Fred Krupp, the president of the Environmental Defense Fund (EDF), published a commentary in the Wall Street Journal titled How Local Utilities Gamed the Natural Gas Market. The article subtitle briefly explains his theory – They booked large orders and then cancelled at the last minute, which pushed electric prices up by 20%.
Krupp’s commentary did not offer much in the way of explanation for why local gas distribution utilities in New England might engage in this kind of behavior. Instead, he makes a vague accusation implying that the gas distribution utilities purposely acted to “limit the amount of gas available to the generators that produce half of the region’s electricity.”
Since gas utilities do not compete directly against electricity in New England, it’s not clear why the companies would want to limit fuel to electricity suppliers.
Though I am not a New Englander, I’ve lived in the region through a couple of winters. I also have some family members who either still live there or who escaped to Florida after living there for a number of years. I say that as a way of establishing standing when making a comment about winter weather in New England. From memory, from family stories and from reviewing data, I can testify that winter weather can be harsh while also being frequently unpredictable.
Firm Delivery Contracting
Weather fronts can be delayed or accelerated with little notice. It makes perfect sense for a gas utility company that is a regulated monopoly with an obligation to serve its customers to enter into gas pipeline contracts with firm commitments to deliver sufficient gas. Their definition of sufficiency would include meeting expected heat demand plus a bit of extra gas in case the demand greatly exceeds expectations.
If the weather front gets delayed and usage isn’t as high as expected, there might be a small cost to the company that gets passed onto customers, but the cost of having a buffer is probably far less than the potentially catastrophic inability to deliver enough gas to keep people from freezing and gas-dependent businesses from having to close.
Krupp goes on to offer a confusing condemnation of the fact that pipeline companies would be happy to build additional pipeline capacity if they could find enough qualified customers to enter into firm delivery contracts similar to those used by gas utility companies. Those contracts carry a moderate premium price over interruptible delivery. They also require a commitment lasting up to 20 years.
Krupp is dismissive of the pipeline companies and their traditional position of requiring that they have customers committed to paying for capacity before they will build that capacity. He writes “the developers want their investment to be risk-free.”
The truth is that the developers need financing from investors and banks before they can spend billions of dollars building a pipeline. Those financial backers are the ones that – rather logically – require pipeline companies to have bankable contracts before they will lend them the money they need.
Betting On The Spot Market
Even though more than 50% of the electricity production in New England now comes from burning natural gas, electricity generating companies are not interested in paying the higher prices and making the multi-year commitment. They are better able to compete by gambling on the spot market to deliver gas at the lowest possible price.
Since they are under no obligation to serve, they have a simple answer when pipeline capacity fills up and they either cannot get fuel or have to pay prices that are several times the normal price. They can bid up the price of electricity to levels approaching $1000/MWhr or they stop generating.
Neither of those options are particularly customer friendly. Generating companies work for investors and believe that their fuel contracting practices make the most economic sense.
Krupp Says He Understands Supply And Demand
It was also rather amusing to note the following quote in Krupp’s piece.
“Econ 101 teaches what happens next. When supply goes down, prices go up.”
Perhaps he should hold some in house training and discussion sessions that emphasize that keen understanding. That way, EDF might begin to rethink its opposition to FERC action aimed at keeping nuclear and coal supply in the market. Like other groups that oppose the action, EDF is claiming that efforts to keep temporarily uncompetitive capacity in the market will inevitably lead to higher prices.
Exactly the same page in the Econ 101 textbook that Krupp mentions tells us that the loss of reliable supply will more likely lead to higher prices since demand is unlikely to disappear just because owners of a few large power plants decide that running them is not profitable enough to cover the costs and risks involved.
One of the reasons those reliable generators are failing to earn enough revenue is that they are forced to compete for sales and prices against virtually “fly by night” generators that burn the cheapest available fuel whenever it is available and quit the market when the going gets tough and customers need them the most.
Krupp is probably right to note that if gas fired power generators purchased fuel with firm delivery commitments, wholesale prices would be likely to increase. Customer bills might even go up. Concerns about pipeline constraints and worries about severe supply shortages should also disappear.
A complete presentation of the real effects might enable customers to recognize that it might be worthwhile to pay a little extra for the security and peace of mind that capacity buffers can provide. It would not be surprising if Krupp and his economist friends resisted, system slack and redundancy aren’t aimed at maximizing efficiency.
PS In 2015, the Environmental Defense Fund paid Fred Krupp $545,000 and provided a benefits package worth $62,000. He is one of seven executives whose compensation exceeded $300,000 in 2015.
EDF collected $135 M in contributions and reported a net asset base of $204 M.
Among their numerous contributors are companies like Chevron, XTO Energy (Exxon-Mobil), Valerio, and Transcanada.
NGO’s like EDF may be ‘non-profits”, but they are demonstrably not altruistic organizations. It is possible that some of their positions are influenced by the interests of their donors.