Shale Glut Driving Down Electricity Prices

Electricity prices in the U.S. have declined by 50 percent since 2008, driven down by abundant new supplies of natural gas coming from shale exploration.

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Natural gas has become the cheapest option for new power generation, reducing investments in costlier energy projects, from wind farms to nuclear plants, while helping to drive down electricity prices, which have historically been linked to the gas market.

Electricity prices have dropped more than 50 percent on average since 2008, and about 10 percent during the fourth quarter of 2011. Prices in the west hub of PJM Interconnection LLC — the largest wholesale market in the U.S. — declined to an average of $39 per megawatt hour in December 2011, from $87 per megawatt hour in the first quarter of 2008.

Falling prices have taken a toll on profit margins as more generators are expected to postpone or abandon coal, nuclear, and wind projects that might have shifted the industry to cleaner forms of energy for decades to come.

“You’re lowering the earnings ceiling every time natural- gas prices drop,” said Mark Pruitt, a Chicago-based independent industry consultant and former director of the Illinois Power Agency, which negotiates power-purchase agreements for the state’s utilities.

Declining prices are expected to hurt fourth-quarter earnings and continue to depress profits in 2012. Independent power producers in unregulated states, such as Texas and Illinois, will be the hardest hit, as they don’t have the protections given to regulated utilities where states allow a certain level of profits.

Hydraulic fracturing and horizontal drilling have allowed producers to tap natural gas deposits locked in dense shale rock formations, particularly the gas-rich Marcellus shale in the eastern United States. The glut of gas that resulted has caused prices to decline since 2008.

Cheap gas makes it difficult for rival forms of energy to compete. Gas-fired generators have historically been the least expensive to build, but were offset by higher fuel costs. Now that gas is below $3, other forms of producing electricity have become less competitive.

The cost, including construction, to produce a single megawatt hour of gas-fueled electricity was $62.37 in the third quarter of 2011 — less expensive than coal, wind, or solar generators. But the problem with natural gas is that it is subject to huge price swings.

In 2005, gas prices climbed to nearly $14 after hurricanes disrupted production in the Gulf of Mexico. Now project cancellations are leaving the industry with fewer alternative sources of energy should any supply disruptions drive up the price of gas.

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To contact the reporter on this story: Emily Knapp at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com