Heating Degree Days Show Winter Never Came
In my previous article on natural gas prices, I stated eventually gas prices were going to come back up. However, I carefully noted in the last sentence “when the winter weather comes”. Based on the data so far, winter is not coming. Below chart comes from the NOAA data showing the previous 30 years of December heating degree day (HDD). As you can see from the chart, December 2011 was warm compared to the last four years. It is almost a whole standard deviation from the average.
Looking at the weekly January HDD, January is trending even lower from normal weather. This natural gas price capitulation could get much worse before it gets better; as the natural gas must be withdrawn in several areas else damage to the aquifers can occur. There are contractual agreements requiring withdrawal of gas by the end of the heating season.
Once again it shows the most important variable to understand is DEMAND – which in this case is driven primarily by weather. This statement is certainly true in power. One can have all the knowledge in market relationships, but if your demand is off all bets are off.
In the longer run (6months+), gas at this price will put significant pressure on the utilities to curtail/retire their marginal coal plants. As natural gas price falls, more coal plants are considered marginal. I suspect some coal plants are running regardless of economics as the operator probably has contracted too much coal. In this case, one would hope the public utility commission steps up and denies some of the fuel cost pass-thru for poor planning; else there will be no incentive to plan better next time. In this low gas price environment, utilities should have weatherized their gas units to perform over the winter while also firming some transportation to their gas plants. They should have adjusted their spot to coal contract ratio to be lower. I know it is easier to quarterback after the fact, but last year showed several indicators that low gas prices are very likely. This is not an after the fact quarterbacking session. As the Managing Director Strategic Planning at AEP, I consistently championed the company to diversify to gas and believed in natural gas being the appropriate fuel in terms of managing capital and market risk. Simple fundamental analysis even back in the 2005-2008 period showed gas prices were not going to rise and stay above $10/mmbtu for long. Large LNG projects were lined up with the capability to supply the US markets for $7/mmbtu with a huge return on investment for those investors. In addition, the free market should drive innovation as the price incentives rose from the $2/mmbtu enviroment to an ever growing price slope – as documented in my previous post. Entrepreneurs who thought they could get gas out of shale for less than the market projections came and developed this shale gas revolution.
The big question to whether natural gas prices climb back above $4 will likely be answered by those who can predict the weather. Will this summer be one of the hottest, coolest, or just normal?
I have been evaluating risk, developing scenarios, and forming hedging programs. Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.
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Environmental Goals: Is it to Save Lives?
As I discussed in my previous blog on the issue with the EPA analysis on MATS / MACT , EPA’s intent is good, but is it worth it given all the other issues. The logic not only applies to EPA regulations but everything we want to do as a society. I always made this argument with my friends and colleagues who are so passionate about global warming. The resources and capital must be spent from somewhere.
The other important point to discuss is the objective. What are the objectives? Many of these passionate arguments conclude the objective is to save lives. I always espoused if saving lives is your objective there are numerous issues with finite cost that can save lives now (e.g. clean water technology, vaccines, education, etc…). I now have a perfect frame of reference to support my thesis. Bill Gates philanthropic adventures show he has saved lives at cost of less than $5K per person. Remember EPA analysis required $3-7 million dollars per life. Think about some of the cost figures to mitigate carbon. On a per life basis these numbers get very high and the returns are not likely seen till many years later.
A rationale argument, perhaps not too morally preferred, would be those lives are not likely related to you. The low cost lifesaving methods are largely focused in the developing world region. However at the same time the rationale used to promote many of the global climate concerns are from studies documenting the greatest harms will be in third world areas.
I don’t have the answers, but I do know we have avoided talking about the objectives and the cost and the alternative use of capital and resources. Unfortunately, I agree that an optimal decision in energy and/or environment will likely result in subpar results as the money will likely be spent frivolously in other areas. However at some point, we can’t all spend money frivolously/non-optimal. We are seeing the result of this across the world as debt spending was an easy way to support frivolous/non-optimal spending.
