2006 Energy Forecast

Gordon H. Hart

March 1, 2006

2005 was a turbulent year for energy prices—and a costly one for consumers. This article explores factors that affected energy costs in 2005, projected demand and costs for 2006 and beyond, and related opportunities for the insulation industry.

Energy Demand and Prices Expected to Increase

First, the bottom line: According to the Energy Information Administration (EIA)—which provides official U.S. governmental energy statistics—in 2006 and 2007, total domestic energy demand is anticipated to increase about 1.4 percent annually, leading to continued market tightness and high prices for oil and natural gas. EIA reports, “Prices for crude oil, petroleum products and natural gas are projected to remain high through 2006 before starting to weaken in 2007.” Figure 1 provides a summary of 2005 averages and projected energy costs for 2006 and 2007.

A comparison of the price of crude oil from December 2004 to December 2005 dramatizes the projected increase. In that year’s time, the per-barrel price increased from $43.50 (in December 2004) to $60.31 (in December 2005)—an increase of 39 percent. For the average consumer, who does not focus on the price of crude oil, the higher cost of energy hit home at the gasoline pump. There, the higher price of crude oil and shortages in refining capacity led to dramatic increases. According to Oil & Gas Journal, average gasoline prices in Indianapolis, for example, increased from $1.690/gallon on December 29, 2004, to $2.154/gallon on December 29, 2005—up $0.46/gallon. Gasoline prices increased to around $3.25 per gallon within a week after Hurricane Katrina. That is the highest Americans have ever seen gasoline prices, even when adjusted for inflation. Although the price did not stay that high for long, it made $2/gallon gasoline look cheap by comparison.

Hurricane Recovery

EIA reports that natural gas and crude oil production, as well as refinery output, continue to recover from Hurricanes Katrina and Rita. At the beginning of January, according to EIA, “some 27.4 percent of normal daily Federal Gulf of Mexico oil production and approximately 19.5 percent of Federal Gulf of Mexico natural gas production remain shut-in due to the hurricanes.” In New Orleans, while some crude oil refineries are operating below normal capacity, all but one are back in service. The final refinery was expected to be back in operation in the first quarter of 2006.

Winter Heating Expenses

One area where consumers will feel the effects of higher energy costs is in their winter heating bills. Figure 2 summarizes EIA’s projections of increased costs for residential heating in winter 2004 to 2005 over the previous winter’s bills. These increases are expected despite early savings in the winter season, as October and November were relatively warm. December was colder than usual, and higher energy prices overall are expected to push expenses up for the following modes of space heating.

The EIA notes that these projections, which provide “a broad guide to changes from last winter,” are dependent on conditions such as local weather, heating equipment in use, thermostat settings, and individual home size and heating efficiency. Although not listed explicitly in the EIA summary of factors, insulation clearly plays a role in how well an individual house/household will weather the winter’s increased energy prices.

Natural Gas

North American homeowners who live in cold-climate areas and rely on natural gas heat have already received their first winter heating bill, and likely saw an increase over last year’s. According to Oil & Gas Journal, the wholesale price of natural gas almost doubled between December 2004 and December 2005, rising from $7.24/million Btu (MMBtu) to $14.26/MMBtu. To bring the broad numbers home, this author’s household saw a rise in the natural gas bill from $212 in December 2004 to $375 in December 2005—a 77-percent increase! Certainly, a good part of that was due to colder weather in late 2005 compared to late 2004, but a large portion was from higher natural gas prices charged to homeowners. In the example provided, the unit price increased from $11.40/MMBtu to $14.31/MMBtu—a 24 percent increase over one year.

According to EIA, because the price of natural gas is still high, and the coming summer (2006) is predicted to be cooler than summer 2005, the total 2006 natural gas demand likely will stay near 2005 levels before increasing (by 1.3 percent) in 2007. Figure 3 summarizes EIA projections for residential and industrial demand.

The demand for natural gas used to produce electricity is projected to fall in 2006 (by 4.7 percent), according to EIA, “because of the assumed return to normal summer weather, then increase by 2.4 percent in 2007.”

It is estimated that domestic dry natural gas production fell 3.1 percent in 2005, primarily as a result of hurricane-cased infrastructure disruptions in the Gulf. Dry gas production is expected to increase in 2006 by 3.8 percent, then increase another 1.1 percent in 2007. Total 2006 liquefied natural gas (LNG) imports are anticipated to increase from 650 billion cubic feet (bcf) in 2005 to 950 bcf in 2006. LNG 2007 imports are projected to climb to 1,200 bcf.

