Natural Gas' Role in PJM

Posted on February 21, 2014
Posted By: Randy Burns

Conventional wisdom may say that natural gas is the primary fuel of electricity generation in the PJM region given the following two facts:

1.     The Calendar Year 2014 strips for NYMEX Henry Hub and PJM West Hub have been approximately 95% correlated since 2008.

2.     Natural gas usage for power generation has increased steadily since 2008 due to decreasing natural gas prices (in fact, Cal `14 gas futures have decreased 75% since 2009).

However, despite these two facts, the region is primarily fueled by coal and nuclear sources. In 2013, natural gas was only responsible for 17% for the electric generation in PJM in comparison to nuclear (37%) and coal (42%). The total of these three fuel types accounts for 96% of the total electric generation in PJM.

This region's fuel mix has remained fairly steady over the years when compared to other regions. Going forward, there may be more growth in natural gas generation due to recent EPA regulations intended to reduce carbon and mercury emissions. However, coal and nuclear power are solidly entrenched in the regional generation stack and change is not necessarily imminent.

So, why do the natural gas and power markets have such a strong correlation despite not owning the lion's share of the fuel source?

The answer lies in the methodology to determine the hourly power price. In PJM (and other regional ISOs), the power price is established by the last generation unit selected to meet demand at any given hour, which is known as the Locational Marginal Pricing (LMP). The LMP is the marginal energy cost, or the cost to serve the next increment of demand at the specific location, or node, that can be produced from the least expensive generating unit in the system that still has available capacity. Although it doesn't provide the bulk of the generation for each interval, natural gas is often the last generator to supply the grid due to its flexibility to be dispatched quickly on short notice whenever needed. Conversely, coal and nuclear plants are typically more associated with the base load generation or the amount of power needed to meet a region's continuous energy demand, but are not available or capable of providing the flexibility to meet the constant fluctuations of system demand.

Thanks to shale gas lowering the cost of gas generation, natural gas will likely continue to make inroads in the generation sector - likely at the expense of older coal plants being shut down.

Gas will continue to be the primary driver of prices. However, it will be difficult to reach a point where coal and nuclear fuel sources are not needed since these two fuels comprise almost 80% of the generation stack at this time.

Source: U.S. Energy Information Administration, Electricity Monthly Update 


Authored By:
Randy Burns graduated from Pennsylvania State University with degrees in Finance and Economics. After graduation, he launched his career at Griffon Energy Capital, LLC, a hedge fund located in Austin, Texas, where he worked as a trading assistant on the Natural Gas and Power Desks. Randy moved back to his hometown of Pittsburgh in January 2009 to work as a consultant for Co-eXprise, a firm focused on procurement solutions. He

Other Posts by: Randy Burns

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February, 26 2014

Don Hirschberg says

PJM? Is that Patty Jean Meyer who sells me GSC ( i.e. Girl Scout Cookies).?

March, 05 2014

Malcolm Rawlingson says

Thanks Don - and I though it stood for Peanuts Jam and Marmalade. I wondered what that had to do with gas prices. Must be getting old I think. :) Malcolm

March, 05 2014

Malcolm Rawlingson says

Seriously though this is a really good article and an accurate picture of what is really going on out there in the big wide world of energy.

I will make one comment though that it is not just the price of natural gas that has affected generation costs it is also the now widespread use of combined cycle plants that have effectively double the amount of electricity you can get from a cubic foot of gas, Combined cycle plants are pushing 70% efficiency nowadays - more than double what gas plants could deliver 20 years ago.

But as gas prices go up coal is the obvious next choice.


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