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Indiana in natural gas dilemma

November 16, 2013

Indiana’s power companies are getting ready to use more natural gas after decades of relying on cheap, but dirty, coal.

They’re doing so to meet upcoming environmental standards with the hope that federal projections for tempered natural gas pricing—historically a volatile commodity—hold true. Prices have already started to calm after a flood of shale gas hit the market a few years ago.

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But critics warn there is too much evidence showing prices will spike again, leaving consumers to foot the bill.

Gas prices could surge as early as 2015 or 2016, said Michelle Foss, chief energy economist and program manager for the Bureau of Economic Geology at the University of Texas in Austin.

That contradicts government forecasts, which say gas prices will settle down after a decade of volatility, climbing only sluggishly over the next 30 years.

“The thing that we’re having a high level of discomfort with is the idea that price volatility is somehow a thing of the past,” Foss said.

Utilities and their suppliers are rushing to build power plants, drilling operations and the accompanying infrastructure in an attempt to meet new federal environmental standards that disfavor coal, which produces about 85 percent of the state’s electricity. Indianapolis Power & Light Co. announced earlier this year it plans to build a $631 million gas plant near Martinsville.

Most of the activity centers around natural gas because the supply glut has pushed prices low enough to justify the shift from coal. But gas prices will skyrocket once all the new plants go online and start burning the fuel, Foss said.

Consumer groups object to natural gas because of the possibility for higher rates.

“There’s incredible uncertainty when it comes to fossil fuels,” said Kerwin Olson, executive director of Citizens Action Coalition, an Indianapolis-based lobby that represents utility consumers in rate cases.

Those increases would add insult to injury for ratepayers already absorbing capital costs to replace coal-fired stations with cleaner gas, he said. IPL, for instance, plans to increase rates 2 percent to 3 percent annually through 2017 to pay for its Martinsville gas plant and $511 million in pollution upgrades to two coal plants.

Utilities don’t have much choice but to convert more production to gas from coal.

They are racing to comply with 2011 regulations aimed at cutting emissions of mercury and other metals in the air by April 2015. The U.S. Environmental Protection Agency reported that a projected $37 billion to $90 billion in annual health care savings would more than compensate for the anticipated annual cost to utilities of $9.6 billion.

“There’s no way you can build a coal plant. It’s just too expensive,” said Charles Fishman, an analyst for Morningstar Inc.

Power companies have three basic options for coal plants: upgrades to pollution controls, shut down the plants and build new, or pay the fines, said Douglas Gotham, director of Purdue University’s State Utility Forecasting Group.

The more cost-effective route is frequently natural gas.

“We’re not counting on today’s rock-bottom prices, but it won’t be as volatile” as in the past, said Richard Benedict, IPL’s director of project development, who is overseeing the Martinsville development.

Passed to consumers

Benedict acknowledged uncertainty with how increasing use of gas will affect customer rates.

“I don’t think we can predict what’s going to happen with fuel prices and what’s going to happen with electricity,” he said.

Skeptics, such as the Citizens Action Coalition, fear power companies will automatically pass on any gas-price spikes to their consumers.

Customers on the heating side of the energy industry have already tasted this year of how utilities pass on fuel costs. Citizens Energy Group expects winter bills to pick up 2 percent this year, and Vectren forecasts 3 percent.

State law allows electric utilities to use “fuel adjustment clauses,” which are additional charges that pass on fuel costs directly to customers. Companies petition the Indiana Utility Regulatory Commission quarterly to adjust their rates.

“They can control the efficiency. They can control the labor costs. But they have no control” over gas prices, said Morningstar’s Fishman.

The utilities can use the adjustments to recover their losses when gas prices peak on the market—as long as the price increases do not translate to profits, an agency spokeswoman said.

State Sen. Jim Buck worries sudden utility price spikes would damage the economy. Manufacturers, especially, have to worry about energy bills.

The Kokomo Republican, who has spoken out against the environmental standards, doubts gas prices will fall enough to justify replacing coal. Energy cost increases will hurt businesses, he said.

“It’s one of those things where you hold your breath,” he said about gas forecasts.

Unpredictable market

Utilities paid as much as $13.54 per million British thermal units one month in 2008 before prices dropped below $4 the next year, according to the U.S. Energy Information Administration.

Then drillers stepped up hydraulic fracturing, commonly known as “fracking.” The practice—controversial for its environmental impacts—dug into previously untapped shale rock formations to extract gas.

The sudden surge in supply in early 2012 drove Indiana natural gas prices as low as $2.54—cheaper than coal.

Gas prices have crept back up this year. Indiana utilities paid an average of $3.87 per million Btu in July, compared with $2.48 for coal.

On average, gas will more than double what coal costs by 2040 in Indiana and its surrounding states, according to a federal forecast.

But many factors outside of basic supply and demand could throw off prices.

Something as basic as an especially cold winter leads to abnormally high demand, quickly pushing up prices.

Or a natural disaster could wipe out drilling operations, cutting off the supply chain, Foss said.

Costs will likely come back down from their spikes, she said, but each time the cycle ends, prices will land higher than they previously were.

Foreign influence

Gas exports and their potential for volatility have become one of the biggest concerns for some energy industry groups.

The U.S. Department of Energy as of September approved four permits, with more pending, that allow liquefied natural gas producers to ship the fuel overseas. Companies can distribute the emerging energy source much more cost-effectively than other fuels, industry research says.

But utilities—the ones that buy gas—and their largest customers—the ones who ultimately pay for it—worry that foreign trade would result in domestic price hikes.

The United States has significantly lower gas costs than most of the world, and increasing foreign trade will subject the U.S. to pricing problems abroad, ultimately making domestic prices more volatile again, according to a June report by PIRA Energy Group in New York.

Lobby groups are petitioning the Department of Energy to reconsider permitting foreign trade.

“As U.S. exports increase, the price of natural gas will become tied to the international markets,” the American Public Gas Association said in a prepared statement.

“Proponents of export might contest the notion of oil as a proper analogy; however, it is inarguable that as you enter into a global market, the natural gas will be sent where the price is highest, driving up prices for all consumers”

Hedging

Power companies have a lot of measures in place to prevent raising their rates if gas prices do spike in the future, noted IPL’s Benedict.

The Indianapolis power company, for example, plans to better balance its energy portfolio, which is almost entirely coal today. Half the utility’s electricity will come from coal and one-third will be gas, with renewable sources covering the remainder.

Prices change hour by hour. If gas spikes, the company can switch to using more coal, which would keep down costs until gas goes back down, Benedict said.

Also of note is a plant’s age, according to Purdue’s Gotham. The overall cost of running a power plant—and what it does to customer rates—largely relies on how efficient it is in converting its fuel into electricity.

“A natural gas plant built in the last few years is much more efficient … than a 50-year-old coal plant is,” he said.

Green energy advocates, such as the Sierra Club, are pushing for power companies to use more renewable energy to hedge against gas’ volatility.

“[Gas] is not a wise choice because we’ll be tying ourselves to yet another fossil fuel that has prices that go up and down,” said Jodi Perras, who heads the Sierra Club’s Beyond Coal campaign in Indiana, “and ratepayers are going to have to pay for those.”•

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