The 87-page National Petroleum Council (NPC) report on natural gas last fall has become the bible of gas policy recommendations for many industry experts, government officials and legislators, but the modeling behind the report appears to be significantly flawed, according to a critique by several prominent economists.

As a result, the NPC’s policy recommendations are misguided and its estimates of $1 trillion in consumer cost savings are greatly exaggerated, the economists said in their critique titled “After the Natural Gas Bubble.”

James F. Wilson of consulting firm LECG LLC, Ken Costello of the National Regulatory Research Institute and Hillard G. Huntington of Stanford University said they are not out to bash the NPC or to oppose its recommendations, which they said “merit consideration.” Rather they want to clarify the limits to the study’s policy analysis and highlight its modeling errors.

“What caught our attention was the large gap in prices between the two major scenarios [in the NPC study] which persists over decades, raising the question — why isn’t the market able to eventually shrink this gap, by expanding supply or shrinking demand?” said Wilson. “This gap is important, because it is behind NPC’s conclusion that implementing a long list of recommended policies can save consumers a trillion.”

The NPC laid out two scenarios in its report: the “Reactive Path” scenario and the “Balanced Future” case. The former preserves the status quo concerning gas policy and projects extremely high gas prices, while the latter includes multiple new policy initiatives that lead to sharply lower prices.

However, the two scenarios greatly understate the likely longer-term response of markets to higher prices with or without new government initiatives, the economists found. This problem is particularly acute in the reactive path scenario, which has natural gas prices persisting over an extended period of time at levels that until recently were seen only during brief price spikes.

While such high prices, which are much higher than many other recent long-term projections by the Energy Information Administration, Stanford University and others, should result in significant supply and demand responses, the NPC results inadequately reflect those expected responses, according to the economists.

For example, the amount of liquefied natural gas (LNG) imports and the timing of the Alaska and Mackenzie Delta pipelines in the reactive path scenario were set outside the model without regard to prices. The LNG assumptions used “seem implausible under the price outcomes of the scenario,” the economists said.

Total industrial demand remains nearly constant over time under the reactive path despite its high price assumptions. Chemical industry gas demand first declines 16% from 2003 to 2010 as prices hover around $5.50; then from 2010 to 2025, prices are forecast to rise to $6 and then to $7 while chemical industry gas demand actually rises 11%.

Also in the reactive path scenario, gas prices rise to $6 and beyond while coal prices decline and oil prices remain flat, resulting in the other fuels having a substantial cost advantage over gas. Nevertheless, the assumptions result in gas-fired power generation capacity increasing at a fairly steady rate over 2011-2025, averaging over 9,000 MW/year with lower quantities of coal capacity additions.

“No new coal capacity is added until 2011, an assumption that appears likely to prove incorrect, as a recent DOE summary identifies approximately 38,000 MW of potential coal additions for 2004-2010 and another 20,000 MW for which an in-service date has not been established,” the economists said.

There are multiple other examples of the flaws in the assumptions behind the reactive path scenario and the same problems occur in the more preferred “Balanced Future” scenario. For example, LNG was assumed to provide 12.5 Bcf/d of supply in 2025 under the reactive path case, and a greater quantity (15 Bcf/d) under the lower-priced balanced future scenario. However, the only difference in assumptions between the two scenarios with regard to LNG is a one-year difference in the time required to obtain permits.

“It seems implausible for a one-year reduction in the lead time to bring an LNG terminal online [to] more than overcome the significantly lower price incentive under the balanced future assumptions, especially considering the large number of receipt terminals already in the planning stage,” the economists noted.

“The muted market reactions to prices lead to an exaggeration of the potential impact of government policies to influence supply, demand and prices and of the NPC study’s overall conclusion that policy makers can generate enormous consumer savings if they act immediately to implement a long list of recommended policies.”

It also should not be assumed that the anticipated consumer savings from the policy recommendations would dwarf the cost and other impacts of the recommended measures, the economists noted. For example, a recent EIA analysis showed that while the Alaska pipeline would save consumers about $10.2 billion over a certain number of years, it also would cost taxpayers $7.2 billion because of the proposed tax credits and Lower 48 gas producers would lose $32.8 billion in revenue.

“In addition to the NPC report’s attention-getting estimates of consumer savings…being greatly overstated, they are also not estimates of the full costs and benefits to society from the proposed policy interventions; namely they do not reflect the full range of impacts on producers, the environment and on interrelated sectors of the economy,” the economists concluded.

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