The Impact of Deregulation in the Energy Industry - Research Proposal Example

The Impact of Deregulation in the Energy Industry Identification 0 Introduction 1 Terms of Reference Data collected by the US Energy Information Administration (EIA) for the period 1949 to 2010 indicates that net imports of petroleum increased between 1982 and 2005. Additionally, net imports have surpassed production levels since 1995. However, there have been signs of improvements since 2006 as US dependence on imported oil fell from 60.3% in 2005 to 49.3% in 2010. This, US EIA (2011) indicates resulted from several factors including efficiency improvements, consumer behavior and ‘patterns of economic growth.’ While this was taking place there was an increase in the level of crude oil output in the US which led to a reduction in crude oil imports. Energy is necessary for carrying on our daily activities. Both individuals and businesses consume energy. Individuals use it at home in the form of gas for heating and electricity for lighting, providing power for the operation of washing machines, computers, televisions, radios, small appliances such as irons and blenders. Businesses use energy in some form to keep their operations going. However, manufacturing firms use energy to produce the goods they depend on in order to generate revenues. Oil and natural gas has been deregulated since the late 1970’s (Horwitz 1990). While deregulating the industry may provide benefits it may have other less favorable consequences. 1.2 Aim of Study This paper looks at the impact of deregulation of the energy industry on consumers, producers and United States economy. The null hypothesis is that deregulation of the energy industry has resulted in increased benefits for both consumers and producers but has resulted in increasing levels of imports and therefore a negative impact on the US trade balance. This study is significant since it will indicate how various levels of deregulation in the energy industry over the years have impacted the US and Canadian economies. This research will definitely help in directing policy changes in the future. 1.3 Research Questions Finding answers to the following research questions will be main focus of this paper. i. What is the impact of deregulation on consumption of energy by consumers and businesses? ii. What is the impact of deregulation on production cost? iii. How has deregulation affected imports and the US balance of trade figures 2.0 Literature Review 2.1 Deregulation explained Hammond and Knott (1986) while looking at deregulation in the financial industry indicated that although theories relating to regulation do not always focus on the same types of variables, researchers indicate that many of them reproduce the same effects – once they have been initiated they are difficult to eliminate and it is almost inevitably leads to more regulation. However, Hammond and Knott (1986) indicate that these arguments do not support the trends since 1975 as there have been significant deregulations in almost every year. Deregulation in various industries such as telecommunications has led to an increases in the number of players Horwitz (1986) indicates that in additional to a number of things the purpose of deregulation is to dismantle the smooth functioning of ‘regulation- enforced cartels’ and to permit the resurgence of competition. In his later work Horwitz (1990) points out that deregulation was one of the buzzwords of the early 1980’s – during the period of the Reagan administration. It was seen as a way of ‘getting the government off the backs of the people’ and promised to remove what was considered to be onerous regulatory controls and grant business managers ‘the freedom of action they had lost to government bureaucrats. and therefore the level of competition. If inflation is rising and productivity is falling as in the 1970’s then deregulation may be a necessary policy prescription to deal with the situation. Hammond and Knotts (1986) provide several reasons in relation why regulation is untenable including the point that maintaining the status quo is very undesirable for the firms and therefore the only favorable alternative is to pressure governments towards deregulation. However, if deregulation is only partial then some firms may not benefit initially and so further deregulation may be required. Therefore Hammond and Knott (1986) indicate that once deregulation is initiated it may be difficult to stop and this would have a snowball effect leading to a state of equilibrium where there is almost no regulation. 2.2 Deregulation of natural gas prices Cooper and Montgomery (1982) looked specifically at a change in policy resulting in the deregulation of natural gas prices. In admitting to the ease in accepting the bias of certain groups, Cooper and Montgomery(1982) pointed out that there is some value in making ‘guesstimates’ of the implications of price deregulation because of the bias in support of deregulation by both economists and businessmen. Cooper and Montgomery (1982) supports this view because of what they describes as ‘horror stories’ in relation to the allocation of resources and what appeared to be the ‘arbitrary conferment of benefits.’ These stories include the wide variation in gas prices at the wellhead – ‘$0.50 per thousand cubic feet to over $8.00.’ Using the practice of what is termed ‘rolled-in-pricing,’ distribution companies which have access to lower price gas are able to mix it with more expensive gas which is then sold to the final consumer (Cooper and Montgomery 1982, p. 372). According to Cooper and Montgomery (1982) deregulation of gas prices would lead to the elimination of what he referred to as allocation and distributional distortions. However, Cooper and Montgomery (1982) indicates that despite the fact that distortions would be eliminated on deregulation and subsequent to the completion of contracts, some other undesirable consequences which would be much worse may follow. They include: redistribution from consumers to producers; macroeconomic impacts and increased dependence on oil imports. Cooper and Montgomery (1982) also states that the magnitude of these effects is highly dependent on the extent to which the existing price regulations resulted in low gas prices. Cooper and Montgomery (1982) indicates that with the introduction of deregulation Wellhead gas prices would then be arrived at after allowing for transportation and other costs of distribution to consumers. Cooper and Montgomery (1982) also points out that on average gas prices have been well below the price of oil on the basis of heat equivalence and so full deregulation would result in a significant increase in the average price of natural gas to as much as 50% at the burner tip with somewhat less for households and more for industrial use but even more at the wellhead. Cooper and Montgomery (1982, p. 375) suggests that the allocation effects to be derived from deregulation are as follows. i. Deregulation will promote the development of sources of that have lower costs. ii. Satisfaction of unsatisfied demand for gas –though there is some uncertainty of how much of this actually exists. iii. Price differences that are not explained by distribution costs may influence the location of industrial activities. iv. Rationalization of consumption, partly away from cheap gas. v. Some industrial users who have been subjected to incremental pricing may serve to benefit from deregulation. The distributional effects would involve a win-win situation for producers for whom no additional costs would be incurred once the well is developed and gas gathering facilities have been installed. Deregulation would therefore benefit producers at the expense of consumers. According to Joskow (2008) the overriding goal of deregulation is to ensure that long-term benefits accrue to society and to ensure that an appropriate share goes to consumers in the form of lower prices which results from the efficiency gains of producers. Joskow (2008) carried out an analysis of the electricity sector liberalization in a number of countries over a 20 year period and identified the attributes of reform models that have exhibited good performance attributes as well as the lessons learnt from liberalization. Joskow 92008) concludes that although a number of problems were encountered firms are now better able to deal with them based on the lessons learnt. However, despite the challenges deregulation resulted in ‘improved performance from existing generators and helped to mobilize significant investments in new generating capacity in several countries’ (Joskow 2008). 2.3 Deregulation of electric utility and operational efficiency Bryan et al (2005) indicate that effect of the 1992 National Energy Policy Act (NEPA) resulted in a significant increase in the level of competition in the electric utility industry in two ways. Nonutility power generators were allowed to produce and sell power in wholesale energy markets. Additionally, they were allowed to access to transmission lines to send power to customers who were far away. Bryan (2005) sought to find out whether deregulation resulted in a reallocation of resources in a systematic way. They found that firms involved in the industry made operational changes that could be considered significant including: outsourcing the production of power and reducing the number of employees and by extension the cost of labor. Although these changes lead to improvements in operating margins at the utility segment these improvements were not sustained during the entire period for which the sample was tested. This may suggest that the benefits of deregulation are short-lived. 2.4 Compensation of CEO’s and owner-manager agency conflict Bryan et al (2005) indicates that with the deregulation of the electric utility industry, price competition has increased and the new competitive environment requires firms operating in this industry to control costs. They have also been induced to look at new ways of adding value to the products they sell or increase their line of business in order to maintain or improve their financial performance. Bryan et al (2005) also point out that since the objective of NEPA was to improve operating efficiencies in the market by substituting market forces for regulation, firms are expected to find ways to become more efficient as well as to motivate CEOs to make decisions that are in keeping with the competitive environment that exists. Therefore, major changes would be expected in both the structure and magnitude of their compensation packages. Rennie (2006) indicates that empirical evidence suggests that deregulation leads to changes in the structure of governance that are consistent with greater control over owner-manager agency conflict. Rennie (2006, p. 1989) put forward some reasons why this may be so. They include the following: i. The lower levels of regulatory supervision that accompanies