Managing Natural Gas Price Volatility and Escalation

Environmental Energy Technologies Division • Energy Analysis Department

Managing Natural Gas PriceVolatility and Escalation:The Value of Renewable Energy

Ryan H. WiserLawrence Berkeley National Laboratory

[email protected] (510-486-5474)http://eetd.lbl.gov/ea/EMS/

NEMS/AEO 2004 ConferenceWashington, D.C.March 23, 2004


Overview

q Renewable energy (RE) provides a hedgeagainst volatile and escalating gas prices:

1) Mitigates Fuel Price Risk: Long-term contractsfor RE are typically offered on a fixed-price basis,unlike gas-fired generation contracts

2) Reduces Natural Gas Prices: Increased REreduces natural gas demand, and consequentlyputs downward pressure on gas prices

q Presentation includes an overview of naturalgas price uncertainty, and discusses researchon both of these possible benefits


Natural Gas Prices Are High and Volatile

Gas fuel costs account for half of the total cost of new natural gas-fired generation, and gas-fired generation often sets the market

clearing price in wholesale electricity markets

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10A

pr-9

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$/M

MB

tu (

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Source: NYMEX

NYMEX natural gas futures strip on 03/16/04Daily price history of 1st-nearby

NYMEX natural gas futures contract


Natural Gas Price Forecasts Show aBroad Range of Possible Outcomes

Source: National Petroleum Council, 2003


…But Be Wary of Price Forecasts…

Historical AEO Wellhead Gas Price Forecasts vs. Actual Wellhead Price

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lhea

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rice

(Nom

inal

$/M

CF

)

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000102

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Source: EIA

Actual Wellhead Price

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The Value of Fixed-Price RE Contracts

q Renewable energy can provide a physical hedge againstvolatile gas prices

• Renewable energy typically offered at fixed prices forlengthy contract durations (>10 yrs)

• Gas-fired generation often offered on a long-term indexedor tolling basis, or sold in short-term volatile markets

q Customers or policymakers that value price stability mayprefer fixed-price over variable-price arrangements

q RE is not unique in providing price stability: gas generatorscan hedge using fixed-price gas futures, forwards, andswaps, though perhaps not for same duration as RE


LBNL’s Accounting for Fuel Price Risk…

Best Practice:• Cost of renewables should be compared to cost of gas-

fired generation based on a guaranteed fuel price

Current Practice:• Cost of renewables is often compared to cost of gas-fired

generation based on uncertain fuel price forecasts

Question: How to compare the levelized cost of fixed-price renewable to variable-price gas-fired generation?

How do guaranteed forward gas prices compare touncertain gas price forecasts?

to

to


Methodology

q Compared forward market prices for natural gas tolong-term spot price gas forecasts

• Forward market data from NYMEX (2002, 2003),Williams/DWR contract (2002), and Enron (2000, 2001),limited to maximum of 10 years

• Contemporaneous forecasts from EIA’s AEO referencecase (adjusted to delivery point for forwards), and fromutility IRP filings

q Limited data availability, especially for long-termforwards, constrains robustness of findings


Forward Prices Exceed Price Forecasts

2.7

2.9

3.1

3.3

3.5

3.7

3.9

4.1

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Nat

ural

Gas

Pric

e ($

/MM

Btu

)

Implied Forward Swap Curve (Enron)

EIA Forecast (AEO 2001)

November 2000

Source: Enron and EIA

2.2

2.7

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4.7

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Nat

ural

Gas

Pric

e ($

/MM

Btu

)

Implied Forward Swap Curve (Enron)


November 2001

Source: Enron and EIA

October 2003

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Nat

ural

Gas

Pric

e ($

/MM

Btu

)

NYMEX Futures Price (Annual Average)


Source: NYMEX and EIA

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2003 2004 2005 2006 2007 2008

Nat

ural

Gas

Pric

e ($

/MM

Btu

)

NYMEX Futures Price (Annual Average)


Source: NYMEX and EIA

November 2002


Levelized Premiums Average $0.7/MMBtu

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Contract Term

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icit

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Enron - AEO 2001 (November 2000) Enron - AEO 2002 (November 2001) NYMEX Futures - AEO 2003 (November 2002) Williams Physical Supply - AEO 2003 (November 2002) NYMEX Futures - AEO 2004 (October 2003) Average

Implicit premium in cents/kWh based on 7000 BTU/kWh heat rate


Gas Price Forecasts in Utility IRPs HaveRecently Been Lower than the EIA’s

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$/M

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AEO 2003 Forecast

Blend of Pacificorp Forward Prices and PIRA March 2002 Forecast

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

$/M

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tu (

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AEO 2002 Gas Price Forecast

Idaho Power/WEFA Natural Gas Price Forecast


Implications

Over last 4 years, forward gas prices have exceeded EIA referencecase forecasts; gas price forecasts used by utilities have beeneven lower, with a greater “wedge” between forwards and forecasts

Use of gas price forecasts (rather than forwards) over this timeperiod may have “biased” investment decisions towards variable-price gas-fired generation, and away from renewable energy

Whether these premiums will continue remains unclear, but doesnot change the fundamental implication of this work:

When possible, use forward prices, not price forecasts, whencomparing the levelized costs of gas-fired and RE generation

For more information:http://eetd.lbl.gov/ea/EMS/reports/53587.pdf


Renewables May Also Put DownwardPressure on Natural Gas Prices

Supply

Price

Quantity Q0

P0

P1

Q1

Original Demand Shifted Demand q Theory: Increased use of

RE will reduce natural gasdemand, placing downwardpressure on gas prices

q Magnitude of price reduction depends on the shape of the gas supplycurve: impact expected to be larger in the short-term than in the long-term due to short-term supply constraints

q Price reduction not strictly a gain in net social welfare – it is a gain togas consumers that comes at the expense of producers; whether suchtransfers support government intervention is subject to debate


