by Jerome a Paris
Sun Oct 23rd, 2005 at 11:45:52 AM EST
The title is slightly misleading, as it is not the price of oil that I will discuss here, but the price of natural gas. It is relevant in that natural gas prices, expressed in price of oil equivalent, are currently at around 80$/boe (barrel of oil equivalent) and show little sign of going down like oil is currently doing, so 100$ "oil" may be reached on the natural gas front before the oil one.
It is highly relevant in that the price of natural gas is the main driver of electricity prices, via the concept of marginal price, which I will try to explain here.
First, the gas prices. I have posted this graph repeatedly, because it is in many ways even more impressive than the oil price curve:
A rule of thumb is that you need to multiply your gas price in $/mbtu by 6 to find a rough equivalent of the price in $/boe. So gas prices breached the 60$/boe line when Katrina struck in early September, and never went down. Then, when Rita came, they jumped again, up to 80-85$/boe, and are now hovering around 75$/boe. Prices for this winter are even higher than that, as can be seen on this page.
With more than 50% of Gulf of Mexico gas production missing and - contrary to the situation for oil - no possibility to import these quantities from anywhere else (Canada is already producing to the hilt, and LNG imports, the only other option, are limited by available terminal capacity), that means that close to 20% of US natural gas consumption has been missing for almost 2 months and will be missing for quite a bit of time still:
This is important because natural gas prices drive the cost of electricity in the US. I've mentioned this before, but I'd like to explain it in more detail here.
In a market situation, as is the case in the US, the price of wholesale electricity is determined by the most expensive (or "marginal") producer necessary to fulfill demand at that moment.
These graphs (which represent future supply curves for the Midwest and Texas electricity systems respectively, in 2040, taking into account some carbon costs) will help explain:
It shows the cost of the various producers as they are added to the grid. The cheapest producers are always used first, logically. In this case, it is wind, which has an almost nil marginal production cost (when it is available), then nuclear, then various forms of coal or natural gas power plants.
Now, the demand changes every season and even every hour, as shown in the graph below for ECAR, in that case between 40,000 MW and 100,000 MW.
(this graph and the above two from this presentation (pdf))
What it means is that when you need only 40,000 MW, you'd use only (on the basis of the above curve, which is a future one, not a current one):
- wind production
- some IGCC (gas combined cycle)
The price of power for such demand is set by the price of the last producer needed, i.e. the IGCC, thus the price would be, in that case, 23$/MWh.
If you need 100,000 MW, at peak demand, you'd use, in addition
For such demand, you need the price to be at 49$/MWh to have enough production, and that's where it will be.
Now let's imagine we're in 2045, and peak demand reaches 200,000 MW. At that time, you'll need all the available production to come online, including the more expensive Gas CT and Steam producers, and the price will be set by these producers, at 80$/MWh. And that price will be paid to all producers, even the wind power producers.
Now, these are wholesale power prices, and they are not passed on to consumers directly. Utilities that purchase wholesale power when they don't produce it themselves manage the hourly variations of the wholesale market and set a fixed rate for their retail clients. That retail rate, however, has to take into account the average price of wholesale electricity.
In the USA, with current production patterns (50% coal fired, 20% nuclear, 20% natural gas, and the rest between hydro and all other sources), the permanent demand is satisfied by hydro, nuclear and coal (which is cheaper than gas when carbon considerations are not added to the calculations, as happens today). Coal plants take the first increases in demand, and natural gas takes the rest, up to peak demand, with variations in each of the regional markets. This means that low demand prices are usually set by coal-fired plants, and are thus pretty low, but high demand prices are increasingly set by natural gas-fired plants, which are the most expensive.
When most of the natural gas-fired plants were built, only a few years ago:
natural gas prices were around 2-4$/mbtu, and gas-fired plants were almost as cheap as coal-fired plants. The power supply curve was thus pretty flat throughout, and wholesale electricity prices changed little between low demand and high demand periods.
Now that natural gas prices have increased to 12+$/mbtu, the whole gas-fired part of the supply curve is moving up, and thus rightwards. Coal is currently much cheaper, thus all coal-fired plants will be used before any of the now more expensive gas plants are called, and low demand prices are still reasonably low. But once all coal-fired capacity is already used, gas-fired plants become necessary, and power prices need to become a lot higher for these plants to be economic and thus turned on. So medium demand prices, and high demand prices are set by naturas gas prices and are becoming extremely high.
This graph from a 2000 study (pdf) showed the impact of an increase in gas prices from 2.5 to 4$/mbtu...
- no impact on low demand situations, as gas-fired plants are not used
- then a growing impact from the demand level that requires gas-fored power
Now imagine the same curve with 12$/mbtu gas prices: the new curve will be 5 times further up from the bottom line than the 4$ curve is, above 30,000 MW of demand. Which means that prices above the demand will jump pretty brutally from 20$/MWh to 40$/MWh or so for such demand level, and much higher beyond. 12$/mbtu gas effectively adds 20$/MWh to the average
wholesale price weighted by demand, which means that such a massive cost increase has to be passed on eventually to end-users.
So, to sum it up:
- wholesale power prices are determined for a given level of demand by the most expensive ("marginal") producer need to fulfill such demand, taking into account all the cheaper sources available;
- in practice, in the USA, for most medium to high demand levels, the marginal producer will be a gas-fired plant;
- current natural gas prices have increased massively in the past few years, and are about 4-5 times more expensive than anticipated a few years back. In particular, due to the physical impossibility to bring in more imports, gas prices have increased more thna oil prices and are now at about 80$/boe
- that means that wholesale electricity prices for a good portion of the demand curve have increased significantly, and that such increases will be passed on to your retail electricity bills.
And in all likelihood, this is just starting. So ironically, the first whiff of peak oil (peak North american gas, in this case) is likely to come on your home electricity bills.
Earlier "Countdown Diaries":
Countdown to 100$ oil (14) - Greenspan acknoweldges peak oil
Countdown to 100$ oil (13) - Katrina strikes / refinery crisis
Countdown to 100$ oil (12) - Al-Qaeda, oil and Asian financial centers
Countdown to 100$ oil (11) - it's Greenspan's fault!
Countdown to 100$ oil (10) - Simmons says 300$ soon - and more
Countdown to 100$ oil (9) - I am taking bets
Countdown to 100$ oil (8) - just raw data
Countdown to 100$ oil (7) - a smart solution: the bike
Countdown to 100$ oil (6) - and the loser is ... Africa
Countdown to 100$ oil (5) - OPEC inexorably raises floor price
Countdown to 100$ oil (4) - WSJ wingnuts vs China
Countdown to 100$ oil (3) - industry is beginning to suffer
Countdown to 100$ oil (2) - the views of the elites on peak oil
Countdown to 100$ oil (1)