Last week I was in Portland, Oregon for the National
Association of Regulatory Commissioners (NARUC) summer conference. I was fortunate enough to land on the agenda
several times to discuss my recent report, asses the interdependence of natural gas and electricity, and to provide a
natural gas market update. It was a
great trip despite foregoing a brewcycle endeavor in favor of a business dinner.
Putting my suds-less induced sorrows aside, it is quite
remarkable how natural gas has changed our energy landscape in a few short
years. Here are the highlights of my natural gas market update.
Natural gas is an important fuel for the nation. It heats
homes, is used in industrial processes (like creating chemicals and
fertilizers), and fuels electric power plants.
Domestic production of natural gas was stagnant between 1997 and 2007,
which led to rising prices (see graph below – also note the impact Hurricanes
Katrina and Rita had on production and prices in 2005). Around 2007, gas
producers began unlocking vast natural gas reserves in shale formations and because
of the widespread use of hydraulic fracturing [1] and production has been soaring since.
On the consumption side of the equation, total natural gas demand was relatively flat between 1997-2007. Despite the recession beginning in 2008, natural gas usage has increased since 2007 because of lower fuel prices. The electric sector is driving the growth (see graph below). In comparison, demand from the commercial and residential sectors has been constant the past 15 years, while industrial consumption steadily decline. In 1997, the electric sector trialed the residential and industrial sectors in gas demand, but in 2011 the electric sector was the largest consumer of natural gas, accounting for 34% of demand.
So what’s behind the electric sector’s growing gas
appetite? One reason is there is a growing number of gas-fired power plants. But the primary reason is power plant dispatch economics are causing higher utilization rates of natural gas-fired power plants.
Electric system operators dispatch power plants based on
variable production costs, have the goal of cost minimization. Variable production costs for power plants
include fuel, emissions allowances, and variable operations and maintenance. The
capital costs to build power plants are not considered in the dispatch equation
( i.e., those costs are sunk). To minimize costs, operators dispatch the
lowest cost units first, and then more expensive units as electricity demand grows.
For many years power plants dispatched in a predictable order. Operators would dispatch – from lowest to highest
cost – baseload hydro (because it has no fuel cost!), then nuclear, coal,
natural gas, and finally oil-fired plants. (I’ll discuss how wind and solar are
handled in a separate post). Decade low natural gas prices has shuffled that order.
Many natural gas plants are now displacing coal plants in
dispatch, resulting in higher utilization of gas units and lower
output from coal units (which can lead to coal unit retirements).
I calculated illustrative production costs for a few
different types of power plants in the table below. Based on current fuel prices, natural gas
combined cycles (CC) produce electricity for about $25.5/MWh.
That puts CCs near price parity with units burning some of the nation’s
cheapest coal from the Powder River Basin (PRB), especially PRB units east of
the Mississippi River where rail shipping costs can be up to 75% of PRB’s delivered
cost. The picture is bleaker for coal
units using coal from Central Appalachia (CAPP). Gas-fired CC units are about $12/MWh cheaper
than units burning CAPP.
On a national level, the pace and scale of fuel-switching from coal to gas has been remarkable. In 2008, coal produced 48% of the nation's electricity, while natural gas produced 21%. In 2011, coal's share slipped to 42% and natural gas generation rose to 25%. Then in April 2012, coal and natural gas generation were equal for the first time, with each fuel producing 32% of the nation's electricity (see graph below).
With the electric sector becoming so gassy, I’m sure coal plant
operators are hoping the industry gets a dose of Beano.*
*Sadly I am not an heir to Beano fortunes. Nor am I related to THE Mr. Bean, but I will
answer by the name.
[1]
Shales are geologically poor reservoirs because they have low porosity (gaps in
the formation to hold gas), and low permeability (the connection of pores to
allow the flow of gas). Hydraulic
fracturing increases the permeability by cracking the rocks with high-pressure
water, lubricants and materials like sand.
The practice unlocked vast reserves of natural gas, and production
soared while prices steadily fell.
