An economic analysis of new gas deregulation

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Title:
An economic analysis of new gas deregulation
Physical Description:
ii, 14 p. : 24 cm.
Language:
English
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United States -- Congress. -- House. -- Committee on Interstate and Foreign Commerce. -- Subcommittee on Energy and Power
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U.S. Govt. Print. Off.
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Washington
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Subjects / Keywords:
Natural gas -- Rates -- United States   ( lcsh )
Gas industry -- United States   ( lcsh )
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federal government publication   ( marcgt )
non-fiction   ( marcgt )

Notes

General Note:
At head of title: 94th Congress, 2d session. Committee print.
Statement of Responsibility:
prepared by the staff for the use of the Subcommittee on Energy and Power of the Committee on Interstate and Foreign Commerce, U.S. House of Representatives, February 1976.

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University of Florida
Rights Management:
All applicable rights reserved by the source institution and holding location.
Resource Identifier:
aleph - 025827086
oclc - 02298458
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AA00022569:00001

Table of Contents
    Front Cover
        Page i
        Page ii
    Summary
        Page 1
        Page 2
    Dollar costs of deregulation
        Page 3
        Page 4
        Page 5
        Page 6
        Page 7
    Macroeconomic impacts of deregulation
        Page 8
        Page 9
    Problems in a transition toward full deregulation
        Page 10
        Page 11
    Legislative options
        Page 12
    Conclusion
        Page 13
        Page 14
Full Text



94th Congress
2d Session


COMMITTEE PRINT


AN 1C%(1N()MI C


ANALYNIS F


N Il:W


T AS I) II I. [ IATI ( )N


byv th(


Staff for the [ se of thl e


S \Ioi(MMITrTEE ()N


OF Tl I E


COMMITTEES


(IN INTERSTATE N ANI)


FOREIGN COMMERCE


U.S. HOUSE OF


RE PRESEN TATIV ES


FEBRUARY 197






U.S. GOVERNMENT PRINTING OFFICE


WASHINGTON : 1976


r I


I


"PrelM1ard


E~ N E IN(i Y A NDI)PO( ) 1, E


6"12 O

















COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE


HARLEY 0. STAGGERS, West Virginia, Chairman


TORBERT H. MACDONALD, Massachusetts
JOHN E. MOSS, California
JOHN D. DINGELL, Michigan
PAUL G. ROGERS, Florida
LIONEL VAN DEERLIN, California
FRED B. ROONEY, Pennsylvania
JOHN M. MURPHY, New York
DAVID E. SATTERFIELD III, Virginia
BROCK ADAMS, Washington
W. S. (BILL) STUCKEY, JR., Georgia
BOB ECKHARDT, Texas
RICHARDSON PREYER, North Carolina
JAMES W. SYMINGTON, Missouri
CHARLES J. CARNEY, Ohio
RALPH H. METCALFE, Illinois
GOODLOE E. BYRON, Maryland
JAMES H. SCHEUER, New York
RICHARD L. OTTINGER, New York


SAMUEL L. DEVINE, Ohio
JAMES T. BROYHILL, North Carolina
TIM LEE CARTER, Kentucky
CLARENCE J. BROWN, Ohio
JOE SKUBITZ, Kansas
JAMES M. COLLINS, Texas
LOUIS FREY, JR., Florida
JOHN Y. McCOLLISTER, Nebraska
NORMAN F. LENT, New York
H. JOHN HEINZ III, Pennsylvania
EDWARD R. MADIGAN, Illinois
CARLOS J. MOORHEAD, California
MATTHEW J. RINALDO, New Jersey
W. HENSON MOORE, Louisiana


HENRY A. WAXMAN, California
ROBERT (BOB) KRUEGER, Texas
TIMOTHY E. WIRTH, Colorado
PHILIP R. SHARP, Indiana
WILLIAM M. BRODHEAD, Michigan
W. G. (BILL) HEFNER, North Carolina
JAMES J. FLORIO, New Jersey
ANTHONY TOBY MOFFETT, Connecticut
JIM SANTINI, Nevada
ANDREW MAGUIRE, New Jersey
W. E. WILLIAMSON, Clerk
KENNETH J. PAINTER, Assistant Clerk
IProfessioial Staff


(IIARLES B. CURTIS
LEE S. HYDE
ELIZABETI IARRISON
JEFFREY II. SCHWARTZ
,[ANIES M. MENGER, Jr.


