The McDonnell Group

By Don McDonnell

ATLANTA – June 20, 2011 - For decades the US electric and natural gas industries have engaged in a drawn out version of what the Japanese call Tsundere.  It’s been in some ways a multi-decade love/hate dance. As shared in panels during the recent 4th annual KEMA executive conference in Denver, the relationship between electric and gas is changing rapidly given dynamic market developments. Change breeds both opportunities and challenges for the "frenemy" relations bewteen the sectors.

Some utilities, including KEMA panel member Jim Torgerson’s UIL Holdings, deliver both electric and gas and enjoy natural and increasing synergies across their consolidated operations. In other markets, electric and gas compete head to head for end-use applications.  So what’s the current role of natural gas in electric smart grid market development?  Could market dynamics pave the way for a massive round of electric and gas industry M&A and cross-industry consolidation?  The answer to the foe or friend question depends squarely on where you sit in terms of vested stakeholder interests within the integrated energy value chain.

Panels at KEMA addressed the strategic view from 30,000 feet, the road to sustainability, and “Gas- Part of the New Smart Grid Paradigm” the title of which sent, for me at least, a clear sense of KEMA’s perspective on this topic.  Subsequent to attending the Kema event, I received a summary memo from Mark Gabriel, SVP of Black & Veatch, who is a friend and colleague from over the years. Mark attended last week’s EEI conference, also held in Colorado, and his memo noted, “utility executives are betting on gas at least for the near future. Relative to previous years, the generation sector is growing more comfortable about the long term reliability, and pricing, of natural gas as a generation fuel.”

The price of gas for electric power production has fallen over 35% in the past five years following the discovery of vast shale reserves.  Coupled with the Fukushima disaster, could the nuclear renaissance be giving way to a natural-gas fired era of smart grid reason? Is cheaper and more plentiful natural gas foe or new found friend to the emerging electric smart grid?

Challenges That Make Natural Gas A Foe to Both Incumbent and Emerging Electric Smart Grid Market Stakeholders

Gas Price/Availability Have Tightened the Renewable Rubric for Regulators (Absent a Cost For Carbon)

While drops in price and new supply have benefitted end- consumers and resulted in what will be the largest/record year for US natural gas exports to Mexico and Canada in 2011, this dynamic has placed additional pressure on the non-subsidized economics for renewable energy sources that utilities increasingly source to meet electric renewable portfolio standards. While the cost differential for grid parity in the dispatch stack that is set by natural gas has been closing in recent years, particularly for wind and solar, the aggregate drop in gas prices and increased access to domestic supply has created a dynamic regulatory challenge for the cost calculus and regulatory economics for renewable electric power sources. Absent a policy construct that incorporates the cost of carbon in fuel sourcing , this has challenged regulators who are squeezed in their attempts to balance cost and environmental objectives.  Not unlike the way periodic drops in crude oil have stalled alternative energy initiatives over the past three decades in transportation, the recent drop in natural gas prices have raised the bar for renewable energy sources.

Gas Price /Availability Have Placed Increased Pressure on Smart Grid Solution Business Cases

Beyond the affect of lower gas prices on renewables as described above, the increased availability and lower price of gas has also created business case pressure for all smart grid technologies that derive a significant portion of their economic value by compressing or displacing needle peak demand.

Natural Gas & Electric Compete For the Future of Cleaner Transportation (& Maybe Cooling!)



Increases in natural gas-fired vehicles and fleets pose a competitive threat to the widely anticipated growth in electric vehicles. And liquefied gas is the undisputed favored choice for clean fuel heavy transportation options as shared during a panel by Craig Wagstaff, SVP of Questar Gas. A careful review of T Boone Pickens’ energy plan -- or listening to him in any almost interview -- reveals his repeated point  concerning the lack of technology for the use of electric in the industrial transportation sector as a replacement for crude. During the KEMA panel, David Carroll, CEO of the Gas Technology Institute, spoke eloquently about a range of gas industry research and development including work on natural-gas fired air conditioning that could challenge electric power’s role as the principal fuel-source for cooling loads nationwide.  This potential market opportunity, which could take years to develop, would radically and fundamentally change the dynamic between electric and gas by peeling off a critical layer of revenue from electric utilities where they have enjoyed dominance for over five decades since the development of the cooling marketplace.  This doesn’t even account for the potential growing role of gas-fired fuel-cells and their potential end-use displacement of electric consumption which were also discussed during the Kema panels. 

While concerns about the potential environmental impact of domestic shale gas production on surface ground water supplies create a degree of uncertainty on the assumptions around continued increases in supply, Carroll’s comments and his framing of these issues at the Kema panel convinced me that the industry fully understands the strategic impact that fickle consumer and state regulatory sentiment could have in the future and that the natural gas production industry is committed to increasing efforts to avoid further incidents like the one that occurred in April 2011 in Canton, Pennsylvania.

Significant Opportunities Likewise Make Natural Gas a Synergistic Friend to Many Electric Industry Stakeholders & Smart Grid Proponents

Natural Gas Combined Cycle Plants are Cleaner and More Efficient Than Baseload Coal

Recent drops in natural gas prices have helped relieve some strain on cash strapped electric customers since electric utilities often have fuel surcharge adjustments in their tariff structures.  The cost that electric utilities have paid for natural gas as a baseload fuel source has dropped over 35% in the past five years and this translates into direct savings for consumers. Since the early 90s electric utilities have increasingly turned to more efficient combined-cycle plants for baseload power expansions. In recent years, this has become a dominant choice for the replacement of aging and retiring coal-fired plants in utility generation fleets.

Natural Gas Fired Peaker Plants Play a Key Role in Grid Reliability Today and This Will Continue in the Future

Gas-fired peakers provide a rapidly dispatchable market resource to independent system operators, making them a historical long-term friend to grid reliability.  As the percentage of variable renewable resources increases in the coming decades, even with expected expansions in cost-effective energy storage of all forms and the increased use of demand-side distributed energy resources, the role of gas fired peakers in managing grid reliability will continue.

Natural Gas Is Increasing its Share of the Integrated Electric Fuel Source Mix of Today



Graphic Courtesy of Ventyx an ABB Company

According to the Energy Information Administration, even in the grip of an historic market downturn, gas-fired electric generation’s share of total power generation increased by 4.3 percent in 2009 to a total share of over 23%. This was its largest position since 1970, before the large wave of the current baseload nuclear generation plants were placed into production in utility fleets. A key consideration for electric power utilities, generators and system operators when considering the economics of different generation sources available is the heat rate of plants within their portfolio. Or, in laymans terms, the amount of electricity generated from the BTU equivalent of the fuel source – how much electricity do I get out compared to what I put into fuel?  Improved heat rates for natural gas plants are more dependent on a higher plant utilization factor than coal plants generally speaking, so this will play an important part in how gas displaces coal in the dispatch stack in years ahead.

In my opnion, this is no longer a question of “if or when” but rather a question of “how much and how fast.”

Conclusion

While gas and electric will continue to compete for end-use applications in the years ahead, the increasing role of natural gas in the electric power sector, the discovery of vast new unconventional gas reserves in the US, and the challenges facing coal and now nuclear have made natural gas an increasingly important friend to the electric smart grid. Presuming natural gas avoids its historic price volatility and that it can be produced safely from shale reserves, gas and electric will continue to become more mutually dependent upon one another over the next decade. As this unfolds, and if regulatory and legal circumstances permit, expect gas and electric company M&A activity to increase significantly in the years ahead.