ENERGY MATTERS: Gas Reality Check

By Published On: June 20, 2008

One symptom of lunacy is repetition of the same action over and over, hoping for a different result. The cartoon coyote believes, against all evidence to the contrary, that this time he will catch the roadrunner. Sane people modify their expectations based on what happens in the real world. What does that tell us about folks who persist in predicting that the inexorable increase in natural gas prices will suddenly come to a halt and perhaps even decline substantially. Folks like the Energy Information Administration, California Energy Commission, and California Public Utilities Commission? In January 1999 the near month NYMEX gas contract traded at $2.37/MMBtu in today’s dollars. As I write this, the contract is trading at $13.30/MMBtu, an increase of nearly 500 percent. This years’ increase is unusually pronounced, but the trend in gas prices over the last decade is markedly upward, having increased 300 percent. Undaunted by reality, in the last 10 years the annual forecasts from EIA predicted that prices will stop increasing and even decline. CEC forecasts were similar. Expectations of future natural gas prices are the most important determinants of U.S. and California energy policies. These policies have been based on the assumption that gas will be cheaper in the future, an assumption supported by the theorists’ price forecasts. As a result, California has over invested in gas and under invested in competing technologies. Consumers pay for this folly, as dependence on gas for electricity generation continues to increase and rates rise accordingly. In recent years regulators also have looked to “the market” for guidance. Contracts for gas delivery a decade hence can be purchased on the NYMEX, and prices are posted daily. It’s not clear that futures contract prices represent expectations for the price of gas in the future. But if so, the market has done no better than the theorists. The chart shows what gas prices have been in the last decade together with the linear trend. The squiggly red line indicates NYMEX futures prices as of June 4, 2008, and the red band shows generally what so-called “fundamental” forecasts are these days. (EIA forecasts are much lower and are now generally ignored by serious analysts.) The blue band illustrates a forecast made with the not unreasonable assumption that the upward trend in gas prices over the last decade will continue. What California decides to do about climate change and renewable energy resources depends on which gas price forecast is used. If gas is expected to be cheap, investing in alternatives appears expensive. But if this rosy forecast is wrong, costs will continue to rise with no benefits whatsoever for consumers and global warming will continue to get worse. The California Air Resources Board must choose a gas price forecast in order to determine what climate change measures are “cost effective.” The CPUC must choose a gas price forecast to decide how much renewable energy resources are worth. Unfortunately, both seem prepared to continue to accept the fantasy that increases in gas prices are a thing of the past. It’s time for a reality check. Would anybody but a theoretical economist look at the chart and conclude that the red forecast is more likely than the blue? Is it reasonable for California to ignore history and assume, yet again, that gas prices suddenly will stop increasing? Will the coyote finally catch the roadrunner?

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