Supply Response in a Regulated Industry: The Case of Natural Gas

This article contains the application of an econometric model to estimate the price responsiveness of nee discoveries of natural gas. The model is fit for the period prior to the beginning of area rate regulation of the wellhead price of natural gas. The theory of joint costs and the effects of dissimilar inventories of undrilled gas and oil prospects are used to explain the pattern of signs and magnitudes of the coefficients derived. These coefficients are then used to simulate discoveries for the regulatory period and the simulation is compared to the record of actual discoveries. The simulated discoveries are uniformly higher than the actual observed discoveries. A possible explanation of this result is the effect of regulation and changes in regulatory policies upon the elasticity of expectations for gas prices, and a rigorous statement of the relation is developed. We close with a general discussion of the magnitude of price increase necessary to clear the market for new gas discoveries.