Managing Natural Gas Price Volatility and Escalation: The Value of - - PowerPoint PPT Presentation

Environmental Energy Technologies Division • Energy Analysis Department

Managing Natural Gas Price Volatility and Escalation:

The Value of Renewable Energy

Ryan H. Wiser

Lawrence Berkeley National Laboratory

RHWiser@lbl.gov (510-486-5474) http://eetd.lbl.gov/ea/EMS/ NEMS/AEO 2004 Conference Washington, D.C. March 23, 2004

Environmental Energy Technologies Division • Energy Analysis Department

Overview

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

1) Mitigates Fuel Price Risk: Long-term contracts for RE are typically offered on a fixed-price basis, unlike gas-fired generation contracts 2) Reduces Natural Gas Prices: Increased RE reduces natural gas demand, and consequently puts downward pressure on gas prices

q Presentation includes an overview of natural gas price uncertainty, and discusses research

• n both of these possible benefits

Environmental Energy Technologies Division • Energy Analysis Department

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

1 2 3 4 5 6 7 8 9 10 Apr-90 Apr-91 Apr-92 Apr-93 Apr-94 Apr-95 Apr-96 Apr-97 Apr-98 Apr-99 Apr-00 Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Mar-07 Mar-08 Mar-09 Mar-10 $/MMBtu (nominal) 1 2 3 4 5 6 7 8 9 10 $/MMBtu (nominal)

Source: NYMEX

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

Environmental Energy Technologies Division • Energy Analysis Department

Natural Gas Price Forecasts Show a Broad Range of Possible Outcomes

Source: National Petroleum Council, 2003

Environmental Energy Technologies Division • Energy Analysis Department

…But Be Wary of Price Forecasts…

Historical AEO Wellhead Gas Price Forecasts vs. Actual Wellhead Price

1 2 3 4 5 6 7 8 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Wellhead Price (Nominal $/MCF)

85 86 87 91 90 89 92 93 94 95 97 98 99 96 00 01 02 03 Source: EIA

Actual Wellhead Price

04

Environmental Energy Technologies Division • Energy Analysis Department

The Value of Fixed-Price RE Contracts

q Renewable energy can provide a physical hedge against

volatile gas prices

• Renewable energy typically offered at fixed prices for

lengthy contract durations (>10 yrs)

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

q Customers or policymakers that value price stability may

prefer fixed-price over variable-price arrangements

q RE is not unique in providing price stability: gas generators

can hedge using fixed-price gas futures, forwards, and swaps, though perhaps not for same duration as RE

Environmental Energy Technologies Division • Energy Analysis Department

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 to uncertain gas price forecasts?

to to

Environmental Energy Technologies Division • Energy Analysis Department

Methodology

q Compared forward market prices for natural gas to

long-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 reference

case (adjusted to delivery point for forwards), and from utility IRP filings

q Limited data availability, especially for long-term

forwards, constrains robustness of findings

Environmental Energy Technologies Division • Energy Analysis Department

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 Natural Gas Price ($/MMBtu)

Implied Forward Swap Curve (Enron) EIA Forecast (AEO 2001)

November 2000

Source: Enron and EIA

2.2 2.7 3.2 3.7 4.2 4.7 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Natural Gas Price ($/MMBtu)

Implied Forward Swap Curve (Enron) EIA Forecast (AEO 2002)

November 2001

Source: Enron and EIA

October 2003

3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 2004 2005 2006 2007 2008 2009 Natural Gas Price ($/MMBtu) NYMEX Futures Price (Annual Average) EIA Forecast (AEO 2004)

Source: NYMEX and EIA

3.0 3.2 3.4 3.6 3.8 4.0 2003 2004 2005 2006 2007 2008 Natural Gas Price ($/MMBtu)

NYMEX Futures Price (Annual Average) EIA Forecast (AEO 2003)

Source: NYMEX and EIA

November 2002

Environmental Energy Technologies Division • Energy Analysis Department

Levelized Premiums Average $0.7/MMBtu

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 2-Year 5-Year 6-Year 7-Year 10-Year Contract Term Implicit Premium ($/MMBtu) 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Implicit Premium (¢/kWh)

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

Environmental Energy Technologies Division • Energy Analysis Department

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

3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 $/MMBtu (nominal)

AEO 2003 Forecast Blend of Pacificorp Forward Prices and PIRA March 2002 Forecast

2.5 3.0 3.5 4.0 4.5 5.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 $/MMBtu (nominal)

AEO 2002 Gas Price Forecast Idaho Power/WEFA Natural Gas Price Forecast

Environmental Energy Technologies Division • Energy Analysis Department

Implications

Over last 4 years, forward gas prices have exceeded EIA reference case forecasts; gas price forecasts used by utilities have been even lower, with a greater “wedge” between forwards and forecasts Use of gas price forecasts (rather than forwards) over this time period may have “biased” investment decisions towards variable- price gas-fired generation, and away from renewable energy Whether these premiums will continue remains unclear, but does not change the fundamental implication of this work: When possible, use forward prices, not price forecasts, when comparing the levelized costs of gas-fired and RE generation

