Natural Gas and Electricity Costs and

Impacts on Industry
DOE/NETL-2008/1320

White Paper on Expected Near-Term

Cost Increases

April 28, 2008

 Disclaimer
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Natural Gas and Electricity Costs and Impacts on Industry

DOE/NETL-2008/1320

A White Paper on Expected Near-Term Cost Increases

April 28, 2008

NETL Contact:

Peter C. Balash
Office of Systems, Analyses, and Planning

National Energy Technology Laboratory

www.netl.doe.gov
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 Table of Contents
Summary…………………………………………………………………………. 1
Background………………………………………………………………………. 1
Forecast Electricity Growth……………………………………………………… 3
Opposition to New Coal Plants and Natural Gas Prospects……………………... 4
Effect of Possible Climate Legislation…………………………………………... 9
Conclusion……………………………………………………………………….. 11

List of Figures
Figure 1: Total Natural Gas Supply to U S. ……………………………………… 1
Figure 2: Real Natural Gas Prices vs. Gas Power Capacity Additions…………… 2
Figure 3: Change in KWH, 2006 v 1999, by State………………………………… 3
Figure 4: Total Electricity Generation Growth Rates……………………………… 4
Figure 5: Can Natural Gas Supply Support a “Dash for Gas?”……………………. 5
Figure 6: Theoretical Coal Displacement by Gas………………………………….. 6
Figure 7: 2006/7 Average and Peak Monthly Generation, Gas Combined Cycle…. 7
Figure 8: Expected Reserve Margins by Region, 2016……………………………. 8
Figure 9: Incremental Natural Gas Demand
with Higher Growth, No New Coal, and Climate Legislation………….. 9
Figure 10: Effect of $30/t CO2 tax and $14/mmBtu Natural Gas on
Current Average Generating Costs, by Region…………………………. 10
 Prepared by:

Peter C. Balash
NETL/OSAP

Kenneth C. Kern
NETL/OSAP
 Acknowledgements
We would like to thank Erik Shuster and Christopher Nichols of NETL’s Office of Systems,
Analyses, and Planning (OSAP) for supporting work. All opinions and conclusions, however,
are solely those of the authors.
 Natural Gas and Electricity Costs and Impacts on Industry
Summary: Natural gas prices continue their recent upward trend. High natural gas prices hurt
all natural gas consumers, especially households and natural gas-intensive industry, with recent
prices three to four times higher than a decade ago. Trade-exposed industry has been hurt the
most. Regions of the country dependent on natural gas fired generation have experienced large
increases in the cost of power. Coal-fired generation has restrained the price of electricity and
has constrained the price of natural gas from matching the rise in the price of oil. Currently,
opposition to coal plants and uncertainty over nuclear power has stymied the construction of new
baseload generation. This threatens a capacity shortage in many areas of the country, in the near
term. Additionally, should climate change legislation pass, the “dash to gas” will be
exacerbated, doubling natural gas consumption for power generation, increasing dependence on
foreign energy sources, and sending natural gas and power prices skyward across the country.

Background
In the early part of this decade, natural gas optimism was high. EIA reflected industry consensus
with projections of over 29 trillion cubic feet (Tcf) by 2010 and nearly 35 Tcf by 2020. The
projections were based on the extrapolation of high growth rates of natural gas use in power
generation, underpinned by assumptions of continued growth in domestic U.S. natural gas
production and available Canadian imports.

Total Natural Gas Supply to U.S.

(Including LNG)
’01 ’03
’02

’04
’05
Tcf/Year

’06
’07

’08
Gradual Decline to < 20 Tcf without LNG

’08
no LNG

Increased Use of Natural Gas in Electricity Will Require LNG;

N. American Natural Gas Supply for U.S. Trending Down
Annual Energy Outlook 2001, 2002, 2003, 2004, 2005, 2006, 2007 and 2008 March revision reference cases

Figure 1

The decline in the FY08 forecast from the FY01 forecast for year 2020 alone, excluding
LNG, is roughly 13Tcf, or nearly equivalent to the expected annual supply from ten Alaskan

1
 pipelines. The main driver has been the increase in natural gas price and the availability of
substitutes, especially coal, embedded in the model. For U.S. natural gas supply to remain
flat, growth in LNG supply is required. Domestic production is projected to decline steadily,
falling below 20 Tcf by 2030 (Figure 1). This implies that significant energy security issues
will arise for the supply of natural gas, in addition to long-standing issues for secure
petroleum supply.

