After hitting highs of $13 per million British thermal units (MMBtu) in 2008, natural gas prices in the US have dropped dramatically in response to soaring supplies. This has been driven by advances in extraction technologies, which have unlocked previously inaccessible shale formation reserves. In early March, gas futures on the New York Mercantile Exchange slumped to a ten-year low of just $2.27/MMBtu.
As gas prices have fallen, they have taken electricity prices down with them. "One of the results of the natural gas glut is that electricity prices have been cut by up to 50% in some cases," Ed Einowski, a partner at law firm Stoel Rives, said at the Infocast Wind Power Finance and Investment Summit in February. "The west hub of (regional transmissions organisation) PJM, the largest wholesale market in the US, had an average price in December 2011 of $39/MWh versus $89 in the first quarter of 2008," he added.
Trouble looms for merchant projects
As a result, part of the market for new wind projects has largely dried up. In competitive wholesale power markets such as PJM, which covers 13 north-eastern states and the District of Columbia, developers had been able to play off high and volatile natural gas prices to build wind plants without long-term power purchase agreements. In 2008, these so-called merchant projects made up 40% of US wind installations.
"For 2012, we estimate that 90-95% of projects built will have long-term power purchase agreements," says Matt Kaplan, a senior analyst at IHS Emerging Energy Research. "It is very difficult to build a merchant wind project. Because gas prices are so low, it has become much more difficult for wind to be competitive, especially in key markets like Texas and New York."
State requirements, the state renewable portfolio standards (RPS), are driving demand for new wind projects in the current market, says Kaplan. But there is concern these targets may be reconsidered, particularly if the federal $0.022/kWh production tax credit (PTC) is allowed to expire at the end of the year."In the face of gas prices and the current state of the economy, there is going to be a lot of pressure on state public service commissions to lighten up on those RPS standards," Timothy Howell, managing director of power and renewable energy at GE Energy Financial services, said in February. "I think they are at risk. That's my gut feeling."
At the same time, a lot of states adopted RPS mandates in order to diversify their generation portfolios using domestically available energy sources, says Kaplan. "I think that is a fundamental offering wind still has. It's very easy to be pessimistic about renewables when you look at how much gas is available and what price does it looks like it is going to come in at? There are other factors involved than just looking at the cost of gas versus the cost of wind. There are different costs and benefits that each technology brings to the table. That will need to be weighed by the policymakers, by the PUCs and by the utilities."
When utility Xcel Energy bought 200MW of wind last year for its Colorado system, it described the project as a hedge against gas-price volatility because it offered a fixed price over 25 years. "That is part of the thinking people are going to have to bring when looking at the economics of wind," Ken Kulak, a partner at law firm Morgan, Lewis & Bockius, told Infocast delegates.
The long-term price of gas is a big question mark. "There is a pretty universal view that these low natural gas prices can't be sustained long term," Einowski said in February. Already, producers are cutting back, and in March the number of rigs drilling for natural gas in the US fell to a ten-year low. Prices might rise if domestic gas companies look to lucrative overseas markets, where gas is selling for $8-12/MMBtu.
Growing concern over the water quality impacts and fugitive methane emissions from the extraction process could lead to new environmental regulations, altering the cost equation. Eventually, gas will also be facing carbon costs, said Einowski.
IHS Emerging Energy Research estimates that gas prices need to be around $6/MMBtu for wind to compete head to head, and that they will not rise to such a level until later in the decade. "We think that is going to be a real challenge for wind to overcome if it wants to reach price parity with gas," says Kaplan.
Still, said Howell, the industry has made tremendous strides in lowering the cost of wind energy. With technological innovations resulting in 10-15% capacity-factor gains, wind will be in a much better position to compete when gas prices rise again.
GAS AND WIND PRICES: WHEN WILL THE TWO MEET AGAIN? BY DAVID MILBORROW
Low natural gas prices in the US are making it an attractive fuel for electricity generation, capable of delivering energy at around $53/MWh. That is a difficult figure for wind to match, although it can be done at higher wind-speed sites and with the production tax credit in place. But the situation could change in the future as the price of gas seems likely to rise.
The central scenario of the Department of Energy's Energy Information Administration (EIA) has gas prices rising nearly 30% by 2020, pushing the electricity price to around $61/MWh. If the Clean Energy Standard (CES) currently proposed in the Senate - which would compel utilities to source from "cleaner", but not necessarily renewable, sources - were to be introduced, gas prices may rise further, pushing electricity costs up to around $78/MWh.
Providing that wind-power generation's installed costs continue to fall, it may be able to match this price by dropping to $74-80/MWh, especially if high investor confidence secures finance at attractive rates. The lower EIA figure of $60/MWh is more challenging - but not impossible (see chart, below).
Cost comparisons like the one illustrated depend on the assumptions made about the cost of capital and the repayment period, which is assumed to be 20 years throughout. The estimates for gas and for wind at the present time assume a 9% cost of capital and the future projections for wind assume an 8% cost of capital.
On this basis, current wind-generation costs generally lie between $100 and 120/MWh, based on an installed cost of $2,200/kW. Two projections of future installed costs are used, one from the EIA and the other from Lawrence Berkeley National Laboratory (LBNL). Each used an installation cost of around $1,800/kW. With increased investor confidence, the cost of capital may be taken as 8%, yielding a generation cost estimate of $95/MWh. LBNL suggests that improved productivity and competitiveness in the wind turbine industry, plus stable prices for steel and other commodities, could lead to installed costs falling to around $1,600/kW this year or next. This would bring the generation cost down to $87/MWh.
All these figures may be regarded as cautious estimates, for gas and for wind. Forecasting future fuel prices is extremely difficult, but it should be noted that US gas prices are currently around one third of oil prices, although the two fuels traditionally trade at the same price levels. While there is no immediate evidence that the two prices will move back into line, the possibility remains. If this were to happen, the cost of gas-fired electricity would move up to around $140/MWh, making wind extremely competitive.