WILLIAM P. ADAMS
ROBERT R. NORDHAUS
BRIAN R. MlOIR
WILLIAM G. PHILLIPS
KAREN NELSON


MARGOT I)INNEEN



SUBCOMM ITTEE ON ENERGY AND POWER
JOHN I). DINGELL, Michigan, Chairman


TIhMOTHtY E. WIRTII, Colorado
PHILIP R. SHARP, Indiana
WILLIAM M. BRODItEAD, Michigan
.JOHN M. MURI)HY, New York
BOB ECKHARDT, Texas
RICHARD L. OTTINGER, New York
ROBERT (BOB) KRUEGER, Texas
ANTHONY TOBY MOFFETT, Connecticut
ANDREW MAGUIRE, New Jersey
HARLEY 0. STAGGERS, West Virginia
(ex officio)


CLARENCE J. BROWN, Ohio
CARLOS J. MOORHEAD. California
JAMES T. BROYHILL, North Carolina
1I. JOHN HEINZ III, Pennsylvania
SAMUEL L. DEVINE, Ohio
(ex officio)


FRANK NI. POTTER. Staff Director and Couisel
WILLIAM F. I)EMAREST, Jr., Counsel
WAT'ER WARREN Si'Hi ()DkR III, Research Analyst


(II)



















AN ECO~NOMlL ANALYSIS Of "NEW GAS biE1(GULAIRON

SUMMARY
T-a biI rd b. S a rs F I OT


r. i,0- I r b in prces Td s

to d emulate th wel lhead price ot new natural gas ar tee t

to graual increases an gas prices to consumers. Those bills, and er

studies that have supported them, aqree that ar orderl- price increase

~Aiuld help bring demand and supply into balance, and slaneous y

reverse the supply imbalance between the unregulated intrastate narket

and the regulated interstate aret. Studies on tre :
have assumed that new (deregulated) qa wo uld sell for a we 1hea i' c

no higher than the equivalent price for o>;1: about $2.11 per mf. Jurir4


to weeks of hearings beore the Sub ittee r Energy a P

many complex features of the natural as arket were explored, ar

criDgitfzedt byhothe r[nter net, Archlve

new gas wellhead prices rise far beyond the oil-equivalent price. Producrs

ould also weld strong power tolIIcn.4 ll20 3 to reneot te ex tin

contracts at higher prices. These factors could cause a sudden increase

in customer charges and producer revenues of more than S13 billion. A

large and sudden price response to deregulation ,uld have dr-3atc cc C

imply ications, far larger than those ant icpated under sudden decontr

of oil prices, and approaching the impact of the oil price crease f the

,ost Arab o;1 ebarg period.

As th most questions of large macroecono'ic i-pact, te c

costs of new gas deregulation will be less acute if price increases are

gradual rather than abrupt. While it is not certain that either S. 2310

or H.R. 11265 will cause a sudden jump in average wellhead prices, they

contain no guarantees of an orderly transition to full eregulat e
















http://archive.org/detaiIs/econsis00unit















incremental pricing provisions in S. 2310, which would load all new gas

price increases onto industry and utility purchasers, represent one

possible approach toward lessening the severity of short-term price response

to deregulation. Additional measures, such as an interim ceiling price

for new gas contracts, could act as a further shield against excessively

high prices over the short term. Such a ceiling price should be high

enough to forestall only inordinately intense bidding competition which

may be sparked by new gas deregulation.











This Committee Print reviews two estimates of short and long ter

costs of new gas deregulation recent published by (I) the General Acco n t I n

Office (GAO) in Implications of Deregulating the Price of Natural Gas ar

(2) the Federal Energy Administration (FEA) in "Natural Gas Deregulatio

Analysis, Technical Report" presented in testimony before the House Sub-

committee on Energy and Power on January 23, 1976. With the assistance of

consultants at Chase Econometrics Associates, the dollar cost of deregulation

from these two studies were simulated on a long term computer model of

the U.S. economy. The model shows how such economic variables as real ''P

consumer prices, and unemployment would be affected by deregulation.

