Berkeley Lab Touts RE Price Stability

For better or worse, natural gas has become the fuel of choice for new power plants being built across the United States. The recent sharp increase in both natural gas prices and gas price volatility, however, calls into question the wisdom of relying too heavily on a single fuel source.

Berkeley, California – August 29, 2003 [] Against this backdrop, renewable energy resources such as wind, solar, biomass, and geothermal power, which by their nature are immune to natural gas fuel price risk, can provide a real economic benefit: unlike many contracts for natural gas-fired electricity generation, renewable generation is typically sold under fixed-price contracts. Although this price stability attribute of renewable energy is widely recognized, utilities, energy analysts, and policymakers often fail to properly account for it when comparing renewable to other types of generation, according to a new report published by Lawrence Berkeley National Laboratory, titled Accounting for Fuel Price Risk: Using Forward Natural Gas Prices Instead of Gas Price Forecasts to Compare Renewable to Natural Gas-Fired Generation. The report, which is co-authored by Mark Bolinger, Ryan Wiser, and William Golove, notes that in order to compare the projected cost of gas-fired generation to other forms of power, one must make an assumption about the future path of natural gas prices. Most often, that assumption is based on a long-term gas price forecast that – like all forecasts – is inherently uncertain. If electricity consumers value long-term price stability, however, then the correct fuel price input is instead the forward price of natural gas that can be locked in today to create price certainty. In other words, to compare renewable and gas-fired generation on an apples-to-apples basis with respect to fuel price risk, a hedged natural gas price is the appropriate fuel price input. To demonstrate this point, the authors sample natural gas forward prices (e.g., from futures, swaps, and physical supply contracts) over the past three years for terms ranging from 2-10 years, and compare them to contemporaneous long-term gas price forecasts. “Although our data set is quite limited,” notes Bolinger, “we find that over the past three years, forward gas prices for terms of 2-10 years have been considerably higher than most forecasts of spot gas prices, including the reference case forecasts developed by the Energy Information Administration (EIA).” For example, the difference (on a levelized basis) between forward natural gas prices and the EIA reference case spot price forecasts has ranged from US$0.4-$0.8/MMBtu, which translates to 0.3-0.6¢/kWh at a heat rate typical of an advanced combined cycle unit. This difference is striking, and implies that resource acquisition, planning, and modeling exercises based on these natural gas price forecasts over the past three years have yielded results that are biased in favor of gas-fired generation relative to fixed-price renewable generation. The report goes on to investigate the possible cause of the observed empirical premiums, offering three potential explanations: hedging natural gas price risk is not costless, gas price forecasts have been biased downwards over this three-year period, or other data sampling problems exist. “None of these potential explanations is either fully satisfying or easily refutable,” notes Wiser. “Regardless of the explanation, however, the basic implications of our study remain the same: one should not blindly rely on gas price forecasts when comparing fixed-price renewable to variable-price gas-fired generation. Assuming that long-term price stability is valued, the most comprehensive way to compare resource options would be to use forward natural gas price data as opposed to natural gas price forecasts. Doing so over the past three years, at least, would have significantly shifted the balance away from natural gas-fired and towards renewable generation.”

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