Tuesday, January 5, 2010

The Price of Energy - Part 2


This is the second of a two-part blog on the Price of Energy. (See Part 1 here.) Let me reiterate that the Price of Energy is nowhere near the Cost of Energy. This is perhaps the biggest market failure of all time. We are just realizing the social, health, and environmental costs of energy. But they have yet to be factored into the price.

In any event, here's the rest of the short primer on the Price of Energy.

PROPANE - Propane is methane's poor stepsister. It comes up with oil and natural gas. But propane condenses into liquid at or near ambient conditions, so the natural gas people don't want it in their pipelines (that are designed to move a gas). On the other hand, propane's energy density is relatively low, and it doesn't come up in the amounts that oil does. So it's not worth transoceanic transport. Propane is transported in railroad cars and trucks. So propane is another "continental" market. But the price of propane is tied, not just to its energy content, but to the price of the gasoline needed to transport it. Indeed, the price of propane tracks the price of oil, and peaked last year at about the same time the price of gasoline did in the US.

COAL - Here's everyone's least favorite energy source, the dirtiest to extract and use. Unfortunately it's also the most abundant. The harder, more desirable coal comes from deep mines. Softer, less energy-dense coal comes from strip mines or mountaintop removal. Either way, they burn a lot of diesel getting it out. It's mostly used for power plants and in the steel industry. But those are pretty big users! Coal is mostly transported by rail and truck. (More diesel.) There is some international transport by ship. So the price of coal is driven by the demand for electricity, but it is heavily influenced by the price of oil.

ELECTRICITY - Electricity is a derivative form of energy. You just don't pump it out of the ground. The price of electricity is affected by the price of the source energy and the demand. The source energy comes from many things - natural gas or coal fired generators, dams, nuclear plants, wind turbines, solar panels. All sorts of stuff. In general, though, there are few oil-fired power plants, and source energy is limited to at most "continental" markets. Electrical networks, however, tend to be regional. So the demand is subject to regional influences. The end result is very complex. For example, the Seattle City Light rate increase I mentioned earlier.

Seattle City light gets the majority of its power from hydropower dams. When there is extra, which is pretty often, they sell it into the regional grid that extends down to California. In California, there are a lot of natural gas fired power plants. So when the price of natural gas is high, or when demand is such that they can't meet it with existing power plants, California utilities seek to buy our hydro power on the open market. And we sell it to them. In fact, those sales subsidize our own usage, and we pay lower electrical rates than most anywhere else in the US thanks to the California consumer.

But when the price of natural gas goes down, as it has now, or demand drops, as it has now, the California utilities prefer to generate their own power and not buy any on the open market. That leaves utilities here in the Northwest with a budget gap. There's suddenly a big hole in the revenue stream that needs to be plugged by a rate increase.

So that's a top-level explanation of the energy markets, and it's clear that "energy is not just energy." If you are planning for a company or an economy, the form of the energy you use is indicative of the risk you are assuming. It is well-worth drafting an Energy Risk Management Plan to spark discussion and plot a risk management path ahead.

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