I have developed many thought provoking concepts in various policy discussion. Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.
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Cross State Air Pollution Rule (CSAPR) Halted – Moral Hazard
Though I may not always agree in the merit of the various environmental regulations, I do believe the courts halt of CSAPR rule was out of line. The rationale of the court and the plaintiff was the regulation was going to wreak havoc on the economy and the reliability of the system. I contend the stay may result in greater havoc for our economy. The utilities arguing for this under the merit of timing are somewhat disingenuous.
The EPA attorneys should note CSAPR is a modified Clean Air Interstate Rule (CAIR). CAIR was issued on March 10, 2005. CAIR was then vacated/remanded in late 2008. The irony is the vacature came from the environmentalist. The environmentalist did not like the fact trading could result in creating hot spots of emissions and could result in no change in downwind states emissions. EPA had to go back and modified the rule so there would be limits on trading, so downwind states will actually see reductions regardless of trading. Utilities expecting CAIR to disappear when it was vacated would have been very foolish. In fact, that is not what occurred. Over the last few years, we saw significant changes to the coal fleet with significant control equipment installation. As noted in AEP sustainability report – “Since 2004, AEP invested more than $5 billion to install state-of-the-art environmental controls that have resulted in significant reductions in regulated emissions from our power plants” I can tell you AEP did not do this for the press release or the sustainability report, but for preparing for CAIR and MACT /MATS along with NSR settlement. The excuse of not having enough time cannot be legitimately used given when CAIR was issued and the fact CSAPR allows significant trading for the first two years. Given a well-designed trading strategy even those ill-prepared plants such as Monticello can continue to run.
There are many assets that have threatened to retire. I would like to call the bluff on many of those. In fact many coal plants, I suspect the owners have financial concerns versus implementation concerns. The best bet for those owners would be to place those assets for sale and / or develop a very aggressive emissions trading program versus retiring, but the threat of retiring allows them to sustain the status quo.
In terms of reliability concern, I would have really liked the courts to have waited for real proof. If they observed brown outs in January or in any other time period, I would have no issue for the court to stay the decision. This premature stay is not conducive for the economy. The court has created a moral hazard. They are making our economy to be reactive not proactive. Those who moved forward and thought ahead and planned are now being punished. Those who waited and did nothing are being rewarded. I understand policies and regulation will likely never be perfect, but if we cannot implement and learn we will never progress.
I have evaluated every environmental program to hit the power sector over the last 10 years. Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.
Your Energy Consultant,
Shale Gas Revolution adds $193 Billion to the US Economy
The naysayers and those who want shale gas to go away have not seriously looked at the benefits of lower natural gas prices to the US economy. In this blog, I decided to evaluate the savings the shale gas revolution has given to the US economy. As I have been espousing, energy is just a means to an end. Reducing energy cost, immediately increases value to society. The inverse is also true.
In order to calculate the value of the shale gas revolution, I looked at the natural gas price trend on a three year rolling average from the EIA. I started in 1997 and stopped the graph in 2008 right before the shale revolution presented itself. Interesting to see the three year rolling average price is quite linear with an R^2=0.9552.
Obviously extracting the equation for future years is a plausible method to calculate the price of natural gas without shale gas. However, there are concerns with that method in that eventually prices do hit a plateau as alternative uses and demand response do occur. A cautious and conservative calculation is to assume the price of $7/mmbtu.
