USA Today
Debate brews: Has oil production peaked?
October 16, 2005
Almost since the dawn of the oil age, people have worried about the taps running dry. So far, the worrywarts have been wrong. Oil men from John D. Rockefeller to T. Boone Pickens always manage to find new gushers.
But now, a vocal minority of experts says world oil production is at or near its peak. Existing wells are tiring. New discoveries have disappointed for a decade. And standard assessments of what remains in the biggest reservoirs in the Middle East, they argue, are little more than guesses…
There's no question that demand is rising. Last year, global oil consumption jumped 3.5%, or 2.8 million barrels a day. The U.S. Energy Information Administration projects demand rising from the current 84 million barrels a day to 103 million barrels by 2015. If China and India — where cars and factories are proliferating madly — start consuming oil at just one-half of current U.S. per-capita levels, global demand would jump 96%, according to Nur.
Such forecasts put the doom in doomsday. Many in the industry reject the notion that global oil production can't keep up. "This is the fifth time we've run out of oil since the 1880s," scoffs Daniel Yergin, who won a Pulitzer Prize for his 1991 oil industry history The Prize.
In June, Yergin's consulting firm, Cambridge Energy Research Associates (CERA) in Cambridge, Mass., concluded oil supplies would exceed demand through 2010. Plenty of new oil is likely to be found in the Middle East and off the coasts of Brazil and Nigeria, Yergin says.
"There's a lot more oil out there still to find," says Peter Jackson, a veteran geologist who co-authored the CERA study.
Based on current technology, peak oil production won't occur before 2020, Yergin says. And even if it does, oil production volumes won't plummet immediately; they'll coast for years on an "undulating plateau," he says.
Debate growing sharper
Both sides in the peak oil controversy agree that oil is a finite resource and that every year, the world consumes more oil than it discovers. But those are about the only things they agree upon.
As the debate has persisted, it's grown personal. "Peak oil" believers disparage those who disagree as mere "economists" in thrall to the magic of the marketplace or simple-minded "optimists" who assume every new well will score.
Yergin emphasizes that the CERA study was developed by geologists and petroleum engineers, not social scientists. Of Simmons, Yergin says: "He's wonderful at stirring up an argument and slinging around rhetoric. ... For some of these people, it seems to be a theological issue. For us, it's an analytic issue."
When they're not trading insults, the two sides disagree fiercely over the likelihood of future technology breakthroughs, prospects for so-called unconventional fuel sources such as oil sands and even the state of Saudi Arabia's reserves.
The world's No. 1 oil exporter, in fact, is at the center of Simmons' new book, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, which has reinvigorated the peak oil argument.
Simmons says it's impossible for global production to keep up with surging demand unless the Saudis can increase daily production beyond today's 9.5 million barrels and continue pumping comfortably for decades. And, indeed, Yergin is counting on the Saudis to reach 13 million barrels a day by 2015.
Yet while the oil reserves of U.S. firms are verified by the U.S. Geological Survey, the Saudis — like other OPEC countries — don't allow independent audits of their reservoirs. So when Riyadh says it has 263 billion barrels locked up beneath the desert, the world has to take it at its word.
Simmons didn't. Instead, two years ago, he pulled about 200 technical papers from the files of the Society of Petroleum Engineers and performed his own assessment. His conclusion: The Saudis are increasingly straining to drag oil out of aging fields and could suffer a "production collapse" at any time.
Yergin is more optimistic both about the Saudis and the industry's prospects in general. If the past is any guide, technological breakthroughs will reshape both demand and supply, he says. In the 1970s, for example, the deepest offshore wells were drilled in 600 feet of water. Today, a Chevron well in the Gulf of Mexico draws oil from 10,011 feet below the surface.
Widespread use of technologies such as remote sensing and automation in "digital oil fields" could boost global oil reserves by 125 billion barrels, CERA says. Already, advanced software and "down hole measurement" devices to track what's happening in the well have elevated recovery rates in some North Sea fields to 60% from the industry average of 35%, Jackson says.
Technology also won't stand still on the consumption side of the equation, Yergin says. "By 2025 or 2030, we'll probably be moving around in vehicles quite different from the ones we drive today. Maybe we'll be driving around in vehicles that get 110 miles to the gallon," he says.
