NATURAL GAS:

Stable price remains the key to shifting power sector from coal to natural gas

The stability of natural gas prices is becoming a new focus of the energy policy community as the U.S. shale gas boom opens the door for electric utilities to burn more of the fuel.

New gas production in giant shale basins stretching from Texas and Louisiana to Pennsylvania is making it easier for electric utilities to turn to gas as they shut down older and dirtier coal-fired power plants. That can be sustained if gas commodity prices don't spike wildly as they have in the past and if state regulators are more willing to accept longer-term contracts proposed by utilities and gas producers, according to a report sponsored by the Bipartisan Policy Center and the American Clean Skies Foundation, a producer-led group that promotes gas.

"The right solution is not for utilities to put all of their supply into long-term contracts but to have a balanced portfolio," said Ralph Cavanagh, co-director of the energy program at the Natural Resources Defense Council, a member of the task force that conducted the study.

The way electric utilities and industrial users buy natural gas should start changing, Cavanagh said. With most U.S. gas supply bought off of a spot market, he said, a greater mix of gas demand and prices could be guaranteed through 10- or 20-year contracts.

"We're at a moment when change is clearly needed," he said. "That's starting to happen."

Natural gas prices spiked to two and three times today's price during the years 2001, 2005 and 2008. That left a sour taste in the mouths of utility regulators. Electricity prices are tied to the price of peak-hour gas-fired generation. In the past two years, however, domestic gas has rested at or below $4 per million British thermal units. That's near a price producers and gas customers contend is about right for expanding the use of gas to meet energy demand and environmental goals. Gas-burning turbines produce far less toxic air pollutants and less carbon dioxide emissions than coal.

Utilities spooked by memories of roller-coaster prices

This report is the latest in a long series of studies out of Washington think tanks, academia and industry groups touting the shale gas boom as a "game changer" for U.S. energy. This one is slightly different. While it uses the same type of language of the game-changing domestic supply picture, it also examines the key question of gas price volatility. Until about a year ago, utility executives and energy policymakers had been spooked by the recent price spikes and held onto long memories of security-of-supply issues stretching back 30 years.

Those fears are now shifting to a discussion about how to mitigate gas price volatility so utilities can tap a nearly 50 percent increase in U.S. gas reserves.

The Bipartisan Policy Center report also brought together corners of the energy world that are often at odds about the "best use" of natural gas. The task force that drafted the report includes representatives from ConocoPhillips, NRDC, Atlanta-based electric utility Southern Co., Dow Chemical Co. and the American Gas Association, which represents local gas distribution companies.

Chemical companies like Dow and local gas utilities had long argued that scarce gas resources should be used primarily to provide feedstock for factories and heat homes. That is changing.

"We're no longer at that point where one end-user is quibbling with another end-user as to gas's best use," said Richard McMahon, vice president for energy supply at the Edison Electric Institute. "We're seeing evidence -- looking at [prices in] the futures and forward gas markets -- that the gas market is evolving."

The combination of greater supply, longer-term contracts, infrastructure development and financial hedges can keep prices relatively stable, McMahon and others said.

"As an industry, our view is that it makes a lot of sense to maintain fuel diversity, including nuclear, coal, gas and renewables," he said, a position long held by EEI, which represents investor-owned utilities with interests in all of those technologies and fuels. "If it proves out that shale is a significant new source of readily accessible domestic gas, that would be terrific," he said. "Right now, there's a lot of education going on."

Switch to fixed-price, long-term contracts

Producers and utilities both are signing longer-term supply deals for gas. McMahon said changes in contracts to help stabilize gas supply and demand will help electric utilities as they spend billions to upgrade infrastructure.

"The capital expansion of the industry on the generation side happens in big, lumpy tranches," he said. Utilities are shifting their emphasis to gas-fired generation and toward more nuclear power in the Southeast instead of building new coal-fired generation or retrofitting the oldest coal plants with expensive technology to cut dangerous emissions. Potential climate change regulations requiring power plants to emit less carbon dioxide and federal regulations requiring utilities to comply with the Clean Air Act are pushing utilities in that direction.

Low natural gas prices have helped also. "Realizing and maximizing these benefits, however, will require that investors have confidence in the mid- to long-term stability of natural gas prices," says the report.

Further, the report says "rules that unnecessarily restrict the use of or raise the cost of long-term contract and hedging tools for managing supply risk should be avoided."

Producers and utilities could sign fixed-price, long-term contracts that build in price adjustments, the groups suggested. Today, gas is often bought through a combination of short- to medium-term supply contracts and a spot market. Increasingly, producers looking for customer guarantees are pressing electric utilities and other buyers to sign longer-term contracts.

Gas storage will play a bigger role in balancing supply and demand as gas consumption continues expanding, according to the report. Nearly 700 billion cubic feet of new natural gas storage capacity has been built in the past decade. Increasingly, gas storage is a critical piece of the puzzle for managing price volatility.

As more gas flows through trading points in the Southeast and Northeast, notes the report, there's a greater need for gas storage facilities near the major markets. "Thus, growth in the amount of storage available to the market -- now at a historic high and still growing -- is an important contributor to more stable and competitive gas markets," says the report.

Questions about 'gas boom' linger

"A first question is to what extent current resource assessments accurately capture the actual economically recoverable resource base," the report notes.

Engineers at the major gas producers are working through a handful of vexing issues: Does robust gas production in one corner of a large shale basin signal reliable gas production throughout the basin? Do "sweet spots" skew assessments of the broader resource? At what rates will gas wells decline? How will the development of gas drilling technology evolve?

The cost of production also remains an issue. Will enough pipelines and processing plants be built to deliver the gas to customers?

But the issue that could cause the industry the most trouble is public concern about the impact of gas drilling on the environment. In the Barnett Shale basin in Texas, for example, thousands of gas wells have been built in and around Fort Worth in the past five years. Residents, local politicians and the regional office of U.S. EPA last year started raising questions about the air pollution and toxic waste resulting from the Texas gas boom.

In Pennsylvania and New York, the concern is mainly the contamination of fresh water supplies and the capacity of state regulators to police gas drillers. At the center of that is hydraulic fracturing, which is the process of blasting water, sand and chemicals some 8,000 feet underground to crack the shale rock and release trapped natural gas. This report reiterates the industry's long-standing response to those concerns, chiefly that fracturing takes place thousands of feet under freshwater aquifers and poses little threat.

Still, media reports documenting water well contamination have prodded EPA to study the threat to water supplies more extensively. Given a two-year window by Congress to study the issue, the agency has faced pressure to narrow its investigation.

The report acknowledges, however, that faulty gas well casings are a legitimate concern. Cracked concrete casings could allow gas and chemicals to seep into water sources.

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