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Brattle Group: Prospects for Natural Gas Under Climate Policy Legislation

Brattle Group: Prospects for Natural Gas Under Climate Policy Legislation

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Published by Yoshi Nishimura
Brattle Group: Prospects for Natural Gas Under Climate Policy Legislation: Will There Be a Boom in Gas Demand?, Natural Gas, Coal, US Climate Legislation
Brattle Group: Prospects for Natural Gas Under Climate Policy Legislation: Will There Be a Boom in Gas Demand?, Natural Gas, Coal, US Climate Legislation

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Published by: Yoshi Nishimura on Mar 24, 2010
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11/27/2010

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DISCUSSIONPAPER
Prospects for Natural Gas UnderClimate Policy Legislation
Will There Be a Boom in Gas Demand?
Copyright
©
2010
The Brattle Group
,
 Inc 
.
The views expressed in this paper are strictly those o the authors and do not necessarily state or reect the views o 
The Brattle Group
,
 Inc.
or its clients.
March 2010
By Steen H. Leine, Frank C. Graes, and Metin Celebi
T
here has been increased public debate re-cently about the role o natural gas inreducing greenhouse gas (GHG) emissions inthe U.S. Some see natural gas as a bridge to atransormed electricity sector that will even-tually rely less on conventional coal-fredgenerating plants and more on nuclear plants,coal plants with carbon capture and sequestra-tion (CCS), and renewable energy sources.In the interim, natural gas-fred generationcan be the means by which the electricityindustry reduces coal-fred generation andGHG emissions. This could occur i there weresubstantial dispatch switching rom coal-fredgeneration to gas-fred generation ollowingthe implementation o a cap and trade programthat would place a price on CO
2
emissions.Others see a larger role or natural gas beyond just a bridge role, especially i low-carbon base-load generating technologies like coal with CCSand nuclear generation are not orthcoming toany substantial degree, and i the supply o low-cost gas, possibly rom shales, proves plentiul.In such a world, natural gas-fred generationcould be the preerred choice or baseloadgeneration, eventually with its own CCS.Gas-fred generation also may fll the capacityand CO
2
reduction void i the development o renewable resources is delayed by contractual,fnancing, or transmission siting issues.Many market observers are thereore hopeulabout a uture boom in natural gas underclimate policies. The underlying logic or thisoptimism is clear: natural gas has approximatelyone-hal the carbon content o coal. Increasingits use in electricity generation while reducingcoal-fred generation has the potential tosubstantially reduce GHG emissions.Moreover, gas-fred generation is attractive dueto its low construction costs, short constructionlead times, and because it is naturally hedgedagainst uctuations in gas prices in marketswhere natural gas is the marginal uel.However, despite these advantages o naturalgas, the role it will play in electricity generationin the U.S. (and in achieving GHG emissionreduction goals) is ar rom clear, even overthe next fve to ten years. In act, some recentorecasts show projected declines in naturalgas demand in the U.S. over the next decade.As shown in Figure 1, the Energy InormationAdministration’s (EIA) recent orecasts showa period o declining demand or natural gasover the next several years, whether or notclimate change legislation is passed.
Thispaper explores why the outlook of decliningdemand in natural gas might be correct,despite a seemingly strong argument forgas to play a larger role.
Introduction
 
Contents
IntroductionSection
 
1
Coal-to-Gas Dispatch SwitchingUnder Cap and Trade Programs
...
3Section 2
Economics o New Gas-FiredPower Plants
.........................
6Section 3
Renewables Displacing Gas-FiredGeneration
...........................
7Section 4
Incentives or Coal-Fired Gen-eration
................................
8 Section
 
5
Non-Electric Gas Demand
.........
9Conclusion
The Brattle Group
providesconsulting and expert test-imony in economics, fnance,and regulation to corporations,law frms, and governmentsaround the world.We have ofces in Cambridge, Massachusetts; San Francisco,Caliornia; and Washington, DC.We also have ofces in Brussels, London, and Madrid.  For more inormation, pleasevisit 
www.brattle.com
.
DISCUSSIONPAPER
 
Prospects for Natural Gas Under Climate Policy Legislation
Page 2
DISCUSSIONPAPER
March 2010
There are many challenges to natural gas demand growth in the coming decade that could ultimatelyresult in the gas demand trajectory shown in Figure 1. Several actors suggest that gas demand may notincrease substantially as a result o uture climate legislation. In particular:
t
 
Coal-fred generation will not be signifcantly displaced by natural gas-fred generation until CO
2
prices reachrelatively high levels, and such high CO
2
prices may not be orthcoming in the next decade under the cap andtrade programs now under consideration. This is due to political concern about CO
2
driving up energy costsand/or a desire to rely on international “osets” to U.S. CO
2
emissions.
t
 
The ongoing development o substantial renewable generation resources tends to reduce natural gas demand or electric power generation, especially since renewable resources are developed as “must-take” resourcesthat can displace the marginal uel rom the dispatch stack; in many regions this is mostly natural gas.While gas-fred generation may be necessary as a capacity back-up or intermittent renewable resources, thevolume o natural gas consumed in this role will be relatively low, not enough to oset the amount o gasdemand that is backed out as a result o new renewables development.
t
 
 Electricity conservation eorts and demand response to carbon cost increases can also result in displacement o natural gas in regions where gas-fred generation is the marginal resource.
t
 
