[BETA] Fortnightly

THE RESIDENTIAL MARKET STANDS AS THE NEXT FRONTIER for natural gas unbundling. In California, Illinois, Maryland, Massachusetts, New Jersey, New York, Ohio, Pennsylvania and elsewhere, states have introduced pilot programs and other unbundling efforts to target residential gas consumers. %n1%n

These efforts are hardly surprising. The residential market, presently dominated by the regulated local distribution companies, appears lucrative. In 1995, the residential sector of the U.S. natural gas industry consumed 4,736 trillion Btu of natural gas or 32 percent of all natural gas delivered by LDCs in that year. %n2%n U.S. residential consumers accounted for $28.7 billion or 59 percent of the gas utility industry's total revenues. %n3%n

Nevertheless, despite all the enthusiasm industry representatives have recently expressed in trade publications and public forums, the creation of a competitive residential market may prove a very slow process. Marketers appear cautious in taking the responsibility of serving residential consumers, %n4%n and for very good reasons. Gaining a sizable portion of this market requires substantial investment in mass marketing, development of name recognition, acquisition of appropriate technology and employment of skillful personnel. Moreover, residential customers do not behave rationally in a "neoclassical" economic sense. They react not only to a price but to several qualitative factors that have yet to be studied by LDCs and marketers.

It appears natural to assume that marketers can take share away from the LDCs by offering commodity price discounts. Some LDCs have sought to turn that assumption to their own advantage, predicting that lower commodity prices will boost gas use and overall throughput, thus increasing LDC revenues from distribution and transportation service. %n5%n But risk lies behind every assumption. Marketers may discover that discounts do not pay off as expected. LDCs may find little opportunity to piggyback. Marketers invest in discounts, but will those expenditures pay off as expected?

This article offers results from creating a software program and model %n6%n that answer two basic questions: (1) What share of the residential natural gas market can be realistically captured by non-regulated suppliers? (2) Will residential unbundling increase total throughput for gas utilities? If so, by how much?

Model Assumptions

The results presented in this study are illustrative. The models' inputs reflect characteristics of a "typical" residential energy market with "typical" end uses, customer profiles and energy prices for the Northeast region. The data taken for an actual LDC can produce a different outcome (at some extent). The data used here to calibrate the model of consumer behavior are not based on empirical studies, but represent judgment and estimates.

This model of a typical utility market makes three assumptions:

1. The market is circumscribed by the service territory of a single incumbent LDC that continues to provide merchant services to residential customers on its system;

2. Each residential consumer has a choice of taking merchant and transportation services from the incumbent LDC or taking merchant services from a marketer and relying on the LDC for transportation services, which are available at an unbundled tariff rate; and

3. All marketers operating in the LDC's service territory act as one "typical"