t i n c r e a s e in t he f i r s t t h r e e y e a r s .
if p r i c e s d o u b l e
( i n c r e a s e b y 100 p e r c e n t )
That
is,
in the f i r s t
t h r e e y e a r s , w h a t w i l l the i m p a c t be o v e r the f i r s t t h r e e
years?
However,
for the s i x y e a r a n d n i n e y e a r i m p a c t s , we
e s t i m a t e t he i m p a c t as a f u n c t i o n o f t he f i v e y e a r p r i c e
increase.
T h a t is, if p r i c e s d o u b l e
in t he f i r s t f i v e
y e a r s , w h a t w i l l the i m p a c t be o v e r t h e f i r s t s i x y e a r s ?
Similarly,
if p r i c e s d o u b l e in t h e f i r s t f i v e y e a r s , w h a t
w i l l t he i m p a c t be in t h e f i r s t n i n e y e a r s ?
The reason the
f i v e y e a r p r i c e i n c r e a s e is u s e d to e s t i m a t e t h e i m p a c t s of
d e c o n t r o l i n t h e s i x a n d n i n e y e a r p e r i o d s is t h a t a l l
analyses exhi b i t only small real pri c e increases after the
first five years.
T h a t is, t h e y a r e p r e d i c a t e d o n t h e
assumption that early price shocks are working their way
through the e conomy and no new p r i c e shocks are projected.
F o r t he p u r p o s e s of m a k i n g t h e s t a n d a r d i z e d e s t i m a t e
of impact
(i.e.,
i m p a c t p e r 100 p e r c e n t p r i c e i n c r e a s e ) , w e
413
h a v e a s s u m e d t h a t the i m p a c t is a l i n e a r f u n c t i o n o f p r i c e
increases.
For e x a m p l e ,
i m p a c t s e s t i m a t e d o n the b a s i s of a
68 p e r c e n t p r i c e i n c r e a s e a r e s c a l e d up to a 100 p e r c e n t
i n c r e a s e b y d i v i d i n g the i m p a c t by
,68; i m p a c t s e s t i m a t e d on
the b a s i s of a 162 p e r c e n t p r i c e i n c r e a s e a r e s c a l e d d o w n to
a 100 p e r c e n t p r i c e i n c r e a s e b y d i v i d i n g b y 1.62.
This may
u n d e r e s t i m a t e the i m p a c t of l a r g e r p r i c e i n c r e a s e s s i n c e
t h e o r y g i v e s us s o m e r e a s o n to e x p e c t i n c r e a s i n g n o n - l i n e a r
trends
(i.e.,, l a r g e r i n c r e a s e s h a v e d i s p r o p o r t i o n a t e l y
larger impacts).
T h e d a t a do s u g g e s t a s l i g h t l y i n c r e a s i n g
n o n - l i n e a r trend.
c.
F u l l a nd P a r t i a l D e c o n t r o l
Th e a n a l y s e s o f f ull d e c o n t r o l a r e t r e a t e d s e p a r a t e
ly f r o m the a n a l y s e s of p a r t i a l d e c o n t r o l .
Fu ll d e c o n t r o l
produces a different price path than partial decontrol, with
price increases heavily concentrated
One w o u l d e x p e c t a d i f f e r e n t
in the e a r l y y e a r s .
i m p a c t o n t he e c o n o m y to r e s u l t
f r o m t h e s e p r i c e p a t h s , at l e a s t in the s h o r t term.
d.
Modified Models
B e c a u s e e c o n o m e t r i c m o d e l s are not d e s i g n e d s p e c i
f i c a l l y to d e a l w i t h e n e r g y p r i c e s h o c k s ,
they m a y not
s i m u l a t e the e c o n o m y ' s r e s p o n s e to t h e s e p r i c e s h o c k s w i t h
the s a m e p r e c i s i o n t h a t t h e y s i m u l a t e t h e e c o n o m y ' s " n o r m a l "
operation.
T h e D e p a r t m e n t of E n e r g y h a s m a d e e f f o r t s to
alter the stand a r d m o d e l s
21-496 0
83
27
( W h a r t o n a n d DRI)
to m a k e t h e m
414
m o r e s e n s i t i v e to t he e c o n o m i c r e s p o n s e s t h a t e c o n o m i c
t h e o r y p r e d i c t w i l l o c c u r w h e n e n e r g y p r i c e s rise.
28
M a n y of the a d j u s t m e n t s a r e w e l l - f o u n d e d .
That
is,
t he m o d e l s a s s u m e t h a t t he e c o n o m y is m o r e r i g i d t h a n it
a c t u a l l y is and,
impacts.
therefore,
the m o d e l s m a y o v e r e s t i m a t e the
For p u r p o s e s of c o m p a r i s o n ,
the r e s u l t s o f the
e c o n o m e t r i c m o d e l s in b o t h t h e i r m o d i f i e d a n d u n m o d i f i e d
forms have been included where they are available.
A t the s a m e time,
u t i l i z e d by DOE —
it s h o u l d be n o t e d t h a t o n e m o d e l
t he H u d s o n / J o r g e n s o n m o d e l —
r a d i c a l l y d i f f e r e n t f r o m the o t h e r m o d e l s .
29
is
It d o e s n o t
i n c l u d e a p r i c e - w a g e - p r i c e s p i r a l , w h i c h is a m a j o r e l e m e n t
o f t he o t h e r m o d e l s .
T h e e x c l u s i o n of the p r i c e - w a g e - p r i c e
spiral d a m p e n s the i n f l a t i o n a r y and o t her impacts c o m p a r e d
to the o t h e r m o d e l s a n d m a y l e a d to a n u n d e r e s t i m a t i o n of
t he i m p a c t s .
T h i s w i l l b e c o m e a p p a r e n t w h e n the r e s u l t s a r e
reviewed.
T h e a b o v e s t e p s , w h e n a p p l i e d to e a c h of t he a v a i l
able analyses,
s h o u l d l e a d to e s t i m a t e s o f t h e i m p a c t o f
n a t u r a l g a s p r i c e i n c r e a s e s t h a t a r e c o m p a r a b l e to o n e
another.
e.
An Adjusted Base Case
One a d d i t i o n a l m e t h o d o l o g i c a l p oint should be made.
A ll of t h e e c o n o m e t r i c a n a l y s e s e x a m i n e t h e i m p a c t of
a c c e l e r a t i n g or e x p a n d i n g the d e c o n t r o l of n a t u r a l g a s
b e y o n d t h e p r i c e inc r e a se s ^ t h a t a r e p r o g r a m m e d into the
415
N a t u r a l G a s P o l i c y Act,
Therefore,
which accelerated decontrol
steeply rising prices
the b a s e l i n e a g a i n s t
is m e a s u r e d i n c o r p o r a t e s f a i r l y
(see F i g u r e 1)
R i s i n g p r i c e s s u c h as
these would ha v e been negat i v e ec o n o m i c
own.
impacts of their
B y f o c u s i n g e x c l u s i v e l y o n a c c e l e r a t e d a nd e x p a n d e d
decontrol,
economic
it b e c o m e s all too e a s y to o v e r l o o k t he o v e r a l l
i m p a c t of r i s i n g n a t u r a l g a s p r i c e s .
If one
focuses on l y on a c c e l e r a t e d d econtrol, one can q u i c k l y lose
s i g h t of the f o r e s t b y l o o k i n g at the tr ee s.
For p u r p o s e s of e s t i m a t i n g t he o v e r a l l
i m p a c t of
r i s i n g n a t u r a l g a s p r i c e s on t he e c o n o m y , w e h a v e m a d e r o u g h
e s t i m a t e s of w h a t the m o d e l r e s u l t s w o u l d h a v e b e e n if t h e y
h a d b§en run w i t h a b a s e c a s e t h a t a s s u m e d f l a t real p r i c e s .
T h i s is n o t to s u g g e s t t h a t f l a t real e n e r g y p r i c e s a r e to
be e x p e c t e d .
Rather,
it is c o n v e n t i o n a l
in e s t i m a t i n g the
i m p a c t of p r i c e c h a n g e s to m e a s u r e t h e m a g a i n s t a b a s e c a s e
w h ich assu m e s flat prices.
In the s h o r t t e r m
e s t i m a t e as f o l l o w s :
(3 y e a r s ) , w e d e r i v e t he a d j u s t e d
the i m p a c t of a 100 p e r c e n t p r i c e
i n c r e a s e is m u l t i p l i e d b y 1.26,
r e f l e c t i n g the f a c t th a t D O E
p r o j e c t s a 26 p e r c e n t real p r i c e i n c r e a s e in g a s p r i c e s
u n d e r N G P A . 30
T h e a d j u s t m e n t in the s e c o n d t h r e e y e a r
p e r i o d a r e b a s e d o n e c o n o m e t r i c a n a l y s i s d o n e b y D O E o n the
i m p a c t of N G P A c o m p a r e d to a f l a t p r i c e b a s e c a s e . 31
l o n g e r p e r i o d s no a d j u s t m e n t f a c t o r is a v a i l a b l e .
For
416
FIGURE 1
AVERAGE WELLHEAD PRICES UNDER
THE NATURAL GAS POLICY ACT
1980 Dollars
per MCF
Department of
Energy Projections
6-
15W
"iwanr
Source: U.S. Department of Energy, A Study of Alternatives to the
Natural Gas Policy Act of 1978 (Office of Policy, Planning
and Analysis, Division of Energy Deregulation, November, 19 81)
p. 11.
417
4.
E s t i m a t e s of t he I m p a c t of
Natural Gas Decontrol
a•
Inflation
T a b l e 5 p r e s e n t s e s t i m a t e s of the i m p a c t of
d e c o n t r o l o n i n f l a t i o n as m e a s u r e d by c h a n g e s
in the G N P
deflator
i.
Short Term
T h e e s t i m a t e s for the i m p a c t of n a t u r a l g a s p r i c e
i n c r e a s e s o n i n f l a t i o n in the s h o r t run
100 p e r c e n t p r i c e
increase)
(3 y e a r
impact per
are q u i t e c o n s i s t e n t ,
all e s t i m a t e s fal l in a f a i r l y n a r r o w range.
T h a t is,
F or p a r t i a l
d e c o n t r o l the l o w e s t i m a t e is a n i n c r e a s e of 2.1 p e r c e n t a g e
p o i n t s a n d the h i g h e s t i m a t e an i n c r e a s e of 3.4 p e r c e n t a g e
p o i n t s.
The average
is 2.7 p e r c e n t a g e p o i n t s ,
decontrol analyses estimate similar
average
is s l i g h t l y l o w e r
impacts,
T h e full
a l t h o u g h the
(+2.2 p e r c e n t a g e p o i n t s )
This
w o u l d be a f u n c t i o n of the f a c t t h a t t h r e e of t he f i v e
m o d e l s in the f u l l d e c o n t r o l a n a l y s e s h a v e b e e n " m o d i f i e d "
by DOE and w o u l d n e c e s s a r i l y p r e d i c t smaller
Thus,
impacts,
a r a n g e of 2.2 to 2.7 p e r c e n t a g e p o i n t s a d d e d
to t he r a t e o f i n f l a t i o n for e v e r y 100 p e r c e n t g a s p r i c e
i n c r e a s e o v e r t h r e e y e a r s as a r e s u l t of a c c e l e r a t e d g a s
decontrol would seem reasonable.
In o t h e r w o r d s ,
annual
.9 p e r c e n t a g e p o i n t s
i n c r e a s e of b e t w e e n
7 and
an av e r a g e
in
the G N P d e f l a t o r c a n be e x p e c t e d for a n y d e c o n t r o l s c e n a r i o
w h i c h d o u b l e s pric e s over a three year period.
of t he r a n g e w o u l d be 2.5 p e r c e n t a g e p o i n t s o v e r
.8 p e r c e n t a g e p o i n t s p e r year.
The m i d p o i n t
3 y e a r s or
418
ESTIMATION OF THE IMPACT OF NATURAL GAS DECONTROL
ON INFLATION
(Measured by GNP Deflator)
Price Changes
(in %)
Change in Inflation
(Percentage points)
3 yr
5 yr
3 yr
6 yr
228
103
237
160
+7.8
+2.1
+4.8
.1
68
124
133
174
165
112
112
112
112
217
130
130
130
130
122
147
9 yr
Change in Inflation,
Standardized Basis
(per 100% price Increase)
6 yr
9 yr
3 yr
¡NATURAL GAS
Partial Decontrol
Wharton3
DOE 1/DRI Partial*3
DOE 2/DRI
Partial Modified
Average
Adjusted to Flat Base
POE
DOE
DOE
DOE
DOE
Full Decontrol
l/DRIb
2/DRI Modified0
2/DRI Modified0
2/Wharton (modified)0
2/HJ°
Average
Adjusted to Flat Base
+1.8
+3.7
+2.5
+2.5
+3.1
+1.6
+ .1
+1.2
+1.9
+1.9
+ .3
- .2
+
.8
+ .1
+ .1
+1.5
+ .8
+ .8
+ .1
- .3
+3.4
+2.1
+2.0
- .1
.4
+ ,1
+2.6
+ .1
+ .1
+2.7
+3.3
+ .7
+2.5
+4 .2
+ .2
+2.2
+2.2
+2.2
+2.8
+1.4
+1.5
+1.5
+1.5
+ .2
- .2
+ .7
+ ..6
+ .6
+ .1
- .2
+2.2
+2.7
.7
+2.5
+ .4
+ .4
November, 1981.
bU.S. Department of Energy, Reducing U.S. Oil Vulnerability, November 10, 1980,
Chapter II.
°U.S. Department of Ehergy, Macroeconomic Consequences of Natural Gas Decontrol,
November 1981. Attachment 1 describes the Hudson/Jorgenson Dynamic General
Equilibrium Model, referred to as DOE/HJ. Attachment 2 describes the DRI Model,
referred to as DOE 2/DRI and the modifications to it. Attachment 3 describes the
Wharton Model, referred to as DOT 2/Vfoarton, and the modifications to it.
419
ii.
Long Term
In the l o n g e r term,
more varied,
For e x a m p l e ,
the e s t i m a t e s b e c o m e s o m e w h a t
the e s t i m a t e s of s i x y e a r
impacts
of n a t u r a l g a s d e c o n t r o l o n i n f l a t i o n r a n g e f r o m -.1 p e r c e n
t a g e p o i n t s to + 2 . 0 p e r c e n t a g e p o i n t s .
p e r c e n t a g e points,
to t h e m e a n .
Thus,
T he a v e r a g e is + .7
the r a n g e is m u c h w i d e r c o m p a r e d
T h e s a m e is t r u e f or the f u l l d e c o n t r o l a n a l y
se s w h i c h h a v e a r a n g e of - . 2 to + 1 . 5 p e r c e n t a g e p o i n t s .
Here again,
t h e m e a n is .7.
T h e s i x y e a r i m p a c t a n a l y s i s s u g g e s t s t h a t the
i m p a c t of a c c e l e r a t e d d e c o n t r o l c o n v e r g e s to t h e N G P A b a s e .
T h a t is, t h e s p e c i f i c i m p a c t a s s o c i a t e d w i t h a c c e l e r a t i n g
decont ro l and extend in g
it to o t h e r c a t e g o r i e s o f g a s
a p p e a r s to h a v e a l a r g e i m p a c t in t h e e a r l y y e a r s ,
s m a l l e r i m p a c t in t h e l a t e r y e a r s .
but a
This occurs because
l a r g e p r i c e i n c r e a s e s w o u l d o c c u r in t h i s p e r i o d a n y w a y d ue
to t h e d e c o n t r o l of g a s p r i c e s p r o g r a m m e d i n t o N G P A .
the first six years,
w o u l d be ab o u t
Over
the i m p a c t s p e c i f i c to c h a n g i n g N G P A
.11 p e r c e n t a g e p o i n t s p e r y e a r a d d e d to the
rate of inflation.
T h i s w o u l d be in a d d i t i o n to t he i m p a c t
of N G P A .
Thus,
it is i m p o r t a n t to k e e p in m i n d t h a t the t o t a l
i m p a c t o f r i s i n g n a t u r a l g a s p r i c e s w o u l d be l a r g e r t h a n
percentage points.
case shows,
to a d d a b o u t
.11
A s t h e a n a l y s i s a d j u s t e d to a f l a t b a s e
the total
impact of rising gas pr i c e s wo u l d be
.5 p e r c e n t a g e p o i n t s to t h e r a t e of i n f l a t i o n
420
e v e r y y e a r for s i x y e a r s ,
cumulating
to m o r e t h a n 2.5
p e r c e n t a g e points.
In the n i n e y e a r p e r i o d ,
all t h e e c o n o m e t r i c m o d e l s
p r e d i c t t h a t the two p r i c e t r a j e c t o r i e s c o n t i n u e to
converge,
H o w e v e r , a l l b u t o n e of t he m o d e l s p r e d i c t t h a t
“h e a c c e l e r a t e d d e c o n t r o l p r i c e p a t h w i l l
N G P A p r i c e path.
r e m a i n a b o v e the
It w o u l d b e c o n s i d e r a b l y a b o v e a f l a t
p r i c e p a t h as F i g u r e 1 i n d i c a t e s ,
a l t h o u g h no e s t i m a t e is
available.
iii.
Modified Models
It m i g h t be n o t e d h e r e t h a t t he m o d i f i c a t i o n s to t he
D R I m o d e l a p p e a r to h a v e l i t t l e
th e
i m p a c t o n the e s t i m a t e s o f
i n f l a t i o n a r y i m p a c t of r i s i n g n a t u r a l g a s p r i c e s .
The
W h a r t o n model, which pred ic ts large i n f l a t io na ry impacts,
a p p e a r s to be m o r e a f f e c t e d b y the m o d i f i c a t i o n s .
other hand,
spiral
models.
O n t he
the mo d e l w h i c h e x c l u d e s a p r i c e - w a g e - p r i c e
(DOE, H/J)
behaves
r a t h e r d i f f e r e n t l y t h a n t he o t h e r
It p r e d i c t s m u c h s m a l l e r
T h i s o u t c o m e is a n o b v i o u s ,
i n f l a t io na ry impacts.
d i r e c t r e s u l t of t h e a s s u m p t i o n
of n o p r i c e - w a g e - p r i c e s p i r a l .
b.
Output
T a b l e 6 p r e s e n t s the e c o n o m e t r i c e s t i m a t e s o f the
l o s s o f o u t p u t d u e to a c c e l e r a t e d d e c o n t r o l o f n a t u r a l g a s .
T h e s e r e s u l t s a r e g e n e r a l l y as c o n s i s t e n t as t he r e s u l t s f or
inflation.
421
Table 5
ESTIMATION OF THE IMPACT OF NATURAL GAS DECONTROL
ON OUTPUT
(Measured as Change in GNP Deflator)
Prica Increase
Partial Decontrol
Wharton
DOE 1/DRI
DOE 2/DRI
DOE 2/HJ
Change in GNP
Change in GNP
Standardized Basis
(per 100% price Increase)
3 yr
6 yr
9 yr
3 yr
5 yr
3 yr
6 yr
9 yr
228
103
58
236
160
124
+2.0
-2.5
.8
.8
-1.7
.1
.4
.a
-1.6
.1
-2.4
-1.2
.3
-1.1
.1
.2
-1.0
.1
68
124
.6
.1
+ .4
.9
.1
+ .3
-1.35
-1.67
.4
-3.2
.3
.2
Average
Adjusted to Flat Base
Full Decontrol
DOE 1/DRI
165
217
-4.9
-4.0
-3.4
-3.0
-1.8
-1.6
DOE 2/DRI (unmodified)
DOE 2/DRI (modified)
112
112
130
-1.5
-1.4
-1.1
-1.8
-1.3
.9
-1.3
-1.3
.8
,7
-1.0
DOE 2/Wharton (modified)
DOE 2/HJ
112
112
130
130
-1.0
.8
.9
.7
,3
+ .2
.9
.6
.6
,7
.2
+ .2
-1.3
-1.6
- .8
-3.6
- .9
.9
Average
Adjusted to Flat Base
Source:
See Table 5.
130
-1.4
422
i,
Short Term
On a v e r a g e , G N P is p r e d i c t e d to be 1 . 3 5 p e r c e n t
lower dur i n g the first three years of a c c e l e r a t e d dec o n t r o l
(about
.4 p e r c e n t l o w e r per y e a r ) , if t he p r i c e i n c r e a s e
100 p e r c e n t in t h o s e t h r e e y ears,
fairly narrow:
is
T h e r a n g e of e s t i m a t e s
is
- .9 to - 2 . 4 7 p e r c e n t for p a r t i a l d e c o n t r o l
a n d - .6 to - 3 . 0 p e r c e n t for full d e c o n t r o l ,
m e n t to a f l a t b a s e c a s e w e r e m a d e ,
so me wh at larger.
If an a d j u s t
t he l o s s in G N P w o u l d be
The l o s s in G N P a d j u s t e d to a f l a t b a s e
w o u l d be b e t w e e n 1.6 and 1,7 p e r c e n t .
ii.
Long Term
T h e m o d e l s p r e d i c t a p a t t e r n of c h a n g e s
in o u t p u t
in
t h e s e c o n d p e r i o d t h a t is s i m i l a r to t h a t w h i c h h e l d for t he
b e h a v i o r of the i m p a c t o n i n f l a t i o n .
Accelerated decontrol
converges toward N GPA because NGPA triggers price increases
of its o w n in the s e c o n d t h r e e years.
However,
the a g g r e
g a t e l e v e l of o u t p u t u n d e r a c c e l e r a t e d d e c o n t r o l r e m a i n s
b e l o w t h a t of N G P A .
M o r e o v e r , w h e n t he l e v e l of o u t p u t
c o m p a r e d to a f l a t p r i c e t r a j e c t o r y ,
r i s i n g g a s p r i c e s is q u i t e l a r g e .
in t h e a g g r e g a t e o r a b o u t
is
t h e l o s s in G N P d u e to
It is 3.2 to 3.6 p e r c e n t
.6 p e r c e n t p e r year.
