U.S. Energy Policy and Its Development Strategies

SCHOOL OF INTERNATIONAL AND PUBLIC AFFAIRS

SHANGHAI JIAOTONG UNIVERSITYSHANGHAI, P.R.C. OCTOBER 22, 2004

ROBERT W. GEEPRESIDENT

GEE STRATEGIES GROUP LLC

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Overview• The policy basis in the United States for restructuring its

electric and natural gas industries to enable market competition to set prices

• How well thus far –- or not -- this policy has worked to achieve its anticipated objectives

• How this policy has led to fresh concerns regarding continued affordability and availability of energy

• What is being considered in the U.S. to address these questions

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Basic Cornerstones of Current U.S. Energy Policy

• Secure supply – generally maintained through diversity of fuel types and source locations

• Safe – no threat to public health and welfare

• Reasonably affordable

• (For electricity) Always available (i.e., reliable and not subject to unintended interruption)

• Clean (non-polluting to air or water)

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The Reality Today:

• Some supply may become increasingly reliant upon foreign sources, making energy security even more important

• Cost of fuel for energy (natural gas & electricity) will likely be volatile and rising

• System could become less reliable as demands grow and necessary infrastructure investment deferred because of lack of regulatory certainty

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Projection Through 2025: The U.S. Thirst for Energy Will Continue

Unabated

• U.S. electricity demand expected to grow by 1.8 percent annually (from 3,600 billion kwh to 5,500 billion kwh)

• Demand for natural gas expected

to grow by 1.4 percent annually (from 22.8 Tcf to 31.4 Tcf)

• Coal consumption will grow by 1.6 percent annually (22.2 quadrillion Btu to 31.7 quadrillion Btu)

Source: Energy Information Administration / Annual Energy Outlook 2004

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U.S. Electricity generation by fuel, 1970-2025

(billion kilowatthours)

• Although coal use has numerous issues, discussion today will be deferred

• Even with environmental challenges, it will remain the dominant fuel

• With a 200-year supply, U.S. is the “Saudi Arabia of coal”

• Major concerns center on natural gas because of supply availability and price volatility

Source: Energy Information Administration / Annual Energy Outlook 2004

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Key Milestones Over The Last Half Century

• For most of the last century, natural gas and electric power were highly regulated by government

• These services were considered “natural monopolies”, unable to draw competition because of high costs of market entry

– Natural gas wellhead prices controlled– Wholesale & retail power prices controlled

• However, by the 1970’s, natural gas shortages occurred because of lack of financial incentives for producers

• Also, electric power generation technology advances made efficient, affordable power from others more feasible

• Eventually, policy makers chose to deregulate prices (in most areas of the U.S.)

• Natural gas supplies grew and prices stayed level for almost a decade

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U.S. Natural Gas Markets Today: Issues Over Price

• Higher spot prices and greater volatility than seen during the 1990’s when gas prices were around $2.00 – 3.00 per MMBtu

– $6.50 – 8.00 per MMBtu in summer– $10.00 per MMBtu in winter

• Allegations of market manipulation being claimed by some, and state and federal investigations were triggered

• Role of traders/speculators questioned in driving up spot prices

• But reason can be largely attributed to economic forces of supply (which is declining) and demand (which is increasing)

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Current U.S. Natural Gas Domestic Supply Forecast through Year 2025

• Higher wellhead gas prices no longer yield greater gas production, contrary to prior wisdom

• More drilling necessary just to maintain production because of higher rates of production declines

• Despite more drilling, higher prices expected because of greater offshore drilling, and use of technology intensive practices

Source: Energy Information Administration / Annual Energy Outlook 2004

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New Sources Of Natural Gas Will Be Required to Meet U.S.

Demand

• Imported Liquefied Natural Gas (LNG)

• Alaskan production• Nonassociated

unconventional sources (tight gas, shale gas, and coalbed methane)

Source: Energy Information Administration / Annual Energy Outlook 2004

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Will LNG be the Answer?• Three dozen LNG proposals being considered

• Each faces daunting technical and permitting hurdles, slowing process of completion

• Safety & security questions raised

• Even if successful, raises reliance on imports thrusting U.S. energy security into global dependence akin to oil

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Electricity Generation’s Growing Dependence on Natural Gas

• Natural gas has become the “fuel of choice” for new power generation – Environmental advantages– Shorter lead times of completion– Improved efficiencies

• From 2000 to 2004, 200,000 Megawatts (MW) of new power plant capacity was added to existing capacity base of 903,000 MW