Installation of a large amount of natural gas-fired capacity – combined cycle units and
combustion turbines - drove natural gas demand much higher. However, disappointing U.S.
production, declining Canadian imports, minimal LNG imports to date, and the continued
rise in the price of oil have caused natural gas prices to more than triple between 2002 and
today (Figure 2).
Real Natural Gas Prices v. Gas Power Capacity
Additions
Real gas prices have increased by a factor of 4,
spurred in part by massive gas capacity increases
250 $10.00

$9.00

200 $8.00

$7.00

150 $6.00

Cumulative $5.00 $/mmBtu

gas capacity
100 $4.00
additions
(GW) $3.00

50 $2.00

$1.00

0 $0.00
01

03

08
89
90
91
92
93
94
95
96
97
98
99
00

02

04
05
06
07
20

20

20
19
19
19
19
19
19
19
19
19
19
19
20

20

20
20
20
20

cumulative adds Avg HH Price

Source: EIA Natural gas Navigator, Annual Energy Review 2006,

Annual Energy Outlook 2008; BEA: GDP deflator; NETL calculations
Figure 2

Natural gas has not matched price the percentage increase in the price of oil because of
competition offered by coal, and favorable weather in two of the past three winters. That is, in
previous projections natural gas was assumed to take market share away from coal due to
competitive electricity costs. However, high natural gas prices caused the cost of electricity from
natural gas to be higher than that from coal. Because of this, and because in many regions there
was surplus electricity capacity, electricity prices were not high enough to make natural gas
generation economic. As a result, natural gas combined cycle (NGCC) units averaged about 40%
capacity factors in 2007 compared to well over 70% in 2002. The warm winters of 2005-2006
and 2006-2007 meant that residential space heating consumption was much lower than normal,
preventing the natural gas price from rising along with oil, but not enough for the price to
significantly displace coal. As of mid-April 2008, the price of oil is $115/barrel while the price
of natural gas is $10.30/mmBtu. An historic 8:1 oil/natural gas price ratio implies a natural gas
price of $14/mmBtu; strict energy equivalence implies a natural gas price of $19/mmBtu.

2
In trade-exposed sectors of industry, especially aluminum, fertilizer, and chemicals, the rise in
natural gas prices, which in the first part of the decade was U.S.-centric, caused production to be
shut in or moved offshore. 1 Middle East production of chemicals, especially, threatens the
competitive position of U.S. industry because of cheap natural gas reserves in the Persian Gulf
area. In addition, natural gas-centered production in the U.S. is also disadvantaged relative to
coal-based industry in China.

Change in KWH, 2006 v 1999, by State

Residential and Commercial use grows in all states; Industrial use varies

60000
TX
50000

40000
GigaWatt Hours

30000

20000 PA IL
MO
GA AL TN
10000 MI MA KY
LA AR
AZ AK NM KS WV
MT OR ME NH DC RI HI
0
MSSD VT ND UT FL WY OK IA NE IN NV CO
NC MD NJ VA CT SC DE WI ID
-10000 MN
NY
CA 90% of industrial load loss in 10 states
-20000 WA 70% in 5 states
OH
-30000

R+C change ind change

Source: Derived from EIA: State Historical Tables

Figure 3

Forecast Electricity Growth

Current projections of electricity generation growth, and in particular sales to industry, are only
1.1% and 0.1% per year, respectively, according to EIA Annual Energy Outlook 2008 2. In fact,
industrial sales growth is deemed to turn negative after 2017. This appears to be an extrapolation
of the most recent period, encompassing the blows to industry caused by the fuel price run-up, a
manufacturing recession centered in Ohio, and industrial retrenchment in California and New
York (see Figure 3).

1
See, for instance, American Chemistry Council, “Impact of High Energy Costs on Consumers and Public,”
testimony before the U.S. House of Representatives, Energy and Mineral Resources Subcommittee, May 19, 2005.
Available at http://www.americanchemistry.com/s_acc/sec_policyissues.asp?CID=311&DID=1137
2
EIA, Annual Energy Review 2008, annual tables, Table 8.

3
 Total Electricity Generation Growth Rates
10%
9%

Percent change from previous year

8%
7%
6%
AEO’
AEO’08
5%
4%
3% 2.4%/yr 20 yr
2% 1.7%/yr 6 yr 1.5%/yr NERC
1%
1.1%/yr EIA
0%
-1%1980 1990 2000 2010 2020 2030

-2%
-3%
Forecast for Electricity Generation Growth Well Below Recent Averages
Electricity generation: EIA,1949−1994: Annual Energy Review 2006; 1995−2006: Electric Power Annual 2006; 2007−2030:
Annual Energy Outlook 2008 revision; NERC 2007 Long-Term Reliability Assessment

Figure 4

Even then the growth rate used for the projection (1.1%) does not reflect recent averages
(1.7% - Figure 4). Extrapolating based on a time period with these embedded events will
likely underestimate electricity consumption over the next few years, once the current
economic slowdown is resolved. Worse, underestimation of industrial growth over the
longer term risks becoming a self-fulfilling prophecy, as demand uncertainty may lead to
failure to install enough electricity generation capacity, causing the price of electricity to rise
needlessly and further weakening U.S. industry.