T h e l o n g e r t e r m b e h a v i o r of o u t p u t is s i m i l a r to
that of inflation.
T h e d e c o n t r o l a n d N G P A p a t h s c o n t i n u e to
c o n v e r g e in the t h i r d t h r e e y e a r p e r i o d .
they c o n v e r g e less rapidly.
However,
note that
T h a t is, the n e g a t i v e
impact on
G N P l i n g e r s l o n g e r a n d is l a r g e r t h a n t h e i n f l a t i o n a r y
423
impact.
F or e x a m p l e ,
by the t h i r d p e r i o d b e t w e e n e i g h t and
n i n e t e n t h s of the i n f l a t i o n a r y i m p a c t h a d w o r k e d its w a y
o u t of the e c o n o m y .
T h a t is, for p a r t i a l d e c o n t r o l ,
+ .3
p e r c e n t a g e p o i n t s r e m a i n in the t h i r d p e r i o d o u t of a + 2.7
p e r c e n t a g e p o i n t i m p a c t in the f i r s t t h r e e y e a r s .
decontrol,
decontrol.
For full
+ .4 o u t of + 2 . 2 p e r c e n t a g e p o i n t s for full
For GNP,
l e s s of the i m p a c t h a s b e e n m i t i g a t e d ,
O n l y b e t w e e n t h r e e - t e n t h s a nd s i x - t e n t h s o f t he i m p a c t h a s
worked
its w a y o u t of the e c o n o m y b y the t h i r d t h r e e y e a r
period
(-.3 p e r c e n t r e m a i n s in t he t h i r d p e r i o d o u t of - 1 . 3 5
p e r c e n t in the f i r s t p e r i o d for p a r t i a l d e c o n t r o l a nd - . 9
o u t of - 1 . 3 p e r c e n t for full d e c o n t r o l )
c.
Unemployment
T a b l e 7 p r e s e n t s the e s t i m a t e s of the i n c r e a s e in
u ne mp loyment that will result from a ccelerated decontrol.
T h e s e are the m o s t c o n s i s t e n t of the t h r e e i m p a c t s r e v i e w e d
he r e .
T h e r a n g e of e s t i m a t e s
i.
is t he n a r r o w e s t b y far.
Short Term
In the s h o r t t e r m
(3 y e ars)
accelerated decontrol
r e a s u l t i n g in a 100 p e r c e n t p r i c e i n c r e a s e is e s t i m a t e d to
i n c r e a s e t he r a t e of u n e m p l o y m e n t b y .5 p e r c e n t a g e p o i n t s —
or
.17 p e r c e n t p e r year.
centage points
T he r a n g e is f r o m
.3 to
.7 p e r
in the p a r t i a l d e c o n t r o l a n a l y s e s and
.9 p e r c e n t a g e p o i n t s for t he f ull d e c o n t r o l a n a l y s e s .
the e s t i m a t e is a d j u s t e d to a f l a t b a s e ,
the o v e r a l l
.3 to
If
424
ESTIMATION OF THE IMPACT OF NATURAL GAS DECONTROL
ON UNEMPLOYMENT
(Measured by Changes in the Unemployment Rate)
Price Changes
(in %)
Partial Decontrol
Wharton
DOE 1/DRI Partial
DOE 2/DRI
Change in
Unemployment
(Percentage points)
3 yr
5 yr
3 yr
6 yr
9 yr
228
103
68
236
160
124
+1.1
+ .7
+ .3
+ .6
+ .2
+ .4
+ .4
+ .2
+ .3
Average
Adjusted to Flat Base
DOE
DOE
DOE
DOE
Full Decontrol
1/DRI
2/DRI (unmodified)
2/DRI (modified)
2/Wharton (modified)
Average
Adjusted to Flat Base
Source:
See Table 5.
165
112
112
112
217
130
130
130
+1.5
+ .5
+ .5
+ .3
+
+
+
-
.8
.3
.3
.1
+ .7
+ .3
+ .3
0
Change in
Unemployment
Standardized Basis
(per 100% price Increase)
3 yr 6 yr
9 yr
+ .5
+ .7
+ .4
+ .3
+ .1
+ .3
+ .2
+ .1
+ .2
+ .5
+ .S
+ .2
+1.1
+ .2
+ .2
+
+
+
+
.9
.4
.4
.3
+ .4
+ .2
+ .2
.1
+ .3
+ .2
+ .2
0
+ .5
+ .6
+ .2
+1.1
+ .2
+ .2
425
increase
points,
in u n e m p l o y m e n t w o u l d be a b o u t
,6 p e r c e n t a g e
o r a b o u t + .2 p e r c e n t a g e p o i n t s p e r year.
i
i.
In t he l o n g e r run,
Longer Term
the p a t t e r n of c o n v e r g e n c e
b e t w e e n N G P A and d e c o n t r o l
is o b s e r v e d again,
ployment associated with accelerated decontrol
The
unem
is + . 2
percentage points
in t he s e c o n d t h r e e y e a r p e r i o d a n d + . 2
percentage points
in t h e t h i r d t h r e e y e a r p e r i o d .
the c a s e for the l o s s of o u t p u t ,
(four-tenths)
As w a s
a l a r g e p a r t o f the i n i t i a l
negative
impact
remains through the third
period.
A d j u s t e d to a f l a t b a s e ,
the i m p a c t is a s u s t a i n e d
+ . 2 p e r c e n t p er y e a r for the f i r s t s ix y e a r s .
d.
Conclusion
i,
Long Term
A n y c o n c l u s i o n a b o u t the m a c r o e c o n o m i c e f f e c t s of
nat u r a l gas d e c o n t r o l shou l d b e g i n wi t h an o b s e r v a t i o n about
t he l o n g e r t e r m impa c t s .
We have
i m p a c t of a c c e l e r a t e d d e c o n t r o l
r e m a r k e d t h a t the s p e c i f i c
"declines"
r e l a t i v e to the
N G P A b a s e in t h e l o n g e r t e r m b e c a u s e N G P A e m b o d i e s l a r g e r
p r i c e i n c r e a s e s of its o wn.
ously misleading
all,
T h i s o b s e r v a t i o n m a y be s e r i
if n o t k e p t in p r o p e r p e r s p e c t i v e .
the l a r g e a n d s i g n i f i c a n t
stemming
Above
impact of rising gas prices
f r o m N G P A i t s e l f m u s t n o t be o v e r l o o k e d .
426
C o m p a r e d to a b a s e c a s e of c o n s t a n t real g a s p r i c e s ,
a c c e l e r a t e d d e c o n t r o l p r o d u c e s a c o n s t a n t p a t t e r n of
negative economic
i m p a c t s o v e r all of the s ix y e a r s for
w h i c h a n a l y s i s is a v a i l a b l e .
It w o u l d c e r t a i n l y p r o d u c e
t h i s p a t t e r n for m o r e t h a n a deca d e .
As T a b l e 8 s h o w s ,
the i n f l a t i o n a r y i m p a c t s a r e v e r y
s h a r p in the f i r s t t h r e e y e a r s a n d t h e n d e c l i n e in the
s e c o n d t h r e e years.
per year,
F r o m a l e v e l of 1.1 p e r c e n t a g e p o i n t s
i n f l a t i o n a r y i m p a c t s w o u l d d r o p to
p o i n t s sp r e a d over six years.
p l o y m e n t i m p a c t s do n o t d e c l i n e
However,
.4 p e r c e n t a g e
t he G N P a n d u n e m
in the s e c o n d t h r e e y e a r s .
O n e c a n e x p e c t G N P to be r e d u c e d b y a b o u t
.6 p e r c e n t e a c h
y e a r for t h e f i r s t six y e a r s , w h i l e u n e m p l o y m e n t w i l l be
i n c r e a s e d b y .2 p e r c e n t a g e p o i n t s p e r y e a r .
i m p a c t s p e r 1 00 p e r c e n t p r i c e i n c r e a s e .
i n c r e a s e s a r e l i k e l y to be l a r g e r .
These are
The actual price
T h e a v e r a g e three year
i n c r e a s e p r o j e c t e d b y t he s t u d i e s r e v i e w e d a b o v e w o u l d be
c l o s e to 130 p e r c e n t a nd t h e f i v e y e a r i n c r e a s e w o u l d be
c l o s e to 1 7 5 p e r c e n t .
T h u s , an e x c e s s i v e c o n c e r n w i t h the i s o l a t i o n of the
specific
i m p a c t of a c c e l e r a t e d d e c o n t r o l m a y l e a d to a
m i s u n d e r s t a n d i n g of the u n d e r l y i n g
i s s u e of the o v e r a l l
impact of rising e n e r g y prices on the economy.
Rising
n a t u r a l g a s p r i c e s o n an a c c e l e r a t e d p a t h w i l l l e a d to
sustained negative
i m p a c t s t h a t w i l l a f f e c t t h e e c o n o m y for
t h e n e x t d e c a d e i n . m u c h the s a m e f a s h i o n as t h e o i l p r i c e
s h o c k o f t he p a s t d e c a d e .
For t he f i r s t six y e a r s ,
t he r a t e
427
Table 8
T H E A V E R A G E A N N U A L I M P A C T OF
RI SING N A T U R A L GAS PRICES
C ALC UL AT ED A G AI NS T A FLAT BASE
First 3 Years
First 6 Years
Inflation
Partial
+1. 1
+ .4
Fu l l
+ .9
+ .4
Partial
-
.6
- .5
Fu l l
- .5
-
.6
+ .2
+
.2
+ .2
+ .2
GNP
Unemployment
Partial
Full
Source:
C a l c u l a t e d f r o m T a b l e s 5-7.
428
of i n f l a t i o n w o u l d be r a i s e d b y + .7 p e r c e n t a g e p o i n t s p e r
y e a r , G N P w o u l d be d e c r e a s e d b y m o r e t h a n 1 p e r c e n t p e r y e a r
a n d u n e m p l o y m e n t w o u l d be I n c r e a s e d b y
.35 p e r c e n t a g e p o i n t s
p e r y e ar.
T h i s o b s e r v a t i o n s u g g e s t s t h a t the real f o c u s of the
a n a l y s i s of a c c e l e r a t e d d e c o n t r o l s h o u l d be o n the s h o r t
term.
T h a t is, D O E h a s r e c e n t l y c o n c l u d e d t h a t the s h o r t
t e r m i m p a c t s of a c c e l e r a t e d d e c o n t r o l a r e b a d b u t t h a t the
long term impacts are o n l y s l i g h t l y w o rse than NGPA.
t h i s is r e a l l y s a y i n g
What
is t h a t t h e l o n g t e r m e c o n o m i c f u t u r e
w i l l be d i m m e d b y r i s i n g g-as p r i c e s d u e to N G P A and t h a t
accelerated decontrol,
if it is p u s h e d t h r o u g h , w i l l d i m t he
n e a r t e r m e c o n o m i c f u t u r e as w e l l .
In o t h e r w o r d s ,
1985, N G P A w i l l d e p r e s s t he e c o n o m y .
T h e rea l
after
i s s u e is
w h e t h e r the i m p a c t w i l l be s t a r t e d e a r l i e r b y a c c e l e r a t i n g
d e c o n t r o l a n d i n c r e a s e d b y e x t e n d i n g d e c o n t r o l to m o r e
c a t e g o r i e s of n a t u r a l gas.
i i . Short Term
T u r n i n g to t he s h o r t run, T a b l e 9 p r e s e n t s a n u m b e r
o f p e r s p e c t i v e s o n the e s t i m a t e s o f t he i m p a c t o f d e c o n t r o l
of gas prices.
The a n a l y s i s focuses on a c c e l e r a t e d d e c o n
trol, as o p p o s e d to i m m e d i a t e ,
f ull d e c o n t r o l .
The mean
e s t i m a t e a n d the r a n g e of e s t i m a t e s for t h e a c c e l e r a t e d
de c o n t r o l analy s e s are shown.
In a d d i t i o n ,
f u l l d e c o n t r o l a n a l y s e s is s h o w n .
t h e m e a n for
F i n a l l y , an e s t i m a t e
429
Table 9
ESTIMATES OF THE SHORT RUN IMPACT OF
ACCELERATED DECONTROL
Phased Decontrol
Analysis
Mean of Full
Decontrol
Analysis
Adjusted Mean
of Oil
Analysis
Mean
Low
High
Inflation
(percentage
points)
+2.7
+2.1
+3.4
+2 .2
+2
Output
(percent)
-1.35
- .9
-2.4
-1.3
-1.27
Unemployment
(percentage pts)
+ .5
+ .3
+ .9
+ .5
Source:
Calculated from Tables 5-7 and Appendix B.
21-496 0 - 8 3 - 2 8
.6
430
b a s e d o n the e a r l i e r oil a n a l y s i s
is p r e s e n t e d ,
The c a l c u l
a t i o n o f t h e e s t i m a t e d e r i v e d f r o m t he o i l a n a l y s i s is
described
in A p p e n d i x B,
In the s h o r t term,
the m e a n of the p a r t i a l d e c o n t r o l
e s t i m a t e s is w e l l w i t h i n the l i m i t s o f all the o t h e r e s t i
mates.
Further,
c h o o s e s the m e a n ,
the r a n g e is q u i t e n a r r o w .
Thus,
if o n e
t h e s e r i e s of a n a l y s e s l e a d to e s t i m a t e s
in w h i c h o n e c a n h a v e c o n s i d e r a b l e c o n f i d e n c e .
Having s ettled on a basic impact e s t i m a t e —
i m p a c t p e r 100 p e r c e n t p r i c e i n c r e a s e —
i.e.,
we must next settle
o n t h e s i z e of t h e e x p e c t e d p r i c e i n c r e a s e .
T h a t is, a ll o f
t h e a n a l y s i s in t h i s s e c t i o n is b a s e d o n a 100 p e r c e n t p r i c e
incre a s e over the first three years.
In an e a r l i e r r e p o r t ,
C E C A / R F has estimated that a three year phased decontrol
w o u l d l e a d to a 1 3 3 p e r c e n t p r i c e i n c r e a s e .
32
In a d d i t i o n ,
it t u r n s o u t t h a t t h i s is the m e a n of the e s t i m a t e s c o n
t a i n e d in the a n a l y s e s r e v i e w e d a b o v e .
Thus, the stand a r d
i m p a c t s e s t i m a t e d a b o v e s h o u l d be s c a l e d u p b y a f a c t o r of
1.33.
T h e r e s u l t i n g e s t i m a t e f o r the s h o r t t e r m w o u l d be
a n i n c r e a s e of 3.6 p e r c e n t a g e p o i n t s in t h e G N P d e f l a t o r ,
d e c r e a s e of 1.9 p e r c e n t in G N P a n d an i n c r e a s e of
p e r c e n t a g e p o i n t s in u n e m p l o y m e n t .
Furthermore,
a
.7
based on
t h e e a r l i e r e s t i m a t e s w e c a n p r o j e c t t h a t t he i m p a c t o n the
C P I w i l l be 1.5 t i m e s as g r e a t as t h e i m p a c t o n t h e G N P
deflator.
Therefore,
t h e CPI w o u l d i n c r e a s e b y a b o u t 5.4
431
p e r c e n t a g e points.
the a v e r a g e a n n u a l
These are three year impacts,
so t h a t
i m p a c t w o u l d be as f o l l o w s :
GNP Deflator
C PI
Unemployment
GNP
+1.2
+1.8
+ ,2
- .6
percentage points
percentage points
percentage points
percent
G i v e n w h a t we h a v e n o t e d a b o v e w i t h r e s p e c t to the
o v e r a l l i m p a c t of g a s p r i c e s , w e w o u l d e x p e c t the u n e m p l o y
m e n t and G N P i m p a c t s to c o n t i n u e at a b o u t the s a m e l e v e l for
the m i d - t e r m at l e a s t .
T he i n f l a t i o n a r y i m p a c t w o u l d r e c e d e
in the s e c o n d t h r e e y e a r p e r i o d .
432
FOOTNOTES
B a s i c , t e c h n i c a l d i s c u s s i o n s of the i m p a c t of e n e r g y
p r i c e s c a n be f o u n d in the f o l l o w i n g a r t i c l e s :
R.J. G o r d o n ,
" A l t e r n a t i v e R e s p o n s e s of P o l i c y to E x t e r n a l S u p p l y S h o c k s , "
B r o o k i n g s P a p e r s o n E c o n o m i c A c t i v i t y 1 ( W a s h i n g t o n , DC:
T he
B r o o k i n g s I n s t i t u t e , 1 975)? E. P h e l p s , " C o m m o d i t y S u p p l y
S h o c k s and F u l l E m p l o y m e n t M o n e t a r y P o l i c y , " J o u r n a l of M o n e y
C r e d i t a nd B a n k i n g 10, Not 2 (1978); W i l l i a m N o r d h a u s , "Oil
a n d E c o n o m i c P e r f o r m a n c e in I n d u s t r i a l C o u n t r i e s , " B r o o k i n g s
P a p e r s o n E c o n o m i c A c t i v i t y 2 (1980) . S o m e w h a t m o r e
a c c e s s i b l e d i s c u s s i o n s c a n be f o u n d in R o b e r t S. D o h n e r ,
" E n e r g y P r i c e s , E c o n o m i c A c t i v i t y a n d I n f l a t i o n ; a S u m m a r y of
I s s u e s and R e s u l t s , " in E n e r g y P r i c e s , I n f l a t i o n and E c o n o m i c
A c t i v i t y , K. M o r k , ed. ( C a m b r i d g e : M I T Pre s s , 1 981); R o b e r t
S. G o r d o n , " P o s t w a r M a c r o e c o n o m i c s :
T h e E v o l u t i o n of E v e n t s
a n d I d e a s , " in T h e A m e r i c a n E c o n o m y in T r a n s i t i o n , ed, M a r t i n
F e l d s t e i n ( C hicago:
C h i c a g o U n i v e r s i t y P r e s s , 1981).
2
T he b e n e f i t s of a c c o m m o d a t i v e r e s p o n s e s h a v e b e e n
n o t e d b y Gordon, P h e l p s , op. c i t . , as w e l l as E, G r a m l i c h ,
" M a c r o P o l i c y R e s p o n s e s to P r i c e S h o c k s , " B r o o k i n g s P a p e r s on
E c o n o m i c A c t i v i t y 1 ( W a s h i n g t o n , DC: T h e B r o o k i n g s I n s t i t u t e ,
1 9 7 9 ) ; K, M o r k a n d R. Hal l , " M a c r o e c o n o m i c A n a l y s i s of E n e r g y
P r i c e S h o c k s a nd O f f s e t t i n g P o l i c i e s ; a n I n t e g r a t e d
A p p r o a c h , " in K. M o r k , E n e r g y P r i c e s .
^U.S. D e p a r t m e n t of E n e r g y (M a c r o e c o n o m i c C o n s e
q u e n c e s of N a t u r a l G a s D e c o n t r o l [ W a s h i n g t o n , DC: G o v e r n m e n t
P r i n t i n g O f f i c e , 198 1 ] , p. 23) n o t e s i n t e r e s t r a t e s e x p l i c i t y
as do T h u r m a n a n d B e r n e r , " A n a l y s i s o f O i l P r i c e S h o c k s i n
t h e M P S M o d e l , " in K. M o r k , E n e r g y P r i c e s .
4
E m p i r i c a l l y , e s t i m a t e s t y p i c a l l y v a r y b y a f a c t o r of
t wo in t he m a g n i t u d e of p r o j e c t e d i m p a c t s .
N o r d h a u s , ("Oil
a n d E c o n o m i c P e r f o r m a n c e , " p. 346) s t a t e s t h a t th e i m p a c t m a y
l a s t f r o m o n e to fou r d e c a d e s for t he lon g run.
5 T h e i m p a c t of r i s i n g e n e r g y p r i c e s o n p r o d u c t i v i t y
has received considerable attention.
D i s c u s s i o n of s p e c i f i c
a s p e c t s of this impact by those who est i m a t e small impacts
c a n be f o u n d in G e o r g e L. P e r r y , " P o t e n t i a l O u t p u t :
Recent
I s s u e s a n d P r e s e n t T r e n d s , " B r o o k i n g s R e p r i n t 336 ( W a s h i n g
t on, DC:
The
B r o o k i n g s I n s t i t u t e , 1978); E. D e n i s o n ,
" E x p l a n a t i o n s o f D e c l i n i n g P r o d u c t i v i t y G r o w t h , " S u r v e y of
C u r r e n t B u s i n e s s 59 (1979); W i l l i a m F e l l n e r , " T h e D e c l i n i n g
G r o w t h of A m e r i c a n P r o d u c t i v i t y :
A n I n t r o d u c t o r y N o t e , " in
N o r d h a u s , ed. C o n t e m p o r a r y E c o n o m i c P r o b l e m s (1979).
T h o s e w h o e s t i m a t e the i m p a c t of r i s i n g e n e r g y p r i c e s
to be l a r g e i n c l u d e R. R a s c h e and J. T a t o m , " E n e r g y P r i c e s
a n d P o t e n t i a l G N P " a n d "The E f f e c t s o f the N e w E n e r g y R e g i m e
433
and E c o n o m i c C a p a c i t y , P r o d u c t i o n and P r i c e s , " F e d e r a l
R e s e r v e B a n k of St. L o u i s R e v i e w (1977); D a l e W. J o r g e n s o n ,
" E n e r g y P r i c e s a nd P r o d u c t i v i t y G r o w t h , " D a t a R e s o u r c e s Inc.
(1979); E.A. H u d s o n a n d D.W. J o r g e n s o n , " E n e r g y P r i c e s a n d
thé U.S. E c o n o m y 1 9 7 2 - 1 9 7 6 , " N a t u r a l R e s o u r c e s J o u r n a l 18
(1978); J. T a t o m , " E n e r g y P r i c e s a n d C a p i t a l F o r m a t i o n " and
" The P r o d u c t i v i t y P r o b l e m , ” F e d e r a l R e s e r v e B a n k of St. L o u i s
R e v i e w (1979); M a r t i n N e i l B a i l y , " P r o d u c t i v i t y a n d the
S e r v i c e s of C a p i t a l a n d L a b o r , " B r o o k i n g s P a p e r o n E c o n o m i c
A c t i v i t y 1 (1981).
