National Lab Exposes Natural Gas Price Bias

Scientists at a prominent national laboratory have found additional evidence that the price volatility of natural gas is not accurately portrayed in futures pricing indexes, and that competitive energy options, and renewable energy in particular, looks much more favorable when this volatility is factored into the comparison.

Berkeley, California – January 16, 2004 [SolarAccess.com] Mark Bolinger and Ryan Wiser of the Lawrence Berkeley National Laboratory have updated the analysis in their August, 2003 report entitled “Accounting for Fuel Price Risk: Using Forward Natural Gas Prices Instead of Gas Price Forecasts to Compare Renewable to Natural Gas-Fired Generation” to include the latest long-term gas price forecast from the Energy Information Agency’s (EIA) 2004 Annual Energy Outlook (AEO). That analysis found 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 EIA. The difference has ranged from $0.4-$0.8/MMBtu, which translates to 0.3-0.6ý/kWh at a heat rate typical of an advanced combined-cycle unit. The new data is consistent with earlier findings. The January and February 2004 NYMEX natural gas futures contracts traded above $7/MMBtu for the first time since last winter’s price spike. Because of the significant higher gas prices, the EIA has revised natural gas price forecasts upward. In the “Key Energy Issues” section of the AEO 2004 early release, the EIA makes the following statement: “For almost 4 years, natural gas prices have remained at levels substantially higher than those of the 1990s. This has led to a reevaluation of expectations about future trends in natural gas markets, the economics of exploration and production, and the size of the natural gas resource. The Annual Energy Outlook 2004 (AEO2004) forecast reflects such revised expectations, projecting greater dependence on more costly alternative supplies of natural gas, such as imports of liquefied natural gas (LNG), with expansion of existing terminals and development of new facilities, and remote resources from Alaska and from the Mackenzie Delta in Canada, with completion of the Alaska Natural Gas Transportation System and the Mackenzie Delta pipeline.” Despite that upward revision, the EIA forecasts are still not on par with where futures contracts have been trading. While the spread between the two data series varies from year to year, on a 6-year levelized basis the premium equals $0.49/MMBtu. 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 3-year period, or other data sampling problems exist. The authors state that the cause for this difference remains uncertain, but one explanation is that it is the implicit value of locking in a natural gas price over the term of the future contract. Whatever the cause, they say, the analysis illustrates that the appropriate number to use when comparing fixed-price renewable to variable-price gas-fired generation is forward natural gas price data as opposed to natural gas price forecasts.
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