1. Homework Chapter 6 Natural Gas
Answers

2. Q1
Identify three negative externalities associated with the hydraulic fracturing (fracking) of natural gas.
Water contamination
Earthquakes
Noise, traffic
What impact do these externalities have on the social cost of natural gas?
Increase social cost
How does this translate into the market price vs. the socially efficient price for natural gas?
Market price below socially efficient price.

3. Q2
What characteristic of natural gas infrastructure led to regulation of the natural gas industry in the first half of the 20th century?
Economies of scale (natural monopoly)
What type of regulation was used?
Average-cost pricing (fair rate-of-return)
What is the economic justification for this type of regulation?
Society gains more from one large regulated company than from many small competitive companies.

4. Q3 Explain the 1954 U.S. Supreme Court Phillips decision.
The U.S. Supreme Court regulated the price of natural gas at the wellhead.
Disagree with the decision
No economies of scale.
Competition would work.

5. Q4
Describe the potential impact rising carbon costs will have on natural gas’s place in the electricity sector.
Carbon pricing will increase the price of natural gas, but by less than coal (or oil).
As nuclear and renewables do not emit carbon, their price will be unaffected, so they will become more competitive with NG.

6. Q5
How does the levelized cost of natural gas compare to other conventional sources of fuel used to generate electricity? In your answer, consider capital costs and fuel costs.
Levelized cost of NG is lower than other conventional fuels (coal, nuclear) as long as natural gas prices remain low by historical levels (say $6/MMBtu).
Capital costs are lower, fuel costs are higher
But with fracking, capital costs somewhat higher, fuel costs somewhat lower.

7. Q6 Levelized cost can best be compared to Marginal cost Average cost
Total cost
Fixed cost

8. Q7
Explain the key FERC regulations that deregulated the natural gas industry, and which stage of the supply chain they targeted.
436, 636
Pipelines first given the option and then required to transport natural gas.
No longer allowed to market NG.
Midstream stage
If you discussed 1978 partial deregulation of NG prices at the wellhead,
Upstream stage.

9. Q8
Why does Robert Howarth argue that natural gas is not preferable to coal?
Methane emissions as bad or worse than CO2
Why do some other analysts disagree with Howarth?
Howarth measured over 20-year period. Others use 100-year period. Methane has greatest impact over 20 years. CO2 has greatest impact over 100 years. Also, Howarth’s data on leakages was not good.

10. Q9
U.S., EU, Japan. How do NG prices compare in these three locations, and why do they differ?
U.S. lowest, EU middle, J highest.
U.S. fracks, EU imports NG (from Russia), J needs LNG.

11. Q10
Japan is trying to decide if they should increase their imports of LNG. They are currently importing 100 MMBtus at a price of $7/MMBtu. If they import 110 MMBtus, they will drive the price up to $7.50/MMBtu, given their monopsonistic position in the LNG import market. Alternatively, they can turn to a renewable backstop fuel that is available at $8/MMBtu. What do you recommend they do?
Total cost for 110 MMBtu = 110×$7.50 = $825
Total cost for 100 MMBtu = 100×$7 = $700
Incremental (Marginal) cost of last 10 MMBtu = $825-$700 = $125
=$12.50/MMBtu. Stay with 100 MMBtu and buy backstop for $8.

12. Q10 Bonus Multiple Choice Version
Japan is trying to decide if they should increase their imports of LNG. They are currently importing 100 MMBtus at a price of $7/MMBtu. If they import 110 MMBtus, they will drive the price up to $7.50/MMBtu, given their monopsonistic position in the LNG import market. Alternatively, they can turn to a renewable backstop fuel that is available at $8/MMBtu. What do you recommend they do?
A. Buy 110 MMBtus of NG and don’t buy the backstop.
B. Buy 110 MMBtus of NG and buy the backstop.
C. Buy 100 MMBtus of NG and don’t buy the backstop.
D. Buy 100 MMBtus of NG and buy the backstop.