Arguments will also be offered that these forecasted economic impacts

of deregulation, while very large in their own right, may understate actual

economic losses resulting from new gas deregulation. Underestimates are

due to the possibility that average wellhead prices for gas could rise

much more quickly than anticipated in either the GAO or FEA reports. The

print concludes with potential legislative measures to avert a sudden in-

crease in wellhead prices, beyond a price equivalence with oil.

Dollar Costs of Deregulation

In a deregulated market for natural gas, consumers (and the pipelines

through which they obtain gas from suppliers) will wish to purchase gas

so long as gas is cheaper than other energy substitutes. The energy content

of a barrel of crude oil or a barrel of #2 distillate (home heating oil)

is 5.6 times the energy content of 1000 cubic feet (MCF) of natural gas.

A BTU equivalent price for oil and natural gas can therefore be computed

by dividing the price of a barrel of oil by 5.6. FEA focuses its analysis

on the relationship between #2 fuel oil and natural gas.

"A number 2 fuel oil price of $15.50/bbl (the average price to

industrial and residential customers in 1974) is comparable to a retail

natural gas price of $2.66/MCF. To get the wellhead price, transportation

and distribution cost are subtracted. In 1974 the average transportation

cost plus distribution mark-up was 55/MCF. This yields a deregulated

wellhead price of ($2.66-.5)=$2.ll/MCF." (FEA,p.18)






4


The GAO, in a less carefully constructed comparison of oil and

natural gas prices, concludes that

'Under deregulation the city-gate price of both interstate and

intrastate natural gas is expected to rise to an average of about $2.10 per

MCF. This is essentially the BTU-equivalent of $12.00 per barrel imported

or uncontrolled domestic crude at the refinery. The $2.10 per MCF

city-gate price is composed of $.35 per MCF which is the average inter-

state pipeline transportation charge, and $1.75 per MCF, the average

deregulated wellhead price.'

The GAO report compares the cost of unrefined oil with the city-gate

price of natural gas. A better procedure would be to compare refined oil

prices paid by utilities with the city-gate price for natural gas, because

utilities buy gas at close to the city-gate price. This possible error

would place a downward bias on the equivalent price for gas as used in

the GAO report and may result in slight underestimates of the cost of de-

regulation.

Assuming that volumes of unregulated gas rise within one year to a

price equivalence with oil, the FEA calculates the first-year dollar cost

of deregulation under the Pearson-Bentsen bill to be about $5.5 billion.

This cost is derived by assuming that 5TCF (about one-half) of intrastate

gas will rise from the present intrastate new contract price of $l.25/MCF

to $2.11 (5 x $.86 = $4.3 billion). Prices for non-jurisdictional sales

and new interstate sales (totaling 1.6 TCF) increase to bring the total

first-year increase in revenues to producers (and expenditures by natural

gas consumers)to $5.5 billion.

The GAO report does not calculate first-year costs, but does provide

net dollar-cost estimates of new gas dereguation for the years 1978,

1980, and 1985. GAO assumes that under continued regulation natural

gas prices will rise by 5c per year in the interstate market and 15C

per year (to the $1.75 MCF equivalence) in the intrastate market.*



Current interstate prices average $.35 per MCF while intrastate prices
average S.50 per MCF.









Net costs of dereg(Ju lat ion are then tC'I utqd y btr Yt r

revenues under cont inued regr at n fr A i t yatt r s rr r

ulat ion. As the fo lowing .hart an te t" fro t GAO :

account has also been taken of the fact that loer product r r

continued regulation will force some customers to al tirnatefu k

Table I
City-Gate Cots of Energy Regulatior a
Deregulation to Consuers of Natural Gas in75
(Bill ions of Dol lars)

Year ReguIlation Deregulation Net Cos

1975 17.8

1978 26.7 35.0 S8.3 Biliorn

1980 31 .9 44.9 S13.0 Billr

1985 40.6 44.9 S 4.3 Bill bo

"The table indicates that in 1975 it is projected tat 21.4 TCF of

natural gas will be del ivered to consumers at an average c ty- ate irief

S-83 per MCF for a total cost of S17.8 billion. In 1980 it s

that, under continued regulation, 18.1 TCF will be d iered t cs 'r

at an average city-gate price of $1.37 per MCF for a total cost of

$24.9 billion. Since 3.3 TCF of 1975 natural gas consuretion must be

replaced by other energy sources at an equivalent city-gate price of $2.10

per MCF, there is an added $7 billion cost to th consumers, giving a total

cost to the consumers of $31.9 billion. This is an increase of $14.1 billion

or 79 percent over their costs for the same amount of energy in 1975.