6 T h e r e is l i t t l e d i s a g r e e m e n t o n the c o n c e p t u a l
c a u s e s of d e c l i n i n g p r o d u c t i v i t y .
R a t h e r , the d i s a g r e e m e n t
c e n t e r s o n the e l a s t i c i t y of s u b s t i t u t i o n b e t w e e n e n e r g y and
o t h e r f a c t o r s of p r o d u c t i o n w h i c h l e a d s to d i s a g r e e m e n t a b o u t
h o w big the i m p a c t is and h o w l ong it lasts.
An i n t e r e s t i n g
e x e r c i s e to d e m o n s t a t e t he s t r i k i n g d i f f e r e n c e in the i m p a c t
on G N P d e p e n d i n g on the a s s u m p t i o n s m a d e a b o u t t he e l a s t i c i t y
of s u b s t i t u t i o n h a s b e e n c o n d u c t e d b y W. H o g a n a n d A l a n
Manne, " E n e r g y - E c o n o m i c I n t e r a c t i o n s :
T h e F a b l e of 'The
E l e p h a n t a n d the R a b b i t ' , " in A d v a n c e s in the E c o n o m i c s of
Energy and Resources:
T h e S t r u c t u r e of É n e r g y M a r k e t s ,
V o l u m e I, ed. R o b e r t S. P i n l y c k ( C o n n e c t i c u t : u ÀÏ, 1979)
^ K e n n e t h A r r o w a n d J o s e p h K a l t (P e t r o l e u m P r i c e
R e g u l a t i o n : S h o u l d W e D e c o n t r o l ? [ W a s h i n g t o n , DC:
American
E n t e r p r i s e I n s t i t u t e , 1979]) e s t a b l i s h an a n a l y t i c f r a m e w o r k
for s t u d y i n g e f f i c i e n c y g a i n s .
G l e n n C. L o u r y (A n A n a l y s i s
of the E f f i c i e n c y a n d I n f l a t i o n a r y I m p a c t o f t h e ~ D e c o n t r o l of
N a t u r a l G a s P r i c e s [ W a s h i n g t o n , DC: N a t u r a l G a s S u p p l y
A s s o c i a t i o n , A p r i l 1981]) a p p l i e s the a r g u m e n t to n a t u r a l
gas, as d o e s DOE, T w o - M a r k e t A n a l y s i s o f N a t u r a l G a s
D e c o n t r o l ( W a s h i n g t o n , DC: G o v e r n m e n t P r i n t i n g O f f i c e ,
N o v e m b e r 1981 ) .
R o d n e y T. S m i t h ("In S e a r c h o f 'Just' U.S.
Oil P o l i c y :
A R e v i e w o f A r r o w , K a l t a nd M o r e , " J o u r n a l of
B u s i n e s s 54 [1981]: 11) t a k e s t h e A r r o w / K a l t a p p r o a c h b u t
r e a c h e s r a t h e r d i f f e r e n t c o n c l u s i o n s t h a n t h e y d i d a b o u t the
most equitable policy.
p
S u b c o m m i t t e e o n O v e r s i g h t and I n v e s t i g a t i o n s of the
Committee on Interstate and Foreign Commerce, United States
H o u s e of R e p r e s e n t a t i v e s , T h e E n e r g y I n f l a t i o n C r i s i s :
S o u r c e s , C o n s e q u e n c e s a n d P o l i c y O p t i o n s ( W a s h i n g t o n , DC :
G o v e r m e n t P r i n t i n g O f f i c e , D e c e m b e r 1980), p. 13.
g
D OE , T h e I n t e r r e l a t i o n s h i p o f E n e r g y a n d the
E c o n o m y : A S u p p l e m e n t to the N a t i o n a l E n e r g y P o l i c y P l a n
( W a s h i n g t o n , DC: G o v e r n m e n t P r i n t i n g O f f i c e , J u l y 198 1 ) .
I d i d . , p. 23.
S e e also, O t t o E c k s t e i n , " S h o c k
I n f l a t i o n , C o r e I n f l a t i o n a n d E n e r g y D i s t u r b a n c e s " in E.
M o r k , ed., E n e r g y P r i c e s , pp. 78- 7 9 .
434
1 2
DO E , T he I n t e r r e l a t i o n s h i p , p. 24; E c k s t e i n ,
I n f l a t i o n , " pp. 76-79.
^ S e e Denison, " Exp la nations;" Tatom,
and Baily, "Productivity."
14
Eckstein,
S e e DOE, T h e I n t e r r e l a t i o n s h i p , pp.
" S h o c k I n f l a t i o n , " pp. 78-79.
1 5 DOE, T h e I n t e r r e l a t i o n s h i p ,
" S h o c k Inflation,*' pp. 78-79.
"Shock
Energy Prices
2 1 - 2 3 and
p. 19 a n d E c k s t e i n ,
^ D O E , T h e I n t e r r e l a t i o n s h i p , p. 6 a n d N o r d h a u s ,
a n d E c o n o m i c P e r f o r m a n c e , " p. 370.
"Oil
1 7 U.S. E x e c u t i v e O f f i c e , E c o n o m i c R e p o r t o f the
P r e s i d e n t , 1 981 ( W a s h i n g t o n , DC: G o v e r n m e n t P r i n t i n g O f f i c e ,
J a n u a r y 1 ^ 8 1 ) , p. 51.
1 8 Ibid . , p. 190.
S i m i l a r l y , M o r k a nd H a l l ,
M a c r o economic A n a l y s i s , show that accommodative policies can
e a s i l y a b s o r b h a l f o f t he m a c r o e c o n o m i c i m p a c t of the p r i c e
shock•
19
O t t o E c k s t e i n (T h e G r e a t R e c e s s i o n :
With a
P o s t s c r i p t o n S t a g f l a t i o n [New Y o r k : N o r t h H o l l a n d , 1 9 7 8 ] , p.
5) h a s c a l l e d e c o n o m e t r i c m o d e l i n g " an e x e r c i s e in
contemporary cliometrics."
C l i o m e t r i c s c a n be d e f i n e d as the
s t u d y of e c o n o m i c h i s t o r y t h r o u g h the c o n s t r u c t i o n of
q u a n t i t a t i v e , c o n t r a f a c t u a l s c e n a r i o s wh i c h test the ca u s a l
i m p o r t a n c e of s p e c i f i c h i s t o r i c a l f a c t s .
F o r e x a m p l e , if_
t h e r e h a d b e e n no e n e r g y p r i c e i n c r e a s e in 1 9 7 9 - 8 0 , w h a t
w o u l d t he c o u r s e o f e c o n o m i c a c t i v i t y h a v e b e e n .
Clio
m e t r i c s , as an a p p r o a c h to e c o n o m i c h i s t o r y , h a s b e e n t h e
s u b j e c t of c o n s i d e r a b l e c o n t r o v e r s y .
O n e of the m o s t
i m p o r t a n t c o n t r o v e r s i e s c e n t e r s on the s p e c i f i c a t i o n of the
c o u n t e r f a c t to be t e s t e d .
If o n e s p e c i f i e s t h e i n c o r r e c t
c o u n t e r f a c t , t he a n a l y s i s l o s e s its l o g i c a l b a s i s (see, f or
example, S tefano Fenoalta, "The D i s c i p l i n e and Theory: N otes
on C o n t r a f a c t u a l M e t h o d o l o g y and the N e w Ec o n o m i c History,"
J o u r n a l o f E u r o p e a n E c o n o m i c H i s t o r y , 2:3.
In t h i s c a s e , t he
f a i l u r e to t a k e a c c o u n t of m o n e t a r y p o l i c y m a y b e a
m i s s p e c i f i c a t i o n of the c o u n t e r f a c t if e n e r g y p r i c e s a nd
r e s t r i c t i v e m o n e t a r y p o l i c y are inseparable.
20
E c k s t e i n , T h e G r e a t R e c e s s i o n , C h a p t e r 9 a n d DOE,
T h e I n t e r r e l a t i o n s h i p , T a b l e s 2 a n d 3.
21
DOE, T h e I n t e r r e l a t i o n s h i p , T a b l e s 2 a n d 3.
2 3 I b i d . , pp.
19-22.
435
L
24
T h e C o n s u m e r E n e r g y C o u n c i l of A m e r i c a R e s e a r c h
F o u n d a t i o n , C r u d e Oil P r i c e D e c o n t r o l a n d the Poor;
A Social
P o l i c y F a i l u r e y p r e p a r e d for the S u b c o m m i t t e e o n I n v e s t m e n t /
J o b s a n d P r i c e s of the J o i n t E c o n o m i c C o m m i t t e e , F e b r u a r y
1982/ T a b l e II-4.
25
C o n s u m e r E n e r g y C o u n c i l of A m e r i c a R e s e a r c h
F o u n d a t i o n , P a s t as P r o l o g u e I:
T h e U n d e r e s t i m a t i o n of P r i c e
I n c r e a s e s in t h e D e c o n t r o l D e b a t e :
A C o m p a r i s o n of Oil a n d
N a t u r a l G a s ( W a s h i n g t o n , DC, F e b r u a r y 1982).
26
T h i s a s s e r t i o n is d e r i v e d b y t a k i n g a w e i g h t e d
a v e r a g e of t he e l a s t i c i t i e s of n a t u r a l g a s in its t w o p r i m a r y
end^juse— c a t e g o r i e s — r e s i d e n t i a l a n d i n d u s t r i a l — a nd
^ c o m p a r i n g it to the w e i g h t e d a v e r a g e of the e l a s t i c i t i e s of
oil in its t h r e e p r i m a r y end u s e c a t e g o r i e s — r e s i d e n t i a l ,
industrial and transportation.
The data are taken from
L e s t e r D. T a y l o r , " T h e D e m a n d for E n e r g y : A S u r v e y of P r i c e
a n d I n c o m e E l a s t i c i t i e s , " in W i l l i a m D. N o r d h a u s , ed.,
I n t e r n a t i o n a l S t u d i e s of t he D e m a n d for E n e r g y (New York:
N o r t h H o l l a n d , 1977) a n d R o b e r t S. P i n d y c k , T h e S t r u c t u r e of
W o r l d E n e r g y D e m a n d ( C a m b r i d g e : M I T Pres s , 1979) . f h e o n l y
two s o u r c e s t h a t e s t i m a t e d the e l a s l t i c i t i e s f or t he full
r a n g e of u s e s of e a c h fuel y i e l d the r e s u l t s c o n t a i n e d in the
f o l l o w i n g t a b l e , w h i c h l e a d s to the c o n c l u s i o n t h a t the
a g g r e g a t e e l a s t i c i t i e s of o il a n d n a t u r a l g a s a r e r o u g h l y
eq u a l .
O t h e r s t u d i e s s h o w e s s e n t i a l l y the s a m e r e l a t i o n s h i p
b e t w e e n the two f u e l s , b u t t h e y do n o t c o v e r the full r a n g e
of e n d - u s e s of e a c h o f the f uels.
Federal Energy
Administration
OIL
Residential
Industrial
Private Gasoline
- .07
Pyndick
- .49
- 1 . 1 0 to
1.38
- 1 . 0 3 to - 1 . 1 1 7
-1.03
GAS
Residential
Industrial
-1.26
- .58
- 1 . 2 8 to - 2 . 0 9
- .41 to - .67
Average
Oil
Gas
- .70
- .85
-1.06
- 1 .09
-
1.01
F e d e r a l E n e r g y A d m i n i s t r a t i o n , N a t i o n a l E n e r g y O u t l o o k : 1976
( F e b r u a r y 197 6 ) , as d e s c r i b e d in T a y l o r , pp. 21, 24,
$2.
Pyndick,
pp.
16,
222,
241.
436
27
D a t a f r o m t he A m e r i c a n P e t r o l e u m I n s t i t u t e (M a r k e t
S h a r e s a n d I n d i v i d u a l C o m p a n y D a t a , 1 9 5 0 - 1 9 7 9 , O c t o b e r 30,
1980) s h o w s t h a t t he 16 l a r g e s t o w n e r s o f c r u d e o i l r e s e r v e s
p o s s e s s 67 p e r c e n t o f a ll d o m e s t i c r e s e r v e s .
T h e s a m e 16
c o m p a n i e s o w n 50 p e r c e n t of all d o m e s t i c g a s r e s e r v e s .
As
f or the c l o s e n e s s of t e c h n o l o g y , w e n e e d o n l y n o t e t h a t
i n d u s t r y s o u r c e s t r e a t o il a n d g a s d r i l l i n g as v i r t u a l l y
i d e n t i c a l w h e n t h e y d i s c u s s the a l l o c a t i o n of r i g s b e t w e e n
the two fuels,
A s for t h e g e o g r a p h i c c o n c e n t r a t i o n of
p r oduction, we can note that five s t ates (Oklahoma, Texas,
L o u i s i a n a , N e w M e x i c o and C a l i f o r n i a ) a c c o u n t e d for 64
p e r c e n t of all d o m e s t i c o i l p r o d u c t i o n in 1 9 8 0 a n d 82 p e r c e n t
of all g a s p r o d u c t i o n in 1979.
T h ese states c o n s t i t u t e less
t h a n 20 p e r c e n t of the t o t a l a r e a o f t h e U.S.
28
T h e m o d i f i c a t i o n s e n t a i l (1) a d j u s t i n g p o t e n t i a l G N P
u p w a r d in the D R I m o d e l to r e f l e c t D O E ' s a s s u m p t i o n o f
r e d u c e d real r e s o u r c e c o s t s in a c q u i r i n g the s a m e q u a n t i t y of
g a s (see p a g e __ above) a n d (2) a l t e r i n g the i n p u t / o u t p u t
m a t r i x in the W h a r t o n m o d e l to a l l o w for i n c r e a s e d c o n s u m p
t i o n of n a t u r a l g a s in t h e i n d u s t r i a l s e c t o r w h e n d e c o n t r o l
occurs, reflecting DOE's a rgument that industrial users were
h e l d b e l o w their o p t i m u m c o n s u m p t i o n of gas by c u r t a i l m e n t s
a n d o t h e r r e s t r i c t i o n s (Fuel U s e A c t ) .
29
S ee C o n s u m e r E n e r g y C o u n c i l of A m e r i c a R e s e a r c h
Foundation, Natural Gas Price Deregulation:
A C a s e of
T r i c k l e - U p E c o n o m i c s for a ful l d e s c r i p t i o n of o n e o f t he
major differences.
30
DOE, T w o M a r k e t A n a l y s i s of N a t u r a l G a s D e c o n t r o l
( N o v e m b e r 1981) A t t a c h m e n t IV.
437
Appendix A
T H E O R E T I C A L E F F I C I E N C Y G A I N S A N D LOSSES
F R O M D E C O N T R O L L I N G E N E R G Y PRICES
A.
Introduction
S i n c e e a r l y 1979, the d i s c u s s i o n of the d e c o n t r o l of
e n e r g y p r i c e s h a s b e c o m e i n c r e a s i n g l y r i g o r o u s and t h e o r e t i
cal.
A n u m b e r of a u t h o r s hav e a t t e m p t e d to c o n c e p t u a l i z e the
p o t e n t i a l b e n e f i t s and c o s t s of d e c o n t r o l . 1
Unfortunately,
the c o n c e p t u a l i z a t i o n s are f r e q u e n t l y d i f f i c u l t to reconcile.
Some a u t h o r s a d d r e s s o n l y c e r t a i n p o t e n t i a l b e n e f i t s , o t h e r s
a d d r e s s o n l y c e r t a i n costs.
sector.
S o m e o n l y a n a l y z e the e n e r g y
O t h e r s a d d r e s s o n l y n o n - e n e r g y sectors.
A m i d this c o n f u s i o n , the m i s c o n c e p t i o n h as b een
c r e a t e d that d e c o n t r o l , of n e c e s s i t y , leads to e f f i c i e n c y
g a i n s in the eco n o m y .
In fact, that is not the case.
A l t h o u g h the r e is a h i g h l i k e l i h o o d t h a t there w i l l be some
e f f i c i e n c y g a i n s in the d o m e s t i c e n e r g y sector, and some
p o s s i b i l i t y that there w i l l be r e s o u r c e g a i n s in the i n t e r
n a t i o n a l sector, t h ere is also a v e r y h i g h l i k e l i h o o d th at
there wil l be r e s o u r c e and e f f i c i e n c y l o s s e s in d o m e s t i c
n o n - e n e r g y secto r s .
T h e o r y is c o m p l e t e l y s i l e n t o n w h e t h e r
the g a i n s w i l l b e l a r g e r than the losses.
T h e u l t i m a t e impact of d e c o n t r o l d e p e n d s on a n u m b e r
of e m p i r i c a l , n ot t h e o r e t i c a l , i s s ues.
W h a t is the m a g n i t u d e
of the pri c e e l a s t i c i t y of s u p p l y and d e m a n d for e n e r g y ?
438
W h a t is the e l a s t i c i t y of s u b s t i t u t i o n b e t w e e n e n e r g y and
o t h e r inputs
(factors of p r o d u c t i o n ) ?
The bulk of the
e m p i r i c a l e v i d e n c e s u g g e s t s that the b o t t o m line impact on
e f f i c i e n c y is negat i v e , not positive.
Thus, the b e l i e f that
d e c o n t r o l leads to e f f i c i e n c y g a i n s in the e c o n o m y is not
o n l y t h e o r e t i c a l l y unfoun d e d ,
it a p p e a r s to be e m p i r i c a l l y
i n c o r r e c t as well.
S e v e r a l of these issues h a v e b e e n a d d r e s s e d in
e a r l i e r s t u d i e s c o n d u c t e d by the C o n s u m e r E n e r g y C o u n c i l of
2
America Research Foundation.
In this A p p e n d i x , we p r e s e n t a
brief, p r e l i m i n a r y ,
formal d i s c u s s i o n of the s ubject.
The
o b j e c t i v e is to s t i m u l a t e f u r t h e r c a r e f u l t h i n k i n g a b o u t the
e f f i c i e n c y i m p l i c a t i o n s of d e c o n t r o l and, t hereby, to c l e a r
u p some of the c o n f u s i o n .
E f f i c i e n c y G a i n s in the E n e r g y S e c t o r
1.
Arrow/Kalt:
M a r k e t s at E q u i l i b r i u m
with Inefficiencies
T h e b a s i c lines of d i s c u s s i o n of e f f i c i e n c y g a i n s
s e e m to h a v e b e e n laid d o w n by A r r o w and Kalt.
t i f i e d two p o t e n t i a l g a i n s fro m d e c o n t r o l .
They iden
A c c o r d i n g to
the i r a r gument, c o n t r o l l e d or s u b s i d i z e d p r i c e s lead
s u p p l i e r s to p r o d u c e less and c o n s u m e r s to d e m a n d m o r e e n e r g y
t han t h e y w o u l d at d e c o n t r o l l e d prices.
Two types of
i n e f f i c i e n c y r e s u l t i n g fro m c o n t r o l s and, theref o r e , two
p o t e n t i a l e f f i c i e n c y g a i n s f rom d e c o n t r o l c an be i d e n t i f i e d .
T h r o u g h o u t the a n a l y s i s we use the terms i n e f f i c i e n c y (due to
439
controls)
decontrol)
and e f f i c i e n c y g a i n s
(potentially achievable with
interchangably.
S u p p l y side i n e f f i c i e n c y is d e f i n e d as the d i f f e r e n c e
b e t w e e n the p r ice we pay
(P^) for s u p p l i e s of e n e r g y in
e xc e s s of the q u a n t i t y of e n e r g y (Qg ) d o m e s t i c s u p p l i e r s are
w i l l i n g to p r o d u c e at the c o n t r o l l e d p r i c e (Pg ) and the
d o m e s t i c r e s o u r c e s that w o u l d h a v e bee n u t i l i z e d d o m e s t i c a l l y
to p r o d u c e that e n e r g y (see F i g u r e A.l).
c o n t a i n e d in t r i a n g l e ABC.
This is the area
T h a t is, the pri c e we p a y for
e n e r g y is a w o r l d price, but the m a r g i n a l cos t of d o m e s t i
c a l l y p r o d u c e d e n e r g y is d e f i n e d by the s u p p l y c u r v e
The d i f f e r e n c e is a p o t e n t i a l e f f i c i e n c y gain.
(S q S q )
We can
d e c r e a s e the import bill and h o l d the r e s o u r c e s in the
d o m e s t i c e c o n o m y b y a l l o w i n g the p r i c e to rise to the w o r l d
level.
T his s h i f t of r e s o u r c e s is t a n t a m o u n t to an i n c r e a s e
in d o m e s t i c p r o d u c e r s u r p l u s
(as c l a s s i c a l l y defined)
^
C o n s u m e r s u r p l u s is u n a f f e c t e d .
D e m a n d side i n e f f i c i e n c y is d e f i n e d as the d i f f e r e n c e
b e t w e e n the p r i c e a c t u a l l y paid for e n e r g y and the v a l u e that
c o n s u m e r s p l a c e on energy.
T h i s is the are a in t r i a n g l e ADE.
That is, b e c a u s e c o n s u m e r s "see" a p r i c e that is l ower than
the n a t i o n a c t u a l l y pays, the y c o n s u m e e n e r g y b e y o n d that
p o i n t w h e r e its u t i l i t y ( e x pressed in the d e m a n d c u r v e
[Dq D q ] ) w o u l d j u s t i f y that c o n s u m p t i o n at the real price.
