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Article Excerpt
1. INTRODUCTION
The current structure of the US natural gas industry has been shaped by the evolution of regulatory policies over the past three decades. Starting out as highly regulated, the industry, starting in the late 1970s, has since adapted more market responsive policies. The deregulation process included a series of acts that involved the removal of wellhead price regulation and deregulation of the natural gas interstate market. The Natural Gas Policy Act of 1978 (NGPA) mandated gradual removal of price controls at the wellhead while the Natural Gas Wellhead Decontrol Act (NGWDA) of 1989 established a removal schedule of price ceilings that remained under NGPA. To complete the transformation to a deregulated interstate gas market, the Federal Energy Regulatory Commission (FERC) enacted a series of orders which concluded with FERC Order 636 in 1992 that required unbundling of pipeline services (distribution, sales, and storage services) which eventually transformed pipeline companies from sellers of a bundled commodity to merely transporters of natural gas.
Various studies have examined the price adjustments, structural changes, (1) and welfare (2) effects in the natural gas industry as a result of regulatory adjustments in response to changing market and network conditions. This research will focus on price adjustments as a result of deregulation. The specific literature in this area have mostly examined how gas prices at the wellhead or field prices (value of gas at the mouth of the well) are cointegrated with city gate prices (sales price of natural gas from pipeline to a local distribution company) as a result of deregulation. Convergence of gas prices across different segments of the market will provide evidence that the deregulation process has resulted into a more integrated, competitive natural gas industry. In this case, markets in different locations will be integrated into one market and will differ only by the amount of transportation and arbitrage costs (DeVany and Walls, 1993).
Studies that have investigated the North American gas markets suggest price convergence over time as a result of the industry restructuring in relation to open access reforms by the FERC. DeVany and Walls (1993) find that most field markets were not cointegrated in 1987 but by 1991, more than 65 percent of the markets have become cointegrated. Open access has made the market more competitive as supported by the increased cointegration of prices. In terms of field markets and city markets, Walls (1994) finds that production fields are strongly integrated but field markets and city markets are less integrated. Both of these studies utilize cointegration analysis. King and Milan (1996), on the other hand, used time-varying parameter analysis (Kalman Filter) to examine spot prices and found a significant increase in the price convergence in natural gas markets since the price deregulation of the mid 1980s. The results of these studies provide support to the idea that deregulation, particularly open access, has created a more competitive US natural gas market. Leitzinger and Collette (2002) contend that the restructuring process brought about by the FERC had increased the integration of gas prices nationally and differentiated only by market-driven location variations.
More recently, Cuddington and Wang (2006) evaluated the degree of US natural gas spot market integration using daily price data. They find that 74 percent of the price gaps they examined lie within the same market with the East and Central regions forming a highly integrated market. However, a single natural gas market for gas is not complete because the Western market seems to be segmented from the East and Central markets. The use of daily price data from 1993-1997 captures market dynamics at a time when active spot markets have evolved, in contrast to De Vany and Walls's (1993) study which examined a period (1987-1991) when active trading was relatively infrequent.
A few studies have also examined market integration for European natural gas markets. Asche, Osmundsen, and Tveteras (2001) show that border prices for gas to France seem to follow the Law of One Price and national market integration extends to multi-country analysis that includes Germany and Belgium. Neumann, Siliverstovs, and Von Hirschhausen (2006) and Robinson (2007) investigated if the liberalization process of the European gas markets successfully created a single gas market. Neumann, et al. (2006) found that although UK and Belgium have almost perfect price convergence with the construction of a pipeline between the two, the absence of continental prices integration across Europe may indicate no single, unified market, has emerged. In contrast, evidence from ten countries within the EU from 1978-2003, did imply some degree of price convergence as shown by the results of Robinson (2007).
The only study that we have found to investigate integration of international gas markets across continents was by Siliverstovs et al. (2005) which looked at the European, North American, and Japanese natural gas markets. Results of the study indicate integration within Europe, within North America, and between Europe and Japan. Europe and North America, and Japan and North America, were however, not integrated.
The research presented here differs from the above studies on two main fronts. The first main difference is that this research will look at the cointegration of gas prices further down the distribution line--at the retail level. The cointegration of the city gate prices and prices received by the end users, particularly residential consumers (residential prices) is investigated. The second difference is that the analysis is state level, so the price pairs will be between city gate prices--residential prices for each state in the US. This will allow for the investigation on how different degrees of unbundling at the state level may yield different degrees of market cointegration. Currently, each state has its own "choice program", with varying degrees of unbundling ranging from 100 percent to some states with no unbundling at all. Since our data set runs from 1989-2007, we are able to investigate a longer time period post restructuring. The series of FERC restructuring measures culminated in 1992 with FERC Order 636. Our data allows us to capture a longer time period when the industry has likely adjusted to the regulatory changes (post 1992).
The rest of the paper is as follows. A brief overview of the FERC orders that restructured the industry as well as the state-level unbundling programs is presented in Section two. Section three describes the data, framework and the empirical tests utilized. Results are presented in Section four. Section five concludes.
2. NATURAL GAS RESTRUCTURING
It has been argued that regulatory actions in the US natural gas industry have led to effective deregulation. The complete price deregulation of the interstate natural gas market as it is today was initiated in 1978 with the enactment of the NGPA and completed with the NGWDA in 1989. To support the wellhead price deregulation and allow the end user of natural gas (residential customers, in this paper) to experience the benefits of wellhead deregulation, the FERC put forth a series of key Orders from 1984-2000 which ultimately helped restructure the industry. In 1984, FERC Order 380 released local distribution companies (LDCs) from their minimum payments obligation under existing long-term supply contracts with pipeline companies to give them opportunities to make alternative, lower-priced transportation arrangements (EIA, 2008). FERC Order 436 in 1985 encouraged the unbundling of sales and transportation services by authorizing blanket certificates to interstate pipeline companies if they offered open access transportation on a first-come, first-served basis. By 1992, with Order 636, FERC required interstate pipeline companies to provide open access transportation and storage and to unbundle sales and transportation services. As such, pipeline companies were essentially transformed from sellers to transporters of natural gas. Market centers, where several pipeline systems interconnect and where several buyers and sellers can make or take gas deliveries likewise developed (EIA, 2008). Market centers offered two key services: (1) transportation between and interconnections with other pipelines with administrative services that facilitate the movement of gas; and (2) physical coverage of short-term receipt /delivery balancing needs (Tobin, 2003). Intermediary service providers, between a gas buyer and all other segments of the industry, known as marketers, also became new market players in the industry. FERC Order 637 updated Order 636 in 2000 by allowing capacity holders to trade their rights in secondary market transactions, suspending price caps for short-term sales, giving shippers more flexibility and expanding reporting requirements on market transactions for pipeline companies. (3) Order 637...
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