"Jnder deregulation natural gas consumption if 18.8 TCF in 1980

at an average city-gate price of $2.10 per MCF for a cost of $39.5

billion; the cost for the alternate energy sources to replace the 2.6

TCF shortfall relative to 1975 ($2.10 per MCF equivalent) is $5.4 billion.

This give a total cost of $44.9 billion. Thus under deregulation city-gate

costs for 1975 natural gas consumers would increase $27.1 bill on

in 1980 over 1975, or S13 billion over what the 1980 costs vpould have been

under continued regulation. Under deregulation city-gate costs in 1980

will be 152 percent greater than 1975 costs and 41 percent greater than

1980 costs with continued regulation. These same calculations for 385







6
c L ts ,uld continue at $44.9 bill ion (152 percent

rar than 175- and regulated costs 1 d cimbf t o 40.6 bill or"(1,.

greater than 1975); in 1985 deregulation costs would be I1 1-rcenL

r t r, ulation." (GAO, pp 44-45

The : )il I c first-year cost of deregulation calculated by FEA

to b con-istent ith the GAO longer-term cost tream.

Th, -oupued cost of deregulation over time is to some degree dependent

ufpto'wfs about supply ies of gas under continued regulation and

deregulation. FEA states that

'To the extent that increased natural gas production
replaces higher priced imported oil, the above (first year
dollar cost) estimate is reduced." (FEA p.19)

FEA, which utilizes a sophisticated model of regional natural gas supply

and demand, argues that domestic production of gas in 1985 would be

4.8 TCF greater with the Pearson-Bentsen bill than with continued req-

ulation. Under the Krueger bill, the difference in projected supplies

is 4.1 TCF. The GAO report, which is not specific with respect to any

new gas deregulation bill, assumes a 1.5 TCF supply differential in

S985.

FEA supply response estimates are based upon extrapolation of his-

torical price-supply relationships to higher prices and into the future.

GAO's estimates, on the other hand, are based largely on geological rather

than economic considerations. According to GAO

"Many studies have claimed that deregulation would reverse the trend

of production decline. Such conclusions are based on the judgements on

the price response to deregulation, the drilling rate response to higher

wellhead prices, the amount of undiscovered resources, and the finding

rates. These judgments are subject to great dispute. However, regardless

of the differing judgments on these factors there is a reasonable con-

sensus in both Government and industry regarding reserve additions required

to achieve a particular level of production.'



'To maintain the current production rate of about 21 TCF requires

an average annual reserve addition of about 23 TCF for the 11-year

peari 1975 to 1985, which is larger than what was observed over any prior










II-year pe riod. On the bais of required reserve addittirIs it .I I 1

that maintaining exist inq eve s f natra? gws
difficult, if not iIpossie.

"To ahieve a reserve addition r at (.,)f0 CE(ar s] ig4t t y

larger than the average rate ro 195 to 1 )od ekes, tare t

discovery of almost 15 TCF per year o few rest rvoirs fr 4bout 4

years, after which revisions and extensions to these new large finds

could sustain the 20 TCF rate with i oer ru n-w rerfi

Since new finds hav( average 4 TCF since 1969, such a possibiIity I t

imply the discovery o at least four or five large reservoirs or

over the period with reserves on the order of 10 TCF apiece. The Gorie,

West Texas, field is the only field 10 TCF or larger discovered over the

same period. This would indicate there is very little likelihood of r*turn-

ing to a sustained 20 TCF reserve addition per year over the period 1975 to 1985.

$Undiscovered recoverable resources form the base for new finds of

natural gas. Within the past year the U. S. Geological Survey has sub-

stantially reduced its estimates of this category for the lower 48. For-

merly its estimates ranged from 715 to 1,415 TCF; today they range from

298 to 528 TCF. This reduction of undiscovered recoverable resources

reduces the prospects for finding large amounts of additional new reserves

in the lower 48.

