News Analysis

 

 

Fuel costs drive electric prices, but generators seem perfectly willing to pay a premium for fuel when they're getting top dollar for power.

Even as the California power crisis drew headlines in mid-winter, natural gas shot up just as much in relative terms, if not more, and the higher prices were more widespread, blanketing the country not so much with spikes as with a sustained plateau, though some signs of weakening were seen in late January and early February.

Gas prices in Southern California reached the $60 range in December, sending insiders scurrying for answers, just as when electricity prices soared in the summer and then again in the fall. But the gas question appeared more complex: Power prices responded in part to higher fuel costs, but what was driving gas prices? Was each commodity reciprocating to the other?

The facts were known to some degree:

• Below-normal rainfall out West curtailed availability of hydropower.
• The hot summer pushed plants to the limit, deferring maintenance and forcing a higher-than expected rate of outages.
• A colder-than-normal fall encouraged high use of electric space heaters.
• The Aug. 19 explosion on the El Paso Natural Gas pipeline system disrupted gas deliveries into Southern California.
• Canadian gas prices spiked as well.

Add to that an increased reliance on natural gas for generation, plus already low stocks of natural gas in storage, and the stage was set. Jim Todaro, senior natural gas analyst at the federal Energy Information Agency, summed up the gas market explosion in California: "It's just a convergence of so many things," he says.

"Clearly it's part reality and it's part perception," says Bob Linden, managing consultant at PA Consulting Group, of the volatile natural gas prices. "It's part market fundamentals and it's part trader speculation. And the cure is not obvious."

It is a generally assumed truism that in order to find a solution, you must first identify the problem-or problems. Is there one factor that can be isolated as the most important? Unfortunately, it might be one of those acts of God. "The lack of hydro is really a big issue," says Todaro.

Streamflow normally collected in reservoirs in the fall and winter for future use is being used right now to serve present needs. "There's barely enough power now, and they're eating their nest egg right now in terms of sucking all that hydropower down when they usually just let the reservoirs fill and use it to supply the Northwest," says Linden. Mother Nature just hasn't cooperated on any fronts, it seems. "There's very low snow pack, not much snow in the Rockies this year, and meanwhile, they're sucking every megawatt hour of power they can out of those reservoirs." And don't forget the environmental concerns about the salmon runs in the spring that will hurt hydropower output. "Something bad is going to come from this, I'm afraid, because there's no quick way of turning it around," Linden says with an air of doom.

Whether you're talking gas or power, the outlook is the same: positive for the long-run, scary for the short-term.

"Long-term, I'm very sanguine about resource capacity," Linden says. "The industry fundamentals are fine, but you can drown in five minutes, and this a 24-month solution we're looking at."

Part of the reason that the power crisis and natural gas prices are tied so closely together, Linden says, is that generators are perfectly willing to pay a premium for fuel when they're getting a premium for their power. "You've got a power market now that allows the luxury of high prices," he says. "And with those high prices comes generators' confidence that they will make back the money used to purchase the natural gas. "You now have much more direct linkage between power prices and gas prices, so when power goes through the ceiling, gas is going to go through the ceiling, because it can. It's a different world. It's a unique market in North America."

Pipeline Problems

One factor cannot be ignored—the Aug. 19 rupture and resulting explosion along El Paso Natural Gas Co.'s South mainline near Carlsbad, New Mexico, which resulted in the deaths of 12 people. By all counts, the incident affected the California natural gas market. "[California] lost 500 million [cubic feet] a day of capacity into the state at that point," points out Linden, noting that while the accident is not the sole reason for the problem, "[I]t's a contributing factor." But is it still having an effect?

The explosion initially affected three lines, and now two of the three are currently operating. However, Kim Wallace, spokesperson for El Paso, minimizes the impact on the California natural gas market by saying that reports of that part of the pipeline operating at 85 percent to 90 percent are misleading. While that figure may be accurate, she says, El Paso is sending the same amount of gas into California as before the explosion, only by different routes. "Shippers are purchasing their gas other places on the system," she says. "In fact, we've been sending more to California than we have in a very long time."

The bulk of El Paso's capacity, Wallace says, is under long-term contracts, so with or without a volatile natural gas market, the company doesn't play much of a role in improving or worsening the situation. Certainly, the pipeline company does hold some interruptible contracts, freeing up a limited amount of capacity to be put up on the bulletin board, but, she claims, "It's basically been going just as it has been." Turning down shippers is a way of life at El Paso.

