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Betting on Low Gas Prices

Issue 2 and Volume 116.

By Russell Ray, Managing Editor

By most accounts, natural gas prices will remain low for the foreseeable future.

The forecasts have inspired utilities to forge ahead with grand plans to build a new fleet of modern-day power plants that will be fueled with low-cost natural gas. Compelled by the promise of cheap fuel, some companies are shelving plans to build new nuclear and wind power capacity to pursue cheaper gas-fired projects.

It’s a risky bet the industry could end up regretting.

One thing is certain: Natural gas prices will spike again, as the chart on this page shows.

Inevitably, demand will catch up with the glut in gas supplies, and there are strong indications that it will be sooner than expected.

If the power sector blindly embraces $4 gas, the results will be disastrous. The massive build-out of new gas-fired generation coupled with significant cutbacks in exploration and production will bring supply and demand back into balance. Wellhead prices for gas will rise to $8 per thousand cubic feet, coal will again be the most cost-effective fuel for power generation and scores of new gas-fired plants will be idled because they will be too expensive to operate.

It’s a very real scenario the industry has experienced before. In the late 1990s, the power sector embarked on a building boom in gas-fired generation amid record low gas prices. For many months, gas prices hovered below $2 per mcf. By December 2005, the price had spiked to about $14 as dozens of new gas-fired plants built on the promise of low-cost fuel were shut down.

Already, natural gas producers are scaling back drilling and production plans to drive prices higher.

Oklahoma City-based Chesapeake Energy Corp., the nation’s second-largest natural gas producer, announced last month plans to cut production by 8 percent, or 500 million cubic feet of gas per day. What’s more, the energy giant said it will cut its drilling activity in half.

Other major gas producers are sure to follow suit.

In addition, ongoing efforts to export more of the nation’s natural gas supplies could drive up domestic prices by as much as 54 percent by 2018, according to an eye-opening report by the Energy Information Administration. Ironically, the push to export more U.S. gas supplies is being driven by producers eager to ship their production to other countries, where gas prices are three to four times higher than the U.S.

Also, the natural gas market is more volatile because the way the commodity is traded has changed. The growth of speculative hedge funds, energy traders and automatic trades has added a lot of volatility to the market. More traders, with no official connection to the producer or consumer, are buying gas and immediately selling it at a profit. About half of the gas transactions are made by outfits that have no interest in taking possession of natural gas.

The truth is that gas prices can skyrocket in the face of ample supplies. It has happened before and it can happen again.

Most utility executives understand this reality and will maintain a diverse portfolio of resources that includes a significant amount of coal-fired generation. Those who don’t, risk higher rates, higher costs and less reliability.

While more gas-fired generation is being built in the name of clean air and low costs, the share of coal-fired generation in the U.S. is not going to change much.

Coal represents 43 percent of the nation’s total power generation today. That number will fall to 39 percent over the next 25 years, according to EIA’s 2012 Annual Energy Outlook. You can hardly call that a shift to natural gas.

Power Engineering recently commissioned a survey of 250 power generators in the U.S., and a whopping 71 percent indicated they will begin retrofitting an existing plant in the next three years to comply with new emission standards for coal-fired plants. Twenty-six percent plan to add carbon capture systems to bring their coal-fired capacity into compliance.

The nation’s coal-fired power plants are valuable assets that foster reliability, security and the economy. Utilities will be working hard to preserve them by making hefty investments in emission control technologies to comply with new rules limiting mercury, sulfur dioxide and nitrogen oxides emissions. More than 90 percent of those emissions will be eliminated under the new rules. The challenge for utilities will be financing, permitting and installing these major improvements in a timely manner. Some power providers have already completed major emission-control investments and will be showcasing their projects in August at COAL-GEN 2012 in Louisville, Ky. To register, go to www.coal-gen.com.

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