[BETA] Fortnightly

There are two major issues confronting power generators in the United States—the emergence of ample supplies of natural gas at moderate to low prices and the prospect of more stringent air emissions regulations, most notably the Cross State Air Pollution Rule (CSAPR). Each presents both threats and opportunities. How utilities respond will be driven largely by how they answer two questions—both relating to the underlying level of certainty of each trend.

First, how resilient will shale gas production be over the long-term?

And second, how will CSAPR fare against re-emergent political opposition and practical economic considerations?

Markets vs. Regulations

While forecasts for shale gas production vary greatly across different sources and points of view, even the lower-end consensus points to a significant shift in the fuel and generation dynamics in North America. Shale gas forecasts (see Figure 1) point to a gas supply whose growth outstrips demand even as drilling pulls back in response to low market prices. This points to a prolonged period of low-priced natural gas.

However, the low-price forecasts aren’t without uncertainties. Concerns over water and the seismic effects of fracking present regulatory risks if the industry can’t show it’s able to operate responsibly. Most important is the risk of success. Many of the shale plays require $4.00 to $6.00 Henry Hub pricing to provide adequate returns on capital. With current gas prices below $3.00 many of the shale plays are technically uneconomical for dry gas development. Ultimately, the current market is unsustainable.

Many industry players have shifted rigs to rich gas or oil shales to improve returns. While this shift will slow the growth of production, present volumes likely are sustainable due to structural considerations, including leasehold retention, tangential gas production from liquid plays such as in the Eagle Ford and Bakken shales, and more efficient production.

Annual investment at no more than current levels of $4 to $6 billion annually likely will be sufficient to maintain supply at current levels. This level of investment is highly plausible even considering the natural pull-back expected at current market price levels.

On the coal side of the equation, the future path of environmental regulation is becoming increasingly uncertain as the power and role of the Environmental Protection Agency (EPA) is hotly debated in Washington, D.C., and on the national campaign trail. How this debate plays out should influence how CSAPR ultimately rolls out. CSAPR requires many older plants to either upgrade their emissions equipment or face retirement.

While there’s significant argument within the industry on the eventual implementation and timing of these regulations, there’s a consensus that the EPA eventually will implement regulations that will place additional clean air requirements on power plants. Once this occurs, it will cause a substantial number of plants to be retired (see Figure 2) . However, while significant, coal retirements might not prove as dramatic as generally anticipated.

Booz & Co. estimates 29