Polar Vortex, Propane Shortages, and Power Price Spikes: Perfect Storm or Signal for Broader Debate?

The past few months have seen unusually cold weather in much of the country due to a combination of typical seasonal trends and a weather phenomenon called the polar vortex (a weather system that typically traps cold air in the Arctic that has temporarily come south). According to the Energy Information Administration (EIA), winter temperatures east of the Rocky Mountains are colder than a 10-year average. This unusual, prolonged, and geographically expansive cold snap has resulted in acute price spikes (and in some cases physical shortages) in some energy markets, including natural gas and propane. In some cases, these commodity price spikes have resulted in dramatic price increases in the electricity sector as well. These shortages and price spikes are in some ways the result of a “perfect storm” of events. But they also signal the need for a broader policy debate that acknowledges that resource sufficiency is not the only component of supply security. There is a need to widen the conversation around both heating fuel and electric power.

Natural Gas

According to EIA, the five highest values of total natural gas consumption since 2005 all occurred in January 2014. As a result of the dramatic demand spike, prices increased as well, with Henry Hub prices well above $5/mmbtu beginning on January 23 through the present, levels not seen since 2010 (on February 5, Henry Hub reached $7.90—a level not seen since 2008). In the Northeast power market, the spot price of natural gas exceeded the price of oil-based heating fuels—an unusual occurrence that resulted in some fuel switching from gas to oil in the region (from January 23–25, according to EIA, nearly a quarter of overall generation in the region was generated with oil compared to a normal level of less than 1 percent).

Spot prices in New York for natural gas reached $20.77 on February 5, compared with $27.45 in Chicago that same day (spot prices started the week in the $5–7 range), a record high only surpassed by a record set the prior week. High prices have resulted despite increased production (dry production is up 1.73 percent year-on-year) and increased imports from Canada (up 16.48 percent year-on-year). Consumption was up, due mostly to greater demand. High prices have led to record high storage withdrawals, with storage levels now below the five-year average.
 

Propane

Propane supplies have also been severely constrained. Propane is used in a variety of applications, including residential and commercial heating. Propane prices have risen dramatically, pushed up by cold weather-driven demand, pipeline capacity constraints and maintenance, low inventories, increased demand for crop drying in what was a bumper year, and reduced propane deliveries from Canada. High prices have led to a significant drawdown of propane stocks, which are about 44 percent lower than a year ago and the lowest they have been since 2011. Stocks in the mid-continent are particularly hard hit, reaching levels not seen since 2008. Meanwhile, the price of propane rose 4.8 percent in the first week of February. EIA expects that the winter average for propane prices will be 39 percent above last year’s average.
 

Electric Power

In the electric power sector, the series of cold snaps in the Midwest, Mid-Atlantic, and Northeast pushed power purchase prices above the allowable threshold of $1,000 per Mwh, leading wholesale market operator PJM (which oversees wholesale markets for all or part of 13 states in the Mid-Atlantic and Midwest and serves 61 million people) to ask the Federal Energy Regulatory Commission (FERC) for permission to waive wholesale price caps until the end of winter. Of the 10 highest winter electric power demand levels on record in the PJM Interconnection, 8 occurred this January. Similarly, in Texas, ERCOT (the wholesale market operator for most of the state) came close to instituting rolling blackouts, adding fuel to debates about whether a capacity market is necessary in the state. Then, a few weeks later, California called on consumers to conserve electricity and Southern California Gas Company (the largest natural gas distributor in the United States) informed its large industrial and commercial customers that they might have their gas supplies cut off (ultimately gas supplies were not cut).

Responses thus Far

Market participants and government actors at the state and federal levels are taking actions to alleviate the problems, including the implementation of temporary, emergency measures to loan money to propane wholesalers, provide low-income consumers with relief, ease restrictions on how many hours drivers can work before resting, and waive shipping restrictions to move more supplies. FERC took the unprecedented step of ordering a pipeline company to give priority to shipments going from Texas to the Midwest and Northeast. (Prudent and farsighted precautionary measures taken in New England by the region’s wholesale system operator beginning in spring 2013 also helped increase reliability in the region.) And Secretary of Energy Ernest Moniz signaled his intention to review the natural gas shortages in New England following an announcement by six of the region’s governors declaring their intention to work together and find new ways of siting new natural gas infrastructure in the crowded Northeast market.

In addition to California, ERCOT in Texas called for consumers to voluntarily reduce demand to keep the grid balanced for the second time in as many months (in January, ERCOT issued an emergency alert and stated that rotating outages might be needed to reduce load. The need for outages did not arise, but demand did hit a new winter peak on January 7). ERCOT released a statement that “some generation capacity has become unavailable due to limitations to natural gas supplies.” As noted above, the PJM market saw record costs as a result of natural gas price spikes, and the contentious issue of lifting price caps for electricity is now before FERC. PJM claims that lifting the price cap is essential to maintaining reliability, while others argue that the removal of the price caps would erode the current market structure and harm consumers. PJM granted the waiver on February 11. (It is worth noting that PJM, like ERCOT, issued calls for demand response, asking customers to voluntarily reduce consumption, and that was not enough to tamp demand or moderate prices.) New York’s wholesale market has also asked FERC to lift its price cap.