That's more than a guess. Toyota's 2001-model Prius hybrid got 48 miles per gallon; the 2005 model was up to 55 mpg. If automakers focused solely on energy efficiency, 110 mpg isn't out of the question.
The Wall Street Journal
Cold Spell
Years of Short-Term Strategy Create a Crunch in Natural Gas
October 17, 2005; Page A1
Behind the soaring natural-gas bill consumers face this winter are powerful economic and political forces that drove the industry to think short-term. That approach seemed to serve it well for years but isn't working now.
Utilities have shunned multiyear supply contracts, forcing them to buy much of the gas they sell at or near the current market price. Regulators have discouraged hedging against price rises. Gas producers have focused on wells they could drill quickly.
All those policies made sense in the 1990s, when prices were mostly falling and forecasters saw a long era of cheap natural gas ahead. The downside: When supplies tighten, consumers feel the hit quickly….
Tight Market
Wells these days are finding less gas and running dry faster. In 1990, energy companies drilling in the lower 48 U.S. states and the Gulf of Mexico could expect a new well to produce 12% less in its second year. By 2004, wells were expected to lose 37% of production in their second year, according to IHS Energy.
The sum of these shifts is a natural-gas market that was remarkably tight even before hurricanes Katrina and Rita battered the Gulf Coast natural-gas industry. Katrina not only smashed gas-processing plants, it also damaged underwater pipelines and toppled 108 platforms. That has reduced production by about 320 billion cubic feet of natural gas, equivalent to more than five days of U.S. consumption. "If we get a cold winter, that could put prices out of sight," says Robert Esser, a senior consultant with Cambridge Energy Research Associates.
Associated Press
Oil-rich countries tap into political power
October 17, 2005
A financial windfall brought on by rising energy prices has emboldened several oil-rich nations to challenge U.S. foreign policy and given them more leverage with U.S. allies that rely on oil imports.
Challenges are coming from an increasingly assertive Venezuela and Iran and a Russia no longer dependent on Western handouts. "Oil is the new currency of foreign policy," says Senate Foreign Relations Committee Chairman Richard Lugar, R-Ind. Iran and Venezuela are "not only less cooperative but almost gleeful that they are able to make trouble for us," Lugar says. "These are huge changes that have not been comprehended by most of the U.S. public."
Oil prices have been driven up by rising global demand, particularly in China and India. The USA remains the world's biggest importer and consumer. It imports more than 12 million barrels of oil a day and uses more than 20 million barrels a day, or 14 percent of the global supply, the Department of Energy says…
As Arab oil nations learned in the 1970s, high prices persuade oil consumers to conserve, which eventually lessens demand and lowers prices. It could be years before that happens.
In the meantime, says Jim Placke, a senior associate at Cambridge Energy Research Associates in Washington, the money gives "regimes the option to do things that are risky."
KABC
Soaring Fuel Costs Are Altering Driving Behavior
October 17, 2005
LOS ANGELES - Gasoline prices in Southern California continue to go up. According to the Automobile Club, the average price of regular unleaded in the Los Angeles-Long Beach area jumped 5.6 cents in the past week to $2.977 a gallon. In orange county the increase was 6-cents to $2.935 a gallon.
Waiter and actor Greg Foshay of Studio City, Calif., said he bikes and walks as much as he can and even started riding the train a year and a half ago to save money on gas, which averages $2.93-a-gallon nationwide. But he still drives to auditions…
It is too soon to tell whether the pullback in energy demand is more than a short-term response to the price spikes after hurricanes Katrina and Rita. But the shifting winds - including repeated calls for energy conservation by the Bush administration - are already being reflected on energy markets.
Crude oil for November delivery fell 7 percent this week, settling Friday at $61.84 per barrel, while gasoline futures plunged 14 percent this week to finish at $1.8292 per gallon.
"Katrina really increased the anxiety about gasoline prices in the U.S. and calls for conservation only add to that," said James Burkhard, global oil director at Cambridge Energy Research Associates in Cambridge, Mass.
Burkhard cautioned against drawing firm conclusions from Energy Department data that show gasoline consumption over the past four weeks was 2.6 percent below year ago levels.
