The energy industry has known for quite some time now that domestic production of natural gas this century never would keep up with demand. Why else would Congress have made such great efforts in the Energy Policy Act of 2005 (EPACT) to promote more domestic drilling and infrastructure development-including construction of LNG terminals?
Alas, we may need to wait several years before EPACT makes a dent in this gloomy supply picture. Meanwhile, we'll likely have to endure a few more press releases and communiqués—some coming even from the White House—suggesting that the experts only now have awakened to the specter of price spikes and shortages.
For example, with respect to natural gas and gasoline, President Bush has urged conservation of energy resources on several occasions in the last two months—a complete policy reversal that has been equated to President Jimmy Carter's "cardigan sweater" approach to energy crises.
Furthermore, several state public utility commissions (PUCs) have issued warnings of a doubling of natural-gas bills in parts of the Northeast and other places. Electric bills also are predicted to increase by one third as a result of reliance on gas-fired power in certain regions.
On Oct. 7, the price of natural gas for November delivery closed at $13.38/MMBTU on the New York Mercantile Exchange. That was up 90 percent from the year before.
Certainly, state leaders are weighing the impacts. In a Rotary Club speech in early October, Florida Gov. Jeb Bush, noting the state's vulnerability to property insurance and energy, said, "We have to recognize that we have to conserve a lot more than we have been. … And it means recognizing that all the new capacity in a fast-growing state can't be natural gas." Of course, much blame for the upcoming winter crisis is being placed on Hurricanes Katrina and Rita-as some 20 percent of the U.S. gas supply comes from the offshore gulf.
Policymakers, regulators, and utility executives are doing whatever they can to contain the effects of the crisis. Yet many wonder why it could not have been averted, given long-understood fundamentals of domestic gas markets. Gulf hurricanes have been seen before, with their attendant effects of production and delivery. In fact, natural-gas prices in the Northeast have spiked during 2003, 2004, and 2005, according to several industry reports.
Given the free market in natural gas, why haven't prices attracted the needed infrastructure or supply? (LNG imports are actually down from last year.) What policies could have been contemplated ahead of national legislation? Or put more simply, why has supply lagged demand?
According to a report from the staff of the Federal Energy Regulatory Commission (FERC) published on Oct. 12 (the same day as the commission's own conference on the state of natural gas infrastructure), "The pump was primed for significant energy price effects well before Hurricane Katrina and Rita hit the Gulf Coast production areas."
The commission adds: "The Gulf storms exacerbated already tight 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:
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.
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 this winter. For example, for our NYC LDC, hedging activities accounted for about 60 percent of the reduction, and about 40 percent was due to our portfolio of Canadian and storage gas.
"Our ability to respond to this emergency situation is limited by the lack of adequate infrastructure serving the Northeast."
But some experts say that even as infrastructure may be an issue, there is a lack of standardization and transparency in respect to utility hedging and risk-management programs. Furthermore, utility commissions are not as engaged in hedging programs as they could be.
Tim Simard, principal consultant at risk management firm RiskAdvisory, believes that state PUCs need to enforce a more mechanistic risk-management and hedging program that is maintained year in and year out. Simard says such an approach would contribute to greater price stability across the entire market. The reason sometimes such programs get dropped, he said, is that PUCs lose their conviction for such hedging programs when high prices fail to materialize, and ratepayers must pay for the program.
Moreover, while infrastructure and risk management have been offered as solutions to reduce future price shocks, not many other options are available. If nothing else, the ultimate option, as with anything absurdly overpriced, will be to find an alternative source for home heating or power.