Effect of Energy Efficiency Standards on Natural Gas Prices

Requiring home appliances to meet fuel efficiency standards can reduce the fuel usage, fuel price, and the life-cycle cost of these appliances (Meyers 2005). Although this seems to be an unambiguous benefit to society, it is sometimes asserted, among other things, that the reduction in consumers' expenditures is obtained at the cost of reductions in the profit of fuel producers and owners of mineral rights and is thus a transfer from one sector of the economy to another, rather than a net benefit to society as a whole (Wiser 2005). In an attempt to resolve this question, we estimate the magnitude of the effects of a standard on the primary sectors affected by the standard and determine how much of the benefits are transfers from other sectors.

Modeling studies generally confirm the intuition that reductions in demand for natural gas will result in reductions in its price as seen at the wellhead (Wiser 2007). The magnitude of the effect on price relative to the demand reduction, and the mechanism through which it occurs, is less well established.

Revenue from the sale of natural gas at the wellhead must cover the cost of production, including the physical operations of exploration, drilling, and development of wells. It must also cover significant payments to land owners for the right to explore and extract the gas, as well as tax payments to government entities at the Federal, State, and local levels. It has been estimated that the Federal government collects, as taxes or lease payments, 40-50 percent of the revenue from natural gas extracted from Federal Offshore lands in the Gulf of Mexico (GAO 2007). The same report provided estimates that the total government share of revenue from the sale of gas produced in the states of Colorado, Wyoming, Texas, Oklahoma, California, and Louisiana are between 50 and 53 percent. The bonus payments, royalties, and taxes that make up this revenue are generally dependent on the value, volume, and price of gas produced. Any reduction in price, volume, or both will therefore directly affect the amount collected. To the extent that there is no offsetting cost savings within the government, reduced tax revenues must be made up by increased rates or additional taxes on other sectors.

Bonuses, rents, and royalties are also paid to private landowners for the right to explore and produce gas underlying their land. The value of those rights is a function of the value of the gas that can be extracted. Reductions in the price of gas will therefore reduce the value of the mineral rights, representing a capital loss to the landowner.

Natural gas producers make their investment decisions on the basis of profitability of a proposed project. Expected price, demand, and cost of production are the primary factors that determine whether a project will be profitable and therefore undertaken.

An unexpected price decline could, therefore, change future decisions and also the profitability of projects already undertaken. If gas producers are able to include the effects of forthcoming standards into the forecasts of demand and price used to make their investment decisions, the introduction of a standard should have no effect on the profitability of their investments. Reduced demand may result in lower production volumes and prices but, as long as investments are willingly made in recognition of these effects, producers' returns cannot be said to be adversely affected by the standard. If the reduced demand results in fewer opportunities for investment in the natural gas sector, capital can be shifted to other sectors.

Even if one assumes that investors could not foresee the effects of the standards, only investments made prior to the introduction of the standard would be adversely affected. Investment decisions made after the standard became known would have been made with full knowledge of the standard's effect, including that of any excess capacity resulting from over-investment prior to introduction of the standard.

The analysis presented in this study used the National Energy Modeling System (NEMS) to estimate the effects of a recently proposed water heater standard. The results indicate that, over the 20 years from 2015 to 2035, the introduction of the standard leads to a $48.9 billion benefit to consumers of gas and electricity. Of that benefit, $9.8 billion represents a transfer from taxpayers or landowners. Over the same period, revenue from gas production declines by $21.6 billion. Approximately $7.1 billion of that reduction represents lower royalty or tax revenue to Federal, State, or local governments, and $2.7 billion results from lower royalty payments to private landowners. Approximately $1.9 billion of the reduction in revenue is associated with production from reserves created prior to 2010 and thus could possibly represent a reduction in producer profit. NEMS also estimates that about 2,000 fewer gas wells would be required over the 20-year period.

This work was supported by the Assistant Secretary for Energy Efficiency and Renewable Energy, Office of Building Technology, State, and Community Programs, of the U.S. Department of Energy under Contract No. DE-AC02-05CH11231.