(Part I)
Retail electricity customers face a host of challenges heading in to the summer of 2013. Part 1 of this 2 part series addresses factors impacting natural gas prices and the impact these will have on electricity prices during this summer and beyond. Part 2 will focus on two more drivers: energy reliability opportunities in electricity markets and weather. Understanding the impact that these 5 drivers have on energy prices is critical for risk management purposes.
The first three drivers that we will address are:
- Level of fracking production (supply side);
- Displacement of coal by natural gas in the U.S. electricity generation sector. (demand side); and
- Higher than normal nuclear outage rates, increasing reliance on natural gas fired generation (demand side).
Fracking—The Natural Gas Supply Revolution
Over the past decade, the use of fracking has enabled access to previously untapped reservoirs of natural gas, both in the form of dry gas and wet gas, which also contains liquefied hydrocarbons. This has created a glut in the market that depressed natural gas prices to a 12 year record low in 2012. As a result of fracking in shale formations, natural gas production increased 10% in 2012 versus 2011 despite a 40% drop in natural gas rig counts over the same time period. This supply bounty will serve as a check on forward natural gas and power prices in 2013.
There are two more drivers that we will discuss in this first part that lend support to natural gas and power prices. These are the displacement of coal as the marginal fuel and the higher than normal nuclear outage rates. Both of these drivers are described in a little more detail below and will have the impact of increasing the demand and hence the price for natural gas and electricity.
Coal-to-Gas switching
As a result of falling natural gas prices over the past few years, power from natural gas fired power plants has displaced coal as the most economic source of generation in several markets as seen in the below graph which compares the average fossil fuel spot prices in $/MWh since January 2012. The chart shows that on equivalent energy content and efficiency basis, natural gas at Henry Hub has been below Central Appalachian Coal prices during this time (source: EIA).
The lower fuel costs of natural gas fired power, coupled with lower capital and environmental compliance costs, suggests that the displacement of coal will continue into the future. As natural gas generation represents an increasing share of the power sector’s output: however, this will put pressure on prices as demand increases.
Nuclear Outage Rates
No significant nuclear capacity has been added to the U.S. generation fleet in over 30 years, meaning that gains in output have been driven by increasing performance efficiency in the existing fleet. However, as nuclear plants continue to age, they will experience more and longer out of service periods as more extensive maintenance is needed.
As seen in the graph below from the EIA, nuclear outages through November 2012 have been significantly higher than during the previous 5 years.
Regarding the development of new nuclear power plants, there are plans for a number of new reactors; however, expectations of low natural gas prices continuing for several years have slowed down such plans and probably less than four new units will come on line by 2020.
EIA shows that nuclear outages in 2012 were higher than in recent years because of extended forced and planned outages at four nuclear power plants. Such outages have continued into 2013. Moreover, with the typical spring refueling outages, the outage rate in early 2013 is well above that seen in the previous 5-years.
In addition to higher outage rates, the duration of such outages has increased. For instance, at Southern California Edison’s SONGS plant between L.A, and San Diego, Unit 2 has been off-line for almost 14 months. Since nuclear generation is low cost and almost always dispatched, the loss of nuclear units more frequently and for longer periods of time will put upward pressure on power prices and increase demand for natural gas as more units are needed to replace the lost nuclear capacity.
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