Division of Economics and Business Working Paper Series Natural Gas Contract Decisions for Electric Power

Natural gas power plants can further specify their procurement contracts with pipeline distributors using a firm contract option that guarantees delivery at an additional cost. Using transaction level data from 2008-2012 we empirically test what characteristics lead to use of firm contracts and how the premium for firm contracts changes with these characteristics. Using variation in power plants technology type (combined vs. simple cycle) and electricity market structure (restructured vs. regulated), we generally find support for transaction cost theory in the data. Smaller plants, plants located in states with more variance in electricity demand, and plants in states with more inflow pipeline capacity are statistically less likely to use a firm contract. Firm contracts are on average 2.5% (14 cents per Mcf) more expensive and this premium increases as the weather is colder and the state a plant is located in has less inflow capacity. JEL classifications: Q40, L94, L95, L14