Experimental economics lab works to spur Cook Inlet exploration, production

A company wants to build a pipeline. It holds an open season. Producers decide whether to commit to the pipeline. With enough commitments the pipeline moves forward.

Simple enough.

There might be a better way, though. Perhaps there is a system more appropriate for Alaska markets. But without a risky and expensive round of trial and error, no one will know what might work and what probably won’t.

That’s one roadblock to increasing natural gas supplies in Cook Inlet. The state and the industry can only guess about what will spur production of a known basin.

But over this coming summer and into the fall, the University of Alaska Anchorage will harness its economics program to study ways for the state and the industry to increase development in Cook Inlet, all without setting foot outside.

“Everyone responds to economic incentive and my job is to try and understand how people respond to those incentives,” Jim Murphy, Rasmuson chair of economics at UAA, told oil and gas stakeholders at a forum hosted by the Alaska Natural Gas Development Authority on May 13.

Using the Experimental Economics Lab, Murphy and other economists will create models that test different pricing systems in Cook Inlet.

Unlike traditional economics, which studies real world statistics to make conclusions about behavior, experimental economics uses controlled experiments to learn how people might actually behave under changing conditions.

The field is best suited for studying economic problems about which little is currently known. By creating and then fine-tuning computer models, the field allows economists to test how markets might work in the real world, without having to actually implement them.

Project came from state-industry roundtables

The work planned for this year is sponsored by the public corporation ANGDA with additional funding from Cook Inlet producers Marathon Oil and Aurora Power, three groups with a stake in the rise and fall of natural gas supplies coming from the Cook Inlet.

The question before the university is how to connect companies to known reserves.

“As I understand it, the shortage is more of an institutional shortage than a physical shortage,” Murphy said. “So what I’ve been told is that the gas exists in the inlet and it can be developed. The question is, ‘How can we create the incentives for that gas to be developed?’”

In early experiments, students will be given money to act as traders, playing games based around a natural gas basin with changing price scenarios — prices tied to Henry Hub, prices based on a competitive market in Cook Inlet and prices fixed through regulations.

The lab then quantifies how each change impacts investment decisions.

Murphy will present initial data from the experiments by the end of the year. If the results are encouraging, the lab will work on more detailed modeling and experiments next year.

Alaska is lucky to have the Experimental Economics Lab right at home, according to Harold Heinze, CEO of ANGDA.

“There’s only a few places in the world where these experiments can be conducted. We happen to have one here,” Heinze said. “We have an opportunity to use a tool here that isn’t available to a lot of other people.”

Heinze hopes the work this summer will kick start a longer relationship among the state, the industry and the lab.

“We believe there are a whole series of questions that lay out in front of us. ... Just looking at Cook Inlet doesn’t even start to get near some of the questions we have on our mind,” Heinze said.

One of the pioneers of experimental economics, Nobel laureate Vernon Smith, also works at UAA and plans to use the field to study alternative ways of conducting an open season on a natural gas pipeline from the North Slope.

Real world nuances make the study challenging

For instance, Murphy said, there is no guarantee that any given investment will lead to gas production. Companies often spend money on dry wells and uneconomic finds.

Also, setting a rule doesn’t mean everyone will follow it. And sometimes people make decisions that run counter to straight economic reasoning.

But the computer system at the lab allows for nuanced modeling. In the experiments, Murphy can account for real-world scenarios like unexpected changes to tax structures, collusion among bidders and companies with existing long-term contracts.

Murphy told the group he didn’t have their knowledge of the natural gas industry, but he knows about markets, rules and auctions. By combining his knowledge with the industry knowledge, he hopes to find an answer to a problem worrying many in Alaska.

“I don’t have a stake in the game. I’m not supportive or against the industry or the producers or anything like that,” Murphy said. “I just want to make sure that my home is heated in a couple of years.”

—Eric Lidji