The d i f f e r e n c e b e t w e e n the w o r l d p r i c e of e n e r g y and its
u t i l i t y is a p o t e n t i a l e f f i c i e n c y gain.
if c a p t u r e d t h r o u g h d e c o n t r o l ,
H o w ever, n o t e t h a t
this e f f i c i e n c y g a i n w o u l d
440
FIGURE A .1
ARROW/KALT:
B A SI C S U P P L Y A ND D E M A N D - S I D E
POTENTIAL EFFICIENCY GAINS
Supplv-side Inefficiency
(i.e. r e s o u r c e s p a i d for
i m p o r t s t hat c o u l d h a v e
been captured by domestic
s u p p l i e r s as a d d i t i o n a l
p r o d u c e r surplus)
Demand-side
Inefficiency
(i.e. loss of
v a l u e to the
e c o n o m y d u e to
c o n s u m p t i o n of
energy beyond
the p o i n t of
its r e a l price,
i.e. e c o n o m i c ,
value)
Quantity
Source: K e n n e t h J< A r r o w a n d J o s e p h P. Kalt, P e t r o l e u m
P r i c e R e g u l a t i o n : S h o u l d W e D e c o n t r o l ? (Washington,
D.C., A m e r i c a n E n t e r p r i s e I n s titute, 1979), pp. 9-27,
441
c a u s e a d e c l i n e in c o n s u m e r surp l u s , as c l a s s i c a l l y defined.
4
The loss w o u l d be equ a l to the area b o u n d e d by ADFG.
2,
Arrow/Kalt:
M o r e S u p p l y Side
Inefficiencies
T h e s e w e r e the bas i c e f f i c i e n c y g a i n s that A r r o w / K a l t
d i s c u s s e d and q u a n t i f i e d c a r e f u l l y .
other potential gains
Howev e r ,
(see Fig u r e A . 2)
t hey als o not e d
If the impo r t p r i c e
d o es not r e f l e c t the full soc i a l c o s t of imports
(e.g., if
there are e x t e r n a l c o s t s of imp o r t s such as n a t i o n a l s e c u r i t y
costs)
then the w o r l d p r i c e is "too low."
c u r v e is r e a l l y d e f i n e d by HS^c
The import s u p p l y
T he p o t e n t i a l e f f i c i e n c y
g a i n s c an be m e a s u r e d as the a rea of t r i a n g l e AHI.
Thi s
i n e f f i c i e n c y c a n be c a l l e d the h i d d e n imp o r t costs.
At the same time, t h e y n ote that i n c r e a s e d d o m e s t i c
s u p p l i e s and d e c r e a s e d d e m a n d c o u l d put d o w n w a r d p r e s s u r e
on the w o r l d p r i c e of energy.
be HS^.
The i mport s u p p l y c u r v e could
The p o t e n t i a l e f f i c i e n c y g a i n s can be m e a s u r e d by
the t r i a n g l e AJH.
Thi s i n e f f i c i e n c y c a n be c a l l e d i m port
pri c e costs.
On the o t h e r hand,
if d o m e s t i c c o n t r o l s g i v e i n c e n
tives to look for e n e r g y in the w r o n g p l a c e s
(e.g., l o w
p r o d u c t i o n s t r i p p e r w e l l s or h i g h c o s t d e e p g a s ) , then the
c o s t of d o m e s t i c gas is h i g h e r tha n it s h o u l d be.
d o m e s t i c s u p p l y c u r v e s h i f t s to S^H.
The
The p o t e n t i a l e f f i c i
e n c y g a i n s c a n be m e a s u r e d as the area of the t r i a n g l e HKL.
T hi s i n e f f i c i e n c y c an be c a l l e d i n e f f i c i e n t d o m e s t i c
p r o d u c t i o n cost.
442
FIGURE A . 2
ARROW/KALT: ADDITIONAL SUPPLY-SIDE EFFICIENCY GAINS,
HIDDEN IMPORT COSTS AND INEFFICIENT
DOMESTIC PRODUCTION COSTS
Price
Source: Kenneth J. Arrow and Joseph P. Kalt, Petroleum
Price Regulation: Should We Decontrol? (Washington,
D . C . f American Enterprise Institute, 1979), pp. 9-27.
443
The a d m i n i s t r a t i v e c o s t s a s s o c i a t e d w i t h c o n t r o l s can
a lso be c o n c e p t u a l i z e d in this way.
T hat is, if we a s s u m e
that the a d m i n i s t r a t i v e c o s t s of c o n t r o l are p a s s e d t h r o u g h
to c o n s u m e r s
, they a p p e a r as an " a r t i f i c i a l l y ” h i g h s u p p l y
curve.
W i t h d e co n t r o l ,
the h i d d e n import costs and import
pri c e c o s t s w o u l d be r e g i s t e r e d as c o n s u m e r s u r p l u s gains,
the y w e r e c a ptured.
if
The i n e f f i c i e n t d o m e s t i c p r o d u c t i o n
c o s t s w o u l d be r e g i s t e r e d as i n c r e a s e s in p r o d u c e r surplus.
2.
Loury:
Shortages
Fro m this base, a n u m b e r of a d d i t i o n s and m o d i f i c a
tions h a v e b e e n made.
No t e that A r r o w and Kalt a s s u m e that
the m a r k e t c l e a r s by i n c r e a s i n g imports.
p r i m a r i l y by a v o i d e d import costs.
market doesn't clear?
de n i e d e n e r g y ?
t his s i t u a t i o n
T h e y m e a s u r e gain s
However, w h a t if the
W h a t if som e c o n s u m e r s are a c t u a l l y
L o u r y has taken a s t e p towa r d d e a l i n g wit h
(see Fig u r e A . 3)
a p h y s i c a l shor t a g e ,
He a r g u e s that if there is
the v a l u e of the loss to the e c o n o m y is
equal to the v a l u e of c o n s u m p t i o n
(i.e., the h e i g h t of the
d e m a n d c u r v e D q D q ) m i n u s the c o s t of p r o d u c i n g the e n e r g y
(the h e i g h t of the s u p p l y c u rve S 0 S Q ) •
the t r i a n g l e ABM.
Thi s area is g i v e n by
L o u r y a r g u e s as follows:
As m a y be s e en in the Figure, the c e i l i n g p r ice
c o n t r o l - i n d u c e d s h o r t f a l l of p r o d u c t i o n b e l o w the
e q u i l i b r i u m level c r e a t e s a s i t u a t i o n w h e r e the
v a l u e of an a d d i t i o n a l unit of g a s to d e m a n d e r s , P ,
e x c e e d s the c ost to s u p p l i e r s of p r o d u c i n g a n o t h e r v
unit, P * The d i f f e r e n c e P - P g is thus the
p o t e n t i a l net g a i n from a n o t h e r unit of p r o d u c t i o n
b e y o n d Q . As p r o d u c t i o n is f u r t h e r e x p a n d e d b e y o n d
444
FIGURE A . 3
L O U R Y : POTENTIAL CURTAILMENT EFFICIENCY GAINS
Pr ice
Curtailment Inefficiencies
( i . e . L loss of v a l u e to the e c o n o m y
Source: G l e n n C. Loury, A n A n a l y s i s of the E f f i c i e n c y a n d
I n f l a t i o n a r y I m p a c t of the D e c o n t r o l of N a t u r a l
Ga s P r i c e s (Natural G as S u p p l y A s s o c i a t i o n , April,
1981), p. 2.
445
Q , the m a r g i n a l cost of a d d i t i o n a l s u p p l i e s rises,
a8d the m a r g i n a l v a lue of a d d i t i o n a l units c o n s u m e d
falls*
T h e s e m a r g i n a l v a l u e s are e q u a l i z e d at the
m a r k e t c l ea r i n g q u a n t i t y Q . The sha d e d area in the
F i g u r e thus r e p r e s e n t s the net e f f i c i e n c y cost of
price c o n t r o l s because, for each uni t of p r o d u c t i o n
in e xcess of Q s , the h e i g h t of the dem a n d cur v e
r e p r e s e n t s the v a l u e of b e n e f i t s from c o n s u m i n g that
unit w h i l e the h e i g h t of the s u p p l y cur v e r e p r e s e n t s
the cost of p r o d u c i n g that unit.
The d i f f e r e n c e is
thus the net social g a i n from h a v i n g that unit
a v ailable*
The sha d e d t r i a n g u l a r area then d e p i c t s
the sum of net s ocial g a i n s f o r e g o n e by v i r t u e of
the s h o r t f a l l of p r o d u c t i o n from Q to Q . It
t h e r e f o r e also r e p r e s e n t s the effi§ iency5 b e n e f i t s
w h i c h cou l d be e n j o y e d if c o n t r o l s w e r e removed.
We can call this c u r t a i l m e n t inefficiency.
With decontrol,
those g a ins c a p t u r e d in the area b e t w e e n
the w o rld p r i c e and the d e m a n d curve
g a i n s in c o n s u m e r surplus.
(surplus)
(ACM) w o u l d be r e a l i z e d as
T h e y are m e a s u r e d as the u t i l i t y
lost by c o n s u m e r s who are c o n s t r a i n e d from using
r e s o u r c e s up to their o p t i m u m q u a n t i t y Q q .
The g a i n s b e t w e e n the wor l d pr ic e and the s u p p l y curve
(ABC) w o u l d be r e g i s t e r e d as incr e a s e s in p r o d u c e r surplus.
T h e y can be d e f i n e d r o u g h l y as in the A r r o w / K a l t scheme.
is, they are the v a l u e
(surplus)
That
that p r o d u c e r s c o uld r e alize if
p r i c e s were a l l o w e d to rise to P w .
Unfortunately,
confused.
the r e m a i n d e r of L o ury's a n a l y s i s b e c o m e s
Hav i n g talked of actual p h y s i c a l s h o r t a g e s , he then
talks of import r e d u c t i o n s
(the A r r o w / K a l t point)
h as sbcrt a g e s , h o w are imports to be r e d u c e d ?
B ut if one
A d d i t i o n s to
s u p p l y will fill u n s a t i s f i e d demand, not d i s p l a c e imports.
Onl y
if oil is not a s u b s t i t u t e for some use s of g a s c a n there be
b o t h c u r t a i l m e n t e f f i c i e n c y g a i n s and import red u c t i o n s .
If
t hat is the case, one m u s t be e x t r e m e l y c a r e f u l in c o u n t i n g
21-496 0
83
29
446
e f f i c i e n c y gains.
If one cou n t s the full A r r o w / K a l t e f f i c i e n c y
g a i n s and the full Loury e f f i c i e n c y gains,
d o u b l e cou n t i n g some gains.
That is,
b u t a b l e to p h y sical shortage,
to imports,
then one m u s t be
the i n e f f i c i e n c y a t t r i
and the i n e f f i c i e n c y a t t r i b u t a b l e
are m u t u a l l y exclusive,
L o u r v ’s c a l c u l a t i o n s of e f f i c i e n c y gai n s are p r o b l e m a t i c
and a m b i g i o u s on this poi n t
(see F igure A . 4)
full c u r t a i l m e n t g a i n s first,
c a l c u l a t e s are abo u t 2 TCF,
m e n t s in 1980«
reality.
However,
He c o u n t s the
the c u r t a i l m e n t s he
This is far above a ctual c u r t a i l
Thus, his t h e o r e t i c a l a r g u m e n t does not fit
Tha t is, he c o n c e p t u a l i z e s and m e a s u r e s the area of
ABM, but, in reality, p h y s i c a l s h o r t a g e s were not that large.
W h a t is more,
L o ury then c o u n t s import r e d u c t i o n gains.
H owever, he v a lues these o n l y at their p r e m i u m a b ove the w o r l d
pri c e of oil.
The p r e m i u m he puts on the import s a v i n g s is
qui t e high, $10 per barrel,
If the $ 1 0/ ba r r e l f igure is
i ntended s t r i c t l y as an a v o i d e d import price cost, then no
d o u b l e c o u n t i n g has occurred.
H owever,
$ 1 0 / b a r r e l is a v e r y
h i g h r e d u c t i o n in import p r i c e s to p r e d i c t and Lou r y ' s d i s c u s
sion s u g g e s t s that the p r e m i um he has in mind is both a h i d d e n
import cost s a ving and an import p r ice saving.
case, then there _is some d o u b l e c ounting.
If that is the
Y o u can't h a v e both a
h i d d e n import cost g a i n and a c u r t a i l m e n t e f f i c i e n c y g a i n of the
m a g n i t u d e L o u r y c alculates.
If there are c u r t a i l m e n t s of the
o r d e r of m a g n i t u d e he e s t i m a t e s , there will be m u c h s m a l l e r
import reductions.
447
FIGURE A . 4
LOURY: A M B I G U I T I E S IN C A L C U L A T I N G E F F I C I E N C Y GAINS
If c u r t a i l m e n t s do not a c t u a l l y
occur, t hen this a rea is n ot a
p o t e n t i a l e f f i c i e n c y gain.
Source: G l e n n C. Loury, A n A n a l y s i s of the E f f i c i e n c y a n d
I n f l a t i o n a r y I m p a c t of t he D e c o n t r o l of N a t u r a l
G a s P r i c e s (Natural G as S u p p l y A s s o c i a t i o n , April,
1981), pp. 2-10.
448
The a m b i g u i t y is of p o t e n t i a l l y large signif i c a n c e .
The i m p o r t - r e l a t e d e f f i c i e n c y ga in s in L o u r y ' s a n a l y s i s are by
far the m o s t important.
If import price s a v i n g s are o n l y hal f
the import gains Loury had in mind,
then a l m o st o n e - q u a r t e r of
the total gains L o u r y e s t i m a t e d are a result of d o u b l e counting.
Loury could c a l c u l a t e all A r r o w / K a l t g a ins first and
the n add some c u r t a i l m e n t gains, but it seems clear that the
total g a i n s w o u l d be m u c h s m a ller than he o r i g i n a l l y estimated,
Finally, L o u r y m e n t i o n s the fact that, w h e r e c u r t a i l
m e n t s a c t u a l l y o c c u r and s u p p l y is rat i o n e d a d m i n i s t r a t i v e l y ,
t h e r e is no g u a r a n t e e that those who v a l u e gas m o s t will have
a c c e s s to it.
T h e r e f o r e there are p o t e n t i a l l y m o r e i n e f f i c i
e n c i e s in a m a r k e t in w h i c h s h o r t a g e s exist,
However, he doe s
not c o n c e p t u a l i z e this effect,
3.
Felmy;
S h o r t a g e s w ith M i s a l l o c a t i o n
Fe lmy fol l ow s L o ury's a p p r o a c h , b u t a v o i d s h is error.
He also c o n c e p u t a l i z e s the rat i o n i n g e f f e c t s a b o u t w h i c h L o u r y
mused
(see Fig u r e A . 5)
Again, e f f i c i e n c y g a i n s are m e a s u r e d as
the d i f f e r e n c e b e t w e e n the cost of p r o d u c t i o n and the v a l u e of
consumption —
the area b e t w e e n the s u p p l y and d e m a n d curves,
t r i a n g l e ABM.
F e l m y c a l l s this the m i n i m u m e f f i c i e n c y g a i n
call it m i n i m u m c u r t a i l m e n t i nefficiency)
(we
F e l m y g o e s on to
c o n c e p t u a l i z e the p o t e n t i a l r a t i o n i n g i n e f f i c i e n c y of c u r t a i l
ments.
S u p p o s e that those who hav e a c c e s s to gas u n der the
r a t i o n i n g s c h e m e are those who v a l u e it least.
Their demand
c u r v e w o u l d be g i v e n by D . D . , not D D and the v a l u e of the
3
11
o o
449
FIGURE A . 5
EELMY: POTENTIAL RATIONING ALLOCATION EFFICIENCY GAINS
Rationing Allocation
Inefficiency (i.e. the
loss of value to the economy
due to the fact that
wrong consumers receive
the energy, which is
determined by the shape
of the demand curve of
those who actually receive
Maximum
Curtailment
Inefficiency
(i.e. the loss
in value to
■the economy
if those who
value energy
least actually
receive it)
Minimum Curtailment
Inefficiency
(i.e. the loss in
value to t h e 'economy
if energy is rationed
administratively
exactly as it would
be allocated by'
Quantity
Source: John Felmy, The Economic Efficiency Gains of Accelerated
Natural Gas Price Decontrol - A Micro-Macro Linked
Approach (ICF Incorporated, submitted to the U.S.
Department of Energy, Office of Policy, Planning and
Analysis, Division of Energy Deregulation, December,
1981)
450
c o n s u m p t i o n lost w o u l d be g i v e n by ABGN,
maximum efficiency gain
He ca lls this the
(we call it m a x i m u m c u r t a i l m e n t
i n e f f i ciency)
R a t i o n i n g a l l o c a t i o n i n e f f i c i e n c y (and t h e r e f o r e the
p o t e n t i a l e f f i c i e n c y gains) w o u l d be the d i f f e r e n c e b e t w e e n the
loss in o u t p u t due to c urtaiIntents , if c u r t a i l m e n t s w e r e
a l l o c a t e d e f f i c i e n t l y and the loss if t hey are not a l l o c a t e d
efficiently.
Thi s is the area b o u n d e d by M B G N .
be r e g i s t e r e d as an i n c r e a s e in c o n s u m e r surplus.
This gain would
The a r e a is
d e t e r m i n e d by the s h a p e and l o c a t i o n of the d e m a n d c u r v e of
t h o s e w h o a c t u a l l y h a v e a c c e s s to gas,
F e l m y d o e s n ot m a k e it a b s o l u t e l y cle a r t h a t p h y s i c a l
s h o r t a g e s m u s t o c c u r for the s e g a i n s to be r e l e v a n t , e v e n t h o u g h
he d o e s not m a k e L o u r y ' s err o r of d o u b l e c o u n t i n g gains,
4•
K rugman:
Additional Clarifications
Kru g ma n , who f o l l o w s A r r o w / K a l t clos e l y , m a k e s c h a n g e s
in the c o n c e p t u a l i z a t i o n s that are usef u l
(see F i g u r e A . 6)
To
b e g i n with, he a s s u m e s that the d o m e s t i c s u p p l y and d e m a n d
c u r v e s do not cross.
T h a t is, the m a r k e t d o e s not c l e a r in
d o m e s t i c e n e r g y sources.
e a r l i e r analysis.
T h i s c o n c e p t was o n l y i m p l i c i t in the
Second, he i n t r o d u c e s a d i f f e r e n c e b e t w e e n
the p r ice paid to s u p p l i e r s
see
(P^).
(Pg ) and the p r i c e w h i c h c o n s u m e r s
T h i s is a p p l i c a b l e to the n a t u r a l g as m a rket.
Third,
he m e a s u r e s the A r r o w / K a l t d e m a n d side i n e f f i c i e n c y , w h i c h he
c a l l s the d e a d w e i g h t c o n s u m p t i o n loss, b e l o w the d e m a n d curve,
451
FIGURE A . 6
KRUGMAN: REFINING ARROW/KALT
Krugman
Krugman
Arrow/Kalt
Paul Krugman, Real Exchange Rate Adjustment and The Welfare
Effects of Oil Price Decontrol (MIT, Energy Laboratory,
Discussion Paper No. 1, May 1981), p. 3.
452
rat h er than a b ove it,
T h i s is c o n c e p t u a l l y p r e f e r a b l e and
m a t h e m a t i c a l l y v e r y c l o s e to A r r o w / K a l t , ^
C,
A S u m m a r y of P o t e n t i a l S f f i c i e n c y G a i n s
On the basis, of t hese c o n c e p t u a l i z a t i o n s , we can d e f i n e
s e v e n d i f f e r e n t i n e f f i c i e n c i e s or p o t e n t i a l e f f i c i e n c y g a i n s
(see F i g u r e A . 7)
Let us b r i e f l y d e s c r i b e the m a r k e t s t r u c t u r e
b e f o r e we d e f i n e the p o t e n t i a l e f f i c i e n c y gains.
First, note that the m a r k e t is t y p i f i e d by a c e i l i n g
p r i c e for p r o d u c e r s
c o n s u m e r s see,
(Pg ) a b ove the a v e r a g e p rice
that
T h i s s i t u a t i o n o b t a i n s in the n a t u r a l gas m a r k e t
due to the p a r t i a l d e c o n t r o l of NGPA,
c u r t a i l m e n t s o c c u r at Q .
c
o ccurs.
(P^)
Further,
note that
Inefficient administrative rationing
The d o m e s t i c s u p p l y ends at point H, w h e r e the import
s u p p l y c u r v e begins.
To a c c o m m o d a t e a m a r k e t w i t h both
c u r t a i l m e n t s and imports, we a s s u m e that i m ports are oil and
s ome c o n s u m e r s who can use o n l y gas are d e n i e d a c c e s s to it.
The i n e f f i c i e n c i e s and p o t e n t i a l e f f i c i e n c y g a i n s are
d e f i n e d as follows:
1.
Rationing allocation inef fi ci en cy :
Loss in v a l u e to the
e c o n o m y d ue to the fact that, r a t i o n i n g p r o v i d e s g a s to
th o s e who v a l u e it less, and d e n i e s gas to tho s e who
v a l u e it m o r e
2.
(NMOVWCXG)
I mport r e s o u r c e i n e f f i c i e n c y :
R e s o u r c e s s p e n t on
imp o rt e d e n e r g y that c o u l d h a v e b e e n paid to d o m e s t i c
p r o d u c e r s r a t h e r than f o r e i g n p r o d u c e r s —
in c r e a s i n g d o m e s t i c p r o d u c e r s u r p l u s
(WHBC)
thereby
Price
FIGURE A.7
454
3.
Curtailment inefficiency:
Los s of v a l u e due to the fact
t hat s o me c o n s u m e r s are d e p r i v e d of g a s and t h e r e f o r e
u n a b l e to u n d e r t a k e e c o n o m i c a c t i v i t y
4.
Hidden import c o s t s :
Th e v a l u e of i m p o r t e d e n e r g y
n o t r e f l e c t e d in its p r i c e
5.
(MIO)
I m p o r t pri c e i n e f f i c i e n c y :
(IAH)
R e s o u r c e s s p e n t on im po rt s
w h o s e p r ice has b e e n i n c r e a s e d due to e x c e s s d o m e s t i c
d e m a n d and r e d u c e d d o m e s t i c s u p p l y
6.