Opposition to New Coal Plants and Natural Gas Prospects

The current push by certain interest groups to forestall the construction of coal fired power
plants, reminiscent of opposition to nuclear power, threatens to:

a. reduce already precarious reserve margins, raising the risk of blackout, and
b. increase the demand for natural gas in the short to medium term.

Expecting natural gas generation to displace coal-fired generation is, at best, problematic. By
2016, in the absence of 18 GW of currently forecast new coal-fired plants, the addition of
natural gas plants to supplant these kWh would demand 1.4 Tcf/year, or almost all of the
presently forecasted LNG growth. If electricity growth is higher, in line with AEO’05
estimates, due to better macroeconomic performance, an additional 2.3 Tcf of natural gas for
gas-fired generation would be needed.

4
 Can Natural Gas Supply Support a “Dash to Gas?”
Total generation AEO’05
Total generation AEO’08
2.3 Tcf
Renewable AEO’08

Nuclear AEO’08

Oil and Natural Gas AEO’08

1.4 Tcf
Generation from coal if no new
plants are built

Coal AEO’08

3.7 TCF of Potential Natural Demand Growth with Declining N. American Supply
Data source: Energy Information Administration’s Annual Energy Outlook 2008 (revision) and AEO2005. Assumes that NG-fired
combined cycle plants operating at 50% efficiency to fill generation gaps

Figure 5

Although LNG regasification capacity could grow by as much as 15 bcf/d, only 5 bcf/d is
certain to appear. Currently LNG capacity is 5 bcf/d, and EIA only expects 3.2 bcf/ of LNG
imports by 2010, implying significantly underutilized regas capacity. Industry’s perception
of likely prices for LNG has also changed. In 2003, Deutsche Bank as well as other energy
analyst groups expected LNG to cause world prices of natural gas to clear at $3.50/mmBtu.
In 2008, the bank notes the success of the United Kingdom in bidding away surplus LNG
cargoes, even though U.S. prices are above $10/mmBtu. 3 At the same time, U.S. domestic
production is not expected to grow, and Canadian imports are expected to decline.

3
Deutsche Bank AG, Natural Gas Outlook 13 June 2003, p. 2; Commodities Weekly 18 April 2008.

5
Wall Street Journal, April 18, 2008

Thus, the likely way for LNG to increase natural gas supply to the US is for price to rise
substantially. This increase could happen, thanks to the confluence of the pressure on coal
utilization and the related possibility of climate change bills.

Theoretical Coal Displacement by Gas

160%

140% Nationally, 20-35% of coal

kilowatt-hours can be displaced
120% by operating existing NGCC units
Percentage of at higher capacity factors*
displaced 100%
coal generation
80% g a s @ 0 .6 5
g a s @ 0 .8 5

60%

40%

20%

0%
W ECC ERCOT FRCC MRO SPP SERC RFC NPCC L -4 8

Most coal-dependent regions have limited ability to displace coal with gas to displace emissions

*Note: abstracting from constraints Source: Energy Velocity database; NETL calculations

Figure 6
Nationally, up to a third of coal kilowatt-hours could be displaced by higher utilization of
natural gas combined cycle units (NGCC), as shown in Figure 6. Coal-dependent regions

6
such as SERC and RFC drive this result, with limited available NGCC capacity. While it
may appear NPCC has enough combined cycle capacity to replace its modest coal use, that
surplus does not exist during peak months.

2006/7 Average and Peak Monthly Generation,

Gas Combined Cycle
In the West, Northeast, Texas and Florida, gas CC
units operating over 65% cf at peak month in 2007
20.00 80%

18.00
70%
16.00
60%
14.00
50%
Monthly TWh, 12.00
average Capacity factors
10.00 40%
and peak
8.00
30%

6.00
20%
4.00
10%
2.00

0.00 0%
RFC MRO SERC SPP WECC NPCC ERCOT FRCC

avg CC mwh peak CC mwh 2006 CC avg cf 2007 CC peak cf

Existing NGCC can not meet peak load growth

Source: Ventyx Energy Velocity database

Figure 7

Other, more natural gas-centric regions such as NPCC have limited ability to displace coal
with existing natural gas plants because these plants already operate at high capacity factors
during peak months (Figure 7). More capacity is clearly needed.

