sumption of gas, where the value of the tax per Mcf, plus the average weighted price of the gas stream equals the price of new gas determined in the market place. This would accomplish three things: (1) The price paid by the consumer would equal the marginal cost of gas, and thus the allocation of resources would be efficient. Wasteful uses of gas at lower prices would be discouraged. (2) Producer windfall profits from old gas would be averted. (3) The tax collected from consumption of old gas could be returned to consumers by a reduction in their social security tax (or some other tax). Thus consumers would receive the benefits of a lower price on old gas, but not by distorting the price paid for gas away from its marginal cost. Offshore prices and large producers A second major assumption which must be satisfied in order for the price system to allocate resources efficiently is that producers must be workably competitive, rather than collusive or monopolistic, in the provision of gas. There are some people who believe that the onshore industry should be deregulated only in steps to see if it will work, perhaps because they have some doubt about the extent of competition in onshore markets and the producers' elasticity of supply. One such step by step approach is suggested by Commissioner Smith. According to the Natural Gas Survey: Commissioner Smith would limit those producers whose new gas prices would be freed from FPC regulation to the small producers who control individually less than 1 percent, and collectively approximately 25 percent of the natural gas supplied to the interstate market. This action would reduce currently regulated producers to a number (less than thirty) which could be regulated on a more rational and responsive basis than is currently possible, while retaining public price surveillance over the bulk of the current supply. Commissioner Smith believes deregulation could be extended to all producers if fuel prices cease to be dominated by the OPEC cartel, and if small producer deregulation results in expanded exploration and development of natural gas." There are others who believe that onshore wellhead markets are workably competitive, but that offshore production may not be, primarily because joint ventures are so common. Some may argue that it is desirable to continue to control offshore prices for a few years until offshore production becomes less concentrated. In the interim, regulated offshore prices could be based on prices determined in the onshore market, with some markup to allow for extra expenses incurred in offshore production. However, there are at least three reasons not to regulate offshore prices if onshore wellhead markets are workably competitive. First, offshore gas and onshore gas are perfect substitutes for one another in consumption. The relevant market for determining whether or not competition is workable in the national market, rather than any particular geographic area. Offshore production will compete strongly with large volumes produced onshore so that offshore gas prices will be limited by prices determined in workably competitive onshore markets. Second, there has been a trend toward lower concentration in offshore markets over several years. Finally, as mentioned earlier, National Gas Survey (1975), vol. I, p. 3. government leasing policies can be changed to lessen the need for joint ventures among producers, thereby reducing concentration even further. The current debate In recent months the debate over natural gas policies have become polarized around two positions, the Carter administration plan and deregulation. Briefly, the administration plan (as embodied in H.R. 8444, the proposed National Energy Act) contains the following central features: (1) Regulatory controls would be extended to include the intrastate market as well as the interstate market for natural gas, It proposes an upper limit on price for what is called newly discovered gas, where the limit would be equivalent to the average refinery acquisition cost of domestic crude oil each year (about $1.75 per Mcf in 1978). (2) Only gas from wells at least 2.5 miles (horizontal distance) from the nearest well producing old gas, or 1,000 feet deeper than production zones containing old gas within the 2.5 mile radius, would be eligible for classification as new gas. (3) Higher prices would be allowed for gas produced from recovery activities which are extraordinarily expensive (including production from certain types of shale, deep wells, and in deep water offshore). (4) Wellhead prices in new contracts for old gas (in particular, gas produced from reserves dedicated to interstate commerce on or before January 20, 1977) would be permitted to rise to $1.45 per Mcf. (5) An "incremental pricing" scheme would be implemented to protect residential consumers from the effects of higher gas prices. It would allocate to consumers of large quantities of natural gas all costs which exceed the present average price of natural gas in new contracts. In short, these consumers would pay higher prices for natural gas than residential users, or other consumers of small quantities of gas. By contrast, the deregulation bill passed in the Senate in the autumn of 1977 (H.R. 5289), the price for interstate onshore new natural gas would be limited to no more than the equivalent of distillate fuel oil in New York harbor for a period of 2 years after enactment, and then deregulated after that. (Offshore new gas prices would be regulated for 5 years and then deregulated.) The primary motivation for such an interim period is that in the short run both demand and supply elasticities are lower than in the long run. A period of phased-in deregulation might serve to smooth out the price fluctuations that would otherwise occur with immediate deregulation.100 Other features of the currently discussed deregulation proposals are the same as the ones addressed earlier in this paper. Therefore, no lengthy reiteration is undertaken here. Briefly, these deregulation 100 For example, see "Natural Gas Pricing Proposals: A Comparative Analysis," printed for the use of the Committee on Energy and Natural Resources, publication number 95-50, September 1977, p. 36. This study indicates that without a phase-in period, new gas prices might rise to $4.00 per Mcf within a year or so of deregulation. a figure which might fall thereafter as the economy is able to adjust to deregulation. Because the underlying structural model used to generate these results is not presented in the publication, it is not easy to examine their veracity. 