• 94 percent of this new capacity was natural gas fueled

• Currently, higher risks for power plant developers:– Exposure to higher fuel costs– Exposure to price volatility

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For New Electric Generation, Natural Gas is the Preferred Fuel

Source: Energy Information Administration / Annual Energy Outlook 2004

Annual Additions To Electricity Generation Capacity By Fuel, 1950-2002 (Gigawatts)

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Electricity Sector Market Reforms

• Until 1990’s, electric utilities held monopolies for transmission, distribution and generation services in all markets

• Early 1990’s: Federal government allowed creation of independent power producers, thereby creating a competitive wholesale power market and deregulating the generation sector; transmission and distribution remained monopolies

• Mid-1990’s: states began to require unbundling of services or functional separation of services/ some generation was sold to independent power producers

• Some states began allowing retail power competition

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But Notable Failures Have Occurred In Competitive Electricity Markets

• California badly designed its deregulated retail market, resulting in an economic and political crisis

• Wholesale prices surged when supplies were short

• Customers were economically harmed by unreasonably high prices passed on at the retail level

• One major utility underwent costly bankruptcy

• Voters removed the Governor of California in special election and elected instead an international action movie star and aging bodybuilder

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California’s Current Governor: A Warrior to Tame the Power Markets . . .

“Conan”

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Electricity Generation’s Current Dilemma: Overcapacity

• Markets are overbuilt with 25-40% excess and some as much as 100%

• Oversupply of generation capacity will last for at least five years in most regions.

• Natural gas and coal will continue to supply the vast majority of generation growth

• Natural gas price volatility will continue to affect electric prices

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But Undercapacity Plagues the Electricity Delivery Infrastructure

System!

• Disproportionate attention has been placed on generation • Transmission system investment has been declining for over 25

years by $115 million/yr in real dollars

Source: E.Hirst, Source: E.Hirst, “Transmission “Transmission Crisis Looming?” Crisis Looming?” Public Utilities Public Utilities FortnightlyFortnightly, , September 15, September 15, 20002000

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Policy Disputes And Regulatory Uncertainty Currently Discourage New Transmission

Infrastructure Investment

• Electric industry restructuring reform has resulted in diffusion of government oversight

• Lack of clarity over which government entity (state or federal) regulates transmission system

• Some states and federal government disagree over jurisdiction

• Transmission-owning utilities unwilling to invest if cost recovery left uncertain

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Proposals to Reexamine the Role of Government Regulation of Power

Generation• Basic Premises:

– Fuel diversity is essential to maintain public policy goal of energy security– Electricity prices must be affordable and fairly consistent over time,

allowing for periodic rate increases

• Many question whether competitive markets will achieve this alone • Others propose greater government role to oversee or mandate electric supply

portfolio:

– Combination of long-term contracted supplies and spot market supplies– Diverse fuel sources

• Others advocate full or partial resumption of government regulation over entire electricity industry, including power generation sector

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Lessons Learned from U.S. market reforms for natural gas and power generation

• Markets tend to function in a cyclical manner, sometimes causing shortages and surpluses of traded commodities (effects of supply and demand)

• Electric power and natural gas are no different -- if they are regarded as commodities, they will be subject to a “boom and bust” cycle

• But the public’s unchecked exposure to these forces can cause political problems and reactionary responses

• Opening natural gas and electricity sectors to market competition was not a mistake

– Consumers benefited from greater available volumes of affordable gas for a lengthy period

– Risk of failure remains on independent power providers, not utility customers

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Lessons Learned from U.S. market reforms for natural gas and power generation

(con’t.)

• But markets can be unforgiving

• Consequently, the proper role of government regulation and oversight needs continued rethinking

• Total reversal of market-oriented policy would be difficult, expensive,

and likely discourage capital urgently needed for infrastructure investment

• Need to properly balance market freedom with government regulation so that public is not asked to shoulder undue market risk

• Government policy can play a constructive role so long as it is focused, coherent, and consistent over time, allowing for fine-tuning calibrations

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Some Lessons for China’s Proposed Energy Sector Reforms• Learn from mistakes of others such as the U.S.

• There is no single “perfect” model for creating an energy market

• Take best practices from other countries

• Don’t delay reform to try to reach a “perfect” outcome, but endeavor to craft a workable scheme that avoids major, ex post facto corrections

• Don’t overreact if something unintended occurs

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Thank You For Your Attention

Xie Xie

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Robert W. GeePresidentGee Strategies Group LLC7609 Brittany Parc CourtFalls Church, VA 22304U.S.A.703.593.0116703.698.2033 (fax)rwgee@geestrategies.comwww.geestrategies.com