Perfect Storm or Larger Issues?

For many reasons these problems can be attributed to a perfect storm of issues. The cold weather doesn’t just affect demand—causing it to spike—it also impacts production in many gas-producing regions, such as the Marcellus, Utica, and Fayetteville shales. As a result of slower production and increasing demand, gas storage saw larger-than-average net withdrawals—significantly higher net withdrawals than the five-year average.

The question is whether persistent and unusually bad weather-related spikes in demand that cannot be matched by supply is cause for worry. Two arguments can be made that there is not much to be concerned about. First, there will always be seasonal volatility, and it is hard to imagine a system in which extreme weather did not trigger some price response. Second, these price spikes were not driven by supply insecurity, but by constraints in infrastructure. So, the argument goes, there is plenty of gas, but our infrastructure has lagged due to the unprecedented surge in areas of new production. Given time, the market will respond to demand pressure and eventually be able to accommodate larger volumes moving to places of traditional infrastructure congestion such as New England. In this view, price spikes are unpleasant but relatively temporary and are symptomatic of deliverability issues, not resource issues. This is cold comfort to people who either lack heat or power, or are worried about losing heat and power, in the face of severe and potentially dangerous cold.

While weather-related volatility and infrastructure lags are some of the causes of the recent price rises, these price spikes also point to broader issues. The first is about exports, and the implications that the current propane situation has on the debate over crude and natural gas exports. It is hard to explain to a public that has repeatedly been told that we are now rich in hydrocarbons that fuel shortages and higher heating costs are simply a temporary problem. It is even harder to explain why we should allow exports of a product that is in such short supply that states are declaring an emergency. There are no restrictions on propane exports. Yet despite high prices in the United States, propane continues to be exported. This causes a serious optics problem that those who want to ease the restrictions on crude exports or expedite liquefied natural gas (LNG) export permits need to confront. The real answer to why exports continued despite high U.S. prices is simple—international prices were higher (and in some cases there were long-term contracts that had to be fulfilled).

Second, there is a question of what role gas should play in the electric power sector. In California, natural gas demand has increased because of the shuttering of the state’s San Onofre nuclear plant in San Diego County. CAISO, the state’s grid operator, said that it was unclear whether the plant’s operation would have relieved the gas issues; nonetheless, it is clear that the electric industry has been relying more heavily on natural gas than was the case even five years ago—and is more exposed to price fluctuations as a result. The reliability issue has been raised by a diverse group of advocates to pursue differing agendas. Nonetheless, it is a legitimate issue. How much fuel diversity is necessary to ensure a reliable system? And is the issue of reliability one of fuel source diversity or one of regulation? For example, the regulatory answer is different if the problem is that utilities are poorly hedged or if it is symptomatic of the inherent risk in these unregulated markets. The polar vortex has put a much-needed spotlight on these issues, but it will certainly not be the last we hear of them.

The other issue is related to the electricity market structure in some parts of the country that impedes pipeline development and leaves utilities susceptible to natural gas price spikes. FERC requires new pipelines to demonstrate “market need” before they can be built—commitments from end users of 10–15 years for the capacity the new pipeline would provide, according to RBN. However, the New England power market doesn’t incentivize generators to make these long-term commitments. The wholesale market regulator is hesitant to allow generators to be compensated for plants that may only be needed during times of peak demand. Even though it would only be needed a few hundred hours per year, the fixed costs would have to be paid for by ratepayers regardless of how much it was needed. Until these issues are dealt with by FERC and by the wholesale market operator, resource sufficiency is not enough to guarantee supply. A similar debate is unfolding in Texas, for different reasons—how much additional generation should be incentivized, even if it is ultimately not needed?

While it is clear that U.S. energy resource adequacy is not the core problem behind these issues, resource adequacy is not the only issue that needs to be addressed to ensure that we are meeting our energy goals of security, reliability, and affordability.

The issue highlighted by the polar vortex is a broader policy question of how we manage sufficiency. Do we ensure that there is enough redundancy in the system to buffer against shortages related to short-term exogenous events (such as weather events)? This is one policy choice, but while it may provide some resiliency, it also creates inefficiencies in the system. The other end of the policy spectrum is to embrace efficiency and the profit business model—which forecloses keeping extra natural gas or propane on hand to resist the effect of high-impact, exogenous events. This is the heart of the matter being debated now in Texas about whether or not to require a capacity market (it is also at the center of nascent debate regarding what to do with the strategic petroleum reserve and whether it still meets our needs in a changed oil market). In short, we can have added cushion in the system—additional propane or natural gas or additional pipelines to get them into areas of need in times of shortage—but there is always an associated cost.

As we begin to grapple with resource sufficiency—and shift mindsets from energy scarcity to energy abundance—we will need to be mindful that seasonal issues and short-term infrastructure constraints are always a possibility. External events—whether they are weather systems or geopolitical events—are a fact of life. But how we are prepared to respond to them is a function of our policy choices. The challenge is not just to understand that we have enough within the United States, but to be thoughtful and deliberate about how to balance the competing policy aims of efficiency and resilience in our energy system.

Sarah Ladislaw is senior fellow and director of the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Michelle Melton is a research associate with the CSIS Energy and National Security Program.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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