DIFFERENT FLEXIBILITY REQUIREMENTS BY SECTOR

Flexibility requirements vary greatly from sector to sector. Residential and small commercial2_{consumers experience large seasonal variations and generate}

a large requirement for flexibility and “swing”3_{, as their consumption is mainly}

for heating purposes. These customers cannot easily switch to other fuels. When they install gas-fired equipment, they become “captives” of their choice for the time it would take to install alternative equipment. Generally, they are economic captives for the 15-to-20-year lifetime of the equipment and are extremely vulnerable if the gas industry is unable to provide the flexibility they require. These customers’ demand can be characterised as highly price- inelastic4_{. Their demand shifts with temperature in the short-term and can}

increase rapidly when outside temperature drops. Their demand does, however, display some degree of price elasticity in the longer term, depending on the economic conditions of installing alternative heating equipment. Residential customers in the United Kingdom, for example, responded significantly over time to the gas price rises of the 1970s and early 1980s.

There are also non-interruptible consumers in industry, typically when gas is for process purposes. For example, when the heat from burning gas is directly

2 A distinction must be made between big and small commercial customers. Small commercial customers do not usually have the possibility to switch to alternative fuels, but big commercial customers, like airports or hospitals, generally have some back-up fuel and fuel-switching capability and a different gas demand profile. 3 The swing is the maximum gas monthly delivery divided by the average monthly delivery in a given year. 4 It should be noted, however, that residential customers can and do respond to price changes (by overheating

rooms in the case of low prices, for instance). But the fact that the price of gas to these customers tends to be averaged and lagged limits their ability to respond to short-term price fluctuations.

applied to a product, the process is sensitive to any interruption, as in making sheet glass. The advantage of gas over alternative fuels, which could be stored at the customers’ site, is its more uniform quality and its easier and more tailor-made handling. The non-interruptible industrial customers require a steady and reliable gas supply, but their demand is not influenced by exogenous factors as is demand for heating. These customers’ demand is price inelastic in the short-term, but is stable and varies only little with outside temperature. This is also the case in industries that use gas as a raw material, notably in the production of fertilisers. If the price of interruptible gas is sufficiently attractive, petrochemical companies may store their end product in order to provide insurance against a gas supply interruption.

Demand from some industrial and larger commercial customers is different. There are a number of energy sources that these customers can substitute for natural gas. Oil and natural gas liquids can both be used as feedstock in the petrochemical industry. Both oil and coal can be used to produce steam in the industrial and electricity-generation sectors. As a result, some large gas users have installed equipment which gives them the capability to switch quickly between these fuels, depending on price and availability. They will optimise their use of two or more fuels according to operating costs, principally fuel costs. In case of power generation based on gas, shutting down the power plant and taking electricity from the grid may be an alternative.

The ability to substitute one fuel for another varies considerably across IEA regions and industries. In many cases, it is possible to switch between fuels only for short periods or with considerable investment and a time lag. Among IEA countries, the short-term fuel-switching capability from gas into oil by power generators and industrial customers is limited at 3.5 mb/d5_{, corresponding}

to approximately 490 mcm/d. It is concentrated in only five countries: the United States, Japan, Korea, Germany and Italy. In most other IEA countries, switching capability is very small and available only for very short periods. Stocks of back-up fuel are not usually kept. Moreover, the alternative fuels for generators or industrial customers are likely to be more polluting than gas. With increasingly stringent environmental rules, switching from gas to oil may no longer be a real option. For these and other reasons, the quality of interruptible contracts varies considerably.

With the opening of the electric markets, the pattern for using gas in power generation has changed. Surplus power capacity can now be traded via the grid between different players and optimisation of power plant dispatch is no longer restricted to predetermined sets of alternatives under the control of individual players – for example, a utility having a portfolio of its own power plants. Electricity taken from or fed into to the grid has become a new alternative price benchmark for each player. In addition, the existence in some IEA countries of non gas-fired power plants, which have been mothballed, indirectly provides additional flexibility to the gas market. In some cases, these can be reactivated, thus freeing gas from power generation for use in other purposes. As new trading patterns and possibilities emerge in electric markets, the time periods for cost-optimising fuel switching become much shorter. Depending on price differentials and the resulting arbitrage possibilities, additional gas demand may be induced. But the new patterns will also allow a single customer to switch much more easily away from gas, as he has the whole electricity system as a back-up. In general, liberalised systems are becoming increasingly responsive to short-term price incentives.

With the increasing development of combined-cycle gas turbines for power generation, fuel-switching capability will become more limited. Dual-firing CCGT units requires distillate rather than residual fuel-oil for back-up. Switching from gas to distillate requires a much higher natural gas price to trigger it. According to James Jensen’s estimates6_{, switching to distillate only became}

effective when natural gas prices approached $6/MBtu during the US gas shortages in the winter of 2000, whereas switching to residual fuel oil became economic when gas prices reached $3.60/MBtu.