deregulation results in firms adopting governance structures that leads to better control of owner-manager agency conflict. ii. A reduction in the level of regulatory interference with market forces that accompanies deregulation leads to increased competition among firms in the industry. Rennie (2006) looks at deregulation in the U.S electric utility sector as a way of investigating the association between changes in the structure of governance and product market competition. In order to explain the changes that occur after deregulation by examining trends in the governance structure characteristics of firms in the industry, Rennie (2006) tested a sample of 101 firms in the U.S. utility sector 101 U.S industrial firms matched to utilities based on their factors including size, prior performance and age for periods before and after the deregulation -1987 and 1990, and 1994 and 1997 respectively. Rennie (2006) found that deregulation in the utilities sector resulted in the enhancement of governance structures but to a lesser extent than comparable industry firms. 3.0 Research Methodology 3.1 Ethical considerations This research will not violate the norms and ethical criteria of the ethical review board of the university as the information used are those from official sources. 3.2 Method of enquiry According to Dawson (2007, p. 15) once you have answered the questions relating to what, why, who, where and when, the next task is to determine the research methodology. In order to ensure a better understanding of research methodology Dawson (2007) points out that this is different from research methods which relates to various types of data collection tools including questionnaires and interviews. There are two main research methodologies. They are the qualitative research methodology and quantitative research methodology. Qualitative research looks at attitudes, behavior and experiences through the use of various research methods including interviews, focus groups as it seeks to obtain an in-depth opinion from the participants. Since attitudes, behavior and experiences are involved fewer participants are required to take part in this research. Quantitative research on the other hand generates statistics through the use of large scale survey research (Dawson 2007, p. 16). Additionally, there is a mixed methods approach which utilizes both methodologies. Kumar (1999) indicates that researchers should not always stick to only one approach as both methodologies are complementary. Bryman (2008) indicates that there are barriers to the integration of these methodologies which result in researchers not getting the most out of their research. A quantitative approach will be employed in carrying out this research. The study will look at how deregulation in the energy sector in the United States has impacted both customers and producers. Therefore, statistics relating to trends in the energy sector will be used to make a determination on this matter. Additionally, the level of increase in relation to consumption, production and importation of energy will be analyzed. The focus will be on trends in the energy sector in the U.S. from 1975 to 2010. 3.3 Data Collection Data from various sources including the US EIA on consumption, production and importation will be analyzed for the period 1975 to 2010 in order to determine how deregulation has impacted consumers (especially businesses and their cost of production), producers, imports and therefore the balance of trade. Data will be collected on the changes in generating capacity of the two periods, changes in consumption, production and importations. 4.0 Results and Analysis of Findings The results will be analyzed using various statistical techniques such as graphs and charts. 5.0 Conclusion This will be based on the information obtained from the analysis of data collected and the results from various sources. References Bryan, S., Hwang, L and Lilien, S. (2005). CEO Compensation after Deregulation: The Case of Electric Utilities. The Journal of Business: 78(5), p. 1709-1752 Bryman, A. (2007). Barriers to Integrating Quantitative and Qualitative Research. Journal of Mixed Methods Research: 1(1), p. 8-22 Cooper, R.N and Montgomery (1982).A Note on Deregulation of Natural Gas Prices. Brookings Papers on Economic Activity: 1982(2), p. 371-394 Dawson, D. (2007). A Practical Guide to Research Methods: A user-friendly manual for mastering research techniques and projects. 3rd ed. Oxford: How to Books Ltd EIA. (2011). Petroleum and Other Oils. Available at: http://www.eia.gov/oog/info/twip/twiparch/110525/twipprint.html. Last accessed 14 February 2012 Hammond, T.H and Knott, J.H. The Deregulatory Snowball: Explaining Deregulation in the Financial Industry. The Journal of Politics: 50(1), p. 3-30 Horwitz, R. B. (1986). Understanding Deregulation. Theory and Society: Special Double Issue: Structures of Capital, 15(1/2), p. 139-174 Horwitz, R. B. (1990).The Irony of Regulatory Reform: The Deregulation of American telecommunications. New York: Oxford Press Joskow, Paul L. "Lessons learned from electricity market liberalization." The Energy Journal Dec. 2008: 9+. Academic OneFile. Web. 1 Feb. 2012 Kumar, R. (1999). Research Methodology: A Step-by-Step Guide for Beginners. 3rd ed. London: Sage Publications, Inc Rennie, C.G. (2006). Governance Structure Changes and Product Market Competition: Evidence from U.S. Electric Utility Deregulation. The Journal of Business: 79(4), p. 1989-2017 Read More