September 1, 2014

Study calls for natural gas pricing reform to facilitate federal carbon tax policy

Lucas  Davis
Lucas Davis

As federal legislators and regulators consider taxing utility companies for carbon emissions, Assistant Professor Lucas Davis suggests a fixed pricing structure on natural gas service that would protect consumers and satisfy utility companies.

Davis, a member of the Haas Economic Analysis and Policy Group, and co-author Erich Muehlegger, assistant professor of public policy, John F. Kennedy School of Government, Harvard University, began their research when they became interested in the design of carbon policy, a federal plan to tax utilities for carbon emissions.

“Eighty percent of greenhouse gas emissions come from the production and consumption of energy,” says Davis. “How utilities price energy is important when thinking of a carbon tax policy.”

In their paper, “Do Americans Consume Too Little Natural Gas? An Empirical Test of Marginal Cost Pricing,” the researchers studied natural gas prices over the past 20 years and found that consumers not only pay the marginal or actual cost of producing the gas, but an additional 40% to cover the utility’s overhead costs such as maintaining its distribution grid or infrastructure.

Under these conditions, the utilities’ biggest consumers of natural gas are, in essence, paying for the cost of all consumers’ gas transmission. Davis notes that while typically the larger consumers may be wealthy families who consume without regard to cost, large low-income families that are, by necessity, higher consumers may also be carrying the burden.

“Our goal is to reform natural gas pricing to pave the way for the government to design a carbon policy,” says Davis.

The study found the easiest way to reform the pricing structure is to “level” prices by 1) imposing or increasing a monthly fee to equal the utilities’ fixed costs and, 2) imposing a separate pricing structure for actual consumption that decreases the price per unit of gas. “This will increase bills for people who use very little gas, and decrease bills for people who use a lot. In related work with Haas School Professor Severin Borenstein, we are finding that families with children would tend to pay less,” says Davis.

In the proposal, all residential customers would pay the same monthly fee and the same rate per unit of gas. Commercial and industrial customers would pay higher monthly fees, commensurate with the more expensive metering and distribution equipment required for these customers.

Davis says this recommendation is similar to most current telephone service agreements. Customers pay a standard monthly fee that pays for the telecommunication companies’ infrastructure, plus additional charges based on the number and time of calls made.

“Energy is central to everything we do. It’s just critical that it is priced appropriately,” says Davis. “By pricing at marginal cost, that lays the foundation for having carbon policy work the way it is supposed to work where carbon taxes aren’t passed along to consumers unfairly.”

In addition to addressing efficiency in pricing, Davis is interested in studying the negative distributional consequences of pricing reform and their affect on low-income families.

See the full paper.

Topics:    Research News