7
 Expected Reserve Margins by Region, 2016
Most of the country will be in precarious situation in 2016 w/o new baseload;
the East will be vulnerable even with expected plants

40%

35%

30%

25%

20%

Reserve margin 15% “comfort” reserve margin level

10%

5%

0%
RFC NPCC SERC SPP MRO FRCC EAST* ERCOT WECC
-5%

-10%

-15%

2016 2016, no new coal 2016, no new coal or nuclear

*East = combination of RFC, NPCC, SERC, SPP, MRO, and FRCC

Source: Ventyx Energy Velocity database, 4/15/2008

Figure 8

The Eastern Interconnect (all regions excluding ERCOT and WECC) is in dire need of new
capacity to ensure safe reserve margins by 2016 (Figure 8). The loss of new coal plants will
reduce reserve margins well below these levels for most of the country, other than ERCOT
(Texas) and SPP. However, since SPP is in the “East” its surplus will be drawn off by the
grid. Should nuclear power also not be available before 2016, the entire Lower-48, save
ERCOT, will be at high risk of power shortages, a present-day South African-like, electricity
supply situation.

The compound influence of these factors could more than double current U.S. power
generation consumption of natural gas, just from running existing combined cycle units at
higher rates, and with incremental new gas-fired additions.

8
 Incremental Natural Gas Demand w/ Higher
Growth, No New Coal, and Climate Legislation

14.35

8.77

5.77

*existing gas CC plants at 65% capacity factor

** existing CC at 85% cf.

Figure 9

In Figure 9, consumption in 2008 of natural gas by combined cycle units will be about 5.1
Tcf. From Figure 5, an additional 3.7 Tcf of natural gas would be needed to replace expected
coal plants and accommodate higher growth. In the event of climate change legislation,
running existing natural gas combined cycle units at higher capacity factors can displace 20-
35% of current coal kilowatt-hours (Figure 6). Such substitution requires another 5.4 Tcf per
year. Clearly, the existing natural gas fleet cannot meet the growth in peak demand expected
before 2016 and also substitute for coal to meet carbon caps. More plants would be needed,
resulting in the incremental natural gas requirements of Figure 9.

Since the approximate 9 Tcf increase in natural gas consumption would be occurring at high
prices, the impact on the economy would be severe. Since both power and heating prices
would escalate, no sector would be exempt, but energy-intensive industry and residential
sectors would certainly bear the heaviest burden.

Effect of Possible Climate Legislation

There is however, one scenario, becoming increasingly likely, that could bring to pass high
natural gas plant utilization, low to dangerous reserve margins, and the collapse of U.S. industrial
competitiveness. A climate change bill with relatively strict cap and trade provisions, such as
S.2191, combined with the attempted moratorium on coal and likely delay of nuclear would
severely impact the U.S. economy as it attempts to adjust.

9
 Figure 10

Electricity and natural gas-intensive industry will be targeted. These effects have been
minimized by most analyses because they neglect the vicious cycle between the prices of natural
gas and of carbon dioxide; in the short term, under a cap and trade, the price of carbon must be
high enough to displace coal kilowatt-hours. Only natural gas generation can do this at sufficient
scale. Most analyses assume cheap and plentiful natural gas, early nuclear, or unlimited
biomass, each a problematic assumption. While states with high rates of coal use will be most
immediately affected, the knock-on natural gas demand effects will be widespread. Due to the
increase in natural gas demand as coal power is backed down, the price of natural gas will rise
dramatically across the country, not only in coal-using regions. As the natural gas price rises,
coal plants regain competitiveness, necessitating a further rise in the carbon dioxide allowance
price, in order to meet the cap. A price of $14/mmBtu, usually seen only in peak days in the
Northeast, could be come commonplace. (This price equates to a price of oil of $84/barrel at a
6:1 energy equivalence ratio and $112/b at a more normal 8:1 ratio). The combined effect of
high fossil fuel prices and a carbon dioxide allowance price of $30/ton would drive the average
MWh cost to well over $110/MWh in natural gas-heavy regions (Figure 10). In fact, in Figure
10, the absolute cost increase of electricity is 31% higher in natural gas-intensive regions than in
coal-intensive ones. On top of the already precarious reliability situation, shortages of natural gas
and power may occur before relief arrives with advanced, but expensive, power generation
technologies.

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Conclusion
Since 2001, perceptions of natural gas supply and consumption have been successively ratcheted
down, without any assurance the decline has halted. Nonetheless, recognition of the extremely
difficult natural gas supply situation facing the United States has not been fully appreciated in
recent energy and climate change analyses. Policies that encourage the use of natural gas to
substitute for coal in power generation could very well lead to spectacular price increases for
households and industry. As prices are pushed higher the need for more LNG will create closer
links to the world oil price, setting the stage for the marginal price of U.S. electricity to be set by
the whims of foreign oil/LNG suppliers, for the first time in U.S. history. This blind eye towards
U.S. energy security extends to the inability to recognize that the nation's coal supply could help
the U.S. forestall this situation. The current opposition to baseload power, and in particular
coal-fired plants, in anticipation of climate change legislation, will have serious and damaging
implications for the reliability of electricity supply and the viability of the U.S. economy in the
initial, costly period of adjustment to a carbon control paradigm.

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