"Industry believes that the best possibilities for large finds in the

lower 48 is the OCS. Areas currently under consideration are mostly

covered by up to 200 meters of water. While this depth poses no serious

technological difficulties for the extraction of natural gas, the recent

failure to find exploitable reserves in the eastern Gulf of Mexico and

off Newfoundland, coupled with the recent significant downward revisions of

undiscovered resources on the OCS, have dampend the expectations of

finding large amounts of gas on the OCS." (GAO, pp. 16-20)









Macroeconomic Impacts of Deregulation

The above shurt and long-term dollar costs of deregulation form the

basis for simulating the effect of new gas deregulations on the overall ecnomy.

Chase Econo etrics Associates waas r-quested by the Subco -ttee staff 10 run

their long range (10 year) computer model of the U.S. economy with higher

natural gas prices. The first year cost, derived by FEA and longer-term GAO

calculations were fed into the model. Resulting impacts*, as forecasted b- the

model, are as follows:

Table 2

Real GNP Consumer Prices Unemployment Rate

1976 down 2.8 up .8, up .1
1977 down 8.4 up 1.1 up .4
1978 down 8.9 up 1.2 up .6
1979 down 7.7 up 1.4 up .7
1980 down 10.7 up 1.5" up .8
1981 down 12.7 up 1.6 up 1.0
1982 down 13.9 up 1.7 up 1.0
1983 down 14.6 up 1.8 up 1.1
1984 down 15.0 up 1.8, up 1.1

Projected dollar and macroeconomic costs of new gas deregulation would

be somewhat lower under the Pearson-Bentsen proposal than under the Krueger

bill. Greater costs attributable to the Krueger bill arise from:

(1) a broader definition of new gas, which would include gas remaining

after an esisting contract expires. The Pearson-Bentsen bill keeps all old

gas under price regulation.

The Krueger bill would deregulate any gas flowing from a well drilled

after January 1, 1976. Pearson-Bentsen would not permit gas from reserves

already discovered and dedicated to be sold at deregulated prices.

(2) Equal pass-through of increased costs to all customers. The

Pearson-Bentsen bill requires distributing companies to provide lower priced

old gas to residential and small users on a priority basis, and thereby focIses

higher costs of new gas onto lower priority industrial users. Congressman

Krueger's bill would distribute higher cost gas evenly among all users. The

potential result of this difference in the two bills is that pipelines under

the Pearson-Bentsen plan would be more anxious to keep prices as low as pos-

sible on new gas, for fear that if too high a price is paid, industrial



All changes are relative to continuation of present regulations, not relative
to current economic conditions.






9



custners would switch ff4 gas to other fue ls.
It iS niot po ,ibie to quantify ~actiy how muh higher orf trrr

prices o)uld r Se under Congress an Kruegers pro poed ereul rt [ ::1 .

Differences between C n resan Kruetger s bill ani the Senat1--pa'-eI P

Bentson bit I are ons iered by h FEA to I ead Z virtuaIIy the e I I

price, but .7 TCF greater production rate in 185 under th Senate bI.

This higher production rate would lead to a net reduction of oil

relative to the Kru ger plan and a correspondig lower fina) cost to

The present average inter-and intrastate wellhead price for ga i< a t

44 per MCF. Under deregulation, this price will ir evitably rise ,y at

least a factor of four. Costs to natural gas consu ers will double. D jr 1:r

the tw- years following the oil embarg, iellhead oil prices also rose by

a factor of four; the price At the cas pump doubled. According tc the

Brookings Institution, 'the quadrupling of oil prices was a major ca se I

the .vorst cost-push inflationary and recessionary period since the dere Jn.

The impact of a four-fold increase in natural gas wellhead prices jnder

deregulation may be nearly as painful as we saw for oil. Whereas oil reprc-

sents 46?. of U. S. energy consumption, natural gas is 31 But, because lrc

dustry (other than transportation) is proportionately more dependent upon

natural gas than oil, gas price increases may have a larger direct effect on

lay-offs, corporate investment plans, and economic growth.

New gas deregulation will shift massive amounts of capital and econoic

power from other sectors of the economy into the natural gas producing sector.

Present revenues to producers, at the current domestic production rate of 19.1.

