Cost of producing energy before subsidies, per megawatt hour. Bloomberg New Energy Finance, 3rd quarter 2009.

Low natural gas prices coupled with discoveries of abundant shale gas reserves have made the last 18 months an exciting time for energy in the United States. Until mid-2009, investors were scrambling to find a low cost, reliable fuel source that could replace coal-fired electricity generation. Even with the decreasing Levelized Cost of Electricity (LCOE) of renewables like wind, solar, and nuclear, coal-fired power plants – which account for 40% of U.S. power generation and 80% of the industries CO2 emissions – were seen by investors as the safest choice for new plant construction, due to low coal prices and a stable, domestically produced supply.

These conditions have been fundamentally altered, causing a rippling effect throughout the entire domestic energy industry. As my colleagues at AEL Elizabeth Campbell and Sam Lederer have reported, technological advancements in drilling have opened up vast reserves of natural gas from shale formations. These shale gas reserves are expected to account for 34% of total natural gas production in 2035, doubling from 18% in 2008. According to Frank Verrastro and Conor Branch of the Center for Strategic International Studies (CSIS), shale gas discoveries have led to a “broad consensus that our nation has enough domestic supplies of natural gas to power the U.S. for generations.”

Natural gas presents utilities and investors with a cleaner alternative to coal at around the same cost. However, this is a value proposition that makes some clean energy proponents nervous. Indeed, some utility-scale wind, nuclear, and solar projects will now face stiff competition from natural gas-fired electricity generation plants. But in other ways, increasing supplies of natural gas might be a blessing in disguise for clean energy technologies. Below are some key points as to what shale gas means to the U.S. energy landscape, and specifically its impacts on cleantech.

Shale Gas Production Will Lead to Lower and More Stable Natural Gas Prices

As a recent Cambridge Energy Research Associates (CERA) report states, “ample gas volumes should keep U.S. prices affordable well into the next decade.” Shale gas reserves have lowered natural gas price projections beneath that of nuclear, solar, and (in some cases) wind. CERA asserts that, in the near future, the only electricity generation method that can compete on price is coal. This is because shale gas brings “a major new shock absorber- an abundant new supply source that can respond relatively quickly to changes in demand compared to more traditional sources of gas supply, shortening the time needed to rebalance the market.” The role of new shale gas reserves as an industry-wide shock absorber should help prevent an “unexpected sustained step up in natural gas prices.”

This last point is important, since predicting energy prices is notoriously tricky. Annual U.S. EIA energy forecasts for natural gas have continually missed the mark for predicting even short term gas price fluctuations. Natural gas, as well as coal, will almost certainly see some price fluctuations in the near future. But the CERA report echoes the sentiments of many experts, which is that the wild price volatility of natural gas prices throughout the 2000’s are unlikely to be replicated in the foreseeable future. Thus, natural gas electricity generation is now cost competitive with coal, a factor which is already having a major impact on the U.S. energy landscape.

Low Gas Prices Will Increase Natural Gas’ Market Share Over Coal in Electricity Generation

Low and relatively stable gas prices, combined with requirements for coal plants to install costly scrubbers, are creating an environment where natural gas plants are being built in lieu of coal-fired plants.

According to Rebecca Smith of the Wall Street Journal, power companies are:

“increasingly switching to natural gas to fuel their electricity plants, driven by low prices and forecasts of vast supplies [of natural gas] for years to come.” Additionally, “most big coal-burning utilities have invested billions of dollars to install pollution-control equipment on their largest coal-fired plants. But they are replacing or idling smaller coal plants for which such expenditures can’t be justified.”

For companies deciding what sort of power plant to build, the shale gas boom and lower forecasted gas prices are having a major impact. Jim Rogers, CEO of Duke Energy, said recently that low gas prices and the regulatory outlook may prompt companies to defer coal projects and instead build plants that burn natural gas. “You will see more and more utilities in the U.S. build gas plants assuming gas prices stay in the range of $4 – $7 per million BTUs.” Current gas prices are hovering around $4.20 per million BTU.

One example of the coal-to-gas switch is North Carolina’s Progress Energy, which is closing four coal-burning plants and replacing them with two gas-fired plants because “it’s cheaper to build gas-fired plants than it is to outfit the coal units with the necessary pollution-control equipment.”

Industry leaders agree that coal to gas switching is becoming the norm, and these decisions will start to substantially alter the U.S. energy landscape for years to come. According to the EIA, coal burning facilities are expected to be just 10% of total new capacity in the U.S. by 2013, while gas is expected to account for 82% of new capacity.

