Northeast Energy Direct Pipeline: Everyone is Right. . . so What is Wrong?

Introduction

Everyone is right. Every argument for and against the Northeast Energy Direct Pipeline I’ve researched is correct. . .but how can it be that we both need a pipeline and don’t need it at the same time? It turns out this not Scrodinger’s pipeline. It is less of a solution and more of a symptom of a massive overhaul in our energy underpinning that is accelerating unchecked; the bigger issue that should be a concern to all parties.

To explain, let me go over the background, explore the overall issue then dive into the deeper problem (if you already know the background feel free to skip ahead).

The Background1

High energy prices due to bottlenecks have been a perpetual challenge in New England. The reason is simple; we’re a fossil fuel island: we have no native sources (we import everything) and we’re at the last stop on national infrastructure. Traditionally the bulk of our fuel has been shipped in via rail, truck, ship, barge and pipeline however pipeline has become more important recently.

For New England, this is all about the Marcellus. New drilling techniques developed in the 1990s (hydraulic fracturing) allow for previously inaccessible shale gas to be extracted from the ground in Pennsylvania, New York and West Virginia leading to an explosion in domestic gas production:

This new gas is inexpensive so it has been quickly replacing other fossil fuels in New England — pay close attention to how small the purple area was in 1990 and how large it is now:

2
Note also how the top of the line is relatively flat; we’re not using that much more energy.

This is why even though we’ve more then doubled our pipeline capacity since 1990 (249%)3 it is still full during peak demand — pipeline gas is replacing coal, oil and nuclear very quickly. In fact it is now the dominant slice of our electric pie:

4

In many ways this is good:

  • Natural Gas is one of the least-dirty fossil fuels (compared to coal, oil and nuclear5)
  • Pipelines are not ideal but they’re arguably one of the least-dangerous fossil fuel transport methods (compared to trains, trucks, barges, tankers, etc).
  • It is a less foreign fossil fuel for New England (remember we have no native fossil fuels).
  • It is currently inexpensive
  • It appears to be available in large quantities

But if the shale gas is cheaper why did our electricity prices go up?

Remember how I said that Marcellus pipeline shale gas has been replacing oil, coal and nuclear? It also has been replacing natural gas transported in by ship (LNG):

6
Note the recent steep decline in LNG imports

as well as gas brought in via pipelines from other locations:

Growing gas production in Marcellus has already made an impact on U.S. gas transportation. As more gas has flowed out of Marcellus, less gas has been needed from the Rockies or the Gulf to serve the eastern United States. This new production has contributed to a reduction in natural gas prices and the long-standing price differentials between the Northeast and other parts of the United States. It has also caused imports from Canada to decrease.7

So electric generation is increasingly concentrated on one fuel source (natural gas) via one transport method (pipeline) from one location (Marcellus):

Our operating experience this winter revealed that the natural gas infrastructure in New England is even more constrained than we previously understood.8

Therefore when energy use peaks in the winter our generators must fight for the gas. . .but it is a game of musical chairs where they lose every time. Pipelines serve the long-term contracts first such as industrial users where as seasonal energy peaks are short-term contracts (they call it the “buying on the spot market”).

Think of it like a black friday sale. The prices are so cheap that everyone bum-rushes the store, the sale items run out and anyone who needs to buy a gift ends up paying higher prices. ISO-NE is the conflicted shopper — they’re directed to always go for the sale (cheap pipeline shale gas generation) but they must always leave the store with an item no matter the cost (the electricity can’t go out!)9

To work around the peak pipeline congestion, ISO-NE has been encouraging their generators to store as much fuel as possible before peak-demand hits. Much like a squirrel burying nuts for winter, they implemented the Winter Reliability Program. This does help because storing oil, coal, LNG, etc is much cheaper then playing pipeline musical chairs but it is difficult to do right because they need to be able to accurately predict New England weather. If they store too much our electric prices go up. If they store too little we’re right back to pipeline musical chairs and. . .you guessed it, electric prices go up:

Demand is constantly changing, challenging grid operators and suppliers responsible for ensuring that supply will meet demand. Consequently, they expend considerable resources to forecast demand. Missed forecasts, where actual demand differs significantly from the forecast, can cause wholesale prices to be higher than they otherwise might have been. [emphasis added].7

The Price Issue

So at quick glance this seems pretty simple and literally right out of the energy 101 handbook:

Pipelines and other equipment need to be sized to account for peak demand.7

and that is the road we’re headed down; the Federal Energy Regulatory Commission (FERC) is considering four pipeline projects over the next five years that combined will nearly double our existing pipeline capacity (88%)10. That is way more energy then we’ll use within New England11. . .but Interstate pipeline rules are clear; a pipeline can’t be built until it is proven that someone will buy the gas12. So who would buy the gas we would not use?