With this price, we can cross multiply the consumption and compare the cost to the US economy with or without shale gas. I know one of the first comments would be higher gas prices would have lowered consumption. I will agree with that in principle. However, did you know from 2002 to 2008 gas demand rose in the midst of the largest sustained gas price rise of over 270%? This growth came from the fact the incremental demand of power had to be met. Since the US did not build any significant baseload generation outside gas units over the past 10 years it was left to gas units to fill the gap. The price of electricity is small when compared to the value it can bring therefore a 270% rise in gas price was not going to stop gas demand. In reviewing my math in the table below, I took a conservative view and held demand at 2009 levels in the case of without shale gas.
| With Shale | Without Shale | ||||||
| Wellhead Price | US Demand | Cost of Gas | Wellhead Price | US Demand | Cost of Gas | US Savings | |
| $/MCF | MMCF | $Billion | $/MCF | MMCF | $Billion | $ Billion | |
| 2009 | 3.67 | 22910078 | $ 84.08 | 7 | 22910078 | $ 160.371 | $76.291 |
| 2010 | 4.48 | 23775388 | $ 106.514 | 7 | 22910078 | $ 160.371 | $53.857 |
| 2011 | 4 | 24466323 | $ 97.865 | 7 | 22910078 | $ 160.371 | $62.505 |
| Total | $192.653 |
With the shale gas revolution, the US saw a stimulus to the tune of $193 billion over the last three years. The $193 billion savings to the US economy is conservative in the fact without shale gas more money would have been expatriated via LNG if it were not for shale gas. To put this number in perspective I reviewed the Recovery Act spending. In the grand scheme $193 billion compared to the total Recover Act of $840 represents 23%. On several individual parts of the Recovery Act, shale gas savings dwarfed many categories (e.g. Unemployment benefits $61 Billion, Infrastructure $24.5 Billion, Energy Incentives $10.8 Billion, Housing $5.5 Billion).
The industry needs to learn how to extract and educate the public on the value it has produced for society. Innovation and hard work produces more return and more transparent stimulus to society than any government program could ever create.
I do agree and support the regulation of the industry to limit the amount of bad actors that are willing to cut corners and sacrifice the environment for small increments. Our recent significant problems (Accounting Scandals to Housing/Banking to Oil Spills) can be blamed on the actors directly involved, but there is much blame to be placed on the appointed regulators for each of those industries. Regulatory capture has been and continues to be a constant theme in these economic woes. More rules do not solve the problem; we need better regulators to enforce existing laws and apply common sense.
The administration should thank and embrace those who created and produced this shale gas revolution, as the economy could be $193 billion worse and rising each year.
I have been prescient in forecasting economic calamity and the impact on the major commodity markets (Forecasted both the 1998 Asian Financial crisis and the recent financial crisis and the drop in the major commodity markets in each case).
We positively and evocatively challenge the current thinking involving any aspect of energy use. We look for projects that offer meaningful, transformative, with impactful outcome to the marketplace or society (see projects).
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The Good, the Bad, and the Ugly of the recent EPA Mercury Air Toxics Standards (MATS)
Mercury Air Toxics Standards (MATS) recently released along with the associated analysis show some interesting numbers. There are quite a few good points in the ruling and the corresponding analysis, even if you are a coal plant owner. Let me first say this and the recent Cross State Air Pollution Rule (CSAPR) was / should have been expected. For those claiming these rules are all of the sudden, they need to get a new risk and planning group and/or better consultants. In the analysis, the EPA did quite an extensive job in analyzing all the benefits of MATS. Overall, I believe they listed out the benefits and cost appropriately, but I am not sure neither the extent nor the valuation of the benefits may be appropriate when put in context of other situations (see the ugly). I actually do agree with their cost estimates. On an annualized basis to 2030 it will cost slightly under $10 billion annualized per year.
There are coal units that are beyond their age that do need to retire. MATS should make these units retire. With the recent shale gas evolution, the economics to replacing these old coal units make it more justified.
The Bad
It is interesting the EPA cost conclusions focus on the claim – increment cost of only 3%. In my analysis, that I worked with the University of Texas Center for Energy Economics, we came to that similar conclusion. However, as this professor would say compounding rates can be misleading. His conclusion “The greatest shortcoming of the human race is our inability to understand exponential functions.” When we presented the analysis, we showed it in the bar graph form below.
