by Tanya Bodell, Energyzt
Changes in specific energy markets are reverberating throughout the energy industry. The simultaneous cross-market march to a new set of equilibria creates a dynamic set of commodity markets that creates challenges and investment opportunities.
Technological innovation to access shale gas has shifted the natural gas supply curve to the right, resulting in excess domestic supply of gas. Combined with a temperate winter last year, prices dropped dramatically. Basis differentials also are experiencing unprecedented volatility as they settle into new levels wrought by new supply geography. Pipeline build out will reset the baseline for basis differentials again and feed into new marginal cost curves for the power sector as generators incorporate the delivered cost of natural gas into their bids.
Oil and natural gas historically had a relatively stable price relationship where the cost of oil in dollars per barrel vs. natural gas in dollars per million British thermal units generally hovered between a 5-1 and 10-1 ratio. This price ratio catapulted to more than 50-to-1 earlier this year before settling down to current levels. In response, drilling rigs transitioned away from natural gas to oil, from dry gas to wet gas plays. As long as oil prices stay high relative to gas prices, oil drilling and its associated natural gas production will continue.
Natural gas is a primary feedstock source for many petrochemicals, and low natural gas prices have generated renewed investment in domestic petrochemical production. Multiple petrochemical companies abroad have announced their desire to invest in the U.S., including Mitsui Chemicals Inc., The Dow Chemical Co. and Mitsubishi Chemical Holdings Corp. Focus in on the shale gas regions. In June, Brazilian chemical company Braskem bought parts of the Marcus Hook plant in Delaware County, Pennsylvania, and Shell announced it would build a $2 billion petrochemical plant near the Marcellus Shale formation. Petrochemical factories consume substantial amounts of electricity but also offer the potential for industrial-scale demand response, impacting local electrical energy demand curves.
More than 90 percent of coal produced in the U.S. is consumed in the production of electrical energy. Traditionally generating close to half of U.S. electrical energy, coal’s share of production has declined as new natural gas-fired facilities came online. Most recently, coal-fired generation has faced a significant short-term challenge by gas-fired power plants, with the relative economics’ converting certain coal-fired power plants from baseload units into seasonal peaker plants. What does that have to do with the price of coal in China? Potentially quite a bit; demand for steam coal in Asia has increased U.S. coal exports to record levels not seen since 1981, exerting upward pressure on prices. A June Energy Information Agency (EIA) Energy Outlook Report projects coal’s share of power production decreasing to 38 percent in 2035. Plants that survive this round of retirements should do well as the power sector settles into a new equilibrium.
Most coal delivered to U.S. power plants is transported by rail. According to the EIA, costs of shipping coal to power plants by railroad has increased nearly 50 percent between 2001 and 2010, with southern Appalachian coal’s having experienced transportation cost increases of 10 percent per year, according to the EIA’s Nov. 13 “Today in Energy” report. Higher rail rates increase delivered coal costs, resulting in higher marginal costs of production, further challenging the ability of coal-fired power plants to compete against natural gas plants. As coal plants retire and geographical demand for coal delivery shifts, expect railroads to implement new service routes and explore innovative rate structures and revenue replacement opportunities.
Electricity markets manifest movements from all of these commodities through bids, demand and market clearing prices. As a result, supply curves have flattened and wholesale market prices for electricity have fallen substantially since 2008. Power plants are modifying operations and investors are reassessing generation portfolio values. Take time to re-examine your investment strategy in light of current price levels and potential outcomes as multiple energy markets settle into a new equilibrium.
Tanya Bodell is executive director of Energyzt, a collaboration of energy experts intent on understanding the impacts of energy integration. Reach her at 617-416-0651 or email@example.com.
“What does that have to do with the price of tea in China?”
A rhetorical question credited to economists in a Nov. 15 webinar, “The New Dynamics of Increasingly Integrated Energy Markets,” in which I served as the electricity expert alongside experts on coal and natural gas.