Tcf, is (S.44/MCF x 19.1 Tcf, or) $8.4 Billion. When all gas has reached FEA's

$2.11 BTU equivalent price with oil, and assuming GAO's conservative l 5

domestic production rate of 17.3 TCF under deregulation, total revenues to

natural gas producers would be $36.5 Billion. This represents an eventual

income transfer of $28 bill ion per year from consumers to gas producers.

Contrast this with a one-year $18 billion tax cut or last year's debate over sudden

decontrol, which involved a potential $13 billion increase in producer rever-Jes

Fried, Edward R. and Schultze, Charles L, Higher Oil Prices and the 'r'
Economy, the Brookings Institution, Washington, D.C. 1975, P. vil.










for old oil. Deregulation of natural gas has potentially twice the economic

cost of sudden oil decontrol, and would effectively neutralize the present

tax cut, if that cut were continued indefinitely.

The Brookings Institution, in a recent report on Higher Oil Prices and

the World Economy, raises further questions of economic policy in response

to a large cost-push price increase for natural gas.

"In the short run, 'cost push' factors can influence the rate of in-

flation and unemployment and thereby set in motion Government policies that

may have lasting effects. When such external shocks as the rise in inter-

national oil prices or other cost push factors increase the rate of inflation,

Government authorities are faced with a painful dilemma. If they do not

accommodate cost push factors by letting aggregate nominal demand rise

sufficiently, then real output will fall and unemployment will increase to

the extent that other prices resist downward pressure. On the other hand,

if these shocks are fully accommodated, forces may be set in motion which

perpetuate and even increase the inflation rate. Should the rate of inflation

accelerate, heavier costs in unemployment, lower output and forgone opportunities

would eventually have to be incurred to bring it under control. For this

reason it is important to examine the probable cost push pressures on prices

over the near term." (page 31)

Relative to present expenditures for energy, an increase in total gas

bills of $28 billion will cost each American an average of $127 per year. The

average household would pay, either directly for heat or indirectly for higher

cost goods and services, an extra $509 per year when gas prices reach an equiv-

alence with oil. Inflation and unemployment are worsened as consumers will

have less to spend on everything except natural gas. And futher problems

could plague our already troubled capital markets.

Problems in a Transition Toward Full Deregulation

While the costs of deregulation, both in dollar and overall economic

terms, are large, two weeks of hearings from January 20 to February 2 before

the Subcommittee on Energy and Power raised serious questions about whether

the transition period toward full deregulation (when all old contracts have

expired) will be protracted and orderly, or sudden and disruptive.













The FEA, GAO, and other recent studies on the impact of n t 5 ot r

ulation assume that average wellhead prices will rise slowly because' ,I) .

gas will sell at a price equivalence with oil and (2) new gas initially

represents only a small proportion of flowing gas under long-term contra-t

The former assumption may have questionable basis in fact. These studies

fail to recognize the possibility that contracts for new gas will initially

be driven far above oil-equivalent prices. Pipelines, not final cutur

buy from producers. Pipelines will bid against one another for new s until

prices rise enough to jeopardize demand from final customers. Pipeline companies

will want to keep the average price of gas to customers below the price of

oil substitutes in order to avoid reductions in final customer demand, But

the price of new gas can, and in all likelihood will, go above the oil-equivalent

price so long as old gas prices are below that equivalence. The higher that

new gas prices are bid in the short run, the more quickly the average prie of

all gas approaches the lonj run oil-equivalent price.

Example: A hypothetical pipeline now delivers I TCF of gas to its custners

at the average interstate price of $.35/MCF. In 1976, 10% of its contracts

will expire, so .1 TCF of new gas contracts are sought. If the pipeline bi I

for, and obtained this amount of gas at a price of $5.0O/MCF, the average

price of gas in the pipeline would be:

90% at .35/MCF and 10% at $5.00.MCF = $.84/MCF

This price is still well below the oil-equivalent price of $2.11 at which

significant losses of customers would begin to jeopardize total pipeline de-

liveries (and revenues). In fact, the higher the price paid by a pipeline

for its gas (all other things being equal) the higher are its permitted revenues.

In the above example, pipelines paying $5.00 per MCF for new gas would drive

the average price of all gas to a BTU equivalence with oil in less than four

years. Again, such a sudden response to new gas deregulation is not inevitable

-- merely possible.

