A study of the electric generation market issued by the GasResearch Institute (GRI) last week offered some good news and badnews for the natural gas industry. The good news was that itprojected gas demand in the generation market will grow 44% from5.5 quadrillion Btus (quads) in 1996 to 9.9 quads in 2015. At thesame time, however, GRI predicted average real electricity priceswill decline by 26% from 6.9 cents per kWh in 1996 to about 5.2cents per kWh in 2015, setting the stage for increased competitionbetween the two energy commodities in the years ahead..

The forecast offered a real mixed bag for the gas industry sincepower generation is both a competitor and a profitable market forgas. The study, titled Electric Generation Sector Summary,projected gas demand in power generation will grow “substantially”in the future. Specifically it estimated about 52% of the 264gigawatts (GWs) of the new generation capacity added by 2015 willbe gas fired (137 GWs), while only 43% will use coal (112 GWs). “Continued low gas prices, improving generating technology, morestringent emission limits and the expected aversion to high capitalexpenditures will make natural gas the favored fuel for new andrepowered capacity, particularly in the near term.”

But despite these new capacity additions, GRI said gas’ share ofthe overall generation market will remain low as it will continueto be out-flanked by coal. It estimated gas will account for 21% ofthe total energy used to generate electricity by 2015, up fromabout 14% in 1996, but still it will pale when compared to about56% for coal by then. Much of the anticipated growth in gas demandwill come from new combined-cycle capacity, which is expected toaccount for 4.3 quads, or 44% of total gas use in generation, by2015. Gas consumption in steam plants is likely to remain nearlyconstant at 3.5 quads (36%), while gas use in turbines and largereciprocating engines will grow to 1.8 quads, or 19% of the total,the study said. Gas demand by small power generators, includingfuel cells, is expected to represent 0.1 quads, or 1%, by 2015.

The fact that coal prices are expected to decline in real termswill continue to give coal an advantage in the overall generationmarket relative to gas, whose prices are projected to remainrelatively stable, GRI said. “Thus, gas-fired technologies need toachieve greater efficiency improvements and capital and operatingcost reductions to maintain or improve their competitive positionversus coal.” At the same time, however, gas generationtechnologies will have an edge over coal in that they require lowerinitial capital costs, it noted. “Higher interest rates tend tomake low capital cost options, such as gas generation, relativelymore attractive” to electric utilities.

Moreover, the stringent environmental regulations that are dueto take effect after 2000 are expected to make natural gas moreattractive. “This may create a market for gas in cases where gas isburned as part of a low-cost hedge or bridge strategy…In general,more stringent limits are expected to make gas generation andemission-control technology more competitive.” The study said theclosure of older nuclear plants, utility divestitures of generatingassets and the growth in unregulated subsidiaries also couldfavorably influence gas demand in the years ahead.

Btu Marketing More Challenging

However, it noted gas demand could suffer if utilities arepermitted to renegotiate contracts that require them to buy powerfrom qualifying facilities at above-cost rates under the PublicUtilities Regulatory Policies Act of 1978. In addition, GRIbelieves the evolution in the market from electric utilities andgas LDCs that provide a limited menu of monopoly services to energyservice companies, which would offer both commodities, could posesome complications for gas. “Markets will be defined by a Btu ofenergy service rather than by a kilowatt-hour of electricity or anMcf of natural gas. This change together with falling electricityprices will make the marketing of natural gas end-use technologiesmore challenging.”

The greatest increases will come in the East, where the NewEngland, Middle Atlantic, South Atlantic and East North Central(Illinois, Michigan, Ohio} Census regions will account for 40% ofgeneration gas demand by 2015, up from the current 29%. Gas demandin the West South Central region (Texas) also will grow in absoluteterms, but its share of overall consumption will drop from 47% in1996 to 30% by 2015, according to the GRI study.

Offsetting the effects of GRI’s prediction of reducedelectricity prices, the institute forecast demand for electricitywill grow at just under 1.9% per year through 2015, which wouldparallel the growth in the gross domestic product. Specifically, itis projected to grow from about 3,000 billion kWh a year to morethan 4,000 billion kWh by 2015. “Electricity demand growth will bemoderated by a continued shift away from energy-intensiveindustries, market saturation of key appliances and greater energyefficiency by end-users,” GRI noted.

GRI’s projection that real average power prices will decline by26% from 6.9 cents per kWh in 1996 to about 5.2 cents per kWh by2015 was in sharp contrast to a recent American Gas Association(AGA) study, which put the price drop closer to 15%. The AGA reportestimated that power prices wouldn’t fall any further than 5.9cents per kWh by 2015. In addition, while GRI said that much of thedecrease in power prices would be driven by electricityrestructuring, the AGA maintained otherwise. It noted any “moderatedeclines” for power prices would be owing to surplus coal-firedcapacity, high-efficiency combined-cycle gas-fired capacity,time-of-use pricing, partial disallowance of stranded costs, andother technological and market factors.

Other implications of the study’s results for the gas industry,according to GRI, include: