John Guy, deputy secretary of the National Petroleum Council (NPC), said agency members plan to have discussions with several economists who claim to have found flaws in projected consumer savings and in the model used in the NPC’s massive natural gas study, which was released last fall. But Guy said the NPC is unlikely to take any action if serious problems in the report are uncovered.

“I think what you really have to do at the end of the day is [ask] would we come up with different gas policy recommendations based on [errors in the model],” Guy said in an interview with NGI. “That’s the bottom line of the whole thing. But our study is done. Our committees are complete, and unless the secretary [of energy] asks us to do it again…we won’t do that.”

Last week three economists — James F. Wilson of consulting firm LECG LLC, Ken Costello of the National Regulatory Research Institute and Hillard G. Huntington, executive director of Stanford University’s Energy Modeling Forum — circulated the second draft of a critique of the NPC study at the summer meeting of the National Association of Regulatory Utility Commissioners in Salt Lake City.

They claim to have found significant flaws in the modeling used in the study, which is highly regarded by many inside and outside the industry. Furthermore, they indicated that the errors resulted in misguided policy recommendations and greatly exaggerated estimates of consumer cost savings from those recommendations.

After obtaining significant details regarding the study directly from the NPC, the economists found that many of the components in the model were set exogenously, or prior to becoming part of the model. The amount of liquefied natural gas (LNG) imports and the timing of the Alaska and Mackenzie Delta pipelines in one of the scenarios were set outside the model, they said. The electric generation capacity mix was the same under very high and very low gas price scenarios. Furthermore, the interplay of various market events and policy changes was diminished or nonexistent.

As a result, the prices in the study were determined without the influence of many supply and demand factors, and NPC’s estimates of $1 trillion in consumer cost savings ended up being greatly exaggerated, the economists said in their critique titled “After the Natural Gas Bubble.”

They claim they are not out to bash the NPC or oppose its recommendations, which they said “merit consideration.” Rather they want to clarify the limits to the study’s policy analysis and highlight its 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 in an interview. “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 generally 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, total industrial demand remains nearly constant over time under the reactive path despite its high price assumptions. Chemical industry gas demand rises after 2010 despite significant price increases. Gas-fired power generation capacity increases at a fairly steady rate over 2011-2025, averaging over 9,000 MW/year with lower quantities of coal capacity additions despite coal’s significant price advantages.

“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 problems 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.”

They said that 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. 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.

“Nobody would look at this and say that all the model work was spot on and we had a view of the future,” Guy admitted. “The purpose of the study was not to do a forecast of future gas supply and demand. The purpose of the study was that the secretary asked us to look at a number of different policy things and to give him advice on policy areas. In order to do that, you have to put some numbers around it; you have to impart the discipline of an analytical process.

“We used the discipline of a modeling process and assumptions, but that is one of the reasons we ran 30 or so sensitivity cases,” he said.

“It was a monumental amount of work that went into the resource reassessment, but I think that any geologist or geophysicist would tell you that we could be wrong. There could be more gas or less gas. It’s an estimate, a guess based on lots of knowledge and with publicly available databases.”

Guy said the NPC used a forecast model from Arlington-based Energy and Environmental Analysis Inc. (EEA) that is widely used in the industry, by the Federal Energy Regulatory Commission and by the Department of Energy.

“We didn’t assume the gas price [projections in the study]; the prices were the result of a model from EEA that we’ve used in two previous gas studies… We felt that model was probably the best that was available in the marketplace.” But he also said that many changes were made to the model prior to using it. “The input assumptions came from our study teams not from the consulting group,” he said. “Plus there were a number of structural changes to the model to improve it.”

Guy also said the criticism of the NPC study on natural gas may be based on misunderstanding or a lack of information. The agency only recently released hundreds of pages of data and information that were used to support the study’s conclusions.

He also noted that the NPC study involved input from hundreds of people from governments both in the United States, Canada and Mexico, from academia, from the industry, from non oil and gas industry participants, from gas consumers both large and small, and from electric and gas utilities.

“It’s a very detailed and in-depth study and I’m not sure whether the authors of the [critique] had full access to all of it when they were initially writing their paper, but they are being given access to it now. And the members or our group have made offers to continue a dialogue with them to help them better understand what the NPC study did and why certain decisions were made.”

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