NGSA Study Finds Gas, Power Price Disconnect out West

The gas price increases in the West over the past year had no direct causal relationship with the price of power there and therefore cannot be blamed for high western wholesale electricity prices, according to a study commissioned by the Natural Gas Supply Association and sent to Capitol Hill and the Federal Energy Regulatory Commission last week.

In a paper titled "The Relationship Between Natural Gas and Electricity Prices," Virginia Polytechnic Institute Professor John Herbert concludes that gas and power prices fluctuate independently of one another with little or no correlation. NGSA asked Herbert to research the issue after many observers witnessed the increase in gas and power prices in the West and concluded they were causally related.

"No matter how one looks at the price data available for April 2000 to April 2001," said Herbert, "no consistent relationship can be found between changes in the price of natural gas --- either in the producing region or at the California border --- and changes in the price of electricity to the California market. In general, the prices do not move together at all. When, for short periods of time, there does seem to be a relationship in the movement of the prices, there is no relationship between the magnitudes of the changes. The electricity price swings are much greater than the natural gas swings. The inescapable conclusion is that while natural gas costs are certainly a factor in the price of electricity, they have not been a major contributing factor impacting the price of electric generation in California."

This study examined 52 weeks of pricing data (April 2000-April 2001) at the Permian Basin in West Texas (gas) and at the Palo Verde Switchyard in Arizona (power). It analyzed the data to determine whether gas and power prices increased at the same time; moved together in the same direction by day, week, or month; fluctuated to the same degree of magnitude; or whether they led or lagged each other.

Herbert, a former senior economist with the Energy Information Administration, found that power prices started a significant increase, 95%, on April 26, 2000, while gas prices on that day actually decreased a couple of pennies per MMBtu. Looking ahead a couple of weeks at weekly price averages, Herbert found that while power prices more than doubled, gas prices actually declined slightly. Using monthly averages, the story is nearly the same, with power prices doubling from April to May, from $34.74 to $73.63, while gas prices increased only about 39 cents, from $2.88/MMBtu to $3.27.

"Based on our analysis, it is evident that natural gas price increases did not cause power prices to increase. On the contrary, to the extent there is any causation at all, it appears that the increase in power prices may have kick-started the increase in natural gas prices," Herbert said.

After examining an entire year of data along the same lines, Herbert concluded that "our ability to predict power price changes from natural gas price changes is no better than our ability to predict the outcome of a flip of a coin on the next toss given the current toss. This lack of relationship holds true whether examining monthly, weekly or daily data."

Looking at monthly averages, he said in five of the 12 months examined, an increase in power prices was coupled with an increase in gas prices. But in seven of the months either an increase in power prices was coupled with a decrease in gas prices or an increase in gas prices was coupled with a decrease in power prices. Weekly data suggested the same result except the case is even more striking, he said.

Examining daily price averages using correlation coefficient measurements, Herbert found nearly zero correlation. "[T]here is little association, let alone a causal relationship, between changes in price on wholesale natural gas and power markets."

Herbert also examined gas prices at the California border and came to the same conclusions. A "straightforward examination of data performed elsewhere shows that when wholesale power prices began to rise in May 2000, natural gas prices rose but not nearly to the extent power prices rose," he said. For seven or eight weeks between Oct. 20 and Dec, 15, Herbert found that there was a slight correlation between the two but "even here the relationship is very weak in terms of magnitude of change for both sources of energy." For the most part the magnitude of the power price changes was much greater than that of the gas price fluctuations, he said.

The results are similar when looking at the other gas basins: San Juan, Western Canadian Sedimentary Basin, and Wyoming. The power price changes were much larger than the gas price changes. And the results are the same when looking at other spot price hubs in the country, he said.

Herbert said high gas prices at the Southern California border are "likely a consequence of transportation and other marketing issues, given that this statistical study does not support the contention that the high electricity prices are due to an increase in the cost of the natural gas commodity in major producing markets."

The lack of correlation between gas and power prices hold true regardless of the efficiency of the gas turbines used to produce the power, he said. Gas was the most likely choice as an incremental fuel for producing power in California, and many of the gas-fired power plants there are inefficient and use a significant amount of gas to produce electricity. Despite the high use of gas, however, there still was little or no correlation between gas prices and power prices in the West.

For a copy of the study contact NGSA's Laurie Cramer, director of communications, at (202) 326-9316.

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