Let’s take a drive down that road to see what happened South of us when the cheap Marcellus pipeline shale gas hit the market:

13
Note the complete reversal in fossil fuel flow

New England is following the same path; in other words we’re going from being an fossil fuel island to an off-ramp on the new American natural gas superhighway:

The gas industry has been consistent and clear about this trend:

With the strong rise in U.S. domestic production, there is now a major trend to develop LNG export facilities in the U.S., in many cases reversing the flow of existing import facilities. Numerous companies have filed with the federal government for export licenses. The U.S. government is projecting that the U.S. will become a net exporter of LNG by 2016.16

What does this mean for our electric bills? This is the price issue — it is not clear. Why? We’ll still be playing pipeline musical chairs — the only thing that changed is that we’ll have double the chairs with double the number of people playing. The exporters will eventually consume all the gas in the pipeline in long-term contracts and when there is a bottleneck power generator’s peak short-term contracts will lose causing prices to spike.

This is the core of the public debate about price; if we were to remain a fossil fuel island like we traditionally had been then more gas supply would likely make prices fall. But this is not a static supply-demand curve. The proposed pipelines don’t just bring more gas they bring more demand. The game changes as we turn from a fossil-fuel last stop to an off-ramp on a highway that adds world demand to ours. Economists call this phenomina supply-driven demand and it is intuitive. Running an interstate highway through a city won’t necessarily help the local trip to the grocery store because you also have to contend with all the interstate traffic, too. Like an Interstate highway won’t necessarily make local commute times faster an international pipeline system won’t nenessarily make local prices lower.17.

With that, let me pause here — it is tempting to argue the price issue but it would overshadow what I think is the deeper economic issue.

Delving Deeper

Let’s re-visit what pipeline shale gas is replacing in New England:

  • Nuclear
  • Coal
  • Oil
  • Gas transported by ship (LNG)
  • Gas from other locations (such as the Gulf of Mexico)

So our energy is coming more and more from one fuel source (natural gas) via one transport method (pipeline) from one location (Marcellus). Just as every investor knows not to put all their money in one stock, it turns out that the risks in managing an emerging Marcellus monoculture is well-known in the energy circles; below are a few examples:

The three planning authorities [NYISO, ISO-NE, PJM] have discussed these studies and key planning issues affecting the Northeast with stakeholders. Some of these issues include environmental regulations and their potential effect on the power system, challenges and solutions facilitating the integration of renewable resources, the need for fuel diversity, and the results of coordinated studies of the natural gas system.18 [emphasis added]

New England has fuel diversity, certainty, and flexibility issues. The region relies heavily on natural-gas-fired capacity, and serious and growing reliability problems have emerged because of fuel constraints of the natural gas delivery system and both the cost and availability of liquefied natural gas (LNG).18 [emphasis added]

Now before I go any further I want to make one point clear that I am not advocating we go back to oil, nuclear and coal. There are many methods to check and balance risk when the markets go too far; for example, when banks take risks they are required to increase cash reserves so they don’t collapse the banking system. When the stock market takes a nose-dive the exchanges have circuit breakers that pause trading and give them time to evaluate what is happening. In fact, I am not advocating for anything in particular; I am highlighting the problem.

So with that, what hedges the risk of a Marcellus monoculture? After reading hundreds of pages of energy reports it is not clear; all the relevant agencies appear to be aware of it but lack tools and authority to address this big picture item. Let’s look at the national level, the regional level, the states and the markets:

At the national level, the FERC doesn’t look at why a pipeline is needed, it regulates how to create it (what route it takes, what the tariff will be, who controls the pipeline, etc). This is surprisingly clear in their policy:

In sum, if an applicant can show that the project is financially viable without subsidies, then it will have established the first indicator of public benefit.12

...there are three major interests that may be adversely affected by approval of major certificate projects, and that must be considered by the Commission. These are: the interests of the applicant's existing customers, the interests of competing existing pipelines and their captive customers, and the interests of landowners and surrounding communities. There are other interests that may need to be separately considered in a certificate proceeding, such as environmental interests.12

In pipeline decisions the FERC thoughtfully listens to considerations like risk but when pressed they appear to be limited by their own policy do the regulatory equivalent of throwing their hands in the air and saying “not it”:

However, the FERC as a matter of policy and in accordance with the Natural Gas Act and other governing regulations, does not direct the development of the natural gas (or other energy types such as solar power) industry's infrastructure regionally or on a project-by-project basis, nor does it have the authority to permit or approval solar energy projects. As such, the FERC staff's evaluation of reasonable alternatives does not include setting project objectives, determining what an applicant's objective "should" be, nor does it include redefining the objectives of a project.19

In a nutshell, if a developer can show they can fill a pipeline the big-picture question of why (or whether) is settled.

