This is a blog post I've been meaning to write for some time. New England is increasingly dependent on natural gas for power generation. This is unlikely to change anytime in the near future (good luck trying to build anything that isn't gas or renewables). In the last ten weeks, we've seen clearly that New England's heavy reliance on natural gas has a trade off which is extreme price volatility when physical natural gas supplies get tight due to high demand for natural gas from winter heating load on very cold days.
Although there are five natural gas pipelines in New England, the Tennessee and Algonquin Pipelines are the most important due to the volume of gas they deliver to the region and due to the high quality pricing data associated with New England zones of each pipeline. Prices for Zone 6 of the Tennessee Pipeline and Algonquin City-Gates tend to be similar. The stunning increase in price volatility in daily physical spot natural gas prices is clearly shown in the graphic below. The winter of 2010-2011 was cold and snowy and spot prices flirted with $15/MMBTU in January 2011 (which I thought was high at the time). Each winter and summer since then we've had some transient price excursions to near ten bucks, but nothing all that worrisome from the perspective of the consumer. Then, around Thanksgiving 2012 things started to get crazy.
This graph is very important for power prices because the New England deregulated electricity market, administered by the Independent System Operator of New England (ISO-NE), uses a pricing system where the spot price for power is set by the cost of the last marginal unit of supply used to meet the last marginal unit of demand. As demand increases, higher cost units come online to meet the increasing demand. This is called merit order dispatch. Most natural gas power plants do not have firm delivery contracts for natural gas. They take what is known as interruptible service and are price takers for whatever the spot price of natural gas is on the pipeline that serves them. They bid into the ISO-NE marketplace based on the spot price of natural gas, the heat rate of the power plant (to be discussed in future blog posts), and whatever margin they require. When prices for spot natural gas go berserk, natural gas power plants offer into the market at prices that reflect the cost of their input fuel. Now that ISO-NE is heavily reliant on natural gas power generation, this causes power prices to come unglued as detailed in the graphic below.
The purple bars represent the Algonquin City Gates Mid-point spot natural gas price. The blue represents the average ISO-NE Day Ahead Locational Marginal Price (DA LMP) of electricity at the Mass Hub pricing node. The natural gas prices are shown on the axis on the right side of the graph. Up until the last three months, spot natural gas prices over $20/MMBTU were very rare. Now, they seem to be occurring weekly. I'm going to delve deeper into this topic in the coming weeks, but I bet there are a lot of energy consumers out there who can't wait until spring.