Little concern has been expressed over the very real possibility that

the average wellhead price for gas could reach the $2.00/MCF level within

four years or less. The structure of the natural gas industry would appear













to facilitate a rapid price rise. Producers, certainly, will not discourage a

bidding war among pipelines leading to higher prices. Pipelines are already

being urged, particularly by their industrial customers, to pay any price

required to insure future gas supplies. Distributors of gas have already

demonstrated a willingness to pay $3.50 or more per MCF -- the cost of

synthetic gas now being produced. Last fall, New England Gas and Electric

paid $5.60 per MCF to Algonquin for synthetic gas.

Producers anxious to get out of long-term contracts at low regulated

prices will find many pipelines willing to renegotiate as an incentive to

obtain needed new gas. Renegotiations of old contracts will also accelerate

the rise in average gas prices.

Some experts argue that there is sufficient excess supply in the intra-

state market to safeguard against any serious short-term prices above the

$2.11 level. It is possible that as interstate prices are bid to this level,

some intrastate customers will be willing to switch away from gas. But intra-

state prices have already pushed through the $2.00 point in the past, and

there is no proof that intrastate buyers would be unwilling to pay even

higher prices in the future, given the premium nature of gas, its unique contrib-

ution to a variety of feedstock and processing applications, and the recent

investments many companies have made in order to locate near a steady supply.

Legislative Options

Absent revisions or appropriate court interpretations, both the Pearson-

Bentsen and Krueger proposals would not foreclose new gas prices being bid up to

inordinately high levels in the short term. Should this rapid escalation ensue,

the consequences for both natural gas customers and the overall economy could

be devastating.

Incremental pricing provisions in the Pearson-Bentsen bill, which require

large industrial users to bear increases in new gas prices, provide a

mechanism to restrain pipeline bidding. The threat of losing industrial

customers will appear to pipelines at an earlier point in the deregulation

process if the industrial submarket bears price increases first. In effect,

incremental pricing provides a more economically efficient mechanism for

coupling marginal cost (to the consumer) to marginal revenues to the producer.

Simply stated, the short-term problem associated with excessive new gas prices













is the result of marginal revenues to producers bein9 "blrred' into

the average cost to customers. The more .ccurately Cuto(erI equate their

marginal costs with marginal revenues to producers, the more efficient mId

orderly will be their conversion to substitute fuels. Even under ther)f--t

effective incremental (or marginal) pricing scheme, a custotmer's short-term

ability to convert to other fuels is limited. Hence the need for measures

to insure that marginal revenues to producers rise slowly, perhaps over a

5 year period

In addition to incremental provisions, other safeguards deserve careful

consideration. A ceiling on new gas prices is one option. But a ceiling

on new gas prices may be an insufficient measure to prevent rapid rises in

average prices, because more attention might simply be placed on renegotiation

of old supply contracts to higher prices. The result might be analogous to

rent control, in which rents are low, but the supply shortage puts the owner

in such a position that he can require the renter to pay, "under the table",

a "key charge" of sizable magnitude before he signs his lease. If the FPC

is given clear responsibility to prohibit suppliers from forcing pipelines

to renegotiate old contracts, a ceiling on new gas prices might prove effective.

If a ceiling on the average, as opposed to the new price of gas, were

imposed over the transition period, the results would be similar to the above

case, but would leave the new gas price/old gas renegotiation decisions to

each buyer and seller.

Ceilings on either new or average gas prices should be set to act as

a shield, rather than a sword, against excessively high prices over the short

term. A ceiling price, or price schedule, should be high enough to forestall

only inordinately intense bidding or renegotiation pressures whiih may-be

sparked by new gas deregulation.

Conclusion

Major revision of the present natural gas regulatory system is now

necessary. But the potential for sudden increases in natural gas prices under

new gas deregulation proposals suggests the need for specific revisions to

prohibit excessive new contract prices. Such provisions would insure a longer,





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more orderly transition toward deregulation. Economic impacts would be lessened

as industrial and residential customers would have more time to plan their

energy use patterns. A more gradual transfer of revenues to producers wold

probably have little negative effect on gas supplies, but would lessen

considerably the economic dislocation associated with any sudden shift of

income as may result from the Krueger, and to a lesser extent, the Pearson-

Bentsen deregulation proposals.