Consumption inefficiency:
(ARH)
T he d i f f e r e n c e b e t w e e n the
p r i c e a c t u a l l y pai d and the u t i l i t y to the n a t i o n of the
energy actually consumed
1,
(JRTU)
Domestic production inefficiency:
R e s o u r c e s s p e n t on
d o m e s t i c p r o d u c t i o n as a r e s u l t of d i r e c t i n g p r o d u c t i o n
o p e r a t i o n s into less tha n the m o s t e c o n o m i c
cost)
patterns
(i.e., l e a s t
(HKL)
In F i g u r e A . 7, for the p u r p o s e of l a b e l i n g g a i n s and
m e a s u r i n g them, the s e i n e f f i c i e n c i e s are d e f i n e d so that g a i n s
b a s e d on a l t e r a t i o n s in r e s o u r c e f lows take preced e n c e .
That
is, e f f i c i e n c i e s w h i c h are s a v i n g s a g a i n s t c u r r e n t i m p o r t s or
d o m e s t i c e x p e n d i t u r e s are c o u n t e d first,
g i v e n s e co n d p r e c e d e n c e .
P r i c e e f f e c t s are
T h a t is, p r o j e c t e d g a i n s due to
455
c h a n g e s in pri c e imp l i c i t in the s u p p l y c u r v e are i d e n t i f i e d
a f t e r c h a n g e s in resources.
E x t e r n a l i t i e s are c o u n t e d third.
T h a t i s r the i mplicit c o s t s of imports are i d e n t i f i e d third.
Finally,
" v a l u a t i o n s " are c o u n t ed last,
That is, the gains d u e
to the impl i c i t v alue p l ac ed on c o n s u m p t i o n by s o c i e t y (implicit
in the d e m a n d curve)
are c o u n t e d last
Th i s a p p r o a c h is t a ken o n l y b e c a u s e it see m s to r e p r e
sent an o r d e r i n g from the m o s t to the least t a n g i b l e effects.
T h a t is, w h e r e r e s o u r c e s are a l r e a d y flowing, then it seems
f a i r l y l i k e l y that g a i n s w h i c h rely on r e d i r e c t i n g flows c an
be‘
realized.
R e s o u r c e s a n d p r i c e e f f e c t s a l s o s e e m to be the
m o s t e a s i l y o b s e r v a b l e and m e a s u r a b l e .
s e n s i t i v e to a s s u m p t i o n s .
T h e y are also mu ch less
V a l u a t i o n s are l a r g e l y implicit.
Indeed, h a v i n g c a r e f u l l y i d e n t i f i e d all of the p o t e n t i a l
e f f i c i e n c y g a i n s of d e c o n t r o l ,
it mus t be said that in g e n eral
t h e y are e x t r e m e l y s e n s i t i v e to a s s u m p t i o n s a b o u t the pri c e
e l a s t i c i t y of s u p p l y and demand.
A b o v e all, as the s u p p l y
e l a s t i c i t i y b e c o m e s small, all of the p o t e n t i a l e f f i c i e n c y g a i n s
e x c e p t the c o n s u m p t i o n g a i n s a p p r o a c h zero
(see F igure A . 8).
Under the a s s u m p t i o n of v e r y low s u p p l y pri c e e l a s t i c i t y , there
is v e r y lit t l e g a i n from dec o n t r o l .
M o r e o v e r , the r e are v e r y
large t r a n s f e r s of w e a l t h w i t h i n the d o m e s t i c e conomy.
T hat is,
c o n s u m e r s u r p l u s is reduced d r a m a t i c a l l y (the area b o u n d e d by
ADFG) w h i l e ^efficiency is inc r e a s e d s l i g h t l y
(the area b o u n d e d
by ADR)
As several o t her a n a l y s e s c o n d u c t e d b y C E C A / R F h ave
shown, the e l a s t i c i t y of s u p p l y in the gas m a r k e t is e x t r e m e l y
456
FIGURE A . 8
C E C A •s R E P R E S E N T A T I O N OF E F F I C I E N C Y G A I N S
RESULTING FROM AN INELASTIC SUPPLY CURVE
Price
Consumption
Inefficiency
Quantity
457
l o w so that e f f i c i e n c y g a i n s are l i k e l y to be small."
m a r k e t looks m o r e like F i g u r e A . 8 than A . 7.
recent analysis,
In fact,
T he
in D O E ' s
the total e f f i c i e n c y g a i n s w e r e o n l y o n e - t h i r d
as large as the loss in c o n s u m e r surplus,
D.
Efficiency Losses
Howe v e r ,
let us a s s u m e that some q u a n t i t y of real
r e s o u r c e s can be g a i n e d in the e n e r g y s e c t o r t h r o u g h decontrol,
We n ext m u s t ask w h a t the c ost of those g a i n s will be in the
n o n - e n e r g y sectors,
Tha t is, d e c o n t r o l d r a m a t i c a l l y raise s the
c o s t of a c r i t i c a l input into the p r o d u c t i o n p r o c e s s and it is
c e r t a i n l y r e a s o n a b l e to ask w h e t h e r or not such a c h a n g e leads
to losses in p r o d u c t i o n e f f i c i e n c y .
7
In fact, the e m p i r i c a l e v i d e n c e s u g g e s t s that in both
the sho r t and long term,
general economy.
there are l osses in e f f i c i e n c y in the
C o n c e p u t a l l y , those l o sses in p r o d u c t i v i t y and
o u t p u t can be e x p l a i n e d w i t h r e f e r e n c e to a p r o d u c t i o n f u n c t i o n
(see Fig u r e A . 9)
energy
(gas)
If the e l a s t i c i t y of s u b s t i t u t i o n b e t w e e n
and o t h e r inputs is low, then a rise in p r i c e s
f orces the e c o n o m y d o w n to a l ower level of output.
Figure A . 9
uses p r o d u c t i o n f u n c t i o n s w i t h zero e l a s t i c i t i e s of s u b s t i t u t i o n
to m a k e this point.
p
P r i o r to d e c o n t r o l ,
tio n f u n c t i o n
(isoquant)
the isoc o s t line from
0^,
p r o d u c t i o n is at poi n t 1, on p r o d u c
An i n c r e a s e in gas p r i c e s sh i f t s
to C^,
T h a t is, the p rice of gas
i n c r e a s e s r e l a t i v e to o t h e r inputs.
B e c a u s e the r e is no
458
FIGURE A . 9
A REPRESENTATION OF EFFICIENCY LOSSES
IN NONENERGY SECTORS
with Zero Elasticity of Substitution
Between Energy and Other Inputs
-decontrol Isocost
assuming resource
s in energy sectors
international sectors
quat e to offset
iciency losses in
energy sectors)
(post-decontrol
Isocost line
assuming- some
resource g a i n s :
in the energy
and international
s ec tors)
459
c a p a c i t y to s u b s t i t u t e for gas, the m a x i m u m o u t p u t a c h i e v a b l e
o c c u r s at p o i n t 2 on the p r o d u c t i o n f u n c t i o n 0^H o w ever,
if real r e s o u r c e s are g a i n e d t h r o u g h e f f i c i e n c y
i m p r o v e m e n t s in the e n e r g y sector,
o n l y c h a n g e in slope,
the isocost line w o u l d not
it w o u l d s h ift up to C^.
m a x i m i z e d at p o i n t 3 on p r o d u c t i o n f u n c t i o n 0^,
be b e l o w the o r i g i n a l level of output.
O u t p u t w o u l d be
It still would
If, and o n l y if, the
gain in r e s o u r c e s in the e n e r g y s e c t o r is large e n o u g h to move
9
the i s o cost line to C^, will there be no loss in output.
Obviously,
the a s s u m p t i o n of a zero e l a s t i c i t i y of
s u b s t i t u t i o n is extreme.
However,
it does s e r v e to i l l u s t r a t e
the p o i n t tha t the o v e r a l l imp a c t of d e c o n t r o l
two e m p i r i c a l issues —
is d e p e n d e n t on
the m a g n i t u d e of r e s o u r c e g a i n s and the
e l a s t i c i t y of s u b s t i t u t i o n ,
As the e l a s t i c i t y of s u b s t i t u t i o n i n c reases,
fewer
reso u r c e g a i n s are n e c e s s a r y to o f f s e t lost o u t p u t due to rising
prices.
H o w ever,
the q u e s t i o n of w h e t h e r or not the b o t t o m line
e f f i c i e n c y o u t c o m e wil l be p o s i t i v e or n e g a t i v e r e m a i n s an
e m p i r i c a l ques t i o n .
T h a t is, one m u s t e m p i r i c a l l y e s t i m a t e what
the e l a s t i c i t y is and h o w large the o u t p u t l o s s e s wil l be and
c o m p a r e these to the r es o u r c e gains.
T h e r e is no t h e o r e t i c a l l y
c e r t a i n conclu s i o n ,
The a v a i l a b l e e v i d e n c e s u g g e s t s that the e l a s t i c i t y of
s u b s t i t u t i o n for n a t u r a l g as in i n d u s t r i a l use is q u i t e low.
rec e n t e s t i m a t e b a sed on d e t a i l e d a n a l y s i s of b oth time s e r i e s
and c r o s s n a t i o n a l d a t a p l a c e d it in the n e i g h b o r h o o d of
,5.10
A
460
If that is the case,
t h e r e w o u l d h a v e to be v e r y large e f f i c i
e n c y r e s o u r c e g a i n s in the e n e r g y s e c t o r as a r e s u l t of
d e c o n t r o l to a c h i e v e an o v e r a l l p o s i t i v e impact.
n o t e d above,
H o w e v e r , as
the a v a i l a b l e e v i d e n c e on the e l a s t i c i t y of
s u p p l i e s of n a t u r a l gas d o e s not s u g g e s t that such l a r g e g a i n s
are possible,
Thus, the e m p i r i c a l e v i d e n c e s u g g e s t s that,
the o v e r a l l economy,
E*
in
t h e r e wil l be net losses, not gains.
A F i nal N o t e
The m a c r o e c o n o m i c d a t a e x a m i n e d in C E C A / R F ' s s t u d i e s of
natural gas decontrol
is c o n s i s t e n t w i t h thi s p e s s i m i s t i c i n t e r
p r e t a t i o n of e m p i r i c a l r eality.
T h a t is, all e c o n o m e t r i c m o d e l s
(except one) p r e d i c t n e g a t i v e e c o n o m i c i m p a c t s p e r s i s t i n g for at
l e a s t a d e cade.
In an e a r l i e r report, J3ECA/RF p o i n t e d o u t t hat
all the e c o n o m e t r i c m o d e l s
(except one)
s u g g e s t t h a t the
n e g a t i v e e c o n o m i c i m p a c t s wil l p e r s i s t ad i n f i n i t u m .
The one e x c e p t i o n to thi s g e n e r a l c o n c l u s i o n o c c u r s in
the H u d s a n / J o r g e n s o n D y n a m i c G e n e r a l E q u i l i b r i u m M o d e l
(DGEM).
As h a s b e e n d i s c u s s e d in an e a r l i e r study, that e x c e p t i o n can be
easily explained.
12
In fact, the D G E M m o d e l p r e d i c t s l o s s e s in p r o d u c t i v i t y
in the o v e r a l l e c o n o m y as a r e s u l t of d e c o n t r o l —
a r e s t i l l in e v i d e n c e 15 y e a r s d o w n the road.
l o s s e s tha t
In fact,
the
d e c l i n e in c o n s u m e r s u r p l u s is t h r e e t i m e s as l a r g e as the
e f f i c i e n c y g a i n s in the e n e r g y se ctor.
In fact, the l o s s e s in
G N P in the e c o n o m y d u e to d e c l i n i n g p r o d u c t i v i t y a s s o c i a t e d w i t h
d e c o n t r o l are l a r g e r t h a n t h e e f f i c i e n c y g a i n s in the e n e r g y
461
sector,
However,
this one model o f f s e t s these d i r e c t losses in
G NP b y an income t r a nsfer m e c h a n i s m that is built into its
structure.
Thereby,
it p r o d u c e s a p o s i t i v e net G N P effect.
The model ach i e v e s this result by a s s u m i n g no pricew a g e - p r i c e spiral and t h e r e f o r e t r a n s l a t e s all price i n c r eases
for gas d i r e c t l y into losses in labor income and i n c r eases in
the income of g a s - r e l a t e d cap i t a l
Thus, there is a m a s s i v e
t r a n s f e r of w e a l t h from those with a hig h p r o p e n s i t y to c o n s u m e
to those with a high p r o p e n s i t y to invest,
In this way, the
m o d e l raises the a g g r e g a t e rate of i n v e s t m e n t in the e c o n o m y
through decontrol
In the long run, the m o d e l p r e d i c t s G N P
i n c r e a s e s rather than d e c r e a s e s
(as the oth e r m o d e l s do)
beca u s e
of this c h a n g e in the a g g r e g a t e i n v e s t m e n t rate,
Thus, even in the D G E M model, e n e r g y price d e c o n t r o l
doe s not stand on its own m e r i t s as e c o n o m i c policy.
line is negative.
The b o t t o m
It a p p e a r s p o s i t i v e o n l y b e c a u s e the model
a s s u m e s a c h a n g e in the a g g r e g a t e rate of investment.
H owever,
if the o b j e c t i v e is to raise the a g g r e g a t e rate
of investment, w h y a p p r o a c h it t h r o u g h e n e r g y p r i c e policy,
w h i c h c a u s e s seve r e sho r t term d i s r u p t i o n s and long term
p r o d u c t i v i t y loss e s ?
The r e s h o u l d be p r e f e r a b l e , m o r e d i r e c t
a p p r o a c h e s w h i c h avoid the d i s r u p t i o n s w h i l e c a p t u r i n g the
benefits,
462
Appendix B
C O M P A R I N G THE OIL A N D GAS A N A L Y S E S
i
Introduction
In this report we hav e r e v i e w e d two sets of e c o n o
m e t r i c a n a l y s e s of the impact of rising e n e r g y p r i c e s
oil and gas analyses.
the
W i t h one set b e ing l a r g e l y r e t r o s p e c t
ive and the o t h e r p r o s p e c t i v e ,
is e x t r e m e l y inviting.
—
a c o m p a r i s o n b e t w e e n the two
Unfortunately,
a n u m b e r of f a c t o r s
mak e such a c o m p a r i s o n e x t r e m e l y complex,
2.
M e t h o d o l o g i c a l I ssues
a,
Basic Adjustments
First, as in the text of this report, we m u s t m e a s u r e
the impact on a s t a n d a r d b a s i s —
percent increase —
e.g.,, impact per ICO
if the c o m p a r i s o n is to be m e a n i n g f u l
Second, as in the text, we m u s t als o a d j u s t the gas a n a l y s i s
to a flat base case b e c a u s e the oil a n a l y s e s are u s u a l l y done
w i t h flat bas e cases.
Even w i t h these a d j u s t m e n t s o t h e r
c o m p l i c a t i o n s arise.
b.
The C o n s u m p t i o n of Fuels
P e t r o l e u m c o n s t i t u t e s a m u c h larg e r p e r c e n t a g e of our
total e n e r g y c o n s u m p t i o n than n a t u r a l g as —
c o m p a r e d to 25 percent.
i n c r e a s e in price,
Therefore,
40 p e r c e n t
for a g i v e n p e r c e n t a g e
the i mpact of the oil p r i c e i n c r e a s e on
the e c o n o m y will be larger.
S i m p l e a r i t h m e t i c s u g g e s t s that
463
the impact w o u l d be 1.6 t i m e s as large
(.4/.25 = 1.6)
Thus,
for a g i v e n p e r c e n t a g e i n c r e a s e in bot h oil and gas, we w o u l d
e x p e c t the oil p r i c e i n c r e a s e to h a v e an i mpact that is 1.6
t imes as large,
However, we h a v e also noted that,
in the
i n d u s t r i a l sector, the p r i c e e l a s t i c i t y of g as is s m a l l e r
than the price e l a s t i c i t y of oil,
Thus, we m i g h t e x p e c t
n a t u r a l gas p r i c e i n c r e a s e s to pose m o r e p r o b l e m s for the
econ o m y .
large.
T h e r e f o r e , an a d j u s t m e n t fact o r of 1.6 ma y be too
However,
for p u r p o s e s of c o m p a r i s o n ,
i.e.,
in o r d e r
to use the oil a n a l y s e s to p r e d i c t the i m pact of gas p r ice
i ncrea s e s , we d i v i d e the oil impact b y 1.6 to a d j u s t the
a n a l y s i s for the fact that we c o n s u m e so m u c h m o r e of it.
c.
Foreign Resource Flows
At the time of the oil p r i c e shock, a b o u t 40 p e r c e n t
of the p e t r o l e u m we c o n s u m e d w as imported.
a b o u t 5 p e r c e n t of n a t u r a l gas is imported.
Presently, only
I n s o f a r as
r e s o u r c e s that are not p aid to f o r e i g n p r o d u c e r s r e c y c l e
w i t h i n the e conomy, e n h a n c e the b a l a n c e of t r a d e and s t r e n g
then the d o llar, the i mpact of r ising p e t r o l e u m p r i c e s led b y
f o r e i g n oil price i n c r e a s es w o u l d h a v e a g r e a t e r impa c t on
the economy.
O u t p u t w o u l d be r e d u ce d m o r e and u n e m p l o y m e n t
w o u l d be i n c r e a s e d more.
How e v e r ,
i n f l a t i o n w o u l d be a b o u t
the same.
If we a s s u me that e v e r y d o l l a r paid for i m p o r t s is
"lost" to the e conomy, s i m p l e a r i t h m e t i c s u g g e s t s t h a t the
i m p a c t of rising oil p r i c e s will be 1.6 t i m e s as lar g e as the
464
impact of ris i n g g as p r i c e s
an a d j u s t m e n t factor,
(,95/.6 = 1.6)
We use this as
T h i s will be an o v e r e s t i m a t e b e c a u s e
not all of the e c o n o m i c b e n e f i t s of the e x p o r t e d d o l l a r s are
lost.
T h a t is, some do recy c l e t h r o u g h the economy,
d,
M o n e t a r y and Fis c a l P o l i c y
As p o i n t e d out in the report,
the oil a n a l y s e s did
n ot take into a c c o u n t the m o n e t a r y and fiscal p o l i c y
r e s p o n s e s to decontrol.
T h a t is, the y a s s u m e d o n l y that
e n e r g y pri c e s had changed.
changes.
T h e y did not a s s u m e o t h e r p o l i c y
S i nce m o n e t a r y and fiscal p o l i c y c h a n g e s w e r e
i n s t i t u t e d in r e s p o n s e to rising e n e r g y prices,
u s e d to judge
the
the b a s e cas e
i m pact of oil p r i c e s is incorrect.
The
a ct u a l imp a c t w o u l d h a v e b e e n d i f f e r e n t had n e u t r a l m o n e t a r y
and fiscal p o l i c y b e e n pursued.
The rule of thu m b that was n o t e d a b ove is that
m o n e t a r y and f iscal p o l i c i e s m a y h a v e d o u b l e d the impact.
T h a t is, l o s s e s in G N P and i n c r e a s e s in u n e m p l o y m e n t m a y h a v e
b e e n r e n d e r e d twi c e as l a r g e as t h e y w o u l d h a v e b e e n if
a c c o m m o d a t i v e r ather than r e s t r i c t i v e p o l i c i e s had bee n
chosen.
Inf l a t i o n, on the o t h e r hand, w as p r o b a b l y r e d u c e d
b y r e s t r i c t i v e policies.
ca s e —
T h a t is, a g a i n s t the p r o p e r b a s e
w i t h n e u t r a l (flat} m o n e t a r y and fis c a l p o l i c i e s —
imp a c t s of rising e n e r g y p r i c e s w o u l d h a v e b e e n s m a l l e r on
o u t p u t and u n e m p l o y m e n t , but l a r g e r on i nflation.
For p u r p o s e s of c o m p a r i s o n , we a s s u m e tha t o n e q u a r t e r of the impact of r ising oil p r i c e s o b s e r v e d in the
the
465
e c o n o m e t r i c a n a l y s e s sho u l d h a v e b e e n a t t r i b u t e d to o t h e r
policies,
T hat is, the oil a n a l y s e s m i s e s t i m a t e the impact
of rising prices.
T h e y u n d e r e s t i m a t e i n f l a t i o n a r y impacts
and o v e r e s t i m a t e o u t p u t m d
3,
e m p l o y m e n t impacts.
Results
T a b l e B.l p r e s e n t s the c o m p a r i s o n b e t w e e n the nat u r a l
g as a n a l y s e s and the oil a n a l y s e s w i t h all of the a d j u s t m e n t s
made.
It can be seen that the results are r e a s o n a b l y close.
The d i r e c t i o n of the p r e d i c t e d impacts are the same and they
tend to d i f f e r by no m o r e than one third.
the report,
As p o i n t e d out in
the a d j u s t e d oil impact e s t i m a t e s fall r o u g h l y
w i t h i n the range of the h i g h and low e s t i m a t e s of the gas
analyses.
The e s t i m a t e s i n c l u d e d in T a b l e 10 in the r e p o r t
are d e r i v e d as follows:
E s t i m a t e from
oil a n a l y s e s
_
A d j u s t e d Oil E s t i m a t e
A d j u s t e d Gas E s t i m a t e
y
. ,
Ins o f a r as the r e t r o s p e c t i v e a n a l y s i s c a n be s e e n as
m o r e t r u s t w o r t h y than the p r o s p e c t i v e anal y s e s ,
the fact that
the two y i e l d r o u g h l y e q u i v a l e n t r e s u l t s r e c o n f i r m s our
c o n f i d e n c e in the p r e d i c t i o n s of the impact of g as p r i c e
increases.
466
Table B.l
COMPARING THE ADJUSTED OIL AND GAS ANALYSES
Difference from a Flat 3ase Case per 100
____._______Percent Price Increases
________
Output
Inflation
Unemployment
(% Change)
(% Change)
(% Change)
GAS3
Partial Deregulation
Average
Adjusted
-1.35
-1.67
- ,4
-3.2
2.7
3.3
,7
2.5
+ ►5
+ .6
+ .2
+ 1.1
Full
Average
Adjusted
-1.3
-1.6
- .8
-3.6
.2
2.7
.7
2.5
+ ,5
+ .6
+ »2
+ 1.1
-3.8
-5.6
-2.9
na
-6.6
-5*8
5.4
5.6
2.9
na
4.8
2.9
+2.7
+3.4
+1.5
na
+6.9
+3.1
-4.1
-1.2
-5.8
-1.7
4.0
2.0
3.9
2.0
+2.5
.75
+ 5.0
1.5
OILb
Mork & Hall
Eckstein/DRI
Thurman/Berner (MPS)
Average
Adjusted
a From Tables 5-7.