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

Environmental Energy Technologies Division • Energy Analysis Department

Renewables May Also Put Downward Pressure on Natural Gas Prices

Sup ply Price Quantity Q P0 P

1

Q

1

Original De mand Shifted Demand

q Theory: Increased use of

RE will reduce natural gas demand, placing downward pressure on gas prices

q Magnitude of price reduction depends on the shape of the gas supply

curve: 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 to

gas consumers that comes at the expense of producers; whether such transfers support government intervention is subject to debate

Environmental Energy Technologies Division • Energy Analysis Department

Methodology

q Recent modeling studies have evaluated impact of increased

RE 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

Environmental Energy Technologies Division • Energy Analysis Department

Increased Renewable Energy Penetration Displaces Natural Gas

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 200 400 600 800 1000 Increase in Renewable Energy Generation (Billion kWh) Natural Gas Displacement (Quads) 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 Tellus 02, 15% RI RPS Tellus 02, 20% RI RPS

Projected Gas Displacement in 2020 Under RPS Studies

Environmental Energy Technologies Division • Energy Analysis Department

Increased RE Penetration Reduces Natural Gas Wellhead Prices

Projected Gas Wellhead Price Reduction in 2020 Under RPS Studies

• 0.6
• 0.5
• 0.4
• 0.3
• 0.2
• 0.1

0.0 0.1 200 400 600 800 1000 Increase in Renewable Energy Generation (Billion kWh) Change in Average Wellhead Gas Prices ($/MMBtu) 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 Tellus 02, 15% RI RPS Tellus 02, 20% RI RPS

Environmental Energy Technologies Division • Energy Analysis Department

Consumer Gas Bill Reductions Substantially Offset Increase in Electricity Bills

• 80
• 60
• 40
• 20

20 40 60 80

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 Billion 2000$ Change in Consumer Natural Gas Bills Change in Consumer Electricity Bills Net Impact of RPS on Combined Bills

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

Environmental Energy Technologies Division • Energy Analysis Department

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 Tellus 02 15% RI RPS Tellus 02 20% RI RPS

Implicit Inverse Price Elasticity of Supply

Inverse price elasticity of supply defined as %_P/%_Q, and measures shape of gas supply curve Long-term avg. inverse elasticity for EIA, UCS, and Tellus varies from less than 0.5 to over 3.5 depending on the study: central tendency 0.75 - 2.5 ACEEE focuses on shorter-term impacts, and shows short-term elasticity

• f over 15, and medium-

term elasticity of ~4

Environmental Energy Technologies Division • Energy Analysis Department

Benchmarking to Other Models, Markets, Data

q Models suggest that 1% drop in gas demand could lead to

0.75% – 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 energy models (Stanford EMF 2003) – Limited empirical literature on historical elasticities for non- renewable energy commodities

q Central tendency of NEMS output is broadly consistent with

limited existing knowledge: reduction in consumer gas bills due to increased RE could therefore largely offset expected incremental cost of RE to consumers

Environmental Energy Technologies Division • Energy Analysis Department

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 across models and years, combined with dismal historical ability to predict gas prices and uncertainty in shape of supply curve, imply that little weight should be placed on any single model result

Environmental Energy Technologies Division • Energy Analysis Department

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

Aggregate Impact of Current State RPS on Gas Prices

• 0.16
• 0.14
• 0.12
• 0.10
• 0.08
• 0.06
• 0.04
• 0.02

0.00 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Change in Gas Price, All Sectors (2002 $/MMBtu)

Inverse Supply Elasticity = 1.0 Inverse Supply Elasticity = 2.0 Inverse Supply Elasticity = 3.0 $1.6 Billion ($20/MWh) US Savings in 2025 (2002$): $3.3 Billion ($39/MWh) $4.9 Billion ($59/MWh)

Environmental Energy Technologies Division • Energy Analysis Department

Conclusions

q Gas prices are high, volatile, unpredictable q Diversification with renewable energy can help hedge

these 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 reference case, suggesting that reference case is either out-of-tune with the market 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 a larger near-term drop)

• Increased consumer electricity prices due to additional RE predicted

to be greatly offset by reduced consumer gas bills

Environmental Energy Technologies Division • Energy Analysis Department

Contact Information

Ryan H. Wiser

Lawrence Berkeley National Laboratory 1 Cyclotron Road, MS 90-4000 Berkeley, California 94720 RHWiser@lbl.gov 510-486-5474

Reports available at: http://eetd.lbl.gov/ea/ems