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Not So Fast

Proving market performance requires detailed analysis.

Fortnightly Magazine - January 2010

Now that fuel prices have fallen recently from the highs seen in 2008 and wholesale electricity prices also have decreased, it might be tempting to attribute the lower prices to the restructuring of the wholesale electricity markets. Unfortunately, it’s a little more complicated than that.

To say fuel prices have been volatile in recent years would be a gross understatement. Natural gas prices in this decade have seen average monthly wellhead prices as low as $2.2 per thousand cubic feet (Mcf) in early 2002 to a high of $10.8/Mcf in June 2008. Then prices dropped again last fall to just below $3/Mcf in September 2009. 1 At this writing in early December 2009, futures prices again are well north of $4/Mcf. Coal prices too have been volatile, particularly northern and central Appala-chia coal spot prices that more than tripled to above $140 a short ton, before dropping back to the pre-2008 levels in late 2009. Other coal prices also saw significant price increases on a percentage basis in 2008, followed by declines in 2009.

Power prices too have followed a similar pattern. Looking only at PJM’s annual average real-time market prices, they increased from $31.6/MWh in 2002 to just over $71/MWh in 2008. 2 Monthly averages peaked in June 2008 above $100/MWh. In 2009, the monthly average prices have decreasedsteadily and were below $40/MWh for each month of April through September in 2009. These monthly averages were lower than any of the previous four years for the same months.

So what is the connection between fuel costs and electricity prices? Obviously there is a connection, but a few points should be kept in mind. First, natural gas has had a disproportionate impact on the price of electricity in RTO energy markets in some regions—that is, disproportionate to the amount of natural gas actually used to generate electricity. U.S. electric utilities saw natural gas costs increase from $2.6 per million Btu (MMBtu) in 1999 to about $10/MMBtu in the middle of 2008, a 285-percent increase. Coal costs for utilities also have increased, but at a relatively more modest pace, increasing from $1.2/MMBtu in 1999 to about $2/MMBtu for the same time period, a 67-percent increase. For PJM, average LMPs increased almost 127 percent from 1999 to the September 2008 price. During this time period, natural gas costs and the LMP seem to move up and down in near (but not complete) unison.

While natural gas cost appears correlated to the energy prices, gas accounted for only 7.3 percent of the generation in PJM during 2008; coal and nuclear sources accounted for almost 90 percent of PJM generation. This proportion of the fuels used to generate electricity has been about the same for several years.

The typical explanation for this disproportionate impact of natural gas on wholesale power prices is that natural gas often is the marginal fuel. In

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