^From Tables 2-4.
467
F O O T N O T E S TO A P P E N D I C E S
The s t u d i e s i n c l u d e d in this r e v i e w are: K e n n e t h J t
A r r o w and J o s e p h P. Kalt* P e t r o l e u m Price R e g u l a t i o n :
Sho u l d
We D e c o n t r o l ? (Washington, DC:
American Enterprise Insti
tute, 1979); G l e n n C. Loury, An A n a l y s i s of the E f f i c i e n c y
and I n f l a t i o n a r y Impa ct of the D e c o n t r o l of N a t u r a l Gas
P r i c e s (Washington, D C : N a t u r a l Gas S u p p l y A s s o c i a t i o n ,
April 1981); J ohn C. Felmy, The E c o n o m i c E f f i c i e n c y G a i n s of
A c c e l e r a t e d N a t u r a l Gas Pri c e Decont r o l ; A M i c r o - M a c r o L i n k e d
A p p r o a c h (ICF I n c o r p o ra t e d , s u b m i t t e d to the U.S. D e p a r t m e n t
of Energy, O f f i c e of Policy, P l a n n i n g and A n alysis, D i v i s i o n
of E n e r g y D e r e g u l a t i o n , D e c e m b e r 1981); Paul Krugman, Real
E x c h a n g e Rate A d j u s t m e n t and the W e l f a r e E f f e c t s of Oil Price
D e c o n t r o l (MIT E n e r g y L a b o ratory, D i s c u s s i o n Paper No, 1, M ay
1981)
2
C o n s u m e r E n e r g y C o u n c i l of A m e r i c a R e s e a r c h
F o u n d a t i o n , N a t u r a l G as D e c o n t r o l : A C a s e of T r i c k l e Up
E c o n o m i c s (Washington, DC, J a n u a r y 1§8 2)
^Krugman, Real E x c h a n g e Rate, p. 4 and U . S t D e p a r t
m e n t of Energy, Two M a r k e t A n a l y s i s of N a t u r a l Gas D e c o n t r o l
(Washington, DC: G o v e r n m e n t P r i n t i n g Office, N o v e m b e r 1981)
d e f i n e p r o d u c e r s u r p l u s or p r o d u c e r g a i n as the area b e t w e e n
the s u p p l y c u r v e and the e q u i l i b r i u m price.
This r e p r e s e n t s
the d i f f e r e n c e b e t w e e n the c o s t of p r o d u c t i o n and the pri c e
p r o d u c e r s receive.
4
C o n s u m e r s u r p l u s is a m o r e f a m i l i a r c o n c e p t than
p r o d u c e r surplus.
It can be m e a s u r e d as the d i f f e r e n c e
b e t w e e n the u t i l i t y of c o n s u m p t i o n for c o n s u m e r s , i m p l i c i t in
the d e m a n d c u r v e and the p r i c e paid (see Paul S a m u l e s o n ,
E c o n o m i c s , E l e v e n t h E d i t i o n [New York: M c G r a w Hill, 1980], p.
TTTT----
^It a p p e a r s to be c o n c e p t u a l l y p r e f e r a b l e sin c e the
d e a d w e i g h t c o n s u m p t i o n loss can be d i r e c t l y c o m p a r e d to the
p o t e n t i a l c h a n g e in c o n s u m e r surplus, that w o u l d o c c u r if the
c o n s u m p t i o n loss w e r e elimin a t e d .
c
C E C A / R F , The Pas t as P r o l g u e I .
^The e l a s t i c i t y of s u b s t i t u t i o n is the c r i t i c a l
d e t e r m i n a n t of the real i n come r e d u c t i o n as o u t l i n e d in the
report.
Thus, all of the s o u r c e s c i t e d in S e c t i o n B a b o v e
are relevant.
A m o s t i n t e r e s t i n g e x e r c i s e w h i c h shows
s p e c i f i c a l l y the impact of d i f f e r e n t a s s u m p t i o n s a b o u t the
e l a s t i c i t y of s u b s t i t u t i o n h as been c o n d u c t e d by W i l l i a m W.
H o g a n and A l a n S. M a n n e (" E n e r g y - E c o n o m y I n t e ra c ti on s :
The
F a b l e of the E l e p h a n t and the R a b b i t ? " in R o b e r t S, Pind y c k ,
e d . , A d v a n c e s in the E c o n o m i c s of E n e r g y and R e s o u r c e s ,
468
Vo l u m e 1:
1979])
The S t r u c t u r e of E n e r g y M a r k e t s
[Connecticut: JAI,
O
If the e l a s t i c i t y of s u b s t i t u t i o n is zero, then the
d e m a n d e l a s t i c i t y w o u l d be zero as well.
O b v i o u s l y figures
A . 1 - A . 8 do not reflect d e m a n d e l a s t i c i t i e s of zero.
The
f i gures are intended to be i l l u s t r a t i v e and any e m p i r i c a l
s p e c i f i c a t i o n of the a r g u m e n t s hould c e r t a i n l y resolve this
apparent inconsitency.
9
S e veral of the s e c o n d a r y p o t e n t i a l e f f i c i e n c y gai n s
i d e n t i f i e d by A r r o w / K a l t — such as p rice s hock p r o t e c t i o n ,
m o r e a p p r o p r i a t e s t o c k p i l i n g b e havior, etc. — can best be
r e p r e s e n t e d e ither as shi f t s in the isocost line or c h a n g e s
in the s hape of the p r o d u c t i o n isoquant.
This is in a d d i t i o n
to the d i r e c t impacts on the e n e r g y sector.
(See, in
a d d i tion, W i l l i a m W, Hogan, "Im p o r t M a n a g e m e n t and Oil
E m e r g e n c i e s , " in David A. Deese and J o s e p h S. N y e , E n e r g y and
S e c u r i t y [Cambridge: Ballinger, 1981])
1 0 Robert S. Pindyck, The S t r u c t u r e of W o r l d E n e r g y
Demand
(Cambridge: M IT Press, 1979), p. 222.
^ C E C A / R F , N a t u r a l Gas Price D e r e g u l a t i o n :
T r i c k l e Up E c o n o m i c s .
12ibid.
A C a s e of
m
Senator J e p s e n . Thank you. Mr. MacAvoy, is Mr. Cooper’s con
cept of economic rent valid ?
M r. M ac A voy . The concept, as I understand it, is one in which as
prices increase due to increases of demand, additional supplies are
forthcoming at higher costs, the existing supplies of gas already in
the system being produced under old contracts, if allowed to go to
the level of the higher cost supplies in clearing the market at a single
price, will earn an additional net income above the cost of providing
that old supply.
In the words of David Ricardo, these are scarcity rents. They aren’t
called monopoly profits because they can accrue to small farmers who
have cheap production conditions as the price at the marginal farm
increases.
These rents are the source of incentives for the exploration and de
velopment of further supplies. It’s the scurrying and hustle for ob
taining those rents that keeps the small, exploratory or wildcat com
pany going in this country. If they fall behind, if the wildcatters fall
behind, those rents go to landowners. The largest landowner in the
world capturing economic rents is the Federal Government of the
United States because those rents get capitalized in the offshore
bidding prices for lease rights to large volume of gas. The second
largest holder is the State government of Texas, and maybe the Uni
versity of Texas is the third largest.
These organizations capture these rents when the exploration and
development process fails to keep up with the incentive. The rents
are essentially transfers from consumer groups who pay the higher
uniform price. These transfers have equity implications, as Mr. Cooper
clearly stated. What he didn’t clearly state is what those equity impli
cations were. Is a transfer from consumers to the Department of In
terior inequitable? It pays off a pitifully small proportion of the
$250 billion deficit we’re now running.
Is the transfer from consumers that are industries or manufacturers
inequitable ? Is the transfer to large-scale, inner-city apartment houses
where the typical rent is $500 a month inequitable?
I have no idea. And no one who has been working on this, and
I ’ve been working on natural gas since my graduate student days in
the late 1950’s and I know most of the people who are working on it,
have the slightest notion of what the equity implications of price
increases of natural gas are. And I will stand corrected if further
questioning suggests that. These transfers have economic utility be
cause they solve the scarcity problem. They’re incentives for explora
tion and development, incentives that are pitifully poor at the present
time. As I said, we’re not replacing our supply and if you reduce
them, we will not replace our supply even more.
How unfair they are remains a mystery, but it is very clear that
it is far more unfair to have low equitable prices and the shortages
that we had in the midwest in 1976, 1977, and 1978, shortages which
were not solved in terms of policy implications by the NGPA, al
though they were transferred and replaced with a ratcheted price.
^So we have to be realistic about what we’re doing and I think at this
time realism calls for a thorough examination of how poorly we have
done in policies designed along the lines that Mr. Cooper proposes
21-496 0
83
30
470
here, that he proposed in 1977 before the NGPA in 1978. Rather than
letting him continue to try to find the nirvana of a regulatory structure
that produces a competitive supply at every rate of output, we really
ought to go back to the market and see if the market can possibly do
better than that mess that we’ve had in recent years.
Senator J e p s e n . Is economic rent in this context a valid concept?
Mr. M ac A voy . The concept of the transfer of income from consum
ers to producers, where those producers receive net income above the
straight out production costs of providing the supply of copper, or
whatever it may be, is correct. There is a valid economic concept of
rent.
Senator J epsen . Mr. Twilley, do you have any comment on that?
Any time any other panel member wants to comment, please do.
Mr. T w il le y . I don’t have any comment on that, Mr. Chairman.
From a practical point of view, I guess I ’d have to be professorial on
that. I look at economic rents as being the difference between the low
cost gas, the old gas, and the market price as being that sum of money
which was available to pay for the exploration of new gas.
Representative L tjngren. Mr. Cooper, I ’d like to follow up on that.
Obviously, you have very different views from Mr. MacAvoy on this.
And I guess it really comes down to your characterization of its as a
concept of market protectors. And Mr. MacAvoy’s interpretation or
characterization of it as governmental arrogance. Now I ’m flattered
that you believe that because I was elected by the people of my district,
and so were other Members, and the Members of the Senate were
elected by the people of their particular States, that somehow we have
the ability to divine what is a proper equity transfer.
But, frankly, I ’ve been around here 5 years and worked on the Hill
before that and I ’ve really come to the conclusion that the best and the
brightest aren’t here. And you acknowledge that we made some major
mistakes—thank goodness I can say the year before I got here—but
nonetheless, the Congress made major mistakes in setting up this
process. And while Mr. MacAvoy suggests that we ought to deregulate,
it seems to me what you’re saying is that we ought to reregulate, but
just do a better job of it.
Where do we get this ability to make these decisions better than the
workings of the market place?
Mr. C ooper. Let me say that I believe in perfect markets and I
don’t believe in perfect regulations.
Representative L ungren . I didn’t say perfect.
Mr. C ooper. I think it’s foolish to shoot for perfect regulations, just
as it’s foolish to believe that the world market is a functioning perfect
market.
I was not a fan of NGPA and the changes I would bring in NGPA
really are changes of structure. I am not trying to guess the market
price. I ’m only guessing the market price by letting NGPA finish its
course. But what I am most interested in, after NGPA plays itself out,
is that set of institutional arrangements which will insure, as best as
possible, that people are out there looking for the least cost gas, that
are going to break up a series of relationships between the wellhead and
the burner tip that reduce the incentive to look for cheap gas, that are
471
going to stop the practice of automatically passing through price in
creases. I am a consumer of the Columbia Transmission Pipeline Sys
tem which is one of the most flagrant violators of what is a simple,
prudent standard. The fact that people execute some take-or-pay
clauses and not others, to my detriment, is unthinkable. I believe that
there are straightforward regulatory approaches which will give me
some protection from that.
Representative L u ngren . On that, on the take-or-pay contract, you
say that we ought to establish regulations so that they are set at levels
that are appropriate. My question is how do you determine what’s
appropriate? We didn’t do a very good job of forecasting what the
market conditions were going to be. How are we going to do a better
job of forecasting such that we, through regulation, can make sure,
quote, unquote, that the take-or-pay contracts are set at levels that
are appropriate ?
Mr. C ooper. Well, I believe that, in the first instance, and in the bills
before the Congress, just about everyone has picked a number. They
picked a number for the short term or the long term. Everyone knows
that the 1990’s and 1995’s »are inappropriate.
In several of the bills, FERC is asked to conduct a study of how the
take-or-pay clauses should be set. And that will involve a study of
financial institutions and how they see where take or pay should be set.
But the problem is that if you believe, as we do, in an imbalance of
bargaining power, then it is encumbent upon the Congress to ask itself,
is that market perfect or imperfect and where we see major imperfec
tions, to design regulation.
I think that is a responsibility of the Congress. I tried to lay this out
in my prepared statement very carefully. It is a difference of percep
tion and assumptions about the underlying nature of the system.
Representative L ungren . Y ou also suggest that this is a very differ
ent market system than that which was involved when we were deregu
lating crude o il; is that correct ?
Mr. C ooper. Oh, absolutely. I loved the reference to the deregulation
of crude oil because I believe that crude oil is currently being trans
acted in the world at least three times its marginal cost of production.
Representative L ungren . Well, let me ask you a question.
Mr. C ooper. Deregulation was June 1979, at about $13 a barrel.
Today, it’s still $29 a barrel.
Representative L ungren . Did you support deregulation of
petroleum ?
Mr. C ooper. Absolutely not, we did not support it.
Representative L ungren . Y ou think we made a mistake on that?
Mr. C ooper. I believe if you look at 11 million people out of work
here, if you look at the tremendous economic costs imposed on this
economy, I believe that you should go back and rethink it. yes.
Representative L ungren . Gasoline price at the pump is 13 cents
lower today than it was 1 year ago.
Mr. C ooper. And it’s 55 cents higher than it was in June 1979, when
deregulation began.
Representative L ungren . Did you make any predictions at that time
like the Senator from Ohio as to how we’re going to have $2 a gallon
gasoline?
472
Mr. C ooper. N o , actually, I haven’t. But I did make a prediction in
April 1979, which said that the choice is whether or not to g o into the
deepest depression since the Great Depression. And frankly, if you
look back over the last 3 years, I think that prediction is as good or
better than anybody else’s prediction.
Representative L u n gr en . I happen to come from a district that pro
duces a lot of crude oil. But it’s not the monopolistic capitalists who
do that. It’s the city and State that I represent, the State of California,
the citizens of the city of Long Beach. We’re the largest independent
oil producer in California.
When we were regulated, there were wells shut down. It wasn’t be
cause they didn’t want to make a dirty profit. We tried to make things
equal. We had an entitlement program that tried to make everything
fair. And the net result of it was that it was more expensive for Chev
ron, or Union, or anybody else to purchase it from the local where it
was regulated than it was to purchase foreign. And ever since that,
I ’ve really had a very tough problem accepting the fact that we can
do a better job in these very, very complicated areas.
We can’t even figure out what the deficit is g o i n g t o be. We’re sup
posed to have some control over that. And we passed a tax increase
last jrear, which I voted against, but we passed one because people said
that it was necessary to bring the deficit down. And 2 weeks later, we
come up with projections of deficits at $100 billion higher.
So, I don’t know. We don’t seem to do a very good job on that sort
of thing.
Senator J epsen . Mr. Cooper, I hear you say that you want pipelines,
for the sake of the consumers, to purchase the cheaper gas.
Now do you mean that, aside from lower prices, there are no other
things to consider about guaranteeing that there will be a long-term
supply.
Mr. C ooper. I clearly recognize that supply is important. But what
I would like to do, what we need to do is to break the link that exists
through current contracts, to push the price of gas up. We all agree
on the current contracts problem. But I believe that there are struc
tural problems underlying the contracts that do not provide proper
incentives for producing gas at reasonable prices. We see no reason to
give away the economic rents of old gas and we see the need to address
the structural problems which push prices above what they need to be
to elicit supply responses.
Now some of those rents are being dissipated in very high cost sup
ply, but an awful lot of those rents are being passed through to con
sumers. Pipelines have not, in fact, just frivolously dissipated those
rents. We believe the consumers are benefiting from the control of oldgas prices. But we believe that consumers also need protection from
the way new supplies are priced. What we need to create is a counter
balance to the market power of producers to simply run prices up.
The way we believe you can discipline the market is by preventing
some of the explicit perverse contract clauses that have come into ex
istence, such as the cross-referencing of prices. We do not believe that
the cross-referencing of prices makes any sense. It destroys the notion
of competition. You talked about competition at the burner tip. But
if the price of gas is indexed to the price of oil, there is no competi
473
tion. For all intents and purposes, if you look at the current structure
of contracts, everything is indexed to the price of No. 2, not No. 6.
We would like to see a set of institutional arrangements that create
a counterpressure—a counterset of forces, market forces, if you will,
but through a regulatory framework—that give pipelines and con
sumers power to balance producers.
Senator J epsen . For the record, I ’d like each member of the panel
to please respond to this question: Can the natural gas market be made
workably competitive as opposed to perfectly competitive ?
Mr. M ac A voy . A s perhaps you might start at the right, Senator,
there are steps or sets of natural gas markets. At the field level there
is a set of markets in which the purchasers are industrial consumers,
local municipalities, and interstate of long-distance pipeline. There’s
a market at the wholesale consumption level in which pipelines pro
vide supply in competition with other sources of energy and among
each other. There’s a retail market for gas in which the retail public
utility provides supply to consumers who make choices on types of
furnaces or stove systems.
With respect to the field level, there has been sufficient, I believe,
and certainly significant research generated modestly from my doc
toral disertation in 1960 through an interminable series of Govern
ment studies that essentially produce findings that there is workable
competition in gas supply because of the ability of the pipeline sys
tems to place one source of supply off against another in all conditions
except during shortage conditions like those in the last half of the
1970 sThere, when there’s a breakdown of the equilibrating process, there
is not workable competition.
At the next level of the industry, above two-thirds of the consumers
in the United States—that is, retail utilities as their agents, and in
dustrial consumers in and around large cities—have two, three, even
four, sources of supply. Maybe not enough to establish perfect com
petition. I ’m not familiar with each transaction sufficient to say that
it’s workable competition in all cases. But certainly, as many sources
of supply as you have available in the automobile industry, or in the
steel industry, or the copper industry in this country.
The competition at retail is not sufficient to prevent the occurrence
of systematic pricing above competitive levels in the absence of regu
lation. But no one I know proposes to deregulate the retail gas utility
company and very few that I know propose to deregulate the pipeline.
What is at issue here is deregulation in the workably competitive
field market for gas as an option to reregulating under the NGPA or
continuing the NGPA through this process that now seems to produce
such a price ratchet.
Mr. T w il l e y . Mr. Chairman, I agree in the retail level-----Senator J epsen . Would you use the microphone, please.
Mr. T w il l e y . I ’m sorry. In the retail level, I don’t think in the
foreseeable future it would be possible to deregulate gas. It’s very diffi
cult for me to comprehend an industrial user competing with a dis
tribution company that is serving 100,000 residents for a given quan
tity of gas. I think that regulation has to be there in order to set
priorities, for one thing.
474
Also, there are many different gas utility sizes. Some are very small
and couldn’t really compete for the purchase of gas in the producers’
field. I think that regulatory bodies are necessary to see that the resi
dential users, particularly, are protected and can receive a supply of
gas.
I think at most all regulators would agree that there is very little
hope, in our judgment, that there can be workable competition at this
level.
The gas industry is a three-legged stool—the producers, the pipelines,
and the distributing companies. The problem, as we see it, is the fact
that deregulation of the producers must be accompanied by some kind
of mechanism that will bring the producers and the ultimate purchasers
together in a free market place. The mechanisms that have been pre
sented so far. in our judgment, are probably not adequate.
What we can say in this area is that it has been a national policy to
head in this direction. I think most regulators will say, well, we will go
as far as we can and try to keep the mechanisms in place that help to
make gas reasonably priced and we’ll consider devices that will make
workable competition possible. Contract carrier requirements for pipe
lines is one, perhaps, in the President’s bill. And even in S. 823, we have
the requirement that if a producer cannot—if some of his gas is backed
out, that the pipeline will have to carry it at 5 cents per 1,000 cubic feet,
plus costs.
These are little things leading toward the possibility of workable
competition and we are willing, I think, as commissioners, to consider
it. But we are very skeptical that this natural resource can possibly
become totally deregulated in a workable, competitive market.
Mr. C o o p e r . I ’d like to typify the market as one of weak market
forces and strong political, or potentially strong political actors.
I have not advocated perpetual regulation through price ceilings.
In that sense, there may be less difference between Mr. MacAvoy and
myself than there appears. I believe that certainly at the pipeline level
and the city-gate level we require regulation. What I want is not a series
of categories, but a series of procedures and processes to elicit the right
responses from pipelines. I would support some sort of contract carrier
provisions so that those consumers who are big enough and have the
access to get into the field can exert their market power.
But what we are talking about as for the wellhead, I ’m aware of the
history of the findings of workable competition at the wellhead. I ’m not
convinced of the criteria of those conditions. But I have not advocated
perpetual regulation at the wellhead. What I ’ve advocated is a series of
institutions between the wellhead and the burner tip that will balance
what I see as a maldistribution of market power between the people on
this side of the wellhead and the people on the other side of the
wellhead.
Mr. M ac A voy . Could I make a comment on Mr. Twilley’s remarks,
just in terms of providing a bit of perspective, gentlemen. NARUC,
in its history, has had prime jurisdiction, primary jurisdiction, over
the railroads and the trucks and the airlines within the State, as well
as the electricity, gas, and telephone companies within State regulation.
My understanding of their positions before Congress through the
last 25 years is that with respect to the railroads and the trucks and
475
the airlines, and now the gas companies, NARUC never knows when
to quit, that they’re really in the regulating business. And it’s fun to
regulate right down to the last day to the last unit of output provided
by the company that’s destroyed by the regulatory process.