Back-to-back hurricanes caused severe, but mostly temporary, disruptions to daily routines along the Gulf Coast. And residents in other parts of the country may gradually fall back into their old driving habits as average U.S. pump prices recede further from $3-a-gallon.
"People need to drive to work, take their kids to school, go to the store and so forth," Burkhard said.
NGI's Daily Gas Price Index
CERA: Henry Hub an Increasingly 'Imperfect Indicator' of Average Gas Price
October 17, 2005
While Sabine Pipe Line continues to lift its force majeure on a few more Henry Hub interconnects each day, Cambridge Energy Research Associates' (CERA) Kenneth Yeasting, director of Eastern North American Energy, wonders if too much emphasis has been placed on the Erath, LA, pipeline hub as the benchmark pricing point for North American natural gas market.
The argument has people within the industry lining up on both sides of the fence. Some agree there is a flaw, while others classify the argument as "silly."
The Henry Hub gas price plays a major role in North American gas markets, serving as a proxy for the continental North American gas price. The hub is where any physical settlement of a Nymex contract occurs and the North American basis is typically stated as the price difference between a regional location and the Henry Hub. The hub gas price is also the common reference point for many physical and financial products.
"Despite these important roles, the Henry Hub gas price is increasingly an unreliable proxy for the average gas price that North American producers are realizing," Yeasting said in a new study from CERA.
The study points out that in 2000, the Henry Hub gas price averaged $0.18/MMBtu above the production-weighted average supply-area gas price for North America. For the 12 months ended August 2005, the Henry Hub gas price averaged $0.50/MMBtu above that average price, which represents the price producers receive when delivering gas to a pipeline system.
"I think there is a flaw," said a Rockies producer. "What was happening is that the indices were driving how the market was going, which creates a disruption. I have a concern because we are seeing a disconnect in certain areas."
He added that the pricing in other regions of the country should follow their own fundamentals instead of the Henry Hub. "For example, following the hurricanes we saw the Midcontinent area have a basis blowout, so to speak, which wasn't logical. The gas should have basically equalized pretty quickly to a certain level, because there was certainly no trapped gas in the Midcontinent area.
"Depending on how long these problems continue, I think you will see a bit of disconnect," the producer added. "On the other hand, if the problem continues long enough you will see the market react, where basically people will quit using the Henry Hub for negotiational pricing."
As to the idea that another spot could take the torch from the Henry Hub, the producer said he would expect that to be a major problem because people will be resistant. "There is the contractual issue where a lot of gas is contractually tied into the Nymex for contracts, so it would take a bit of time for people to get those type of things unwound. It may take on the order of months before people start to realize that it is not good for their contracts."
Commercial Brokerage Corp. broker Ed Kennedy said he sees the situation differently. "The Henry Hub was just another gathering point in a spider web system," he said. "But when you create a futures contract, you have to pick a spot, like Cushing OK for crude. Is that the center of the crude market, no, Rotterdam is, but they picked a spot and the market adjusted to it.
"With the Henry Hub, what has happened is the price structure for the entire industry is on a basis relationship above or below that spot. It's an arbitrary point, which it usually is when you start a futures contract, but the market pricing structure has adjusted to it. People might say it is not the best spot, but it is 'the spot' now because everything else is adjusted to it. It is a silly statement to say the Henry Hub is an increasingly unreliable proxy.
"Why pick an inch instead of a centimeter, well this is the yard stick we chose to use, and the country adjusted to it," Kennedy said. "All of your basis relationships are based on it now, so the Henry Hub is the important spot, even though it is arbitrary."
As for switching the proxy to another point like Chicago, Kennedy said it wouldn't make a difference. "The basis relationships are actively traded now, so because everybody is using the same yardstick -- Henry Hub -- you are in effect trading Chicago, because you can trade the basis relationships."
In the study, Yeasting pointed out that "it is clear" that the Henry Hub gas price "is increasingly an imperfect indicator of the average gas price that North American producers receive." As for the reason behind the widening gap trend, the director pointed to the declining share of gas productive capacity represented by gas supply sources near the Henry Hub (Louisiana, Mississippi, and Alabama on- and offshore gas supply). As evidence, the study points out that these production areas consisted of a little over 30% of North American dry productive gas capacity in 2000, but had slipped below the 30% mark as of 2005. By 2020, the study predicts these production areas are expected to represent 20% of North American production.