So if the FERC doesn’t look at the bigger-picture why, that punts the problem down to the regional operator, ISO-NE. Do they handle it? We already established they are well-aware of the issue but it turns out that they don’t have many tools; they have some short-term levers like their Winter Reliability Program but in the long-term they’re severely boxed in by two things: 1) what type of electric plants developers want to build and 2) what pipelines developers want to build:

New England also faces the retirement of non-gas-fired generation, which will likely increase the regional reliance on natural-gas-fired generation.18

Unlike the electric power industry, which builds infrastructure in anticipation of demand, interstate natural gas pipeline companies build or expand pipeline capacity using a business and regulatory model that requires gas shippers and customers to enter into long-term firm commitments before the infrastructure can be developed.18

So they side-step the problem of dwindling diversity and focus on making gas supply meet gas demand by bringing in. . .you guessed it, more gas:

Recent improvements to the interregional natural gas infrastructure have helped increase the supply of natural gas from the Marcellus Shale production areas, displacing the Northeast's traditional supply sources, such as the Gulf of Mexico. Additional enhancements to the regional pipeline network are planned and would allow New England to access the larger quantities of natural gas for the region's power generators. Further expansion, however, is likely required, which would improve fuel certainty for the electric power system and provide access to more economical natural gas supply.18

 

Then they effectively say “not it” and prop the all eggs in one basket problem up on two legs: 1) The markets and 2) The states:

Investment in new generation ensures that the grid operates reliably and that adequate supply is available to meet demand. Because private firms make this investment and not public utilities, consumers are shielded from the investment risks they had been exposed to before the introduction of competitive markets. ...Tomorrow's Energy Mix: State Renewable Portfolio Standards (RPS) promote the development of renewable energy resources by requiring electricity providers (electric distribution companies and competitive suppliers) to serve a minimum percentage of their retail load using renewable energy.20 [emphasis added]

First, let’s look at the markets. At this point even if you can’t understand regulator-speak or financial markets your spidey senses should be tingling because it is both circular logic and nebulous (the markets will safe-guard against risky market-driven behavior). Nonetheless let’s unwind how it works:

A key financial contract structure used in natural gas and electric markets is the swap, or contract for differences. The CFTC defines a swap as an "exchange of one asset or liability for a similar asset or liability ..."7

These are derivatives and derivatives are a tool that protect against market fluctuations. The general idea is if you duct-tape together lemmings it will protect them from transient problems like hawks. . .but the key is it won’t stop the herd from jumping off a cliff21. Derivatives work, they’re just not the tool that protects against systemic (big picture) issues. It is like saying seat-belts will protect us from speeding. Speed limits set outside of the car protects against risky speed choices just like policy outside of the markets protect against risky portfolio choices. In other words the markets themselves don’t hedge any risk of a Marcellus mono-culture.

But what about the states’ renewable portfolio standards (RPS)? This does help balance our Marcellus-heavy portfolio and it is the right direction but the wrong scale. It is like trying to balance out an elephant with a lively squirrel. Look again at the charts earlier in this article. To make the renewable slice of the pie as big as the gas slice we would need to grow renewables to 50% of our portfolio as fast as the pipelines are coming in — in about five years. We would need a program that makes Germany’s energiewende look like child’s play. I’m not saying it is not possible but I am saying that it is irresponsible and unrealistic to dump the energy diversity issue solely on the states without a renewables and efficiency plan that is at least as massive as the shale gas boom.

So what does this all mean? New England is going all-in on Marcellus pipeline shale gas and there is effectively nothing realistic to hedge the risk. This is a much deeper economic problem.

