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Low natural gas prices may drive up FY 2014-2015 power rates
6/5/2012 12:00 AM
It may surprise people, but the price of natural gas is likely the most significant driver of BPA's power rates for the 2014-2015 rate period.
Since BPA concluded the last case, natural gas prices have fallen significantly. Futures have moved steadily downward to levels thought inconceivable just a year or two ago. The changed outlook for the price of natural gas has significant implications for future electricity prices and, therefore, BPA's net secondary revenue and power rates.
Natural gas prices drive wholesale electricity prices several months of the year, and the price of electricity largely determines the amount of net secondary revenue the agency receives. Net secondary revenue, in turn, augments the agency's revenues and, thus, affects power rates. As net secondary revenues increase, power rates can go down. However, if this significant source of revenue diminishes, then revenue from preference customers through rates needs to make up the difference.
At this point, BPA's forecast of natural gas prices for the fiscal year 2014-2015 rate period suggests that net secondary revenue will decline by $114 million a year relative to what was assumed when the agency set fiscal year 2012-13 power rates. This decline could increase to $196 million annually if gas prices stay at their currently depressed level. A $114 million reduction would result in a roughly 8 percent rate increase for public utility customers. The reduction of $196 million would translate into a 14 percent increase, all other things being equal.
Other factors that will arise in the rate case will also affect the final rates, but net secondary revenues alone are likely to have far and away the most impact on BPA's power rates for fiscal years 2014 and 2015.
The graphs below demonstrate the connection between natural gas prices and power prices and reveal how low both are.
What is driving natural gas prices?
Much has been written over the past few years about "fracking," the technology of hydraulic fracturing in horizontally drilled wells that has made it possible to extract natural gas from abundant shale formations. This has radically changed the U.S. natural gas supply picture. Production in the U.S. lower 48 states has accelerated since 2009 and hit record levels of over 62 billion cubic feet per day in 2011. The steady increase in supply has been a major contributor to the low prices of the past few years compared to 2008 and earlier.
Additionally, rig technology continues to improve, leading to lower drilling costs and higher initial rates of gas production. And gas is essentially being produced free as a byproduct of drilling for oil using the same technologies that unlocked the shale gas boom. All of these factors have led to increased domestic supply at lower cost.
Weather and storage
In spite of strong domestic production, natural gas prices held at around $4 per million British thermal units (MMBtu) until falling dramatically over the past six months. The largest driver of this recent precipitous price decline is an unusually mild winter, which reduced demand for heating.
On average across the U.S., the winter of 2011-2012 was the warmest in 60 years by a large margin. The estimated decline in U.S. demand for gas ranges from 400 billion cubic feet (Bcf) to 800 Bcf due to temperature variation alone. Combined with the continued strength in production, the mild weather resulted in an end-of-winter gas storage level of almost 2.5 trillion cubic feet (Tcf), which is projected to hit storage capacity limits of 4.1 Tcf by October and has recently sent forward prices below $2/MMBtu.
Can prices remain low?
It is BPA's view that the current $2 price level does not represent equilibrium in the long-term marginal cost of gas production in a balanced market but is a reaction to the abundance of gas in storage, probably the biggest driver of current prices. Over time, the market should rebalance to reflect a more appropriate equilibrium gas price around the $4 to $5 range.
At present, production remains high, storage is at record levels and there are limited short-term opportunities for increases in demand, all of which contribute to continuing lower prices as well as lower price forecasts.
Forecasting when natural gas prices will return to the $4 to $5 range is very difficult given the variables at play, but BPA must make assumptions when setting rates sufficient to recover the agency's costs. The price of natural gas seems determined to stay in the $2 to $3 range before perhaps approaching $4 in 2014. BPA is monitoring the market closely for any trends in production as we head into the summer months.
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