In addition, CERA pointed out that swings in trading that temporarily cause dislocations in Nymex prices boil over to Henry Hub physical trading, but have less effect on the less-liquidly traded points of other producing regions. CERA has, since 2003, described the divergence between eastern and western natural gas prices as "the Continental Divide."
CERA uses this concept to explain how short-term or long-term factors can cause gas prices in eastern North American to separate from gas prices in western North America, adding that the divergence of Henry Hub from producing region prices is part of the Continental Divide.
"Although CERA does not expect Henry Hub to lose its central role as a price proxy and reference point, buyers and sellers must take greater care to understand the growing divide between not only East and West basis, but between Henry Hub and other producing regions," Yeasting said.
CERA said the divergence that has occurred since 2000 has generally increased the difference between eastern and western North American gas prices. The company anticipates that the West's share of North American gas productive capacity (or supply gap) will continue to grow.
"Absent substantial new west-to-east pipeline capacity, this will tend to increase the gas price differentials between western and eastern North America," he said. "The significant increase in liquefied natural gas (LNG) imports in the East in 2008-10 will temporarily stop this westward shift from increasing, but it will grow again thereafter."
CERA pointed out that the implications from the West's growing share of gas supply and the resulting expansion of basis differentials between western and eastern markets include:
Producers making economic decisions on the basis of a planning price set in Henry Hub terms may overstate the value of investments, particularly those in the West.
Buyers and sellers of forward gas and power contracts must take into account the growing divergence of Henry Hub gas prices from continental average prices, and that Henry Hub should not be viewed as a wide indicator of gas supply area prices.
The westward shift of productive capacity and the rise in Henry Hub prices relative to average producing area prices will ensure that gas prices in the Northeast will continue to be the highest in North America.
LNG import terminals will continue to make the most economic sense in the eastern half of North America, and barring an overbuild of LNG in the East, LNG sales agreements based on Henry Hub will yield higher prices than those for the average unit of domestic production.
Western end users of gas and power will generally have a competitive energy cost advantage over eastern end users -- an advantage that may increase over time.
Western producers need to consider supporting construction of more west-to-east pipeline capacity to narrow the gas price gap, provided there is an expected net increase in revenues (higher gas supply area price less cost of transportation).
The growing western basis discount is increasingly putting downward pressure on gas prices in the Midwest, especially Chicago.
CERA said the divergence in prices underscores the need for market participants to increasingly focus on regional price formation and basis dynamics -- especially players in the western market. Short-term events, such as weather and supply disruptions, cause temporary swings in the west-to-east gas basis. The study pointed out that Hurricanes Katrina and Ivan were perfect examples because the very substantial impact on eastern gas supply can cause a substantial increase in eastern gas prices relative to western gas prices, especially for southern and northeast markets that have a heavy reliance on Gulf Coast gas supply.
"The Continental Divide has generally resulted in the Henry Hub gas price becoming a less representative proxy for gas prices in North America," Yeasting summarized. "Further, it has contributed to the difference between eastern and western North American gas prices. Buyers and sellers must take into account both the short-term drivers of this east/west price disparity and the long-term drivers that could further widen both the gas supply gap and prices."
Platts Commodity News
CERA touts restructuring savings, warns industry on price hikes.
October 19, 005
US consumers have paid $34-bil less for power since 1997 than they would have if traditional regulation had continued and power industry restructuring had not begun, according to a new Cambridge Energy Research Associates study. Those savings stem from both retail rate freezes and a more competitive wholesale power market, said Lawrence Makovich, managing director of CERA's gas and power group and project director for the study. Instead of the costs of new generation going into utilty ratebase and paid by consumers, deregulation shifted the costs of new plants to investors, CERA said. With wholesale gas and power prices climbing, "there's a real danger going forward that any increases in prices will be seen as a failure of deregulation," but that is not the case, Makovich said. Power prices will increase in both regulated and restructured markets and that "should not be misinterpreted as a failure of deregulation," he said.
