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Energy Market Deregulation: Be Careful What You Wish For

Oil RIg Sunset

U.S. oil and gas companies are licking their chops over the prospect of deregulation, but they could be faced with too much of a “good thing.” Historically low natural gas prices are already throwing markets into turmoil. Incremental gas production unleashed as a result of a less stringent regulatory environment could exacerbate some of the challenges gas and power market players currently face. Wholesale power price weakness is eroding the economics of generating electricity in deregulated markets and depressed benchmark gas prices are weighing on gas producer profitability. Increasing gas production volumes would likely amplify these challenges.

The Trump administration has made clear that scaling back regulations in an effort to give corporations more operational freedom – particularly in the energy sector – is a high priority. And companies are excited about the prospect of navigating fewer regulations, even if some long-term policy uncertainty remains. “We certainly hope that the administration at least in terms of what they've talked about is going to give us a little bit of regulatory relief, which we think is good,” ConocoPhillips’ Chairman and CEO Rayan Lance said during their Q4 2016 earnings call. “We've seen President Trump make his decisions on DAPL [Dakota Access Pipeline] and on Keystone, so hopefully some of that infrastructure will get moving that's needed to be there,” Lance added. Related: Oil Has Room To Fall As Speculators Bail On Bullish Bets

But the U.S. gas market is struggling with an over-supply problem that is partially the result of warm winter weather which greatly reduced demand for the space-heating fuel. Even without regulatory changes, the U.S. gas production outlook appears headed for an upward trend as more rigs go back to work following last year’s price weakness.

(Click to enlarge)

Source: EIA

Easing regulations on an industry segment like pipeline construction would likely bring additional volumes to market and exert additional downward pressure on prices. The administration is also working to roll back Obama-era rules that limit venting and flaring methane. Companies complain such regulatory compliance would place additional administrative and cost burdens on their industry during a difficult commodity price cycle. Perhaps ironically, easing some of these regulatory constraints could help keep a lid on gas prices.

The power sector is another area that has been dramatically transformed by the tight gas revolution, which sent production soaring and natural gas prices plummeting. Cheap gas, along with increasing renewable energy production and flat demand has depressed wholesale power prices in many U.S. markets. Natural gas is used to generate electricity which is in high demand during hot summer weather when air conditioning use spikes. Fuel costs are one of the main components in the cost of generating electricity, so lower gas prices translate into lower power prices. As natural gas gained considerable market share from coal over the past decade, gas and power prices have become closely correlated. Related: The Oil Market Is At A Major Turning Point

Stagnant wholesale power prices have proved challenging for nuclear power generation, which has become unprofitable in most deregulated U.S. markets, pressuring investor-owned utilities to exit the merchant power business in some cases. Entergy is one example. “Key considerations in our decision to shut down Indian Point [nuclear plant] ahead of schedule include sustained low current and projected wholesale energy prices that have reduced revenues, as well as increased operating costs,” Bill Mohl, president of Entergy Wholesale Commodities said in a statement. “Record low gas prices, due primarily to supply from the Marcellus Shale formation, have driven down power prices by about 45 percent, or by about $36 per megawatt-hour, over the last ten years, to a record low of $28 per megawatt-hour. A $10 per megawatt-hour drop in power prices reduces annual revenues by approximately $160 million for nuclear power plants such as Indian Point,” said Mohl.

The EIA estimates Marcellus production will increase by 184 mcf/d month-over-month from March to April and that output from the Utica formation will grow by 100 mcf/d over the same period. And those estimates don’t account for any deregulatory impacts that could emerge over the medium term. Drillers operating in the Marcellus and Utica face infrastructure bottlenecks that impede transporting gas from the prolific production centers to higher-demand markets. If the Trump administration can successfully ease gas pipeline permitting and construction – one of its stated goals – it will bode poorly for power generators struggling with the same commodity price dynamics Entergy describes.

By. Jared Anderson for Oilprice.com

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