NGI The Weekly Gas Market Report / NGI All News Access

Gas Appeal Bolstered by Power Shortage, Price Spikes

August 10, 1998
/ Print
| Share More
/ Text Size+

Gas Appeal Bolstered by Power Shortage, Price Spikes

The recent price spikes and generation outages in the Midwest electricity market have undermined the reliability reputation of electric suppliers and opened the door wide for the natural gas industry to capture a greater share of the industrial energy market, says a senior economist.

Utilities over the years always have used reliability of electric service as a key selling point to industrial customers, noted Harry Chernoff of Science Applications International Corp. in McLean, VA. "But now they're curtailing electric. So the gas companies are rightly going to [remind industrials] 'your electric was just curtailed,' or 'your peak prices just went way up,' or 'you've been offered a new combination of rate schedules where firm [service] is a lot more expensive than it used to be and emergency [service] is way more expensive than it used to be..'" In the final analysis, "unless you [the industrial] got a load profile that can handle it, you're taking a risk."

Natural gas companies should target "industrials that have processes that require continuous energy supplies," and that have the flexibility to consume either gas or electricity, he said. The upheaval in the electric market in June is "a significant marketing issue [for gas], and I would think that a lot of the industrials are going to take a look now at what kind of reliability is being offered from gas." Chernoff, a former FERC staff member, believes gas service has become increasingly more reliable over the years, with companies installing a lot of peak delivery capacity - such as storage.

On a related topic, he said he expects to see a "massive shift" towards natural gas in the electricity industry within the next 10 years. "If you look at what the big and shrewd utilities and independent power producers are doing, it's gas power plants, it's gas pipeline investments, [and] in some cases it's gas production."

Chernoff's remarks came at a press briefing last week sponsored by the American Gas Association (AGA),which unveiled the results of a study on the impact of electric restructuring on electricity prices. Chernoff, who authored the study, predicts industrial customers will see greater rate reductions (20-25%) out to 2015, while rate savings for residential and commercial electric customers will be lower - in the 10% range. Specifically, he foresees industrial electric rates dropping from 4.2 cents per kWh in 2000 to 3.4 cents in 2015, commercial rates falling from 7.5 cents kWh to 6.9 cents, and residential rates tumbling from 8.2 cents per kWh to 7.7 cents.

But few, if any, of the rate savings for residentials and commercials will be the result of restructuring, he says. Savings for these two customer classes mostly will be due to "system efficiencies," such as declining natural gas prices, improvements in nuclear performance, coal surpluses, and the construction of combined-cycle gas turbines by exempt wholesale generators.

The big winners in restructuring will be industrial power users, he said. "Deregulation gets the industrials what they want. And not surprisingly industrials are the big supporters of deregulation. Deregulation gets the exempt wholesale generators and the independent power producers what they want, which is access to the expensive service territories. Deregulation also gets you [the] stranded-cost issue."

Chernoff contends that industrial customers are trying to "unwind" the regulatory protections that residential customers now enjoy. "The unwinding is taking place fairly rapidly. The utility commissions in the last 10 years have come to realize that industrials aren't making idle threats. There's been a fair number of closures of plants where [they] made explicit to the commissions why those jobs were lost," namely high electricity prices. A few of the commissions "started really to get religion" after that, Chernoff said.

Residentials Last in Line

His conclusions are in sharp contrast to a recent Department of Energy (DOE) study, which found that restructuring would cause residential electric prices to fall at a faster clip than industrial rates. "Well that conflicts with what I call the first principles [of] economics. If you ask yourself how is it that the group with the least market power does the best when you deregulate, the answer is that it doesn't make any sense..."

Just "look at what the states who are deregulating - California, Illinois, Massachusetts - are saying to their ratepayers. They're saying, 'deregulation will create these huge savings, immense savings. And by the way, we're going to mandate rate reductions for the residential and commercial classes.' You've got to ask yourself if these savings from deregulation are huge, why are the rate reductions mandated. Well the answer is they're not huge for the residential and commercial sectors. They're huge for the industrials."

Experiments with customer choice at the state level have proven this to be true so far, Chernoff noted. "In New Hampshire, for example, the experiments show that most of the savings came about due to companies buying their way into markets to get experience. I know for a fact that companies are taking losses just to get experience and create a presence. We've seen that Enron has withdrawn from the retail residential markets in California, New Hampshire and Massachusetts [citing the losses as the reason]. If you've got stranded-cost recovery and everybody's got to pay it, the savings just aren't that great."

Chernoff believes that restructuring is unnecessary to a certain extent. "...[A] lot of what's taking place under the name of deregulation[the] states could do if they wanted to under regulation," he told reporters.

Still, he said restructuring "makes sense" for high-cost states, such as California, New Jersey and states in the New England region. "It doesn't deliver the residential savings they're expecting, but it does deliver the industrial savings." However, he doesn't think it makes sense in low-cost states, especially those that have an abundance of hydroelectricity, such as Idaho. That would be the last state where he would expect to see a deregulated power market, Chernoff noted. He said he is opposed to a "one-size-fits-all solution" for electricity restructuring.

New Englanders Could Suffer

Separately, Chernoff believes the price spikes that the Midwest electricity market saw in late June could happen again. His study finds that "market power is going to go up and volatility is going to go up, and they're both going to go up in a big way" in the years ahead.

"And the most likely place you're going to see that is New England," he said. "...[I]f New England this summer had [had] either Texas temperatures or the midwestern outages, they would have been in the same boat as the Midwest. And it wouldn't have had anything to do with the default of any power marketers. It would have had to do with [the fact that] they got several of their big plants off line."

Moreover, he doesn't agree that the contract defaults by power marketers were the reason for the short run-up in Midwest electricity prices to $7,000 per MWh in June. "I don't really buy that. A lot of utilities [were] complaining that some of the intermediary utilities who could have wheeled in the surplus power from either the East Coast or from further West or South were refusing to [do so], citing transmission-loading constraints on their native load." He thinks this may be a more plausible reason.

In retrospect, the fact that electricity prices in the Midwest got as high as they did "seems crazy to me," Chernoff said. "I can't see any utility deciding that its incremental customer's worth $7,000 [per] MWh."

Susan Parker

©Copyright 1998 Intelligence Press, Inc. All rights reserved. The preceding news report may not be republished or redistributed in whole or in part without prior written consent of Intelligence Press, Inc.

ISSN © 2577-9877 | ISSN © 1532-1266
Comments powered by Disqus