Global Energy and Environmental Markets and

Chile’s Energy Policy

Frank A. WolakDirector, Program on Energy and Sustainable

Development (PESD)and

Professor of Economicswolak@zia.stanford.edu

http://www.stanford.edu/~wolak

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Purpose of Talk• Massive changes in global energy markets

over past decade• Growing concern for environmental

implications of greenhouse gas emissions in many countries

• How should Chile’s energy and environmental policies respond to these trends?– Given initial conditions Chile’s energy sector– Accounting for the costs and benefits to Chile of

the policies chosen

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Outline of Talk• Review major changes in global energy markets

– Global Implications of US Shale Gas Revolution• Coal to Natural Gas Switching in US Electricity Sector• Gas to Coal Switching in European Electricity Sector• Costs and Benefit of US Shale Gas Exports

– Shale gas revolution and global coal market• Coal on gas competition in global coal market

– Shale gas revolution and renewables• Case study of Californian experience

• Review major changes in global environmental policy

• Initial conditions in Chile• Suggestions for adapting Chile’s energy and

environmental policies to new regime

Unconventional Natural Gas and Oil Revolution

US Natural Gas Supply

Tight gas is another source of unconventional natural gas

2004

Difficult to predict where and when innovation in fossil fuel supply will occur

Liquefied Natural Gas (LNG) Is Essential to California’s Energy FutureDecember 2004

“…at current rates of consumption in the United States and Canada, the estimated natural gas reserves in North America are expected to run out in fewer than 15 years.

“Although it is unclear if natural gas prices higher than $5.50/MMBTU… will continue into the future, it is difficult to imagine prices ever getting below the breakeven price for an LNG [import] facility on the Pacific Coast.”

Don’t Bet Against Innovation in Energy Sector

US Natural Gas Supply

Tight gas is another source of unconventional natural gas

2004

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Major North American Shale Plays

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US Monthly Shale Gas Production

Monthly U.S. Natural Gas Withdrawals(January 1980 to June 2014)

Source: http://www.eia.gov/dnav/ng/hist/n9010us2m.htm

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Real Price of Natural Gas at Henry Hub. (Monthly Average Prices)

(August 2014 dollars)

Source: http://www.eia.gov/dnav/ng/hist/rngwhhdd.htmConsumer Price Index, All Urban Consumers (1982-1984=100)

Monthly US Oil ProductionMillions of Barrels per Day

Virtually all domestic oil production Increase is from shale oil

Prices at Cushing and BrentDollars per Barrel

Implications for US Energy Sector

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Coal Gas Nuclear Hydro Renewables Other

In April 2012, Coal provided 34% and Natural Gas 32% of Total US Generation

Increasing Role of Gas in US Power SectorShare of Total US Generation by Input Fuel

What Explains Increasing US Gas Use?– Economics favors natural gas-fired generation

versus coal-fired generation• Average heat rate of typical coal-fired unit significantly larger than

that for combined-cycle gas turbine (CCGT) unit– Heat Rate = MMBTU of input fuel per MWh of electricity produced

» MMBTU = millions of British Thermal Units» MWh = Megawatt-hour

• Average heat rate of an existing coal unit could be twice that of CCGT generation unit– Even if price of coal is less than price of natural gas, economics

could favor running CCGT unit because of lower heat rate» 12 MMBTU/MWh x $2/MMBTU coal = $24/MWh from coal» 7 MMBTU/MWh x $3/MMBTU gas = $21/MWh from gas» Variable O&M cost for coal > Variable O&M cost for gas

• $/MW of capacity cost for coal-fired power unit greater than $/MW of capacity cost for natural gas-fired unit

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Increased US Gas Use in Power Sector• Many coal-fired generation unit owners are retiring units

and proposing unit retirements• Many claim that EPA regulations are causing these retirements

– Environmental Protection Agency (EPA) rules• Mercury and Air Toxics Standards (MATS) for coal-fired power

plants• Cross-State Air Pollution Rule (CSAPR)

