What do Lower Oil Prices Mean for the Power Sector?

cauldron
“Double, double toil and trouble; Fire burn, and cauldron bubble.” – Shakespeare’s “Macbeth”

by Tanya Bodell, Energyzt

Brent crude prices have fallen from $115 per barrel to below $80 this past month, with further declines on the horizon. Saudi Arabia has indicated it does not intend to give up market share by reducing production to support prices. Russia has announced it is prepared for an elongated oil price slump. Response from the U.S. is mixed; some are voicing concerns that lower prices will end our march toward energy independence and others are expecting a net positive impact because of minimal impact on shale production combined with a boost to the economy. How will the power sector respond?

“Thrice the Brinded Cat Hath Mewed”

Lowering oil prices in response to potentially competitive alternatives is a standard play for Saudi Arabia. It is no coincidence that as renewable resources gained traction in the past, oil prices would fall to levels making such alternative technologies appear uneconomic. With renewables’ continuing to gain market share and shale oil and gas production in the U.S. reaching levels high enough to prompt Citigroup Inc. to announce U.S. energy independence by 2020, OPEC has responded with its standard play. The rather blasé response of Saudi Arabia to complaints immediately issued by other OPEC nations implies that lower prices could become the new normal as large oil players in the world attempt to discern the marginal cost of shale oil production in the U.S. In the meantime, the U.S. shale industry has shown an amazing flexibility to redeploy rigs in response to energy commodity price changes. Expect a shift from higher marginal cost shale plays to more economic fields during the next year in response to lower oil prices. Although the pace of natural gas production might fall in the short run, resulting in a brief uptick in prices during the next six months, resumption of shale output thereafter will continue the trend of relatively low electric generation fuel prices.

“Thrice, and Once the Hedge-pig Whined”

Many shale production companies reportedly are hedged for the next 12-18 months, making them somewhat immune to lower oil prices. This protection, combined with a stated intention to continue drilling, is expected to continue upward trends in domestic oil and natural gas production. The bigger driver in power generation fuel prices likely will be constraints on natural gas pipelines as the midstream market adjusts to the location of new supply sources. Short-term spikes in natural gas prices will continue in areas such as northeastern markets, where transportation resources approach full capacity during periods of high demand; however, high prices are the best solution to high prices. Although another polar vortex can affect fuel prices nationwide, the power sector has proved itself able to maintain system reliability while deploying different resources in response to changing fuel prices.

“Harpier Cries, ”Tis time, ’tis time'”

So what is a power generator to do? How should independent system operators respond? What must developers consider?

Listen to the market. Lower oil prices can make dual-fuel units more competitive, especially during natural gas price spikes. Although there might be interim pressure on U.S. shale production, the plethora of reserves are not going away in the long term, so plan on continuing natural gas supply to fuel the power sector. Renewable resource developers should continue their message to legislators about the importance of sustainable, long-term energy independence. Think through alternative futures and enter into commercial arrangements that address expected conditions while increasing flexibility to respond to changing conditions that are bound to occur.

“Boil Thou First i’ th’ Charmèd Pot”

The U.S. is one of the largest oil producers in the world, overtaking Saudi Arabia and Russia this past year because of its shale oil shale production. Access to domestic shale reserves reflects a significant supply shift domestically and potentially worldwide, promising a continuing period of lower oil prices to which players will respond. OPEC producers unable to compete at current levels already have tried to pressure the organization to reduce production to increase prices to no avail so far. Despite its bravado, Russia will find it increasingly difficult to sustain its foreign policy with oil prices at current levels. U.S. shale producers will have less ability to shift its rigs to lower cost resources. Just as the best solution to high prices is high prices, low prices will beget the response required to raise them to sustainable levels. In the meantime, the U.S. power sector will adapt to oil price volatility and changing natural gas supply in both short-run dispatch and long-term investment decisions.

Author

Tanya Bodell is executive director of Energyzt (www.energyzt.com), a global collaboration of energy experts who create value for investors in energy through actionable insights. Reach her at tanya.bodell@energyzt.com or 617-416-0651.

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