The CERA findings contradict some press accounts that conclude deregulation has not produced savings, but the savings also should not be seen as proof that deregulation has been successful, Makovich said at a Washington press conference. "If people think deregulation is a finished exercise that is wrong. There's an awful lot of work that needs to be done" with a power industry that is in between a fully competitive model and traditional regulation, he said. With a hybrid of competitive markets and traditional regulation imposed in the US, "people need to start accepting that the hybrid model" will be the end state in the industry for the foreseeable future. While some states may pull back from retail competition, others will continue their efforts and "we're not likely to move away" from competitive markets anytime soon, Makovich said. Given that, creating stability within the hybrid model becomes a policy challenge and CERA said the industry will need to restore confidence among investors, adopt regional approaches to resolve federal and state conflict and adopt policies tailored to meet different industry models. The hybrid state of competitive markets presents some critical questions for the industry to address, and resource adequacy rules are "the most pressing issue facing the power industry today," he said. Many of the resource adequacy models being tried at the state level are insufficient to ensure supplies will be able to meet demand, and the window to build facilities on time is rapidly closing. CERA expects an increased reliance on competitive solicitations and requests for proposals, resulting in more purchased power agreements from utilities.
Dow Jones Newswires
CERA: Power Deregulation Saved US $34B Over 7 Yrs - Study
October 19, 2005
SAN FRANCISCO (Dow Jones)--Contrary to conventional wisdom, competition in the U.S. power industry has lowered total electricity costs, according to a study released Wednesday by the Cambridge Energy Research Associates.
The country spent some $34 billion less on power between 1997 and 2004 compared with what costs would have been if traditional regulation had continued, the consulting firm said. However, while most U.S. consumers have paid less for electricity since the onset of power deregulation, residents of western states spent about $7 billion more than they would have under traditional regulation, according to the report.
The gap between actual savings and the common perception that electric deregulation has failed can lead to poor decisions, warned Lawrence J. Makovich, the head of CERA's natural gas and power.
"However, lower real power prices in the deregulation period compared with the regulated period do not prove that deregulation was successful," because simply equating success with lower prices is wrong, Makovich said in a press release. Instead, power prices need to fluctuate to send the right price signals to consumers.
Over the next few years, electricity costs will undoubtedly rise due to much higher fossil fuel costs, but deregulation shouldn't be blamed for the higher bills. Higher prices for natural gas, coal and oil would certainly boost electricity rates under traditional regulation, too, according to the report.
"These real power price increases in the years ahead should not be misinterpreted as a failure of deregulation," Makovich said.
CERA expects short-term political pressure to prompt intervention and distortions that may be difficult to reverse in the future, and "concludes that a persistent crisis in confidence will surround the power sector's ability to build adequate new supply."
Competition in the power business has, as expected, heightened efficiency, innovation, and cost discipline. Yet a significant portion of the gains are due to power customers' not paying the cost of the many new power plants built since 1997, said CERA.
Traditionally, the costs of new generators would automatically go into rates set by state utility commissions. Over the past seven years, though, investors in independent power producers have paid those costs.
The greatest savings have been in the Northeast, where deregulation has reduced average rates by 0.73 cents per kilowatt-hour. The Midwest has rates that are about 0.42 cents/kWh lower than they would be under traditional regulation.
Even if traditional electricity regulation had continued, the West would still have had a power shortage in 2000-01, but the shortage wouldn't have cost consumers so much, according to the study.
CERA warned of the current dislocation: The risks associated with a shortage fall on consumers, as happened in the West, whereas the risks associated with a surplus fall on investors, as seen in the rest of the country. Since the boom of 2000-01, power profits plunged and a few large, independent power producers went bankrupt.
In sum, CERA gave U.S. electric deregulation a grade of C+. Though workable markets are developing in some regions, and in some cases are performing well, the report concludes, "after nearly a decade of restructuring, progress in moving to competitive electricity markets is mediocre at best."
Not enough high-voltage transmission lines are being built due to rate freezes and uncertainty about incumbent utilities' obligation to serve all local customers. The increased use of markets to acquire supplies, meanwhile, requires more transmission lines than under traditional regulation, in which utilities generated much more of their own power locally.