– Reduce SO2, NOx, and Particulate emissions• At many existing power plants substantial new capital investments

are necessary to meet these standards– Economics (low-priced natural gas) appears to dominate

these retirement decisions• Most of these units are very old, 40 to 60 years old• Have very high heat rates

– Replacing these units with modern natural gas-fired units makes economic sense and has environmental benefits• Hedge against future carbon policy

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Greenhouse Gas EmissionsBenefits of Innovation in

Unconventional Natural Gas

18Most of reduction due to coal-to-gas switching

Start of Rapid Growth in Shale Gas Production

Impact on Global Energy Sector

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Estimated Landed LNG Prices for June 2015 in $/MMBTU

US Coal delivered to Europe and Asia produces electricity at lower variable cost relative to Liquefied Natural Gas (LNG)Currently, there are no operating LNG export facilities in Continental US to sell US natural gas in global market

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US Coal Exports

• Virtually all US coal exports leave through Atlantic coast ports in spite of thefact that the vast majority of US Coal Production occurs West of Mississippi River

• Limited West Coast Coal Export Capacity

Coal Use in Europe– According to US Energy Information

Administration (EIA), from 2009 to 2012 coal use in Europe increased by 6 percent

– Despite of massive deployment of renewables brought about the Energiewende, coal consumption in Germany increased by 8 percent from 2009 to 2012

– In UK coal consumption increased by 30 percent between 2009 and 2012

– Cheaper BTUs delivered to Europe from imported coal relative to natural gas• No net change in GHG emissions from European

electricity sector between 2009 and 2012

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Asia and Global Coal Market

All others

India

China

China’s Future Coal Demand

Nuclear

Wind

CoalHydro

Global Liquefied Natural Gas (LNG) Market

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Global Natural Gas Market• Natural gas moves typically moves across

continents as liquefied natural gas (LNG)• Liquefaction reduces volume to 1/600th of volume in

gaseous state• Liquefaction is an energy intensive process

– Waterborne transportation requires• Construction of liquefaction facility at origin and re-

gasification facility at destination – Both are extremely capital intensive facilities involving a

significant siting and construction lag• Roughly $3/MMBTU to $4/MMBTU is average cost of

liquefaction, transportation, and re-gasification– Both factors allow large delivered natural gas

price differences across locations to persist

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Global LNG Market

MTPA = Millions of tons per annum1 Million tons of LNG = 49,257,899 MMBTUIn a combined-cycle natural gas-fired power plant 7 MMBTU produces roughly 1 MWh

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Global Natural Gas Market– Recall $3/MMBTU to $4/MMBTU average cost

of liquefaction, transportation, and re-gasification and need for specialized export and import facilities

– Implications of the high cost of global LNG trade• Regions where LNG is marginal source of natural gas

supply, BTU-arbitrage will continue to favor imported coal over LNG in all virtually uses

• As more regions develop their domestic shale gas resources, the economic case for coal in the remaining regions will become stronger – Lower price of coal in global markets

– Can the US become a major LNG exporter?

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Can the US become a major LNG exporter?

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The Challenge of Natural Gas Exports– Bringing on-line an LNG export facility can take

from 6 to 10 years• From conception to initial production• Environmental and regulatory hurdles in countries

outside of the US likely to be less stringent than US– Liquefaction of natural gas and regasification at

destination involves energy losses– Total cost for liquefaction, transportation, and

regasification estimated to around $3-$4/MMBTU – At current LNG prices in Europe and Asia, US

price of natural gas plus $3-$4/MMBTU average infrastructure cost implies significant potential profits for US LNG exports• US LNG export projects are under construction

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The Rest of the World Has Substantial Shale Gas Reserves

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The “Other US Export”– Horizontal drilling, hydraulic fracturing, and better

seismic modeling technologies can be exported– US firms excel at developing new technologies

and exporting them to rest of the world• Many US firms are currently attempting to apply these

technologies around the world– China has substantial shale gas reserves

• China has goal of meeting 6 percent of its energy needs from shale gas by 2020

– India also has shale gas reserves– Several Latin American countries have significant

shale gas reserves• Argentina estimated to have as many reserves as US

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Don’t Bet Against Ingenuity of US Firms– Investing in LNG export facility is a bet against the ability of