Natural Gas is a Necessary Complement to Utility-Scale Wind and Solar Projects

The natural gas juggernaut is not necessarily a bad thing for cleantech. After all, as CSIS reports, natural gas “is an essential partner to the development of renewables, providing cleaner, reliable backup power when the sun is not shining or the wind dies down.” This is a process known as cycling, in which natural-gas fired plants have the ability to quickly scale up, or scale down, the quantity of electricity they produce, unlike most coal plants. “This ability to adjust power production levels within minutes has several key advantages for both integration with renewable energy sources and serving as a reliable supply for meeting peak demand.” Furthermore, unlike nuclear plants, natural gas plants are can be built cheaply and quickly.

In the near term, natural gas backup plants appear to be critical for deployment of utility-scale solar and wind plants. In the future, as energy storage and transmission/smart grid technologies improve, the intermittency problems facing renewable might be solved without a fossil fuel–fired backup. But the development of such cost-effective technologies at scale is years, if not decades, away.

So in one respect, the increasing supply of cheap, domestically produced gas is a good thing for cleantech. Natural gas is increasingly seen as a “bridge” fuel, one which both displaces new coal-fueled power plants as wells as helps to solve the intermittency problem inherent in most renewable energy generation technologies. John Day, a venture capitalist at Black Coral Ventures, says “proponents or renewable power push away from natural gas to their own detriment. They should be embracing natural gas as a key partner for the near-to-mid term. Coal and renewables will likely never be good friends. Natural gas and renewables can at least be allies.”

The Challenge of Low Gas Prices on the Cleantech Industry

Industry experts are largely uncertain as to what extent low gas prices will affect cleantech. Yet, some trends are already starting to emerge.

First off, many current renewable energy projects are built to meet state requirements for clean energy generation. Mark Griffith from the engineering giant Black and Veatch argues that utilities make their renewable energy decisions largely based out of complying with state mandates such as renewable portfolio standards (RPS), present in 30 states, which require utilities to buy and sell certain amounts of renewable energy. Based on this analysis, and because natural gas is not covered by RPSs, low natural gas prices may not have a substantial effect on the construction of renewable energy facilities in those thirty states.

But, without a national renewable efficiency standard or a price on carbon, banks are increasingly shying away from investing in large renewable generation projects. There is valid concern within the cleantech space that utilities will choose to build a natural gas plant instead of a solar or wind project. While gas plants cannot be applied to a state’s renewable portfolio standard , competitive gas prices give utilities a cleaner option than coal at a price lower than what many wind and solar developers can match. As analyst Nick Hodge points out, it is tough for wind and solar to compete (even with subsidies) when gas prices translate into electricity at roughly $0.05/kWh.

Therefore, low natural gas prices might make major grid-scale renewable energy projects more difficult for investors to stomach, unless these investments are specifically applied to projects which comply with an RPS mandate. Natural gas is a cleaner fuel than coal and cheaper than most renewable energy generation technologies, such as solar. In some areas of the country, wind farms can compete on cost with natural gas. But the fact that gas plants can be built close to population centers gives it a decided advantage – wind farms can only be built where the wind is blowing, and these areas can be remote locations that require additional investment in costly transmission and distribution infrastructure.

At the very least, it is likely that wind, solar, and nuclear companies are going to be facing even tighter margins moving forward as they bid against gas plants. As the New York Times reported, Excelon (an Illinois-based utility) is delaying its construction of a nuclear reactor due to low prices of natural gas, in addition to the lack of a price on carbon dioxide.

How Should U.S. Policy Address the Natural Gas/Cleantech Dilemma?

One possible way to address this dilemma is to change the way we invest in clean energy technology. In a Foreign Policy op ed, cleantech investment giant Vonod Khosla argues that some federal investments for wind and solar generation projects should be diverted back to the laboratory. Instead of investing in current cleantech projects, we should “also be focusing on developing the better tools of tomorrow.” As Khosla states, “many argue that since we already have some technology today, we should simply deploy it. I believe doing this alone runs the risk of spending a significant amount of money on infrastructure that will require continued subsidies to survive.”

Affordable natural gas isn’t going anywhere anytime soon, so it might be better to use the next few years to focus developments on new, and possibly game changing technologies, rather than investing in major cleantech infrastructure projects that are simply too expensive and unable to scale without substantial subsidies. For example, the solar industry still needs key innovations in everything from improved efficiency of solar panels to more cost effective manufacturing processes before it can openly compete with coal, natural gas, and onshore wind.

Khosla’s concerns are echoed by a variety of experts and think tanks from across the political spectrum, including The Breakthrough Institute, The Heritage Foundation, and The Third Way. These groups have called for policies which make clean energy cheaper, rather than making dirty energy more expensive. By making wind, solar, nuclear, hydro, and biomass generation at a comparable price as gas, both renewables and gas can increase market share and become the dominant forms of electricity generation.

A finite supply of gas cannot shoulder all of the world’s energy needs forever. Renewables will continue to increase market share, and these clean energy industries will be critical for long term economic development. Strategic federal support is necessary to stimulate the innovation pipeline which will in turn bring down the real, unsubsidized prices of clean energy technologies.