At the end of 2005 (December 30), working gas in storage was estimated at 2,641 bcf, or 79 bcf below levels of a year ago (although still 168 bcf over the five-year average). Storage levels at the close of 2006 and 2007 are expected to be near the five-year average.

One byproduct of high natural gas prices is an exciting new application for mechanical insulation: LNG receiving terminals. These facilities, which operate at cryogenic temperatures of -260 F, require large quantities of cellular insulation on the piping, huge quantities of expanded perlite on the storage tanks (on the tops and sides), and cellular glass (on the bottoms). Since LNG, as a means of transporting natural gas to North America, requires wholesale prices to exceed at least $3/MMBtu, today’s economic environment is very encouraging for construction of new LNG receiving terminals. Consequently, there are several LNG receiving terminals in the permitting/design/construction process in North America. When these are all online (by 2009), they will have increased U.S. LNG receiving capacity from about 10 million tones/year to about 60 million tones/year—a six-fold increase. That is a dramatic and direct consequence of sustained high natural gas prices in North America, in the recent past and into the future.

Petroleum

As painful as the natural gas heating bill scenario is to report, households using heating oil have not fared any better, with increases in delivered heating oil prices reported, too. In the global market, EIA forecasts a slowdown in the stable increases seen in the prices of crude oil and petroleum products over the last two years. In fact, a reversal is expected, although not large enough to yield dramatic reductions. According to EIA, “Many of the same factors that drove world oil markets in 2005, such as low world spare oil production capacity and rapid world oil demand growth, will continue to affect markets in 2006-2007.” Additional factors that are more difficult to quantify—although certainly not without great potential impact—include the hurricanes and other extreme weather conditions, as well as geopolitical instability.

In the United States, total 2006 petroleum demand is anticipated to average 21.0 million bbl/d, 1.7 percent higher than the 2005 level, according to EIA. That figure is expected to rise another 1.9 percent in 2007. The demand for motor gasoline is also projected to rise—about 1.7 percent/year, keeping up with highway travel growth.

EIA reports the average U.S. price at the pump for regular gasoline reached $2.24/gallon on January 2, 2006—up 9 cents/gallon from early December 2005, and 46 cents/gallon over the same time last year. While distillate and jet fuel inventories are higher than last year’s levels, “motor gasoline and residual fuel oil inventories continue to lag behind,” according to the EIA report.

EIA also notes “Several new petroleum product regulations [ultra-low-sulfur diesel fuel, the phasing out of methyl tertiary butyl ether (MTBE), Tier 2 gasoline requirements, and the renewable fuels mandate] are expected to have a noticeable impact this year.” They estimate an additional cost of 4 to 6 cents/gallon for producing and distributing ultra-low-sulfur diesel fuel.

Additionally, according to the EIA report, “removal of MTBE as a blending component from motor gasoline, another pending change, will likely increase gasoline prices and possibly lead to greater price volatility: Some MTBE removed from the gasoline pool may be replaced by ethanol, which continues to grow in supply.” In summation, the report notes, “While major supply disruptions are not expected, these new regulatory constraints and uncertainties may contribute to price volatility in some regions of the country.”

Electricity

Electricity demand, driven by weather factors and continued economic growth, is expected to increase by 1.3 percent in 2006 and another 1.6 percent in 2007, according to EIA. Prices for electricity in the residential sector are projected to run from “8 cents per kilowatt-hour (kW-hr) in the West North Central region to 13.8 cents per kW-hr in New England.” 2007 prices are projected to stay near 2006 levels.

Perhaps the biggest impact of higher fossil fuel prices on mechanical insulation is the structural changes coming to the electrical power industry. From about 1998 to 2003, electric utilities and independent power producers added over 200,000 MW of natural gas-fired electrical generating capacity in the United States. This was done when natural gas was inexpensive, below $4/MMBtu wholesale. Today, many of these plants are too expensive to operate as baseline units (i.e., units that operate 24×7). In contrast, coal is a relatively inexpensive fuel, at about $1.50/MMBtu—a fraction of the cost of fuel oil or natural gas.

Consequently, there recently has been a renaissance of interest in coal-fueled plants. Currently, there are some 120 new coal-fueled electric-generating stations in the United States being permitted, designed or constructed. While several different designs are being implemented, all must meet current Clean Air Act requirements, so they must have the equipment to reduce primary pollutants: fly ash, sulfur oxides, nitrogen oxides and mercury emissions. Air pollution control equipment (such as precipitators, bag houses, scrubbers and selective catalytic reducers [SCRs]) generally require huge quantities of thermal insulation to operate correctly. Likewise, about 500 existing U.S. coal-fired, electric-generating stations need to be retrofitted with scrubbers and SCRs, also requiring large quantities of mechanical insulation.