US firms to deploy horizontal drilling, hydraulic fracturing, and seismic modeling technologies outside of US

– Likely that by the time significant US LNG export facilities are built, a sufficient amount of shale gas resources will have been developed near large consuming regions• If gas can be delivered by pipeline, the energy losses from

liquefaction and regasification can be avoided– More difficult for US LNG supplies to compete with domestic sources

• Some of these new sources of shale gas can enter LNG export market more quickly because of lower environmental and regulatory hurdles to constructing facilities in these countries– US LNG suppliers will face greater competition from these LNG suppliers

– US firms could face a “build it and no one comes outcome” with LNG export facilities• Similar to US experience with LNG import facilities a few years ago

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The Case Against the Triumph of the Ingenuity of US Firms Abroad

– US legal and regulatory institutions are unique• Long history of property rights definition and enforcement in US• Private ownership of mineral rights in US creates stakeholder interested

in shale gas development• Government ownership or muddled ownership of mineral rights creates

only opposition– US infrastructure is unique

• Natural gas transportation, storage, access to water and fracking chemicals

– Foreign governments may not allow US firms to access shale gas resources on commercially attractive terms

– These factors clearly make shale gas development abroad more difficult than it is in the US• Experience of US firms with deploying oil extraction technology around

the world strongly supports argument that these challenges will be overcome

• Current price differential between imported LNG and expected domestic shale gas price is too attractive

– US LNG export facilities closest to completion are financed with revenues from long-term contracts to export US natural gas (to Asia)

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Renewables and the Shale Gas Revolution

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Blue = Residential Systems Yellow =Commercial

According to California Solar Initiative (CSI) Data: Average Cost of Residential System is $4/Watt Average Cost of a Commercial System is $3.5/Watt(Note: These costs exclude any tax credits or subsidies)

Solar PV Prices in California

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But Wind is Major Renewable Resource in US

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US Wind Installations 1998-2014

Production Tax Credit (PTC) Renewals Explains Investment Patterns

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Wind Project Costs $/kW

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Technical Change for All – Cheap natural gas reduces levelized cost of

energy from combined cycle natural gas-fired technology in US• Roughly a $55 to 60/MWh levelized cost of energy

– Although both solar and wind have experienced cost reductions, gap between levelized cost of wind and solar versus natural gas-fired generation has increased as a result of unconventional natural gas boom

– Important lesson—Competition to find least expensive energy services can reduce prices of both carbon intensive and low-carbon energy sources

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Shale Gas and Economics of Renewables• Majority of solar panels are produced in China

In 2014, 6 of the top 10 of solar panels producers were located in China.

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Renewables and California– California has a 33% of load renewables goal by 2020

• Currently approximately of 25% annual load from renewables– To provide an idea of the cost of this policy in new

shale gas regime consider• Average price paid by residential consumer in Pacific Gas and

Electric (PG&E) and Southen California Edison (SCE) service territory in 2014 is $0.21/KWh

• Average cost of wholesale energy in California ISO market in 2014 is $0.05/KWh

• Average cost of distribution network and electricity retailing is $0.04/KWh

• Average cost of transmission network is $0.02/KWh– Remaining $0.10/KWh goes to pay for renewables

procurement, other sunk costs, and social programs– California giving up substantial retail electricity savings

from shale gas revolution to pursue renewables goals

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Global Environmental Policies

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Global Environmental Policies– Top-down versus bottom-up carbon policies

• Top-down--United Nations Conference of Parties global climate policy

• Bottom-up—Each region adopts their own policy– Trend towards regional carbon policies

• Regions with their own carbon policy– European Union Emissions Trading System (EU-ETS)– California, Quebec, British Colombia

» California and Quebec linked policies on 1/1/2014– Many other regions considering adopting their own policies