EPA-CSAPR+MATS Fixed Cost
Instead of annualizing the cost, we showed from the reference case the cost would be over 80% from the base case for the time period of 2012-2030. (Note the CSAPR case includes MATS. More details of this analysis can be obtained by emailing or calling me.) Annualizing the data does produce 3%, but people need to understand the math of compounding if you plan to present it that way. Annualized 3% increases will double the cost in 24 years.
Another bad is the fact the totals cost are being reflected across the system. However, there are regions/states where the cost increase will be much greater. Several states could see an annualized increase of 6% over the reference case. Generalizing numbers for the entire system is good for understanding overall impacts, but actual implementation does require some local understanding and reality checks.
Another outcome of this ruling, which is not good but is not ugly, will be inefficient decision making from local utilities and commissions. I already hear from my various sources many plants will be installing very expensive control equipment under the concepts of maintaining jobs and the cost will be fully recovered through the rate base. Without full prudent unbiased evaluation of these types of decisions, the rate based will be overburden. It has been my experience when inefficient decision making occurs in regulated utilities, reliability will fall. This happens because the rate base can only take so much. Cost cutting becomes inevitable to make up for the costly decisions. Unfortunately, we don’t live in the university economics land where cost cutting is optimally done. Cost cuts will likely first come from the downstream portion of the business (Distribution), as many executives are farther removed from these decisions.
Another point to ponder, bordering on the ugly, is the point a good friend told me few years back. Eventually environmental mitigations become a subsidy for the wealthy. This takes much thought to fully appreciate this point. If the environment becomes clean to remove immediate concerns, but we continue to make it cleaner. In effect, we are making society pay for issues that are probably not directly affecting them as compared to other issues. As an example, I would surmise the poor will be more concern about food, education, housing, transportation, etc… before they are concerned about the environment, whereas the wealthy already has all those issues resolved for them. Therefore the wealthy would like the environment to be even cleaner. By making society pay for cleaner environment, eventually you are asking the poor to subsidize the wealthy in their agenda.
The Ugly
The ugly comes from the development / de-evolution of our society. Society has chosen to focus and develop specialties reducing the role of generalist/universalist who cover multi-fields. This trend has led to our lobbyist nature to find a particular subject and attack it at all cost regardless of the collateral damage it may set on other issues. This thinking along with insatiable use of debt has created a system that has lost the concept of capital allocation. We cannot solve everything at full levels of commitment. There are finite resources for both human and capital resources. I spoke about this at the 15th Annual Washington Energy Policy Conference, US Electricity Dynamics: Markets and Policy Options.
As I mentioned in the good, I do agree there are harms being generated from burning of fossil fuel and in particular coal. Coal does produce particulate matter and releases toxic chemicals. However, the report does not talk about the benefits of burning and using coal. These benefits can be seen in learning and reflecting upon the history of our electrification and the benefits it has so greatly given to us. There is also no context of the amount of pollution that has been reduced. Most people don’t know the amount of SO2 being emitted in the US is now close to the levels seen in the 1920’s. Considering we have more people and a much larger economy this is an amazing accomplishment. I do believe as a human race we can always say things can be better. It is a matter of balancing which of these things we focus on (e.g. healthcare, education, environment, security, poverty, hunger, etc…)
Below are key statements from the EPA analysis I want to focus on:
“EPA estimates that this final rule will yield annual monetized benefits (in 2007$) of between $37 to $90 billion using a 3% discount rate”
“The reduction in premature fatalities each year accounts for over 90% of total monetized benefits.”
“The great majority of the estimates are attributable to co-benefits from 4,200 to 11,000 fewer PM2.5-related premature mortalities”
“For a period of time (2004-2008), the Office of Air and Radiation (OAR) valued mortality risk reductions using a value of statistical life (VSL) estimate derived from a limited analysis of some of the available studies. OAR arrived at a VSL using a range of $1 million to $10 million (2000$) consistent with two meta-analyses of the wage-risk literature.”
“The mean VSL across these studies is $6.3 million (2000$).”
