BA212: Class 2

An Overview of the Natural Gas and Electricity Industries

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2004 US CO2 Emissions by Sector

Transportation

Electricity Generation

Household NG & Oil

Commercial NG & Oil

Industrial Coal

Industrial NG & Oil

Source: EIA, http://www.eia.doe.gov/oiaf/archive/aeo06/emission.html

The Natural Gas Industry

Untying the Regulatory Knot

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Gas: The “clean” fossil fuel

Emissions Characteristics of Major Fossil Fuels

0

500

1,000

1,500

2,000

2,500

3,000

NaturalGas

Oil Coal

Fuel/Pollutant

Emissions

Carbon Dioxide

Nitrogen Oxides

Sulfur Dioxide

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The Natural Gas Industry:traditional structure

Production

– Discovery, extraction, gathering, processing

Transmission

– pipelines (inter-state and intra-state)

– Growing role of Liquified Natural Gas (LNG)

Distribution (LDCs)

– From the pipeline to the end-user

Characterized by functional separation and multi-layered regulation

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Natural Gas Usage (2005)Natural Gas Consumption 2005

Electricity Generation26%

Industrial Usage30%

Residential22%

Oil & Gas Operations5%

Pipeline3%

Commercial 14%

Vehicle fuel0%

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Natural Monopoly and Regulation

Distribution (and retail sales)

– regulated by states

– usually ‘cost of service’ regulation

Interstate Pipelines (‘sales for resale’)

– regulated by the federal government (FPC and then FERC) since 1938.

Production (‘first sales’)

– transactions with inter-state pipelines increasingly regulated by FPC from 1938 to 1978. Rapidly deregulated after 1978

– transactions with intra-state pipelines and LDCs sometimes regulated by States.

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Unnatural Movements ofNatural Gas Prices

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The Unraveling of Regulation

Supply Shortages (NGPA 1978)

Common Carriage (FERC 436 and 636)

What else did pipelines do?– ‘marketing’ (sales and re-sales)– storage– risk management

Competitive marketing = competitive commodity market– no need to regulate commodity prices!

Regulation of distribution is a mixed bag– Retail choice in some states– Core/non-core– Hedging concerns

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Transition pains

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US Natural Gas Production

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The Future of Natural Gas

Still an attractive alternative to coal from an environmental perspective

Historically different from oil in important ways

– Continental markets served by pipelines• North American market fairly independent of other regions

– Fragmented production - almost no producer market power

– Competition issues focused on transportation/pipelines

With Liquified Natural Gas (LNG) the market is becoming global

– Lots of producer market power in the rest of the world

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Unnatural Movements ofNatural Gas Prices

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Natural Gas Production

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Natural Gas Reserves

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World Natural Gas Trade

The Electricity Industry

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The Electricity Industry: Traditional Structure

Production

– Generation – the process of converting, rather than extracting, inputs.

Transmission

– High voltage wires.

Distribution

– From high voltage to your living room.

Retailing

– Billing & customer service.

The industry has predominantly been vertically integrated across all four sectors.

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Key Economic Characteristics of the Industry (1)

Costs vary by resource.

Total Cost

Q

Gas (CT)

Coal

Nuclear

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Key Economic Characteristics of the Industry (2)

Electricity, for the

most part, cannot

be stored.

End-use demand

is very inelastic.

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Key Economic Characteristics of the Industry (3)

Physical characteristics of the transmission grid create externalities

across grid “users.”

– The transmission grid has limited capacity, especially at

times of peak demand.

– For example, when transmission capacity is limited, not all

the generators on the Delta can supply power to San

Francisco.

– The more one plant on the Delta produces, the less other

plants can.

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Vertical Integration and Regulation

Originally, producers needed to distribute to get their product sold

– Production and distribution linked from the beginning.

Coordination issues across sectors (e.g. externalities on the transmission grid) made vertical integration attractive.

Economies of scale

– Prevalent in every sector early on.

– Still present on the “wires” side (transmission & distribution).

With vertical integration, if one sector is a natural monopoly, the whole industry must be regulated.

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Market Organization

Outside US

– Nationalized, vertically integrated electric company

United States (pre-1998)

– Investor owned electric company

– Vertically integrated

– Regulated by state utility commissions

– Geographically small (Balkanized network)

The Exceptions (US)

– Federal power: the ultimate exercise in economies of scale

– Municipal utilities: going it ‘alone’

– Wholesale power markets

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What happened?

The golden years (1930-1970)

– Economies of scale keep driving costs down as demand keeps growing.

Everything goes wrong (the 70’s)

– fuel price shocks: demand stops growing

– nuclear power and regulatory risk

Steps towards deregulation (part II, the 80’s)

– the 70’s continued

– PURPA

– renewable generation

– ‘least-cost’ planning

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Average Retail Price of Electricity, 1960-2005

Source: EIA, http://www.eia.doe.gov/emeu/aer/pdf/pages/sec8_38.pdf.

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Different approaches give different results

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2003 Average Residential Prices

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Electricity Prices around the World

Residential Industrial

USA 9.0 5.3

France 14.1 5.0

Germany 17.6 6.5

United Kingdom 13.8 6.7

Japan 19.6 12.7

Canada 6.2 4.9

Australia 6.2 3.6

Norway 6.9 4.3

Russia N/A 2.9

Italy 19.1 16.2

Switzerland 14.3 8.5

Average Price of Electricity (2003/04 US cents/ kWh)

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Where are we now?

International wave of privatization

– No consensus on new model

US Energy Policy Act of 1992

– toward unregulated generation sales

– ‘unbundling’ of transmission

– what was in the bundle?

“Radical” restructuring

– beyond unbundling to ‘separation’

– the ‘Independent System Operator’ (ISO)

– California, PJM, New England, New York, Texas

– Chile, UK, Norway, Australia, New Zealand, Spain, Netherlands

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Electricity and the Environment

In the US in 2004, the electricity industry accounted for:

– 39% of CO2 emissions

– 69% of SO2 emissions

– 22% of NOx emissions

The industry is also a major water user.

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Location & Size of US Power Plants, 2004

Source: NRDC, http://www.nrdc.org/air/pollution/benchmarking/2004/benchmark2004.pdf.

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Carbon Emissions at US Power Plants, 2002