Methodology

q Recent modeling studies have evaluated impact of increasedRE and EE deployment on gas prices (most use NEMS)

q Our analysis reviews results of nine of these studies• 5 EIA studies of the impact of national RPS proposals• 2 UCS studies of the impact of national RPS proposals• 1 Tellus study of the impact of New England RPS (focus on RI)• 1 ACEEE study of the impact of national RE/EE deployment

q Our Approach– review economic theory of the price suppression effect– review modeling output to test for model consistency over time, across

models, and with economic theory– compare results with empirical estimates of supply elasticities– determine whether existing models are treating this effect within reason– focus on national impacts initially – regional impact analysis up next


Increased Renewable EnergyPenetration Displaces Natural Gas

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Increase in Renewable Energy Generation (Billion kWh)

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as D

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EIA 98, 10% RPS

EIA 00, 7.5% RPS

EIA 01, 10% RPS

EIA 01, 20% RPS

EIA 02, 10% RPS

EIA 02, 20% RPS

EIA 03, 10% RPS

UCS 02, 10% RPS

Tellus 02, 10% RI RPS



Projected Gas Displacement in 2020 Under RPS Studies


Increased RE Penetration ReducesNatural Gas Wellhead Prices

Projected Gas Wellhead Price Reduction in 2020 Under RPS Studies

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Increase in Renewable Energy Generation (Billion kWh)

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ellh

ead

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($/M

MB

tu)

EIA 98, 10% RPS

EIA 00, 7.5% RPS

EIA 01, 10% RPS

EIA 01, 20% RPS

EIA 02, 10% RPS

EIA 02, 20% RPS

EIA 03, 10% RPS

UCS 02, 10% RPS





Consumer Gas Bill Reductions SubstantiallyOffset Increase in Electricity Bills

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EIA 98,10% RPS

EIA 00,7.5% RPS

EIA 01,10% RPS

EIA 01,20% RPS

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EIA 02,20% RPS

EIA 03,10% RPS

UCS 02,10% RPS

Bill

ion

200

0$

Change in ConsumerNatural Gas BillsChange in ConsumerElectricity BillsNet Impact of RPS onCombined Bills

Net Present Value of RPS Impacts on Natural Gas andElectricity Bills (1999-2020, 5% real discount rate)


Model Consistency

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

EIA 98 10% RPS

EIA 00 7.5% RPS

EIA 01 10% RPS

EIA 01 20% RPS

EIA 02 10% RPS

EIA 02 20% RPS

EIA 03 10% RPS

UCS 01 20% RPS and EE

UCS 02 10% RPS

Tellus 02 10% RI RPS



Implicit Inverse Price Elasticity of Supply

Inverse price elasticity ofsupply defined as%_P/%_Q, and measuresshape of gas supply curve

Long-term avg. inverseelasticity for EIA, UCS, andTellus varies from lessthan 0.5 to over 3.5depending on the study:central tendency 0.75 - 2.5

ACEEE focuses onshorter-term impacts, andshows short-term elasticityof over 15, and medium-term elasticity of ~4


Benchmarking to Other Models, Markets, Data

q Models suggest that 1% drop in gas demand could lead to0.75% – 2.5% reduction in long-term wellhead prices,with some models predicting even larger effects

q These results for NEMS are somewhat consistent with:

– NEMS AEO economic growth cases

– Implicit elasticities embedded in a number of other energymodels (Stanford EMF 2003)

– Limited empirical literature on historical elasticities for non-renewable energy commodities

q Central tendency of NEMS output is broadly consistent withlimited existing knowledge: reduction in consumer gasbills due to increased RE could therefore largely offsetexpected incremental cost of RE to consumers


Simplified Method – Inputs

“Model” results, without having to run the model!

• Gas Displacement (1 MWh RE = 0.6 MWh Gas-fired)

• Heat Rate of Displaced Gas-Fired (7,500 Btu/kWh)

• US Gas Consumption Forecast (from AEO)

• Inverse Elasticity of Supply (range from +1 to +3)

• US Gas Wellhead Price Forecast (from AEO)

• Wellhead to Delivered Prices (1:1)

Despite central tendency, variation in implicit elasticities acrossmodels and years, combined with dismal historical ability to

predict gas prices and uncertainty in shape of supply curve, implythat little weight should be placed on any single model result


Example Results: Impact of Existing StateRPS Policies, ~16,000 MW of New RE

Aggregate Impact of Current State RPS on Gas Prices

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Inverse Supply Elasticity = 1.0 Inverse Supply Elasticity = 2.0 Inverse Supply Elasticity = 3.0

$1.6 Billion ($20/MWh)

US Savings in 2025 (2002$) :




Conclusions

q Gas prices are high, volatile, unpredictable

q Diversification with renewable energy can help hedgethese risks over the medium to long term

q Cost of renewables is steady, predictable• Achieving similar gas price stability with futures, forwards, or swaps

has cost ~$0.7/MMBtu over last 4 years relative to EIA referencecase, suggesting that reference case is either out-of-tune with themarket or there is a cost to hedging gas price risk

q RE reduces gas consumption and prices• Modeling studies imply that a 1% drop in gas demand leads to a long-

term 0.75% - 2.5% drop in gas prices on average (and possibly alarger near-term drop)

• Increased consumer electricity prices due to additional RE predictedto be greatly offset by reduced consumer gas bills


Contact Information

Ryan H. WiserLawrence Berkeley National Laboratory

1 Cyclotron Road, MS 90-4000

Berkeley, California 94720

[email protected]

510-486-5474

Reports available at:

http://eetd.lbl.gov/ea/ems

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Managing Natural Gas Price Volatility and Escalation

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