And I think NAIIUC here has given us essentially the same testi
mony they gave on the Railroad Reorganization Act of 1976 or maybe
even the same they gave us on the Airline Act of 1938, that they’re just
not ready to quit.
Mr. T w il le y . Mr. Chairman, we’re right on this one.
M r. M ac A voy . Why are you always wrong on the others, every
time you appear ?
Representative L ungren . Mr. MacAvoy, from your comments, it’s
obvious that you would rather us go to a deregulation mode as soon
as possible. You criticize the administration’s proposal for being in
some ways confusing.
Do I take it from your testimony, however, that you do think that
the administration’s proposal is preferable to the present law?
Mr. M ac A voy . I can’t really tell, Congressman, because it is impos
sible for me, with my limited resources, to determine the complex
effect of the combinations of gas cap, renegotiation, and the elimina
tion of incremental pricing—never mind the elimination of FUA
and PURPA—in terms of the net impact that these conditions have
on prices.
I have a fair idea from studying NGPA for the last 5 years that
NGPA has a good shot at increasing prices about one-third and that
if we were to eliminate both the vintage pricing provisions in NGPA
and the take-or-pay/favored-nations clauses to essentially deregulate
without all the bells and whistles of the administration act, that we
can save 10 percent of that price increase, that the prices that would
occur from that combination of straightforward, simple deregulation,
now while there is excess supply in the market, will bring prices
down 10 percent below what they would be under the NGPA as the
NGPA works its way through in its own stately fashion.
So that deregulation will produce relative price decreases. They
won’t produce absolute price decreases, because demand is increasing
too fast for that. But they’ll produce relative price decreases.
The administration’s bill, like the NGPA, is so darned complicated
that I can’t figure out what it will do.
Representative L ungren . Perhaps that’s one of the ways that they
think they could get it through.
M r. M ac A voy . Well, it is a smokescreen. I agree. You lay down a
smokescreen in front of the first four battleships and then you might
be able to get around behind the Graf Spee and do some damage. I
agree.
Representative L u ngren . Mr. Cooper, you’ve grabbed the micro
phone. I assume you want to say something on that.
Mr. C ooper. I agree that the current contract structure is propping
up certain prices. The critical question is how quickly you think the
contracts on low cost old gas will be renegotiated under the adminis
tration plan, renegotiated upward, compared to how quickly you think
the contracts on high cost gas will be renegotiated downward.
476
Frankly, having watched this market for the last 3 years struggle
to resist tremendous downward pressures on price, one has to expect
that you will get a much more rapid renegotiation upward on old gas
prices than downward on new gas prices. The result will have to be
large price increase rather than a price decrease. Again, that has to do
with how you view the market. I look at who’s out there, who’s acting
and who’s not, what has been accomplished in the last 3 years as every
one began to recognize that the contract structure was unsupportable,
and what has not.
Given the sort of political economic reality that I see, I think, under
administration’s bill we must experience an increase in price, simply
because of the arithmetic of how renegotiations will take place.
Representative L ungren . Let me ask one question of the entire
panel and this has to do with something that we were getting into a
little while ago.
What is the legitimate way, in your individual views, of encourag
ing the wildcatter, encouraging the producer, of gas ?
Mr. M ac A voy . There are two elements of discouragement. One is
and has to do with ability to expect some constancy in contract terms.
Since 1974, contract terms at the wellhead have changed so radically
three or four times, first by opinion 699 of the Federal Power Com
mission; second, by the Natural Gas Policy Act; third now with these
various proposals, certainly, that if one is in the business of supplying
gas over a 20-year period, it is difficult, if not impossible, to have a
clear, predictive grasp of what is going to happen under that contract.
Stability of terms that would reduce uncertainty can only be
achieved by reducing the manipulation occurring in FERC or the
Federal Power Commission and statute regulations.
The second element is within those conditions of high uncertainty,
where is price likely to go in the middle and long term and can, on the
basis of that price prediction, we expect to be able to generate scarcity
rents sufficient to pay the cost of exploration and development ?
My guess is, my judgment is that with respect to those conditions,
under any one of these different proposals, we’re not going to see very
substantial differences in the level of exploration and development
over the next 3 to 5 years, that the Cooper plan or Mr. Johnson’s plan
or my fresh deregulation will not produce very much change in ex
ploratory activity because these are dominated by the uncertain con
ditions that I described first.
Mr. T w iix e y . I f I may comment briefly on this, and I don’t want to
be sounding like I ’m protecting producers. But I think that we have
to recognize that take-or-pay contracts, long-term contracts, have
been in this industry for a long time because when a well driller finds
a well, he must have the security for the banks that lent him the money
of a market for his well for a long period of time.
So it’s been natural in this industry that these long-term contracts
are created. And I think that the problem today is m reliance upon
the Natural Gas Policy Act, which created the climate that made these
high, take-or-pay contracts possible. It is that error that must now be
legislatively corrected.
But most of the bills that are before Congress would not outlaw
take-or-pay contracts. They are generally requiring that takes be re
duced to some percentage of contracted amount or deliverability.
477
When we were considering S. 823, this issue was discussed broadly.
In fact, it was the California commissioners who recommended the
50-percent cap or reduction because that would meet the foreseeable
problems in California.
So in order to keep a climate for wildcat discovery, I don’t think
that long-term contracts are bad, or even that take-or-pay provisions
are bad. It’s only when they’re excessive. And I think if we can bear
that in mind as the present disruption gradually resolves itself, this
danger may not continue with us much longer.
Senator J e p s e n . I ’m pleased to hear you say that. You know, one of
the dangers in this I found out very early from experience with the
folks who are concerned with this issue is that we generate a lot more
heat than light.
The take-and-pay clauses are the normal procedure for doing busi
ness and have always been around. But we must be careful, too, about
how they interact with regulation. As I have personally said many
times that the 1978 Natural Gas Policy Act has been used by some in
the private sector. They hide behind it so they can drag their feet in
adjusting the contracts to reality. They don’t need the Government to
tell them that they’ve got a market-out clause or they’ve got to change
to take and pay.
On the other hand, there are many pipeline contracts. And so when
you say simply, go and get your contract changed, that’s one thing.
But to change 6,000 contracts with 900 suppliers, that doesn’t happen
overnight.
I have been advised that in this whole natural gas productiondistribution system, there are about 30,000 contracts involved.
Mr. C ooper. I would point out that those contracts were, in fact,
changed with tremendous rapidity after the act was written. And I ’m
talking about existing contracts on old gas.
Senator J epsen . Excuse me. Say that again.
Mr. C ooper. I ’m saying that existing contracts on old gas were
reopened and renegotiated with tremendous speed to put in all of these
clauses that we are so concerned about today. At least 30 percent, which
is the number in the first study that I saw, and probably in excess of
50 percent.
And when I ’ve asked people at the Energy Information Administra
tion, who have been studying the contracts, why didn*t you keep mon
itoring how many existing contracts were reopened on a regular basis,
their answer was, these contracts are opened every day. That is, every
time you spud a new well, you go in and you reopen these contracts.
The fascinating thing, and I have said this in public and I have said
to Chairman Butler, the fascinating thing is that they only get re
negotiated in one direction. Over 16 months ago I testified before the
Senate Energy Committee and I said, there are downward pressures
on prices. When Chairman Butler can come in and say that there’s been
a massive renegotiation to reduce take-or-pay clauses, we will see mar
ket forces operating.
In 16 months no ground has been given to take the very clauses out
of contracts that got into those contracts almost instantaneously.
Senator J epsen . When you ask representatives o f the industry why—
they’ll say, that’s because the Natural Gas Policy Act says it. We don’t
have any other choice.
478
Mr. C ooper. Well, the clauses that we’re talking about were not part
of the Natural Gas Policy Act. They were a function of, I believe, the
bargaining power of two parties in a tight market. When the market
turned around, and it’s been slack now for quite some time, the bar
gaining power hasn’t shifted. The pipelines cannot bring producers to
take those clauses out and producers will talk about royalty owners
and everything else. It’s exactly that maldistribution of power that
concerns me in the renegotiation process.
Mr. M ac A voy . Mr. Cooper is simply describing a situation, Senator,
where you and I agree that I sell to you some No. 2 Red Winter at $2.80
forward 6 months from now. And when we get up to the 6-month time,
it turns out that that is only $2.15 on the spot market in Chicago. Why
should I renegotiate that contract with you? You and I entered into
it in good faith. Unless we both agree that I should take a 75-cent loss,
there will not be such renegotiations.
These are valid contracts, describing exactly the way, it can be de
scribed in exactly the way you did. They’re between two parties and if
the party has a take-or-pay clause in there that gives him 92 percent
utilization when the system, as a whole, is on 65 percent utilization, he’s
going to enforce it.
What’s at issue here is whether the take-or-pay clause would exist
if we had an open and free market for these contracts. And I submit
to you, humbly, that we didn’t have take or pay with 92 percent or 95
percent before we had the NGPA. And it’s been signed since the
NGPA because the supplier comes in and says, OK, I have some 107
gas that goes at a price of $7. You have a whole set of contracts for
102 gas at $2. I want you to take my gas first because I know what
you’re going to do if you’re a pipeline and demand goes down. You’re
going to take the cheap gas first.
So that the contract only occurs in that way because you have the
vintage pricing. I f everybody were paying the same price, everyone
would have the same rate of take or pay. What we need in those
clauses is a simple statute revision of the Natural Gas Act which says,
take or pay clauses cannot be discriminatory.
It’s as simple as that, which if you take from me and you take from
the Congressmen, you take at the same rate.
Senator J epsen . Good. I hear what you’re saying.
Some of the regulations have gone too far. It’s kind of like sticking
your hand in a bucket of glue and then sticking it in a sack of feathers
and then you try to shake the feathers off. To believe that regulation
is going to solve all our problems is an approach that has not worked.
Reasonable people, with experience in the business world, look at it,
they shake their head.
Thank you all—and I would ask, Congressman Lungren, do you have
anything else ? I ’m going to ask for closing statements here.
Representative L ungren . No ; I don’t. Thank you, Mr. Chairman.
Senator J epsen . I will also advise that the record will be kept open
in the event that there are any members of the committee who have
questions they’d like to submit, and I would appreciate it if you would
respond.
At this time, if you have any closing statements, the Chair would be
pleased to have them entered into the record.
479
M r. M ac A voy . I w ould wish on ly to say, with due hum ility, that I
support you r last statement strongly.
Senator J e p s e n . I ’ll have to remember it. [Laughter.]
Mr. Twilley.
Mr. T w i l l e y . N o, Mr. Chairman.
Mr. C o o per . I appreciate the opportunity and the committee’s efforts
to raise the level of this debate. As someone who is involved in the
politics of it, I do appreciate and enjoy the opportunity to debate it at
a somewhat different level than we’re frequently used to around here.
Thank you.
Senator J e p s e n . Thank you, Mr. Cooper. I think that’s a compliment.
Mr. C o o p e r . It w a s fully intended as a compliment. [Laughter.]
Senator J e p s e n . Thank you, sir. The committee will now stand
adjourned.
[Whereupon, at 12:35 p.m., the committee adjourned, subject to the
call of the Chair.]
[The following information was subsequently supplied for the
record:]
480
Congress of the United States
Joint Economic Committee
Hearings on Natural Gas Issues
NATURAL GAS POLICY: INTERNATIONAL ASPECTS
M. A. Adelman
Department of Economics & Energy Laboratory
Massachusetts Institute of Technology
Cambridge, Mass. 01239
The effect of the proposed natural gas legislation would be
to unlock large amounts of g a s f available at lower prices than
c u r r e n t , from Canada and Mexico. The import of Alaskan gas, and of
liquefied natural gas (LNG), which are clearly uneconomic# would no
longer be considered# and should not be.
Push a balloon in one place, it pops out in another.
Fixing natural gas prices below the market-clearing price generated
excess demand.
When some gas was exempted from regulation, the whole
force of the excess was focussed upon the exempt supply, raising its
price above the market-clearing price, which would prevail absent any
controls.
The more severely we repressed the regulated gas price below the
market-clearing price, the higher we forced up the price of exempted
gas. This gave false signals to everyone, and generated massive waste
of resources, by concentrating the search for gas into new and very
expensive sources,
instead of expanding supplies of gas from new
deposits which happened to be located in "old" leases.
Matters were — and still are — made much worse by pipelines
"rolling in" old with new gas. The bigger the cushion of old gas, and
the lower its price, the more extravagantly high the exempt gas price.
Pipelines were and are ready to pay much higher prices for gas than
any of_their customers could be made to pay, because they can recoup
those ultra-high prices they pay by raising the average price they
charge to all their customers.
The situation became much worse after
1978 because the second oil price explosion pulled up the prices of
all substitutes for oil, including natural gas. Hence the rise in
exempt gas prices, and the frenzied boom in deep gas drilling, which
1
481
collapsed last year,
In recent years, price control has tended both to block gas
supplies from Canada and Mexico, and to embitter relations with them.
Our neighbors argued, and correctly, that their gas was just as good
as the new or otherwise exempt gas, hence it ought to receive the same
high price. They erred in not seeing that the ultra-high prices could
only hold for a limited part of total gas supply, and only for a
limited time.
The situation was already bad before 1979. A large proposed
sale
from Mexico was stopped because the price was higher than the
regulated price, although lower than some unregulated ones. Had it
been called off quietly,
it would not have been so damaging. But it
became a matter of high policy, and in effect though not in form, of
government-to-government confrontation.
It was made still worse by
offensive insulting language used by some American officials.
In fact, our government was trying to discourage Mexican oil as
well as gas imports, because too fast a buildup of those imports
"would jeopardize carefully nurtured relations in the Middle East."
(New York Times, November 30, 1978)
The same illusions were setting our policy then as now.
"American strategists have always found a silver lining in the stable
pro-Western Gulf that high oil prices helped to create."
(New York
Times, March 6, 1983.) True, high oil prices and billions in oil
revenues have made the Persian Gulf what it is. "Stable" and "proWestern"? I would rather look at the real world, of petroleum markets.
The second price explosion of 1979 made excess gas demand
all the greater, because it made both industry and government think
that oil and gas were becoming terribly scarce, and that prices must
soar higher, forever and ever, or at least until 2000 A. D.
At home, oilmen clamored to borrow, and banks crowded to
lend, on the basis of discounted-cash-flow projections of prices
rising by 9 percent or more per year.
Mexico could commit to huge increases in spending, while
expanding oil production at a moderate rate, putting gas development
on the shelf.
increases.
In
Canada also, the government banked on continuing steep
It bought out some foreign producing interests, at fancy
2
482
prices, and forced out some by imposing sharing agreements upon them,
because it expected the future value of those interests to be so much
greater than the present value.
In the same spirit, they decreased
permissible exports of natural gas to the United States.
In this country, the obsession with scarcity led pipelines,
with the encouragement of our government, not only to buy the
extravagantly priced gas, but to sign extravagant take-or-pay clauses,
which were in effect substitutes for still-higher prices.
The reaction began to appear in 1980. Canadian gas became
difficult to sell
even at permitted prices, because demand was
dropping.
In 1982, the demand for deep gas collapsed, and only those
high inflexible take-or-pay contracts keep sizable amounts flowing, to
the chagrin of the pipelines and the grievance of consumers. Deep gas
that once fetched $9 or $10 is now selling at between $3.50 and $5.50
where permitted by re-negotiation or "market-out" clauses. Canadian
gas, once held back because $4.94 was "too low", is now unsalable
because it is obviously too high. Only about 40 percent of the
Canadian allowable is actually exported.
The attempt to get gas export prices which are increasingly
out of touch with reality has suppressed exploration and development
of Canadian oil and especially gas, to their own injury and ours.
Known reserves are lying fallow,
and
there is little or no
exploration in areas with good prospects.
The current Canadian government cannot afford to admit
that they have wasted the nation's resources,
because the truth is
too shaming to them. But there are already signs of change. Mr. Edge
of the National Energy Board, said early in March that the p'rice would
have to come down. Some quavers are heard in the chorus about how the
current U. S. surplus will become a shortage "again" in the mid-1980s.
In time, it will be recognized that there never was any shortage in
the United States, except the one created by price control.
The Canadian gas potential is very large, though I will
refrain from guessing how many trillion cubic feet could be developed
and produced. The fact is that nobody knows, that the only mechanism
for finding it out is by allowing the Canadian industry to export, at
a price which will move the gas. This would make it worth their while
to develop the known deposits, which are considerable, and also to
explore for those not yet known, which may be much larger. One
transmission company has offered $3.45, and nobody doubts there is a
great deal available at that price.
As for Mexico, proved reserves
(excluding the dubious
Chicontepec area) are being depleted at the rate of only 2 percent per
year, and a sizable fraction of this is flared. Probable and potential
reserves are much larger than proved, and the Mexican method of
483
reserve estimation is conservative.
As Mexican oil production expands, as it must to restore
foreign exchange receipts, more gas associated with oil will be
produced also and be worth gathering and exporting.
In addition,
there are some promising discoveries of non-associated gas in the
Northeast, not very far from the American border.
Because Mexico is
so close to the United States, gas can be shipped there relatively
cheaply, and fuel oil used at home instead of being exported into
today’
s glutted oil markets.
I hope
expand output or
or fair treatment
We will never win
don't deserve to.
we can refrain from pressuring Canada and Mexico to
reduce prices in the name of hemispheric solidarity,
of our consumers, or some such highfalutin reason.
an argument couched in terms of right or wrong, and
In fact, negotiations are perfectly unnecessary.
The biggest favor we could do them— and us— would be to
enact the proposed gas decontrol measure to bring all gas prices
together at the market-clearing level. That would rapidly destroy the
artificially low-priced gas which was responsible for the artificially
high priced gas, which has been dazzling our neighbors' eyes.
The bill would immediately create a market in long term gas
contracts. Sellers would seek out buyers, and vice versa. For the
first time, producers could bargain directly with consumers, with one
or more pipelines involved as carrier for a fee. There would be a wide
range of alternatives for choice. All parties could come together to
establish prices for sizable blocks of new supply. That is the crucial
piece of information, which is always being generated in any market in
long term assets, and which decades of regulation have destroyed in
this country. Field price regulation has plunged everybody into
ignorance.
The
regulation has grown increasingly complex
and
convoluted, to the point where nobody can say what is the price of gas
today with which to compare the cost of new finding and development
projects.
Today, the average field price paid for natural gas is
around $2.75. How high would be the market-clearing field price of
natural gas? The evidence is that it would be no higher and probably
lower than what is current today for new gas, which is around $3.50.
At this price, more gas is being offered than is being demanded.
Recall that the gas surplus has persisted for several years, even
before the onset of the recession in 1981. Apparently we are coming
out of that recession, but few expect "smokestack industry" to revive
quickly to where it used to be.
In the interim, if as we all hope it is that, we will have
an opportunity to see how well domestic gas reserves respond to higher
¥
484
prices» In 1-981, natural gas reserves-added exceeded consumption by 14
percent.
Nobody knows whether this will happen again.
If it does,
field prices cannot rise. But let us suppose that reserves-added in
this country will be insufficient to offset consumption at a price
around $3.50. Large supplies can be developed in Canada and Mexico, at
that price or less.
If they would be willing to supply considerable
amounts, the price cannot rise.
Canadian and Mexican supplies would compete in Texas, the
West Coast, or the East Coast, treated no differently from any
American producers. They would be reckoning with prices considerably
lower than the last transactions they made, and they would have to
decide whether to sell at that price, or at a lower price, or hold the
gas in the ground.
Holding oil or gas in the ground is partly a fetish, and a
tribute to prejudice.
Canadian gas is too good for the Yanks,
Mexican oil or gas too good for los g r i n g o s , just as American
(Alaskan) oil is too good for the Japanese, Scottish oil too good for
the English, still less the Continental Europeans, etc., etc. Holding
mineral assets in the ground makes economic sense if — and only if
the price is expected to rise at a rate faster than the rate of
interest,
Otherwise, the owner loses what he could have done in the
interim with the proceeds, had he sold the mineral. We have it on
venerable authority (Matthew 25:14) that if you cannot put assets to
good use, lend them out in the money market, but don't leave them in
the ground as did the "unprofitable servant", who did not deserve his
trust. Delay has already cost sellers heavily.
Decontrol of gas field prices over a short period, during
which the network of commitments to deliver and pay can be r e
examined, would be a net gain to all three nations, because it would
expand output of energy at a lower cost than available anywhere else.
Gas from Canada and Mexico would be forthcoming in much larger amounts
than in the past.
There would be no more restriction of supply north
or south of the border, in the vain hope of higher prices, but rather
new export commitments, fed by new exploration and development
creating larger reserves than exist now.
The panic which seizes on many consumers and Congress, to the effect
that given decontrol all field prices will leap to $9, was not
justified even a year ago, when such prices were actually being
collected. It is completely delusive today.
Many people are sincerely afraid of a gas price "flyup"#
that given decontrol all field prices will leap to $9. The as»u«ption
is wrong, and the billions in additional payments are only a hash of
meaningless arithmetic. Not only has the "flyup" already happened, it
has overshot. If price controls were swept away, field prices on new
?*s contracts would be lower not higher, because new gas could n©
onger be rolled in with cheap old gas.
485
At the consumer end, gas is going unsold today because the
price is higher than what users are willing to pay, given alternative
fuels. Thus without controls the prospect would be for some price
decline. This excess has transmitted back to the field, where gas is
likewise in surplus, more being offered than is demanded at top
permitted prices, in the neighborhood of $3.50.
The cheap "old gas", which today generates b o much acrid
controversy, is a wasting asset.
In ten years,
it will be largely
gone. If we perist in holding down field prices, we will have replaced
it with new supplies priced at $7 and more from Algeria, a supplier
which broke agreement after agreement with the French in the 1960s,
and did the same thing to European and U. S. buyers of gas recently,
stopping delivery "for technical reasons" until they obtained higher
prices than in the contract. We will also have gas from Alaska costing
$12 to $15, and more deep gas costing $9 or $10. That this will have
been done in the name of protecting consumers from high prices makes a
rather sour joke.
