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Cheap gas means demand is rising [ClearOnMoney]
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Cheap gas means demand is rising

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Commentary

Cheap gas means demand is rising

20 Sep 2010 by Jim Fickett.

The gas market is working as it should. Current cheap gas prices, and expectations of more of the same, are resulting in plans to increase the use of gas. Supply and demand are currently in balance, and demand is set to grow. This is one more reason to expect that gas prices will rise.

The price of heat from gas has been decreasing, in comparison to the price of the same amount of heat from coal or oil, for several years:

Most mainstream commentators expect the price of gas to remain very low for decades. I differ. I've already commented that current production is not profitable and that production is already decelerating. Now I'd like to look at the demand side of the equation.

Last week the Wall Street Journal, in an article entitled Turning Away From Coal, pointed out that the predictions for cheap gas have already started a wave of conversions from coal to gas in the electric power industry.

Power companies are increasingly switching to natural gas to fuel their electricity plants, driven by low prices and forecasts of vast supplies for years to come.

… Some utilities are closing coal-fired plants; others are converting them to run on gas.

The switch is occurring globally and is getting a push from regulators who want to limit emissions that contribute to climate change, haze and health problems such as respiratory illness. …

“It's pretty clear that, whether it's caused by future carbon legislation or action by the EPA, the migration away from coal has begun,” says Constellation Energy Group Chief Executive Mayo Shattuck.

Coal-burning facilities are expected to slip to 10% of total new capacity in the U.S. in 2013, down from 18% in 2009, the U.S. Energy Information Administration reports. Gas, meanwhile, is expected to soar to 82% of new capacity in 2013 from 42% last year.

Natural gas also has the edge in Europe. In 2009, far more gas- than coal-burning plants were built in the European Union—24% of new capacity versus 8.7%. …

Most big coal-burning utilities have invested billions of dollars to install pollution-control equipment on their largest coal-fired plants. But they are replacing or idling smaller coal plants for which such expenditures can't be justified.

In August, Xcel Energy Inc., based in Minneapolis, notified regulators it wants to close a coal-burning plant in Boulder, Colo., and convert four units at its Cherokee plant in Denver to burn natural gas instead of coal. Xcel says the changes would cost the company $1.3 billion but still would be $225 million cheaper than installing pollution-control equipment on the aging coal units. …

Calpine Corp., Houston, says it will convert to gas some of the coal-fired plants in Delaware and New Jersey that it is buying from Pepco Holdings Inc., in a $1.65 billion deal. The units are older plants that are in need of upgrades. Calpine says it can change the burners for less than it would cost to add pollution-control equipment like scrubbers.

Progress Energy Inc. of Raleigh, N.C., intends to close four coal-burning plants and replace two of them with gas-fired plants by 2017. The company says it's cheaper to build gas-fired plants than it is to outfit the coal units with the necessary pollution-control equipment.

All this takes time, and is probably making little impact on the demand data so far. However the harder the EPA pushes, and the longer gas remains cheap, the more power plants will switch to gas. So it would be rather surprising if gas remained historically cheap, as it is now, for many years.

In the short run, is there any evidence that recovering demand is catching up to decelerating production? Yes. The following graph shows the year-over-year change in the EIA's monthly estimate of working gas in storage:

There are two things to note in this graph. First, the recent “gas glut” resulted in changes in storage that are not remarkable at all by historical standards. Second, the year-over-year change is now approximately zero (-0.4% in June, to be precise); i.e. the big increases in inventory of the last year or so are over.

For now, at least, demand is approximately in balance with supply. And there is little doubt, from the news in the public utility sector, that demand will be growing from here.

Footnote on details of energy price computation

Fossil fuel prices vary depending on the exact definition but, to look at large-scale trends there is not very much difference between different series. Historical data on fuel prices was obtained as follows:

Each of these series was adjusted for inflation using the Producer Price Index for “fuels and related products and power”. Then barrels, thousand cubic feet, and short tons were converted to million Btu.

  • According to the EIA Energy Conversion Calculator, one barrel crude is 5.8 million Btu, and one thousand cubic feet of gas is 1.03 million Btu
  • According to an energy page at the University of Wiconsin, one short ton of bituminous coal produces 24 million Btu

In the end we have the real price per million BTU, in 1982 dollars, for each of the three fuels.