Conclusion

I said in the introduction that the Northeast Energy Direct pipeline is a symptom, not a solution. It is not clear if the pipeline is beneficial to us from an energy-cost perspective. The economics that are clear, however, is that there is no check nor balance on our current path. Turning over more of New England’s energy portfolio to one fuel source (natural gas) via one transport method (pipeline) from one location (Marcellus) without an accompanying risk-management plan of the same scale is reckless. Moving away from the dirtier fossil fuels is certainly good; doing so recklessly risks undermining all the progress we have made.

This is a solve-able problem with solid solutions but the key now is to focus and consolidate on what we want and then bring together the experts22. Looking back, this is much like mid-century transportation policy that both brought us our wonderful interstate highway system but also had the unintended consequence of tearing down 1/3 of old Boston to build a highway to it. Analysis about what went wrong back then seem shockingly familiar in our energy debate and can guide our path forward:

It became clear that citizens could not effectively contribute to a highway decision by the time the project had already been designed. Many of the concerns related to the basic issue of whether to build the highway project at all and the consideration of alternative modes of transportation.23

Freeways cannot be planned independently of the areas through which they pass. The planning concept should extend to the entire sector of the city within the environs of the freeway. The conference recommendations reinforced the need to integrate highway planning and urban development.23

The planning process had still not become multimodal and was not adequately evaluating a wide range of alternatives.22

What did they do back then? Governor Sargent implemented a moratorium on new highways within the 128 belt and empowered the experts to encompass the big picture. Some may argue whether the results were ideal but they certainly are better then the path we were headed down. We need to take charge of our energy path and re-focus it to the big picture.


1: I’ve explained many complex and technical things from powertrains to the Internet backbone but I’ve found this particular subject extremely difficult to balance accuracy, scope, background, readability and frankly, how much time I’ve spent on it. For example, if I explain in great detail it becomes accurate, convincing and harder to attack. . .but it will be boring and few will read it (eyes quickly glaze over when I use terms like “demand elasticity” and “spinning dispatch”). If I keep it short it will be no better then the one-line sound-bites like we need the pipeline to lower our electric bill (which is easy to understand but completely misses the core issues). I’ve come to the conclusion that my goal is to explain it better then the sound-bites but be easier to read then the technical reports and live with the risk it is wide open for attack.

2: CERC: Shedding Light on Electrical Generation July/August 2014

3: EIA State to State Gasline Capacity

4: ISO New England -> Key Facts -> Resource Mix

5: Yes, nuclear has lower emissions then natural gas but there are other well-known complex fuel issues.

6: Northeast Gas Association: The Role of LNG in the Northeast Natural Gas (and Energy) Market

7: FERC Energy Primer

8: US Department of Energy — Quadrennial Energy Review Meeting

9: The most extreme case of the conflicted-shopper syndrome was the California energy crisis in the early 2000s; when Enron was playing games and manipulating the energy market PG&E had to buy whatever was on the market no matter the price. The end-result was rolling blackouts and PG&E going bankrupt despite ample energy supply!

10: EIA Gas Pipeline Projects

11: Massachusetts Low Demand Analysis

12: FEDERAL ENERGY REGULATORY COMMISSION STATEMENT OF POLICY

13: I need to track down where I got this image from and will update this as soon as I do. If someone else finds the source before I do please let me know!

14: www.Fool.com: 3 High-Yield Stocks That Could Have the Solution to New England’s Gas Problem

15: Spectra Energy: Atlantic Bridge Project

16: The Role of LNG in the Northeast Natural Gas (and Energy) Market

17: To know whether increased supply will lower prices one has to know what the demand will be. For an example of how hard world demand is to predict, see the cavets listed on page 10 of the EIA’s 2014 Effect of Increased Levels of Liquefied Natural Gas Exports on U.S. Energy Markets. That list of unknowns does not even include things like geopolitical events!

18: ISO-NE Regional System Plan 14

19: Final Environmental Impact Statement for the Constitution Pipeline and Wright Interconnect Projects (CP13-499-000 and CP13-502-000)

20: ISO New England -> Key Facts -> Resource Mix

21: Yes, lemmings mindlessly jumping off a cliff is a myth however it is still a useful metaphor.

22: When there is laser-like focus on problems the solutions are unleashed. There are brilliant people in the energy circles (much smarter then I) and they, too, see the issues but I believe a general fear of one particular solution (going back to oil, coal and nuclear) is making many side-step the problem — but the paradox is if we ignore the problem we also ignore all other [much better] solutions!

23: Urban Transportation Planning In The US – A Historical Overview/Nov 1992

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Northeast Energy Direct Pipeline: Everyone is Right. . . so What is Wrong?

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