21-496 0
83
31
486
A m e r ic a n F a r m
B u r e a u F e d e ra tio n
W A S H IN G T O N O F F IC E
•OO MARYLAND AVE . S.W
SUITE BOO
W ASHINGTON. D C 20024
AREA CODE 202 - 4 *4-2222
April 15, 1983
Honorable Roger W. Jepsen
Chairman
Joint Economic Committee
Senate Dirksen G-01
Washington, DC 20510
RE:
Natural Gas Legislation
Dear Senator Jepsen:
Farm Bureau is the nation's largest general farm organization,
with over three million voluntary member families in 48 states and
Puerto Rico. We estimate that about 85 percent of the working farmers
and ranchers in the United States are Farm Bureau members.
Farm Bureau policy is developed from the grass roots up through
the ranks of the organization. Because of the nature and scope of our
policy process, we are confident that our adopted policies represent
the thinking of a majority of individual farmers and ranchers in this
country.
1983 Farm Bureau policy on energy, adopted in January at the 6Uth
annual meeting, calls for deregulation of natural gas. This position
is based upon the concerns of farmers and ranchers for adequate and
timely supplies of energy necessary to produce, process and transport
food and fiber for our nation. We believe that the market is the
better allocator and price setter for all energy supplies, including
natural gas.
The federal government has regulated natural gas since at least
1951*. Federal controls kept natural gas prices artificially low. As
a result, natural gas was overused in relation to alternative energy
sources. Also, exploration and development of new natural gas
supplies dwindled due to the lack of economic incentives. By the
winter of 1976-1977, there was a severe shortage of natural gas,
except in the unregulated intrastate markets of the producing states.
Factories had to be shut down, schools closed, and many people were
unable to heat their homes.
In response to this energy crisis, Congress debated decontrol,
but finally chose to enact the Natural Gas Policy Act (NGPA). The
NGPA gave rise to new problems and compounded the old ones.
Regulations multiplied. Over twenty price categories were set
favoring the most expensive gas to produce. The intrastate gas market
487
was brought under federal control. New gas would eventually escape
control, but old gas was to be forever regulated.
Today, in spite of an apparent abundance of gas supplies, prices
are rising sharply. Consumers are angry and demanding relief. So
Congress is again considering whether to deregulate or reregulate.
We submit that federal controls have not only failed, but have
been the principal cause of supply and price problems for the
consumer. Now is the time to completely decontrol all natural gas
supplies. We believe that all consumers and every segment of our
economy will benefit from decontrol.
Deregulation would have an impact on production agriculture
primarily in the supply and prices of ammonia (nitrogen) fertilizer
made from natural gas. The major uses of ammonia fertilizer are
concentrated on corn, cotton, wheat, fruits, and vegetables. Ammonia
fertilizer accounts for about 36 percent of fertilizer expenditures
and about 2.4 percent of overall production costs. Approximately 40
percent of the cost of ammonia production is the cost of the natural
gas input.
On a straight arithmetical basis, each 10 percent increase in
natural gas prices would result in a 4.0 percent increase in the price
of farm ammonia or a ,1 percent increase in overall farm production
costs. This means that even if natural gas prices doubled there would
be only a 1 percent increase in farm costs. This assumes that gas
price increases would flow straight through the production chain and
that all else would remain the same. But all else would not remain
the same. Ammonia producers would improve efficiencies. Farmers
would accelerate the adjustments they are now making, such as using
less ammonia, adopting more efficient methods of application, or
switching to other nitrogen fertilizers.
We do not, however, foresee drastic price increases for natural
gas under decontrol. We do foresee increased natural gas production
and added competition among various energy sources, particularly
petroleum based liquid fuels. This is very significant for production
agriculture which spent $8.8 billion for gasoline, diesel fuel, and
lubricants in 1982, more than one and one-half times the direct and
indirect expenditures for natural gas. An abundance of natural gas
not only places price pressures on liquid fuels, but also releases
liquid fuel supplies for uses where there is no readily available
alternative energy source, such as production agriculture.
Irrigation pumping and crop drying are the other major uses of
natural gas in production agriculture that would be affected by dere
gulation. The use of natural gas for irrigation pumping takes place
primarily in the states of Texas, Kansas, New Mexico and Arizona.
Propane, derived from natural gas, has its highest usage in the states
of Nebraska, Texas, Arkansas, New Mexico and Oklahoma. However,
nationally 70 percent of irrigation pumping units rely on electricity,
while only 19 percent use natural gas.
488
The use of natural gas for crop drying is highest in the corn
belt. Usage varies considerably depending upon the weather which
affects moisture content. Also, there already has been considerable
interest by corn belt farmers in converting to low temperature natural
air dryers and various solar applications for drying.
Overall, we believe the impact of natural gas deregulation would
be minimal even under the worst-case projections for gas prices. Most
farmers and ranchers can make compensating adjustments, and will do so
better than they did when gasoline and diesel fuel prices skyrocketed
under the OPEC embargoes. Assuming for the moment that the worst-case
gas prices would occur, the increased supply advantages would still
outweigh the price disadvantages. Furthermore, the present time is
the best time to decontrol natural gas as far as agriculture is
concerned. Tremendous commodity surpluses are dictating reductions in
agricultural production, which means there will be reduced demands for
natural gas based fertilizers. If decontrol were to occur now,
natural gas price adjustments to market clearing levels would take
place when agriculture’
s demands are lowest.
However, we do not believe worst-case price increases will
result. If deregulation were to occur immediately, we believe overall
gas prices would decline, particularly now that oil prices are
dropping drastically. The present situation with petroleum is a good
example of the benefits to be derived from deregulation of natural
gas.
Numerous bills have been introduced in Congress which propose
either reregulation or deregulation. We are opposed to those which
call for reregulation through price rollbacks and freezes for all
natural gas, both old and new. These measures would only compound
today's problems and make the ultimate adjustment to marketplace
determinations that much more difficult and injurious to consumers.
The Administration has proposed phased deregulation of all
natural gas by January 1, 1986. Introduced in the Senate as S. 615
and as H.R. 1760 in the House, the Administration's proposal would
encourage voluntary contract renegotiation during the transition
period to correct current distortions in the regulated market.
Consumers would be protected from further NGPA price distortions
through price caps and Federal Energy Regulatory Commission reviews on
cost pass-throughs above the rate of inflation. Take-or-pay
obligations will be restricted to 70 percent, and parties to all
pre-enactment contracts will have the right to market-out on
January 1, 1985. The Administration's proposal also would repeal the
Fuels Use Act of 1978 which restricts natural gas uses.
While we would prefer immediate, total decontrol, Farm Bureau
can support passage of the Administration's proposal as contained in
S. 615 and H.R. 1760. We recognize that there are refinements and
improvements that can and will be made to the Administration's
proposal.
489
However, we believe it is critical that there be no extension
beyond the January 1, 1986, date for total decontrol, and that all
gas— both old and new— be deregulated.
We reiterate that federal controls on natural gas have not only
failed, but have been the principal cause of our supply and price
problems. The last thing we need now is more of the same.
We will appreciate your consideration of our views in this matter
of utmost importance. We request that our views be included in the
Committee's hearing record on natural gas legislation.
Respectfully
John C. Datt
Secretary and Director
Washington Office
lh
cc: Committee Members
490
AMERICAN
J
iMEAT
I
J
i
T
l :
INSTITUTE
Serving The Meat Industry Since 1906
April 29, 1982
The Honorable Roger W. Jepsun
Chairman
Joint Economic Committee
Room SD-G01
United States Senate
Washington, D.C. 20510
Re:
/
Natural Gas Legislation
Dear Chairman Jepsun:
This letter is intended to provide you, and the members of your
Committee, with the views of the American Meat Institute (AMI) regard
ing legislation relevant to the regulation of natural gas. AMI is the
oldest national trade association representing packers and processors
of red meat. Although AMI's membership includes some of the nation's
largest meat companies, more than 70% of the Institute's members
employ 100 or fewer individuals. AMI's members are significant users
of natural gas and, therefore, we are most interested in the way in
which it is to be regulated.
The complexity of the issues involved in natural gas legislation
and the multiplicity of proposals brought forward effectively limit
AMI's ability to address each potential problem. Therefore, AMI's
Energy Committee has concluded that comments reflecting the Associa
tion's general concerns in this area, rather than a detailed review of
each aspect of each possible approach reflected in legislation already
introduced and before the Committee, probably would be the most help
ful imput which we can provide you.
AMI respectfully requests that these comments be included in that
portion of the record of the Subcommittee's proceedings which you
consider to be most appropriate.
The Meat Packing Industry
and Its Use of Natural Gas
The red meat industry, SIC Codes 2011, 2013, consumes an esti
mated 100 trillion BTUs of energy per year in its facilities, accord
ing to various U.S. Department of Energy (DOE) studies. The 1982 AMI
energy efficiency report to DOE indicated that natural gas presently
represents 63.5 percent of all energy used by meat packing plants.
Thus an estimate of natural gas use in the meat industry is about 64
billion cubic feet per year. Assuming natural gas prices at $4.00 per
thousand cubic feet, this represents natural gas sales to meat packers
totaling an estimated $250 million per year.
P.O. Box 3556, Washington, D.C. 20007
-
1700 North Moore Street, Arlington, VA. 22209
•
703/841-2400
491
The industry is comprised primarily of a very large number of
relatively small sized plants throughout the country and is character
ized by extreme competition and very tight profit margins (often less
than one cent per dollar of sales). The natural gas bills for a meat
plant (rarely larger than $500,000.00 per year) and the net profits of
a meat plant frequently are of the same order of magnitude. Thus, any
large or sudden changes in retail prices for natural gas will have an
immediate, and potentially significant impact on a meat plant's profit
ability.
In the meat industry, natural gas is used for efficiency and
economy in minor process needs for which there is no alternative to
natural gas (except propane) such as hog singeing and in direct fired
meat processing ovens.* However, an estimated 85 percent of the
natural gas used by the meat industry is for boiler fuel where the
normal alternative fuel is either No. 6 oil or No. 2 oil, or, in a few
cases, coal, and in rare cases, even propane.
Typical larger plant strategy is to use natural gas for all fuel
needs and to switch boilers, where possible, to installed alternate
fuel oil use as soon as oil is cheaper. This has already happened in
locations where No. 6 oil has become cheaper than the retail price for
natural gas. Plants dependent on only No. 2 oil for standby boiler
fuel still have alternative fuel costs well above even current natural
gas rates. This strategy is not available to many smaller plants
which are less capable of economically installing the capacity to
consume an alternate boiler fuel. Moreover, throughout the industry,
process gas needs will continue to be met with available natural gas,
even when it greatly exceeds oil costs. Since there is essentially no
profit market available to absorb higher fuel costs, higher natural
gas prices will be reflected in resulting higher cost of meat to
consumers.
Thus, while there exists significant elasticity of demand for
higher cost natural gas if oil becomes cheaper, an increase in natural
gas prices has a direct inflationary impact on meat prices.
In the mid-1970's, many meat packers dependent on interstate
natural gas experienced severe curtailments of natural gas supplies.
Interference with production occured where alternate fuel capability
did not exist. Capital was spent on installing alternate fuel sy
stems. Extended periods of curtailment required the use of expensive
alternate fuels, often at prices over twice the cost of the natural
gas curtailed.
* The United States Department of Agriculture has not approved the
use of fuel oil substitutes for natural gas (or propane) for use in
these processes where the combustion by-products come in contact with
human food.
492
The Natural Gas Policy Act of 1978 (NGPA) put natural gas on a
road to price decontrol in order to assure adequate supplies. Since
then, natural gas supply problems have virtually disappeared as an
issue. The issue now is price.
Natural gas prices have escalated at rates above inflation and in
excess of those anticipated under the NGPA decontrol scheme. Large
price differences between regions of.the country are now commonplace.
Where natural gas has exceeded the cost of alternate fuels such as No.
6 oil, switching to oil has occurred and natural gas distributors are
offering reduced rates to such users. The experience of the meat
industry during a period in which its supplies of natural gas, i.e.,
prior to 1978, were curtailed, shows that the return to abundant
supplies of natural gas since 1978 has saved the industry many millions
of dollars per year in fuel costs.
Despite its flaws, enactment of the NGPA has resulted in a rever
sal of the problems of chronic natural gas shortages due to the inter
state natural gas market. The pricing problems now experienced under
the phased decontrol are several, summarized as follows:
(a)
low cost older gas is not being produced in volumes expected,
due to its remaining under controls;
(b)
new gas, while undergoing phased deregulation, is still well
below market value, and a price fly-up could occur when new
gas is totally deregulated;
(c)
deregulated gas is being sold at well above its true market
value because pipelines can average all gas costs to their
customers;
(d)
regional price differences are becoming large because some
pipelines enjoy a greater ratio of old to new gas;
(e)
take-or-pay provisions of deregulated gas sources and import
contracts are causing more expensive gas to be taken in lieu
of controlled sources; and
(f)
end-users of gas concerned about the large percentage in
creases in gas rates, now at 20 to 30 percent per year, feel
such a rate of price climb is too high or too fast for the
economy to absorb.
These serious pricing issues are precipitating requests for Congress
to consider new legislation to refine the present course of decontrol
of natural gas.
493
Principal Concerns of the Meat Industry
With Respect to Legislation Regarding
the Regulation of Natural Gas
As discussed above, the meat industry's composition, i.e., primari
ly small plants, dispersed throughout the country, and its low margin
of profit result in its being highly vulnerable to gyrations in the
market for natural gas. Despite the best efforts of legislators,and
regulators, the substitution of regulatory programs for the operation
of historic market mechanisms has resulted in unsatisfactory distor
tions in the natural gas market, first in the area of supply and more
currently in price. Thus, AMI believes that any additional legisla
tion should have as its primary objective the achievement of a true
"market” for natural gas, subject to the operation of historic market
mechanism. However, AMI recognized that the achievement of that objec
tive must be accomplished in a manner which does not inflict an unac
ceptable burden on the economy. Moreover, AMI recognizes that the
extensive participation of the government in the natural gas market
since the 1950's has shaped that market and created some obstacles to
a smooth transition to an unregulated environment.
Absent affirmative action to eliminate the obstacles resulting
from the government's intervention, the "deregulation" of natural gas
would make little sense, since obstacles, such as long term contracts
which do not provide both parties with the opportunity to adjust to
changing market conditions would effectively inhibit the operation of
historic market mechanisms. In short, the government's past involve
ment in the natural gas market has created more obstacles to the free
operation of that market than just its current regulatory program.
The elimination of these derivative impediments must be addressed
prior to the elimination of the regulatory program itself.
A prime example of a "derivative" impediment to the free opera
tion of market mechanisms is the so-called "contract problem," i.e.,
the existence of price-escalator clauses, most-favored-nation clauses,
and take-or-pay clauses in most producer contracts. These lopsided
provisions protect the producer to the detriment of end-users. A more
balanced contract with increased protection to the end-users would
leave all these provisions intact but add to them, for the period of
phase-out of controls, a market-out clause. Thus, if a producer
prices himself out of the market, h.e would be forced to renegotiate
the gas price to a point where the natural gas could be marketed
successfully. At the point in time that natural gas is completely
decontrolled, the forced inclusion of market-out provisions would be
eliminated.
AMI is also very concerned about certain perceptions of advantages of
the contract carrier provision proposed. Past experience leads us to believe
that it would not have all the advantages one might expect. One of our
member's experience with the former "533 Program" in 1979 helped us
understand the practical problems of buying prodacer gas and arranging
494
to transport that gas when the volume needed is small. In retrospect,
we felt it was not practical to expect small gas users to be success
ful in finding gas sources for themselves and then expect them to be
successful in negotiating with the one or more interstate pipelines
involved in the actual transport route and then negotiate with the
local gas distribution company for final delivery.
Very large industrial gas users will probably be supportive of
the contract carrier provision, but small industrial users, such as
almost every meat packer, would not enjoy the same benefits. When
small gas volumes are involved, neither producers nor pipelines would
likely want to incur the administrative costs for such transactions.
We do not disagree with the inclusion of the contract carrier
authorization. Instead, we merely want to be sure that its advocates
understand that its benefits would flow primarily to very large indus
trial gas users only and that it would not serve as a practical means
of providing "free market" priced gas to the much larger number of
small industrial and commercial gas users.
With the foregoing as background, AMI hopes that the following
comments on broad, general proposals will be helpful to you and other
members of the Subcommittee:
(1)
Immediate decontrol would trigger price-escalator clauses
and most-favored-nation clauses of producer contracts with pipelines,
and the take-or-pay provisions of many supply contracts. Such action
likely would result in an immediate and significant increase in natur
al gas prices at the wellhead. These costs will be transmitted to
distributors who will immediately pass through higher averaged costs
to end-users by use of the purchased gas adjustment mechanism. End
users whose natural gas price exceeds their available alternative fuel
costs will cease to use natural gas and opt for the lower cost alter
nate fuel. Those users who have no alternate or have high cost alter
nate fuels will see a significant increase in their natural gas prices.
State utility commissions unwilling to let the full impact of this
increase affect residential users of natural gas may choose to freeze
the retail natural gas price, forcing business users to absorb the
sudden increase in natural gas rates. Industrial users who have left
the natural gas system for cheaper alternate fuels may be given dis
counted natural gas rates by distributors who need the industrial load
to help carry the fixed costs of distribution of natural gas.
From the view of a meat packer, two affects of immediate decon
trol would be felt: (1) an immediate increase in boiler fuel cost
relative to the alternate fuel price, with boiler fuel price stabiliza
tion at that point, and (2) a second and much higher price increase
for process gas. Those with only No. 2 oil for a boiler fuel alter
native would have such a sizeable increase that consideration would be
given to installing No. 6 capability to reduce fuel costs. These
higher operating costs cannot be absorbed and, thus, would be reflected
in price increases in the products. However, the degree of impact
will vary regionally causing some packers more economic stress than
others.
495
Natural gas supplies would remain plentiful, but costly with, a
two-tier price likely for natural gas depending on use — one for
boiler use, and another higher price for non-boiler use. Long-term
supplies of natural gas would be expected to be excellent and, eventu
ally, regional differences in natural gas price would likely lessen.
Energy conservation would become even more important and waste heat
recovery would be absolutely essential for energy cost control.
In summary, the scenario described above would cause immediate
and serious economic disruption temporarily but, in the long-run,
these problems would wane. Meat prices will have been forced upward
as a direct result and, regionally, some packers will likely be more
severely affected as compared to others. Packers less capable of
implementing cost-effective state-of-the-art energy conservation
measures would tend to lose in their relative competitive positions.
(2) Accelerated decontrol of new gas would have the same type
of impact as described above for the immediate decontrol scenario, but
in a much more muted fashion. Supplies of natural gas would remain as
good as today, but higher natural gas costs will be felt which would
be regionally different. Higher meat prices would result from a
fundamental income transfer from the public to the natural gas pro
ducer. Accelerated decontrol merely hastens the transition period to
the time of full decontrol which adds further economic stress at a
time such stress may not be in the National interest. From a packer's
viewpoint, costs would increase with very little compelling justifica
tion such as an improvement in natural gas supply assurance.
(3) Phased decontrol of old gas, however, would tend to increase
the availability of this very low cost source of natural gas to pipe
lines to help them lower the average of all wellhead natural gas
purchases. If phased properly, the net economic impact to packers
would be minimal. If decontrolled too quickly, the economic impact
would be negative, resulting in unneeded income transfer from the
public to owners of old gas sources.
(4) Retaining the NGPA decontrol plan would continue the present
environment of ample natural gas supplies and steadily increasing
natural gas rates like those of the past few years and continuing
regional differences in natural gas costs until 1985, when new gas is
decontrolled or reconsidered for extended controls. At that time, no
one knows if a price fly-up will or will not occur, but some sudden
readjustments in prices is very likely. The more serious problem with
no change in the NGPA is the continued full control of old gas causing
less than optimal production of this economical source of natural gas.
(5) Extending controls beyond NGPA. If Congress were to extend
controls on new gas and keep controls on old gas, the present problems
in natural gas pricing would be prolonged. The extended short-term
projection would be dampened price increases, while easing economic
stress, would continue the present problems of marketing natural gas,
496
and would provide strong disincentives to needed production. Meat
packers would see continued pricing/problems regionally and could
experience an increasing level of curtailment.
(6) A price freezing would fix, in time, the present pricing
problems in natural gas without a solution and, at the same time,
provide a strong disincentive for needed production. Ironically,
natural gas prices to a packer would still increase even under the
freeze due to inflation increasing the transmission and distribution
costs and, in the long-term, increased curtailments would be assured.
(7) Continue the NGPA decontrol plan, but pass legislation to
initiate phased decontrol of gas. Assuming a resolution of the "con
tracts problem," this scenario attempts to strike the best compromise
between achieving decontrol in the long-run and minimizing economic
stress in the short-run. The new legislation addressing decontrol of
old gas would allow producers of this very economical and available
source of natural gas the proper incentive to continue and promote
production. The benefits to the end-user packers would be two-fold:
(1) it would further improve natural gas supply, and (2) the more
economically produced old gas would act to dampen the need to buy the
new and higher priced natural gas sources. While natural gas prices
to end-users would be unlikely to drop as a result, the increased
production of old gas would help stabilize overall natural gas prices
and lead to less differences in regional natural gas prices.
Should old gas decontrol be mandated, the inclusion of a windfall
profits tax would be counterproductive. Such a tax would remove the
very incentives to production intended by phasing out controls on old
gas.
Finally, packers are best served by insuring that retail natural
gas pricing reflects cost-of-service based on ratemaking for all
users. Attempts to load the price of decontrol onto any one user group
should be strenuously opposed. Repeal of incremental pricing would be
consistent with this support for fairness in rates to all users.
AMI appreciates this opportunity to share its views with you. If
you or your staff have any questions regarding AMI1s comments, or if
we might provide further information upon which our position is based,
please do not hesitate to contact us.
Sincerely,
C. Manly Molpus
President
CMM/lwc
o
@FedFRASER