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Natural gas substitution under the "National Energy Strategy."

The Bush Administration's "National Energy Strategy" (NES), released in February 1991, is intended to promote greater energy security and efficiency while protecting the environment and facilitating continued economic growth. [1] As we suggested in an earlier article, the substitution of natural gas for other fossil fuels can contribute significantly to greater energy security and environmental protection, often at lower cost than alternative measures. [2] In this article, we address the question of how much induced natural gas substitution can be expected from full implementation of NES.

The text of NES states: "If fully implemented, the National Energy Strategy measures would increase U.S. consumption of natural gas by almost 1 trillion cubic feet (approximately 5 percent) over what it would have been in the year 2000 under pre-Strategy policies." [3] The "measures" include complete deregulation of natural gas wellhead prices, acceleration of new gas pipeline construction, reform of gas pipeline rate making, improved access to pipeline transportation services, elimination of gas import and export regulation, and encouragement of natural gas as a transportation fuel. [4] Not included are higher taxes on gasoline or coal to reflect their greater environmental costs or any sort of oil import fee, which would further encourage natural gas substitution. It appears, then, that the substitution implied by NES would stem solely from the lower costs of producing and delivering natural gas resulting from the above deregulatory actions.

The NES estimate of changes in energy consumption by primary source (oil, gas, etc.) is derived from simulation of the Department of Energy's "integrated model." First, a base case, which assumes no change in current policy, is simulated, and then the NES scenario is simulated to observe the differences. The "integrated model" combines the energy sector and the rest of the economy to capture interrelationships. Some of the key assumptions in the base case are: free markets; a U.S. real GNP growth rate averaging 2.3 percent per year; world oil prices rising to about $50 per barrel (in 1990 dollars) over the next 40 years; continued improvement in energy efficiency in all sectors, from industry to transportation; and a "low cost" U.S. resource base of 80 billion barrels of oil and 770 trillion cubic feet of gas. [5]

The table shows the actual percentage composition of primary energy consumption and the predicted composition in the base case and the NES case. [6] (The NES prediction extends to the year 2030, but the last 20 years are omitted here as increasingly speculative.) The 1990 figures are: oil, 39.6 percent; coal, 22.4 percent; natural gas, 22.7 percent; and "others" (nuclear, hydro, solar, etc.), 15.3 percent. The 2010 base case figures are: oil, 37.9 percent; coal, 28.2 percent; natural gas, 19.5 percent; and others, 14.4 percent. Total energy consumption in the base case increases from 84.7 quads (quadrillion Btu) in 1990 to 118.1 quads in 2010, and all primary sources share to some degree in that increase. In relative terms, however, the share of coal rises at the expense of all other sources, and natural gas fares worst of all, its share falling by nearly one-sixth (from 22.7 percent to 19.5 percent).

In the NES scenario, the shares as of 2010 are: oil, 34.3 percent; coal, 25.1 percent; natural gas, 20.6 percent; and others, 20.0 percent. Here, in contrast with the base case, both coal and others gain in share, while oil and natural gas both lose. However, the share loss is greater for oil than in the base case and smaller for natural gas. Furthermore, under NES, the growth of total primary energy is lower: from 84.7 quads in 1990 to 110.8 quads in 2010. Thus, there is an aggregate "conservation" effect of the NES of 7.3 quads, or 6.2 percent of the base case total. Partly as a result of this effect, the consumption of oil is reduced by 6.8 quads in comparison with the base case, coal by 5.5 quads, and natural gas by 0.2 quads, while the "others" category increases by 5.2 quads.

The change in consumption of any primary source of energy is the algebraic sum of the conservation effect and the substitution effect, conservation reducing consumption and substitution for other sources increasing it. Thus, if one proportionately distributes the conservation effect (6.2 percent of the base case total) to each source to derive a conservation-adjusted NES case, the difference between it and the base case equals the amount of substitution implied by full implementation of NES. The conservation-adjusted figures for 2010 are: oil, 40.5 quads; coal, 29.6 quads; natural gas, 24.3 quads; and others, 23.6 quads. Relative to the base case, the changes are: oil, -4.3 quads; coal, -3.7 quads; natural gas, +1.3 quads; [7] and others, +6.6 quads. In other words, allowing for a small rounding error, 8 quads of natural gas, nuclear, hydro, and other nonfossil sources are substituted for 8 quads of oil and coal between 1990 and 2010. The degree of gas substitution, then, is only a fifth as large as the degree of nonfossil source substitution for oil and coal.

The figure illustrates the evolution of the consumption of natural gas by three measures: the current policy base case, the conservation-adjusted NES case, and the full implementation NES case. The implication is obvious: the National Energy Strategy, if fully implemented, will do little to encourage substitution of natural gas for other fossil fuels and even less to encourage the domestic production of natural gas. Under both the base case and the NES case, natural gas imports are expected to rise by 2.1 quads from 1990 and 2010, 0.8 quads more than the above substitution effect.

But at least the substitution effect is positive. When it is recalled that NES does not include--indeed, explicitly rejects-the more obvious measures to induce natural gas substitution, such as a carbon tax" in proportion to emissions resulting from combustion of different fuels, it should be clear that the potential for substitution under an active environmental policy is really quite substantial. In future articles, we hope to provide reasonable estimates of that potential.

- Stephen L McDonald Professor of Economics and Senior Fellow and Mina Mohammadioun Senior Economist Bureau of Business Research

Notes

1. National Energy Strategy: Powerful Ideas for America (Washington, D.C.: Department of Energy, 1991).

2. Stephen McDonald and Mina Mohammadioun, "The Prospects for Natural Gas Substitution," Texas Business Review, August 1991.

3. National Energy Strategy: Powerful Ideas for America, P. 11.

4. Ibid.

5. National Energy Strategy, Technical Annex 2: Integrated Analysis Supporting the NES (Washington, D.C.: Department of Energy, 1991), pp. 8-9.

6. The data in this table and in die next four paragraphs of the text are from Technical Annex 2, pp. 11 and 22; percentage shares calculated by the authors.

7. This substitution of energy is the equivalent of 1.4 trillion cubic feet of natural gas.

Editor: Lois Glenn Shrout Assistant Editor: Sally Furgeson

Texas Business Review is published six times a year February, April, June, August, October, and December) by the Bureau of Business Research, Graduate School of Business, University of Texas at Austin. Texas Business Review is distributed free upon request.

The Bureau of Business Research serves as a primary source for economic and demographic data on the state of Texas. An integral part of UT Austin's Graduate School of Business, the Bureau is located on the sixth floor of the College of Business Administration building.

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Author:McDonald, Stephen L.
Publication:Texas Business Review
Date:Feb 1, 1992
Words:1387
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