The protections and incentives oered to coal-fred generation under proposed cap and trade policies, includ-ing the allocation o ree emission allowances to merchant coal generators, may keep coal plants operatinglonger and more requently than they otherwise would, again limiting gas demand growth.
t
 
 Non-electric gas demand growth is likely to be low due to retail conservation programs and price impacts o CO
2
policy that may negatively impact industrial gas demand.
Many o these pressures work against growth in gas demand over the next decade and beyond.Prognostications o uture natural gas demand and prices must take these actors into consideration.The uture mix o electricity generation resources in the U.S. is particularly important to understandingthe uture o natural gas. I coal-fred generation maintains or strengthens its position in meeting U.S.electricity demand, and there is strong growth in renewable (wind and solar) resources, the uture o natural gas demand may not be as bright as many industry participants hope or expect.
Figure 1
 Projected Natural Gas Consumption
50.052.054.056.058.060.062.064.02008200920102011201220132014201520162017201820192020
   B  c   f   /   D  a  y
Source
: EIA, "Energy Market and Economic Impacts of H.R. 2454," August 2009.
No CO
2
Policy(EIA Reference Case)CO
2
Policy(EIA Basic Case)
 
Prospects for Natural Gas Under Climate Policy Legislation
March 2010
DISCUSSIONPAPER
Indeed, there is the possibility that the U.S. mayexperience a perverse outcome in which renewablesserve to back out natural gas-fred generationrather than coal-fred generation. The implicationo such a scenario is that U.S. consumers will bepaying a lot or CO
2
emission reductions sincenatural gas does not emit as much CO
2
as coal,and gas can oten displace CO
2
rom coal at a muchlower cost per ton than some renewables.This paper discusses these issues in more detail.We explain the economics o dispatch switchingbetween coal and gas plants. We review theconstruction costs o gas-fred generation plantsrelative to other types o plants, and show howgas-fred plants are likely to be an economic choiceunder cap and trade, until CO
2
prices become quitehigh — enough to make nuclear and integratedgasifcation combined cycle (IGCC) coal with CCSthe preerred generation technologies. Nonethe-less, gas plants may not be built in proportion totheir societal attractiveness.We conclude that despite the environmentaladvantages o natural gas and cost advantages o gas-fred generation, a boom in gas demand is ar romcertain. However, dierent regions will experiencethe eects o climate policy more strongly or weaklythan others, with dierent impacts on regional gasdemand depending on the specifc characteristics o the electric generation eet.
Section 1
 
COAL-TO-GAS DISPATCHSWITCHING UNDER CAPAND TRADE PROGRAMS
While the pace o implementation o climate policyin the U.S. is quite uncertain, it is airly likelythat within a ew years some orm o restrictions o greenhouse gas emissions (mostly rom CO
2
) will bepassed. The climate bills that have been proposedin the U.S. House (the Waxman-Markey bill) andSenate (the Kerry-Boxer bill) both establish a capand trade program, i.e., a market-based programthat caps the amount o allowed CO
2
emissions andcreates tradable emission allowances.Allowance trading sets a price or CO
2
emissionsthat becomes a surcharge on ossil uel consump-tion, which creates economic incentives to reduceCO
2
emissions. The CO
2
price acts as a penalty orelectricity generation sources that emit CO
2
(namelycoal, natural gas, and oil-fred power plants), whicheectively raises the cost o electricity generationor power plants that use these ossil uels.Figure 2 shows the impact o a CO
2
price on thedispatch cost or both coal-fred and natural gas-fred electricity generating units. Dispatch costsare shown or both efcient (low heat rate, new,or large) and inefcient (high heat rate, older, orsmaller) generating plants.As shown, the higher the CO
2
price, the higher thedispatch cost or both coal- and gas-fred units.However, as CO
2
prices increase the dispatch costo coal-fred generation increases more rapidlythan it does or natural gas-fred generation. Thisreects the higher carbon content o coal relativeto natural gas (thus the steeper slope o the linesor coal-fred units).While coal plants emit roughly 1.0 tons or moreo CO
2
per MWh, natural gas plants emit roughly40% as much, or approximately 0.4 tons o CO
2
perMWh. For each $1/ton increase in the CO
2
allowancecost, there is roughly a $1/MWh increase in thedispatch cost o a coal-fred generating plant, butonly a $0.40/MWh increase in the dispatch cost o a gas-fred generating plant.Figure 2 also shows the “crossover” points wherethe dispatch cost o a gas unit becomes equal tothat o a coal unit such that or higher CO
2
prices,the gas unit will dispatch sooner than the coalunit. Thereore, at a CO
2
price o $10/ton, anefcient gas-fred power plant (e.g., a combinedcycle plant with a 7,000 Btu/kWh heat rate) willdisplace an inefcient coal-fred power plant inthe dispatch order (at the assumed $6/MMBtu gasprice and $1.70/MMBtu coal price).At a $40/ton CO
2
price, an efcient gas-fred powerplant will displace an efcient coal-fred powerplant. However, efcient coal plants can surviveagainst some gas plants up to as high a price orCO
2
as $80/ton, at which point even an inefcientgas plant will displace a typical efcient coal plant(assumed to have a 9,000 Btu/kWh heat rate).Thus, coal is not thoroughly displaced by gas untilCO
2
prices are in the range o $50-$100/ton, levelsthat may not be observed (per EIA orecasts) until
Page 3

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