Coal

The demand for coal from the electric power sector in 2006 is projected to increase 2.2 percent, then to rise another 1.2 percent in 2007, largely in response to higher oil and natural gas prices. EIA reports that coal production in the United States will likely grow by 3.9 percent in 2006 and stay at that level in 2007. The price of coal to this sector is expected to increase, but at a slower rate than experienced in early 2005. Coal prices in the electric power sector are anticipated to increase in 2006 an average of 5.5 percent, and an in 2007 an additional 2.6 percent—increasing from $1.54/MMBtu in 2005 to $1.66/MMBtu by 2007.

Coal conversion technologies represent another area that could lead to increased use of mechanical insulation. Examples include the use of coal to make methane gas (the main ingredient in natural gas), or use of coal to make diesel fuel. Both of these processes require large chemical plants that operate at high temperatures, needing mechanical insulation for successful operation. Several plants are in the early permitting stages. Certainly, with natural gas selling at more than $10/MMBtu, and coal at $1.50/MMBtu, there is a huge price disparity that would encourage investment into expensive coal-conversion technologies.

Nuclear Power

As with coal, nuclear power is in the early stages of a renaissance. While two years ago no electrical utilities were talking openly about constructing new nuclear plants, now several are. Some have even started the permitting process for new plant construction. While it is expected to take a decade to bring any of these new plants online, and mechanical insulation is added near the tail end of the construction cycle, the impact on the mechanical insulation industry will be significant. As with coal-fueled power plant construction, the primary economic force encouraging construction of new nuclear power plants is expensive refined oil products and natural gas.

Impact of High Energy Costs on Industry

Industry has experienced increases in energy prices similar to those that consumers (drivers and homeowners) have seen; and has had to respond to the new, higher prices of a gallon of heating oil, a million Btu of natural gas, and a kW-hr of electricity. While companies do not pay as high a unit price as the homeowner does, industry consumes large quantities. In May, one oil refinery engineer noted that about 40 percent of his refinery’s operating costs were to purchase natural gas, which at the time was about $7/MMBtu cheaper than it is today. Today, the portion spent on natural gas is probably more than 50 percent of total operation costs at that refinery. Oil refining is an energy-intensive industry, but it is not the only one. Many chemical industries are energy intensive, and many material manufacturing processes that require drying are energy intensive. Even some segments of the insulation manufacturing industry are energy intensive, such as fiberglass manufacturing, which requires large quantities of heat to produce molten glass.

What do higher energy prices mean for industry in general? The more energy-intensive production is, the more production costs have increased. If, in 2004, energy represented 25 percent of a company’s production costs, and energy prices increased 35 percent, then that company’s production costs increased 8.75 percent, assuming all other costs stayed the same—which is not likely, since many raw materials also increased at least 10 percent over the year and shipping costs increased dramatically along with fuel costs. Annual 2004 to 2005 production cost increases of over 10 percent, caused primarily by energy cost increases, are not uncommon in industry.

How can industry respond to higher energy prices? There are three basic options:

  1. Do nothing, hoping that energy prices return to a much lower level (such as those in the late 1990s—about $15/barrel for oil and $3.50/MMBtu for natural gas);
  2. Increase prices in proportion to production cost increases; or
  3. Reduce energy intensity through energy efficiency and conservation measures.

Option 1 is probably wishful thinking and means reduced earnings as long as energy prices stay near where they are currently or, worse, they increase. Option 2 likely leads to losing market share, unless all competitors also increase prices. Option 3, on the other hand, means being more competitive in a market of increasing production costs.

Option 3 is where mechanical insulation comes in; it is an energy-efficiency measure that can reduce an energy-intensive manufacturer’s production costs—or, if not reduce them, keep them from increasing as fast as the cost of energy.

Previous Insulation Outlook articles have shown that mechanical insulation on hot surfaces has a payback time as short as one month. Perhaps more important, however, is that insulation upgrades can significantly reduce production costs at an energy-intensive production facility. As maintenance managers and facility engineers look to implement Option 3 at their facility and study their energy-efficiency options, mechanical insulation should rise to the top of the list: It is relatively inexpensive to install and maintain and starts returning dollars as soon as the facility starts up.

Conclusion

In summary, consider a few basic truths about the state of energy demand in the United States.

  1. The United States uses 25 percent of the world’s crude oil and natural gas—the largest portion for any single country;
  2. The United States continues to increase its consumption and import of crude oil and crude oil-refined products and natural gas; and
  3. U.S. energy efficiency and conservation have yet to have a significant impact on the marketplace.

These truths, and the opportunities discussed throughout this article, seem to indicate that as energy prices continue to increase, the future of mechanical insulation in North America looks brighter.