EIA Annual Energy Outlook AEO 2012 Points of Interest
Each year when the EIA releases their Annual Energy Outlook AEO, there is much talk about the results. The problem I find each year is trying to understand the change in the relationships between various markets. This is a function of the underlying model they are using. They are using the NEMS model which uses a general equilibrium concept. Personally, I never felt modeling should be left to the model. General equilibrium models are very dependent on all the experts to enter the relationships. Then the model will model those relationships. However, if you don’t have an expert of all things, the model may produce interesting relationship changes; since these experts are experts without integration.
My quick review focused on the Natural Gas, Coal, and Distillate: This is largely because the power market comingles these fuels, therefore, these relationships should be acted upon by the power market. Below are the gas price comparisons to coal and distillate deltas to the 2011 AEO deltas.
AEO 2012 decided in this year’s outlook that the oil spread to gas will be larger than last years by over $5/MMbtu. The gas to coal spread will decline by $0.30/MMbtu. This is largely a result of coal prices being stronger than gas prices being weaker.
Given these relationships before examining the consumption numbers, I would believe that more gas will be in the power sector. Coal use should decline. There should be some gas to liquids (GTL) at some point given the large economic incentive.
The consumptions on a high level show coal consumption being 10% less – no surprise there. However, total gas consumption is essentially the same as last year’s AEO 2011. Digging deeper the power sector use of natural gas climbs over 12% from last year’s AEO. Where is the demand for gas falling to keep the totals the same? It would seem the EIA has a more bearish outlook for natural gas use in the industrial sector and commercial sector. The commercial sector falls 7% which perhaps can be accounted for by efficiency improvements. Industrials seem counter intuitive given the many chemical projects recently announced.
Coal to liquids (CTL) demand fell by half, directionally correct since coal prices are higher but certainly not to the degree that liquid prices are higher. Interesting to see no gas to liquid (GTL) demand. I understand the complexity of GTL (I have a BS Chemical Engineering degree from the University of Texas). Numerous reports suggest GTL likely many years out. However all those reports were written when gas and oil were much closer to parity in the United States.
In addition, the driver for GTL was for stranded gas not in the US. The US innovative market structure plus the sustained large spread between gas and oil should lead to GTL development. My skepticism in GTL lies in the premise the spread will be that large for such a sustained time period. Based on my assessment, the amount of natural gas usage in the power sector is still too low by around 20%. It would be hard press to maintain the coal fleet as it ages with gas prices below $5/MMbtu for the next 10 years. In terms of balancing capital and environmental risk, no other form of generation can beat natural gas for baseload demand across the country. New coal units cannot compete with new natural gas plants with gas-coal spreads less than $3/MMbtu. Around $3/MMbtu, it is marginable and when considering the CO2 risk, it would take spreads closer $4/MMbtu+. Commissions approving coal plants in this environment are typically incorporating other unrelated energy economics (e.g. local jobs, resources). The only thing that haunts natural gas is the price spike seen in 2005-2008. However, if you think about the catalyst that drove that price rise, hurricane Katrina, it becomes less likely to vision in the future. Shale gas has created another layer of gas in the supply curve, which is less sensitive to gulf coast storms.
Further analysis of the AEO is warranted. A certain credit must be given to them for being the pundit willing to go out on the limb and supply every bit of information. I don’t usually agree with the EIA forecast, but they have made great strides in their forecasting ability. They have incorporated more reasonable capital cost projections. They are a good benchmark for modeling. We can only wish other countries around the world would emulate the EIA in supplying historical information and estimated forecast figures.
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