A Data Envelopment Analysis of Gas Utilities' Efficiency

By Hollas, Daniel R.; Macleod, Kenneth R. et al. | Journal of Economics and Finance, Summer 2002 | Go to article overview

A Data Envelopment Analysis of Gas Utilities' Efficiency


Hollas, Daniel R., Macleod, Kenneth R., Stansell, Stanley R., Journal of Economics and Finance


Abstract

This study examines the Natural Gas Policy Act of 1978 and Federal Energy Regulatory Commission (FERC) policies that culminated in Order 636 in 1992. The regulatory environment in which natural gas distribution utilities operate was altered. FERC policies forced local gas distribution utilities into an increasingly competitive environment. Restructuring of the industry may affect economic efficiency. Data Envelopment Analysis is used to examine the economic efficiency of gas distributors during 1975-94. Federal policy appears to lead to a reduction in scale due to restructuring and more competition. Reduced scale economies have not altered the economic efficiency of the utilities. (JEL D40, LI 11, L95)

Introduction

The purpose of this study is to examine the impact of federal legislative and Federal Energy Regulatory Commission (FERC) policies on economic efficiency and productivity of 33 natural gas distribution utilities over a 20-year period from 1975 to 1994. Although much of the focus of those policies has been on wellhead pricing and restructuring of the interstate gas pipeline industry, the gas distribution utility industry has been affected as well. During this period gas utilities were impacted by major structural changes in the form of federal and state policies that either deregulated, or promoted competition in, the gas industry.

The focus of this study is the Natural Gas Policy Act of 1978 and a series of FERC policies that culminated in FERC Order 636 in 1992. These and other federal policies have altered the regulatory and competitive environment in which natural gas distribution utilities operate. Local gas distribution utilities are now more responsible for obtaining their own supplies in an increasingly competitive environment as a result of FERC's policies. Due to enhanced competitive pressures, restructuring the natural gas industry may have affected economic efficiency.

Two studies by Hollas (1994, 1999) examine gas utility pricing during restructuring. Although Hollas (1999) discusses economic (in)efficiencies that might have resulted and affected pricing, those studies did not explicitly examine economic efficiency. Parts of the efficiency discussion contained in this paper are based on Hollas (1999).

The inter-temporal variations in federal policies under which gas distributors operated over this period provide a potentially fruitful context in which to examine economic efficiency. Economic efficiency of gas distributors is examined in the context of technical efficiency, economies of scale, and change in productivity over the period 1975-94. The non-parametric mathematical programming technique employed to examine production characteristics of the local gas distributors is Data Envelopment Analysis (DEA). An in-depth treatment can be found in Fare, Grosskopf, and Lovell (1985, 1994). Measures of efficiency are in terms of observed utilities' performance rather than a theoretical standard. Each gas utility within the data set is compared to the best performing gas utility of the data set. Possible linkages between economic (in)efficiency and changes in public policies during the period are examined. Malmquist (1953) methods are applied to panel data to examine productivity changes over the period. See Grifell-Tatje and Lovell (1997) for a Malmquist DEA application to Spanish banking.

FERC Policies and Competition in the Gas Distribution Industry

A series of deregulation and pro-competition policies during the period from the latter 1970s to the present affords researchers an exceptional opportunity to investigate an important energy industry in regulatory transition and to examine economic (in)efficiencies that may have resulted. Public support for deregulation policies may not be strong, possibly due to the uneven benefits enjoyed by consumers (Winston 1993). The California electric deregulation experience is a good example of the potentially negative public fallout when deregulation does not proceed smoothly. …

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