41-907 O-79-47 measures would leave intrastate markets beyond federal jurisdiction, and retain regulation for old gas prices, and possibly include some form of a wellhead tax (discussed further below). We conclude by making some observations about the administration and deregulation proposals. The proposal of the administration to extend regulation to intrastate markets would have several effects suggested by our earlier discussion. First, to the extent that the ceiling prices for new gas are set at equal levels in the interstrate and intrastate markets, the incentives for producers to dedicate new reserves only to intrastate markets will disappear. Producers would be indifferent regarding the choice of market when the wellhead prices for the two are identical. Second, if wellhead prices are based on the average refinery acquisition cost of domestic crude oil, then the regulated price would be above the present level in the interstate market and below the current levels in intrastate markets. This would lead to a reduction in the excess demand for natural gas in interstate markets, a reduction in the amount of income transfer that consumers who are now able to purchase interstate gas receive as a result of regulation, and the creation of a shortage in intrastate markets. The nature of the redistribution of income, curtailments, and economic inefficiency resulting from this scheme are as discussed in sections 3 and 4 above. The implications of the second alternative, deregulation of new gas (but not old gas) prices have already been discussed at length in the present section. For reasons noted earlier, on the grounds of economie efficiency it may be desirable to include an excise tax on old gas to bring the price of old gas to the consumer up to the price of new gas.101 Further, in order to avoid giving producers an incentive to hold back production, it would seem desirable to set the delineation date separating old and new gas once and for all, either by a ruling of the FERC or by statute. It is even more important that new gas wells drilled in old reservoirs should not qualify as new gas wells if large windfall profits to producers are to be averted. Further, at a minimum the FERC will have to carefully scrutinize the transfer prices charged by producers to pipeline affiliates in contracts between themselves, given the incentives for excessive wellhead prices that result for a vertically integrated firm. SELECTED REFERENCES "An Analysis of the Impacts of the Projected Natural Gas Curtailments for the Winter 1975-76," report of the Office of Technology Assessments, November 4, 1975. Annual Report of the Federal Power Commission, 1974. Balestra, P., "The Demand for Natural Gas in the United States," Amsterdam: North Holland Publishing Company, 1967. Balestra, P. and Nerlove, M., "Pooling Cross-Section and Time Series Data in the Estimation of a Dynamic Model: The Demand for Natural Gas," Econometrica, vol. 34, No. 3 (July, 1966), pp. 585–612. 101 Other forms of wellhead taxes have been suggested, but are not economically efficient. For example, in "Natural Gas Pricing Proposals: A Comparative Analysis," p. 32, it is suggested that a tax be placed on new gas rather than on old gas. Such a tax would distort the price of new gas away from its marginal cost, and would therefore lead to an inefficient allocation of resources. The report also suggests that a tax on all revenues above a certain amount (p. 33) which, among other things, could (as the report itself notes) encourage producers to delay production. Breyer, S. G. and MacAvoy, P. W., "Energy Regulation by the Federal Power Commission," Washington, D.C., The Brookings Institution, 1973. Breyer, S. G. and MacAvoy, Paul W., "The Natural Gas Shortage and the Regulation of Natural Gas Producers," Harvard Law Review, Vol. 86, No. 6 (April 1973), pp. 941-987. Demsetz, H., "Why Regulate Utilities," Journal of Law and Economics, April 1968. Erickson, E. W. and Spann, R. M., "Supply Price in a Regulated Industry, The FPC News, (Federal Power Commission) vol. 8, No. 35, August 29, 1975. Helms, Robert B., "Natural Gas Regulations, An Evaluation of FPC Price Con- Khazoom, "The FPC Staff's Econometric Model of Natural Gas Supply in the Kohlmeier, Louis M., Jr., "Watchdog Agencies and The Public Interest: The Regulators," 1969, Harper and Row. MacAvoy, Paul W., "The Regulation-Induced Shortage of Natural Gas," JLE, Vol. 14, No. 1 (April 1971), pp. 167-99. MacAvoy, Paul W., "Price Formation in Natural Gas Fields," Yale, 1962. MacAvoy, Paul W., "The Reasons and Results in Natural Gas Field Price Regulation," in "The Crisis of the Regulatory Commissions," ed., Paul W. MacAvoy, 1970 (reference 1970a). MacAvoy, Paul W., "Price Formulation in Natural Gas Fields." New Haven, Conn. Yale University Press, 1962. MacAvoy, Paul W., "The Effectiveness of the Federal Power Commission," Bell Journal of Economics, Spring, 1970 (reference 1970b). MacAvoy, Paul W., and Pindyck, Robert S., "Alternative Regulatory Policies for Dealing with the Natural Gas Shortage," The Bell Journal of Economics and Management Science, Autumn, 1973. MacAvoy, Paul W., and Pindyck, Robert S., "Price Controls and the Natural Gas Shortage," American Enterprise Institute for Public Policy Research, 1975. Natural Gas Curtailments, 1975-76 Heating Season, Natural Gas Task Force, Federal Energy Administration, October, 1975. National Gas Survey, United States Federal Power Commission, 1975. National Petroleum Council, U.S. Energy Outlook, Washington, D.C., December, 1972. Sales by Producers of Natural Gas to Interstate Pipeline Companies, Federal Power Commission, Annual. Scherer, F. M., "Industrial Market Structure and Economic Performance," Rand McNally, 1970. Smith, V. L., "Economies of Production from Natural Resources," American Economic Review, June 1968. The Natural Gas Industry, Hearing before The Subcommittee on Antitrust and Monopoly of The Committee on The Judiciary, United States Senate. June 26-28, 1973. U.S. Federal Power Commission, Annual Report, Washington, D.C., U.S. Government Printing Office, Annual. Weiss, Leonard W. and Strickland, Allyn D., "Regulation: A Case Approach," McGraw-Hill Book Company, 1976. Wellicz, S. H., "Regulation of Natural Gas Pipeline Companies: An Economie Analysis," 71 Journal of Political Economy 30 (1969), pp. 30-43. Wilcox, Clair, and Shepherd, William G., "Public Policies Toward Business," Irwin, 5th Ed., 1975. Willig, R. D. [1976] "Consumer Surplus Without Apology," American Economic Review, December 1976. |