• Modest price of carbon– EU-ETS ~7 Euros per metric ton– California/Quebec ~12 US Dollars per metric ton– British Columbia 30 Canadian Dollar per metric ton carbon

tax

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Global Environmental Policies– Little indication of success of top-down

approach to setting a global price of carbon– Bottom-up, regional policy approach seems

more likely to lead to success– Cost/Benefit analysis implies that the bottom-up

approach should set a modest price of carbon until sufficient number of regions join• Regions that initially set a high price of carbon harm

their economies with little global environmental benefit– Note that British Columbia carbon tax if primarily a gasoline

tax as province receives more than 90% of its electricity from hydroelectric facilities

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Chile’s Energy and Environmental Policies

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Initial Conditions in Chile– Chile has no significant fossil fuel

deposits• Virtually all fossil fuels must be imported• Chile has constructed several LNG import facilities

– Chile’s electricity supply industry dominated by hydroelectricity• Difficult to site and built new hydroelectric facilities

– Fossil fuels have an increasing energy share• Coal, and more recently, natural gas provide this

electricity– Chile has a growing demand for electricity

relative to industrialized countries• Historical growth at around 4 percent per year

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Chilean Energy Policy– In spite of shale gas boom in US, LNG imports

to Chile are still likely to be in $8/MMBTU or higher over medium to long term• Current delivered price to Chile is higher because

deliveries are occurring under long-term contracts negotiated in higher LNG price regime

– Global coal prices are significantly lower on dollar per MMBTU basis• Current delivered price in Chile likely to be

approximately $3/MMBTU • Calculation based on current delivered European

prices shown earlier and average heat rate of imported coal plus an $1.00/MMBTU adder for Latin American delivery

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Chilean Energy Policy– Imported coal likely to beat imported LNG at

$8/MMBTU price in dispatch order even at highest global price of carbon

– If assume heat rates for natural gas unit of 7 MMBTU/MWh for and for coal unit of 10 MMBTU/MWh• Variable fuel cost of natural gas is $56/MWh• Variable fuel cost of coal is $30/MWh

– At these variable fuel costs, at least a $52/ton price carbon would be required for natural gas to be lower cost than coal• Exceeds highest price global price of carbon

– Conclusion—Coal is likely to continue to be the least variable cost fossil fuel for Chile

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Chilean Environmental Policy– Setting a price of carbon in Chile imposes a

significant expense on Chilean economy with little global environmental benefit• This is true for any small country

– It makes economic sense for Chile to put in place mechanisms to measure GHG emissions in preparation for future global carbon market

– If Chile would like to invest in new fossil fuel generation in a global carbon-neutral manner it could require new fossil fuel generation unit owner to purchase allowances from any of the currently existing global carbon markets• GHG emissions are a global stock pollutant

– Existing fossil fuel generation units need not be subject to this requirement

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Chilean Environmental Policy– As case of California demonstrates, support

mechanisms for construction of wind and solar photovoltaic (PV) facilities using existing technologies can be expensive• Wind turbine and solar PV technologies are mature • Further cost reductions due to learning-by-doing for

either technology seem unlikely– Fall in global price of fossil fuels likely to make

renewables support mechanisms more even expensive

– Renewables support mechanisms for Chile make sense to the extent that they take of advantage of unique Chile-specific renewable resources

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Conclusions/Summary– Global supply of fossil has increased

dramatically• Only likely to increase more as shale oil and gas

technology spreads to the rest of the world– Global price of carbon is unlikely to exist for

some time• Number of regional carbon policies is likely to

continue to increase, but these favor a modest price of carbon

– At prices of carbon likely to exist in these markets, coal is still a very viable, if not most viable, option for baseload electricity generation in Chile

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Conclusions/Summary– Developing carbon measurement system for

Chile makes sense for eventual global carbon market

– To the extent that Chile wants zero carbon expansion of fossil fuel generation capacity, it can require new unit to purchase GHG allowances on any regional carbon market

– Significant renewable energy goals using existing wind and solar technologies difficult to rationalize for Chile given current global fossil fuel prices

– Focus of developing renewables that take advantage of unique Chile-specific resource

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Questions/Comments