If we look at the first statement, we can multiply the benefits by 90% to get a sense of the value of an unborn person. Using the 11,000 saved figure per year from premature fatalities the value of an unborn person amounts to $3 to $7 million. I do not have or thought of value to life, but I do believe I have the logic to put suggested values into context. A $3million value for an unborn is a very considerable figure, particularly when we put this into context. Currently, there are around 1 million abortions per year in the US. Based on the EPA logic this amounts to, on the low end, a $3 trillion dollar loss per year if we could prevent those. Perhaps the above context may have not been the best linkage for an unemotional discussion, but it was the only direct context I found that directly involved unborn with a potential for mitigation.
Non-direct context is to compare the cost to other issues to evaluate whether this is a more appropriate issue to allocate $10 billion per year. Personally I like to focus on children issues since they are not directly at fault with any of the current problems, plus they have a full life ahead of them to make it better. I found the following statements from the Children Defense:
“A total of 15.5 million children, or one in every five children in America, lived in poverty in 2009, an increase of nearly four million children since 2000.”
“According to the USDA, over 16 million children lived in food insecure (low food security and very low food security) households in 2010.”
According to Feeding America, they note $1 can represent 8 meals. This is a very fascinating figure, I am not sure the reality of that figure, but imagine $10 billion a year being allocated to give the 16 million children food security. Using $1 represent 2 meals, each of those 16 million children could have 3 meals a day for the entire year. Is it best to allocate $10 billion a year to 11,000 unborn or to help those 16 million children who are currently hungry?
I know the argument to my logic is the allocation of capital is not that fungible. In addition, poor funding is inevitable therefore to optimize this spending will just result in wasteful spending somewhere else. This is the ugly part of our system that I cannot disagree. We do spend on issues, which perhaps could be allocated to other parts of society that would be more productive.
Conclusion
The truth is we have fixed amount of human and capital resources. Any spending will be taken from something else. We do not directly see this now, because much of our spending is based on debt. Debt spending is taking the ability from future generation to make decisions. Increasing the cost of compliance across this country will result in allocating capital to an issue to save 11,000 unborn fatalities. Can this cost be better allocated? I do agree this expenditure is a worthy cause, I just don’t know if it is the best or even a top 10 cause given all the other issues. We need to bring back the Universalist thinkers so we can make better decisions not just for the immediate future, but for future generations.
I have done numerous Policy/Regulation impact studies. Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.
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Gasoline Prices for Next Year
Repost from my other blog with an updated note.
One of the most common questions I get asked by my friends is “What will be the price of gasoline?”
I have this rule of thumb that I learned by observation – I never really tested the theory till now. The rule I tell my friends just take the average of 4th quarter price of gasoline and you can expect the peak price in the driving season to be around 70 cents/gallon higher.
Once again with the magic of the Internet one can test that rule of thumb. I went back from 2010 to 2000 and discovered the US Gulf Coast (USGC) December average subtracted by the peak of next year driving season averaged 76 cents/gallon. Over the last five years the min was 40 cents/gallon and the max was 1.70 cents/gallon. Now of course my friends are focused on the retail price so I say if you are looking at the wholesale price you need to add another 70 cents/gallon to get to retail.
Clearly gasoline and the crude oil markets are seasonal. What I find really funny is the politicians and economist touting how petroleum prices were down over the last few months. Relative to last year our 4Q average YTD gasoline price is up by almost 30% – 58 cents/gallon. This does not bode well for next years driving season nor the economy. We could very likely see $4/gallon pump prices next year given the current prices.
Added note – beyond the simple seasonal demand trend of gasoline, prices also move up due to the cost to produce gasoline goes up. Gasoline blend changes in the summer time. This blend reduces the Reid Vapor Pressure (RVP) of the gasoline which makes it less likely to evaporate. Typically summer gasoline will have less butane which is more cost effective than other components that make up gasoline.
I can help you forecast any commodity through a fundamental approach of supply/demand and finding cross market dynamics. Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.
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