The responsibilities for building new infrastructure should be clearly defined, and transmission siting should be shifted from the states to larger regions, CERA recommended.
Also, the current power supply surplus will disappear in most regions of the U.S. between 2008 and 2012, and the country faces a potential repeat of a California-type energy crisis, CERA warned.
"The window of opportunity for building new generation or transmission facilities is rapidly closing," the report said.
A hybrid mixture of regulated processes and competitive forces is likely to dominate the electricity industry for the foreseeable future, CERA said, and creating stability in this hybrid is a policy challenge.
Reuters
Oil settles above $60
October 21, 2005
Oil prices got a boost Friday, rising from three-month lows as powerful Hurricane Wilma showed signs of hindering the recovery of oil operations in the storm-battered Gulf of Mexico.
"There have been signals within the industry that mobile rigs operating in areas that might be in the way of Wilma are moving out of the way," said William Ferer, president of investment management firm W. H. Reeves and Co.
Wilma was hammering Mexico's famed Caribbean beach resorts on the Yucatan Peninsula Friday on a track toward Florida, well-away from rigs and platforms, but oil companies were taking few risks after damage from Katrina and Rita in August and September…
Oil's bounce Friday ended a week-long slide triggered by reports of rising oil and natural gas stockpile levels and added proof that record prices were leading the world's top consumer to burn less fuel.
Prices are 24 percent stronger than at the start of the year and remain at historically high levels.
Concrete evidence was emerging that oil at or near $70 a barrel -- a level reached this summer -- had taken a toll on energy consumption, according to Daniel Yergin, a leading energy expert.
"I suspect demand is on a different track now... I think globally," the chairman of Cambridge Energy Research Associates told Reuters.
Megawatt Daily
CERA: N.A. restructuring only gets grade of C+
October 21, 2005
Electricity industry restructuring has produced significant savings for consumers since the late 1990s, but there is still much work to do because it stands between traditional regulation and fully competitive markets, asserts a study released Wednesday.
United States consumers have paid $34 billion less for power since 1997 than if traditional regulation had continued and power industry restructuring, or deregulation, had not begun, according to study authors and consultants Cambridge Energy Research Associates.
Savings stem from retail rate freezes and a more competitive wholesale power market, said Lawrence Makovich, managing director of CERA's natural gas and power group and project director for the study. Instead of the costs of new generation going into utility ratebase and paid by consumers, deregulation shifted the costs of new plants to investors, CERA said.
The South had the largest total savings in absolute terms, $24 billion, but the difference in costs was power at $5.20/MWh less.
The highest per-unit savings was in the Northeast, where the $8.5 billion in savings spread out among power sales yielded a difference of $7.30/MWh. In the West, because there was a shortage of power and customers experienced market forces as a result, retail customers paid $7.3 billion more than they would have under traditional regulation, CERA said.
With wholesale gas and power prices climbing, "there's a real danger going forward that any increases in prices will be seen as a failure of deregulation," but that is not the case,
Makovich said. Power prices will increase in both regulated and restructured markets and that "should not be misinterpreted as a failure of deregulation."
The study, "Beyond the Crossroads: The Future of Power Industry Restructuring," is a conclusion to a 2002 CERA study that developed criteria for grading restructuring policies.
The CERA findings contradict some press accounts that conclude deregulation has not produced savings, but the savings also should not be seen as proof that deregulation has been successful, Makovich said during a Washington news conference. "If people think deregulation is a finished exercise that is wrong. There's an awful lot of work that needs to be done" with a power industry that is in between a fully competitive model and traditional regulation, he said.
The CERA study graded restructuring efforts--generally pretty poorly--to coordinate retail and wholesale markets, stimulate transmission planning and investment, expand regional transmission organizations, create capacity markets, adopt pricing mechanism to manage transmission congestion and connect demand and market conditions. "After nearly a decade of restructuring, progress in moving to competitive electricity markets is mediocre at best," the report said. "Although workable markets are developing in some regions, and in some cases are performing well, power industry restructuring across North America overall earns an aggregate grade of C+."
