Changing the mix

July 2, 2012
The biggest change in OGJ's latest Midyear Forecast, p. 28, is the surge in the use of natural gas, especially as it cuts into the use of coal for electric power generation in the US.

The biggest change in OGJ's latest Midyear Forecast, p. 28, is the surge in the use of natural gas, especially as it cuts into the use of coal for electric power generation in the US.

Last month the US Energy Information Administration released a report, Fuel Competition in Power Generation & Elasticities of Substitution, which analyzed the competition among coal, gas, and petroleum used for power generation. Substitution elasticity measures how the use of the fuels varies as their relative prices change.

Many factors other than fuel prices determine which power plants are utilized to meet electricity demand, including environmental regulations, generators' nonfuel variable operating costs, startup and shutdown costs, emission rates and allowance costs, electricity grid flow constraints, and reliability constraints.

Recently high oil prices and a sudden increase in spot prices for Appalachian coal converged with a sustained decline in the delivered cost of gas.

The rapid change in the prices of coal and gas between 2008 and 2009 illustrates the elasticity estimates. Over the period, the average price of coal delivered to electric generators increased to $2.21/MMbtu from $2.07/MMbtu, while the average price of delivered gas declined to $4.74/MMbtu from $9.01/MMbtu. The ratio of coal to gas prices increased by about 103%, the report said.

Results, limitations

This report updates earlier work to reflect dispatching patterns during 2005-10. The model results indicate that for the US as a whole, a 10% increase in the ratio of the delivered fuel price of coal to the delivered price of gas leads to a 1.4% increase in the use of gas relative to coal. But generators' use of oil is much more responsive to relative fuel-price changes. A 10% increase in the price ratio of gas to oil leads to a 19% increase in the relative use of petroleum compared to gas.

While fuel-substitution results for the Midwest and Texas are relatively insignificant, the trend of gas displacing coal was especially evident in the southeastern US between 2008 and 2009, according to the report. While coal generation in the South Atlantic region declined by 18% to 77 Gw-hr during 2008-09, generation fueled by gas increased by 21% to 29 Gw-hr. In other words, natural gas's share of fossil fuel generation in the South Atlantic region jumped to 32% from 24% between those 2 years, while coal's share fell to 65% from 73%.

This shift in fuel use coincided with a drop of 34% in the average annual cost of gas delivered to South Atlantic electric generators and an increase of 13% in the annual average delivered cost of coal in the region. Although various factors contributed to this shift in the generation fuel mix, the relative change in fuel prices was likely one of the primary drivers, the report said. This shift from coal to gas in the Southeast has continued into 2012.

The study results concluded that power producers do have some flexibility to alter the generation-fuel mix in response to changing prices. However, overall, the estimated substitution elasticities are relatively low, with the exception of fuel displacement between oil and gas.

The model used in the study attempted to account for changes in capacity over the long run, but the estimated dynamic adjustment coefficients were quite low, possibly because the capacity mix varied little over the sample period, the authors of the report conceded.

Another limitation, they said, is that the model relied on data measured in British thermal units, whereas ideally, fuel price would be measured in $/Mw-hr in order to account for relative technological efficiencies and heat rates between generators that use different types of fuel.

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About the Author

Marilyn Radler | Senior Editor - Economics

Covers worldwide oil and gas market developments, creates forecasts, and compiles production and reserves statistics for Oil & Gas Journal. She joined OGJ in 1996 as Survey Editor. She holds a BA in Economics from the University of Texas at Austin. A Past President of the Houston chapter of the United States Association for Energy Economics, Marilyn currently serves as a USAEE council member.