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CEIC-06-12

"The Value of Using Coal Gasification as a Long-Term Natural Gas Hedge for Ratepayers"
David C. Rode and Paul S. Fischbeck

Abstract:
Natural gas has become a commodity of extraordinary volatility, with a growing share of demand met by imports. Demand growth resulting from the rapid expansion of gas-fired power-generation capacity over the last decade has introduced a substantial element of fuel price risk into basic goods (natural gas and electricity) required by consumers, exacerbating the already-high level of price volatility in natural gas used for heating.
Because of the highly inelastic nature of both electricity and home-heating demand, volatility in natural gas prices can be a particular burden to residential and commercial consumers. Despite the potentially significant value to be gained from developing a means of limiting price risk for consumers, there are very few alternatives available for long-term hedging of natural gas prices. Coal gasification represents not only a means of obtaining a large long-term supply of natural gas at a reasonable price, but also one of the few alternatives available as a long-term physical hedge for natural gas price volatility. In this paper we determine the value of using coal gasification as a long-term hedge to consumers and discuss the potential value to gas utilities. Although the results presented in this paper can be applied generally, our analysis focuses specifically on the value to Indiana residential and commercial heating consumers of a proposed SNG project in Southwest Indiana.

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