With a hybrid of competitive markets and traditional regulation imposed in the United States, "people need to start accepting that the hybrid model" will be the end state in the industry for the foreseeable future, Makovich said. While some states may pull back from retail competition, others will continue their efforts and "we're not likely to move away" from competitive markets anytime soon, he said.
Given that, creating stability within the hybrid model becomes a policy challenge and CERA said the industry will need to restore confidence among investors, adopt regional approaches to resolve federal and state conflict and adopt policies tailored to meet different industry models. The hybrid state of competitive markets presents some critical questions for the industry to address, and resource adequacy rules are "the most pressing issue facing the power industry today," he said.
Many of the resource adequacy models being tried at the state level are insufficient to ensure supplies will be able to meet demand, and the window to build facilities on time is rapidly closing. CERA expects an increased reliance on competitive solicitations and requests for proposals, resulting in more purchased power agreements from utilities. It also recommended independent parties should administer RFPs, asserting that utility involvement can skew the results and prevent the best price from winning bids
CERA identified some regions with competitive market models and others with traditional regulation, along with a group it termed "muddling middle" which includes the Ohio, Illinois and Michigan portions of the Midwest Independent Transmission System Operator, the Ohio, Illinois and Virginia portions of the PJM Interconnection, California and Ontario. Retail markets in these areas have been restructured but customer choice is not exercised much and where it is it's due to factors such as skewed rates or special market incentives.
These areas "likely face the greatest challenges ahead and the greatest risks of market dysfunction and unintended consequences," particularly regarding resource adequacy, the report said. "Simply stated, the problem for these regions is who will build the next major increment of generating requirements and under what cost-recovery mechanism?" CERA said, noting that in some areas "there is not a lot of time left to resolve this question and meet the lead times necessary for new capacity planning and construction."
The Electric Power Supply Assn. praised the CERA study, saying it adds "to the growing body of work from independent analysts demonstrating that competitive power markets reduce costs, lower prices, drive innovation" and spur economic growth. The study contradicts the conventional wisdom that competition failed to lower power prices for residential customers, said EPSA President and CEO John Shelk.
ESPA said customers could have saved even more than the $34 billion given the uneven pace of restructuring, and it acknowledged the low grade for restructuring overall.
"This grade does not detract from the overall conclusions regarding the benefits to consumers of competition. It is important to recognize that structural implementation of competitive markets is a long-term process that is contingent on resolving many issues, including those identified by CERA," Shelk said.
Electric Net
Study: Power Deregulation Saved $34 Billion, Benefited Consumers Over Past 7 Years
October 21, 2005
Washington, DC - The majority of U.S. consumers have paid less for electricity since the onset of power system deregulation in 1997, achieving total savings of about $34 billion compared with the costs if traditional regulation had continued, according to a new Cambridge Energy Research Associates (CERA), an IHS company, study titled Beyond the Crossroads: The Future Direction of Power Industry Restructuring.
“Despite the conventional wisdom that deregulation did not lower prices for consumers, the average US real price of power declined over the era of deregulation from 1997 to 2004.” said Lawrence J. Makovich, Project Director and CERA Managing Director, Gas and Power Group. “This gap between perception and reality suggests that power price trends are widely misunderstood, a misunderstanding that can lead to poor decision-making.”
“However, lower real power prices in the deregulation period compared with the regulated period do not prove that deregulation was successful,” according to Makovich. “Power prices ought to signal the real resource cost of consuming an additional amount of electricity. If power prices are held above or below this level, then economic distortions and inefficiency result. When power prices send the wrong signal, distortions and inefficiencies are more than just theoretical. Someone has to shoulder the costs of economic inefficiency.”
“The expectation embodied in the conventional wisdom—that for deregulation to be considered a success, power prices in nominal terms should have decreased continuously over the period under consideration—is inappropriate. Power prices needed to fluctuate in order to convey the appropriate signal for economic efficiency,” he added. CERA’s current analyses shows that the rapid increases in fossil fuel prices over the past year mean real power prices will increase in the near term—whether power prices are regulated or deregulated. Makovich concluded, “These real power price increases in the years ahead should not be misinterpreted as a failure of deregulation.”
