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Is the predicted crisis this winter a failure of policy, the market, or both?

Fortnightly Magazine - November 2005

supply and demand conditions, increasing prices for fuels … after steady upward pressure on prices throughout the summer of 2005."

The report found that most of the price increases were due to lagging gas supply additions, coupled with increased demand for natural gas as a fuel for electric generation, owing to years of investment in gas-fired power plants and a significantly warmer-than-average summer.

Moreover, FERC in its had identified several gas transportation challenges the Northeast faces. The report concludes that "periodic gas and power price spikes during coincidental winter peaks will continue in the Northeast, particularly in New England, until additional pipeline capacity and LNG vaporization capacity is added."

The 2004 report had cited several problems that still stand in the way of new project development:

  • Pipeline Contracting. Not enough demand from local distribution companies (LDCs) for long-term transportation contracts to encourage developers to build new pipeline capacity.
  • Price Triggers. Ironically, price spikes in the Northeast still were not high enough to justify buying incremental firm transportation service on a just-in-time basis.
  • Construction Costs. New pipelines would cost much more than existing capacity.
  • NIMBY. Local opposition to new projects was not going away.

Obviously, as the FERC report found, developers will not build new pipeline capacity without long-term firm transportation contracts. It is unclear, however, who will want to sign up for firm transportation service.

Retail gas consumption for space heating is growing only moderately and thus will limit the need for incremental firm service. For several reasons, gas-fired generators continue to limit their exposure to firm transportation reservation charges by not contracting. Monthly capacity factors averaged between 33 percent and 50 percent for gas-fired plants in 2004 in areas managed by independent system operators in New York and New England. ISO New England capacity payments are insufficient to cover the cost of firm transportation service, and interruptible transportation service remains reliable in summer and shoulder periods.

At the same time, buying incremental firm service still appeared uneconomical for many market participants. Despite historical high average annual basis at key trading points in the Northeast during 2003 and 2004, the frequency and duration of spikes had not yet justified buying firm transportation on straight economic grounds.

Meanwhile, because of high construction costs for new projects, opportunities to increase gas deliverability into the Northeast through relatively low-cost compression expansions still were limited. Therefore, as the report found, it was likely that new gas-pipeline capacity would require at least some looping and would result in higher cost-based rates.

Risk Management: A Partial Answer?

David Manning, vice-president, corporate affairs, at KeySpan Energy, speaking on behalf of the American Gas Association before FERC's gas infrastructure conference, predicted that wholesale prices for flowing natural gas this winter will just about double those of the year before.

He saw risk management as no complete panacea, owing to past shortfalls in infrastructure development:

"Due to our hedging activities and our diverse portfolio-including western and eastern Canadian supplies, as well as gas on storage-we anticipate [as of Oct. 1] that our customers will experience a 35 to 40 percent increase