Between September 2012 and April 2013, the Vectren Corporation sponsored research at Indiana University to estimate the impact of a natural gas pricing agreement between Indiana Gasification LLC and the Indiana State Finance Authority on state employment, earnings, income, and GDP. The agreement, while making possible the construction of a three billion dollar substitute natural gas (SNG) plant within the state, is expected to result in natural gas prices for consumers that significantly exceed market prices. This anticipated consumer price increase is due to an agreement made prior to technology changes in natural gas extraction that have driven down natural gas production prices. In this paper, we present the policy analysis process and results from applying an econometric model of Indiana’s economy to estimate the impacts of the original, but now-controversial, 30-year pricing agreement.

The model used in this policy analysis is a recently developed, dynamic, simultaneous equation econometric model of Indiana’s energy demand and economic activity. It describes the state economy, with particular emphasis on the connection between energy demand, energy prices, and economic activity. The model links consumption of natural gas, motor gasoline, coal and electricity across four end use categories (residential, commercial, transportation, and industrial) and ten economic sectors. Standard economic indicators are used for these sectors, including employment, earnings, state GDP, per capita income, and unemployment. The exogenous variables in the model include national GDP; national employment by sector; energy prices for motor gas, natural gas, and electricity; and climate change indicators such as heating and cooling degree days, average temperatures, and temperature variances. 

The paper describes the critical elements of the model’s equation structure that are used to address the SNG plant’s impacts in both the construction and operations phases, identifies the assumptions and mechanism by which the policy is modelled, presents evaluative data on the model, and identifies the projected policy impacts of the pricing agreement. We find that regardless of which consumers bear the burden of higher natural gas prices (residential; residential and commercial; or residential, commercial, and industrial users), significant negative net cumulative impacts are expected for state GDP, earnings, employment, and total income between 2017 and 2025. These impacts for state GDP range from -$1.2 billion to -$1.9 billion, and for employment from -830 to -1800 full time jobs. The policy analysis also breaks down how higher natural gas prices will affect earnings and income by industry over the 2017 to 2025 period. Moreover, the model was used to prepare a report that has shaped the policy discussion and contributed to passing legislation to revisit the original 30-year price agreement.

This application also serves as a “proof of concept” for using this multi-equation econometric model as a policy analysis tool. The paper concludes with a discussion of how such models can be applied to other policy analysis scenarios and how they can be generalized to other regions.  The research reported here is an illustration of how past relationships, reflected in the model’s specification, become a force for policy improvement.