Consumer Savings
The savings from deregulation reflect many of the expected gains from introducing more competitive pressures into the power business—greater efficiency, more innovation, and cost discipline. Yet a significant portion of the gains are due to power customers’ not shouldering the cost of much of the capacity added in the post-1997 period, according to CERA’s analysis. Instead of the costs of new supply going into ratebase and thus regulated prices, deregulation shifted the costs to investors who held the market risk.
The cumulative estimated savings in non-western regions over the deregulation period in real 1997 dollars is $42 billion. Although the South has the largest savings in absolute terms ($24 billion), it works out to about $5.20 per megawatt-hour (MWh). The highest per-unit savings is in the Northeast, where spreading $8.5 billion savings over sales yields at $7.30 per MWh difference. The Midwest is the smallest in both absolute and per unit terms: $9 billion and $4.20 per MWh. In the West, on net, had regulation continued, residential power customers would have experienced the shortage but spent $7.3 billion less on electricity than they did with a shortage and deregulation.
One implication is clear—deregulation reallocated risk in the power business. The risks associated with a shortage fell on consumers (the outcome in the western region), whereas the risks associated with a surplus (the outcomes in the other regions) fell on investors.
Grading Deregulation
The report grades US deregulation and finds that “After nearly a decade of restructuring, progress in moving to competitive electricity markets is mediocre at best. Although workable markets are developing in some regions, and in some cases are performing well, power industry restructuring across North America overall earns an aggregate grade of C+.”
Transmission
Despite the critical importance of the power transmission grid, the CERA report finds increasing underinvestment in transmission, with rate freezes, regulatory uncertainty and uncertainty about the load serving entity obligation contributing to gridlock. While the grid is called on to support much larger volumes of regional trade over a larger footprint than in the pre-competition days, most aspects of transmission expansion -- aside from the formation of regional transmission organizations -- have not changed.
In CERA’s view, five steps are necessary to attract the investment needed to create the robust transmission grid backbone the industry needs:
• Rationalize transmission planning by integrating the evaluation of economic and reliability criteria and clearly assigning responsibilities for building new infrastructure;
• Regionalize transmission siting to align with regional transmission boundaries;
• Default to systemwide cost allocation for regional transmission projects;
• Implement formula-based transmission rates to reduce regulatory lag for transmission investment; and
• Combine long-term transmission rights with transmission expansion planning to assure certainty of access and costs in the next round of countrywide base-load capacity decision-making.
Resource Adequacy
Resolving issues of resource adequacy – keeping supply and demand in balance – is one of the most important challenges facing the power sector, according to CERA’s analysis. With the power supply surplus disappearing in most regions of the U.S. between 2008 and 2012, the country faces a potential repeat of a California-type energy crisis. And the window of opportunity for building new generation or transmission facilities is rapidly closing. The study identifies nine different mechanisms currently evolving in the U.S. power sector to address resource adequacy in a spectrum from public power to unfettered energy markets.
CERA expects a wide variety and combinations of mechanisms to be adopted with varying degrees of success. CERA also expects short-term political pressure to prompt intervention and distortions in resource adequacy mechanism implementation that may be difficult to reverse in the future, and concludes that a persistent crisis in confidence will surround the power sectors ability to build adequate new supply in a timely fashion in the years ahead.
Stabilizing the Hybrid
In the hybrid mixture of regulated processes and competitive forces that is likely to be the dominant state of the U.S. electricity industry for the foreseeable future, creating stability in this hybrid becomes a policy challenge, according to CERA. This will require more fact-based decision making, better setting and tracking of goals and performance metrics, restoration of confidence among investors, regionalized approaches to resolving federal and state conflicts, proactive resolution of distortions produced by unlevel playing fields, and recognition that policy needs to be tailored to the various industry models that have evolved in the power sector.
Beyond the Crossroads: The Future Direction of Power Industry Restructuring, the product of a collaborative process involving various stakeholder groups, provides specific recommendations to contribute to the policy dialogue at a time when power industry restructuring has lost momentum. Nevertheless, action is required to bring stability to the industry’s hybrid structure. “Policymakers, legislators and regulators need to work together to ensure that directional changes at the federal, regional and state levels are informed, coordinated, sequential and measured,” the report concluded.
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