Wallace's next argument is that if you want to look for bottlenecks, don't bother looking in the direction of El Paso. Instead focus inside the state of California, at the distribution system. El Paso, she claims, is carrying as much gas to the California border that the utility-owned intrastate system can handle. "We're up against the distribution system," she says. "We're producing as much [gas] to the border as can be taken away."

If Linden at PA Consulting sees constraints within the intrastate system, it's only with qualifications. "It hasn't been a problem [in the past]. I imagine that there are bottlenecks emerging. ... I'm sure there are portions of the [utility systems] that are full up right now, getting as much gas as they can to the power plants."

But no bottlenecks outside the state? "I know the San Juan lateral is loaded up. You've got BP Amoco and Burlington Resources and everybody else in the San Juan screaming. There has been a huge fight with El Paso for years about access out of the San Juan."

Just look at the numbers, Linden says. They'll tell you the bottleneck story on the long-haul pipelines. "If you look at the basis differential between the way it's been running between San Juan and Topok [at the California border], it's been as high as $4. Why does that happen? It happens because there's a bottleneck there. Every time you see a big basis differential between two points, you know you've got a bottleneck problem."

Still, the rote response of the pipelines appears to be that, regardless of natural gas market volatility in California, it's business as usual for them. Jay Story, director of gas control and transportation services for PG&E Gas Transmission, another of the approximately five major pipelines that carry natural gas to the state line, says that, sure, his pipeline's capacity is typically all taken up these days, but that's nothing unusual. "We're a high load factor pipeline," he says. "We remain pretty close to full year-round." On any given day, Story says, PG&E Gas Transmission can have more requests than the pipeline capacity might allow. "For our pipeline, it's been a way of life for some time."

Whether or not turning down shippers is nothing new, though, the implication is that there's a hunger for new pipeline capacity that needs to be satiated. Pipeline companies, therefore, conceivably should be eager to meet that need, given the profit potential. In spite of the bottleneck denials, are they enhancing their systems? Yes.

On Jan. 2, PG&E Gas Transmission Northwest, another of the major pipelines going to California, launched an open season for new capacity on its mainline system, offering up an additional 200 Mdth per day for service Nov. 1, 2002. Previously, in November, PG&E Corp. and the international subsidiary of Sempra Energy announced that they have signed precedent agreements for over half of the capacity on the proposed North Baja Pipeline Project, and that they are going full-steam ahead to obtain permits to build the 215-mile pipeline. "We're moving ahead and hope to have that online in 2002," says Sandra McDonough, vice president, external affairs for PG&E National Energy Group. "We're doing everything we can do to make that happen."

El Paso, meanwhile, is working on system enhancements of its own. In February 2000, the company purchased All American pipeline, an abandoned oil line. All American was a particularly attractive investment because, for the most part, it happens to parallel El Paso's South mainline. In fact, El Paso says that it bought the pipeline not necessarily for increased capacity, but for maintenance flexibility—to be able to replace compression on its own parallel line with the heavy duty pipe.

But with pipeline expansion running rampant, couldn't El Paso capitalize on the increased capacity? In fact, that's basically what the Federal Energy Regulatory Commission asked El Paso in the ongoing proceeding on All American. Yes, El Paso told the federal regulators, the newly acquired line could be used for expansion. But, says Wallace, "Our initial [FERC application] was not for expansion. It was for construction."

In a phase of high demand for capacity, however, maintenance flexibility can't be the only reason for the investment. Bottom line, points out Linden, is that El Paso suddenly has some new capacity at its fingertips that must be counted when adding up overall pipeline expansion into California. "I know that the public purpose was to reduce cost, but I think if the end is near, they certainly are going to run those compressors. It's an infrastructure capability that is now available. ... They've created the capacity, one way or another." Meanwhile, El Paso is working with the Office of Pipeline Safety (the federal Department of Transportation) to return the ruptured line near Carlsbad, NM back to operation.

"Every major pipeline is expanding," notes Linden. "Clearly everybody is trying to get to the California border and get those prices."

The Fix

With a wave of pipeline expansion leading the way, the long-term outlook looks good. "You've got half the problem solved just with expansions on the table," Linden observes. That's not accounting for load growth, but on the other hand, eventually the older inefficient steam generators will be retired in favor of the combined cycle turbines that can double efficiency in terms of natural gas consumption, mirroring a trend happening elsewhere around the country: increased generation with less natural gas use.

And the buzz of new activity goes all the way to the wellhead-even right within the state of California, where drilling has been going on for a century. The Temblor Formation in the San Joaquin Basin 100 miles northwest of Los Angeles, was scheduled to start producing natural gas from a 19,000-foot well in the first quarter. And some of the same forces—i.e., technology allowing for profitable drilling to such depths—are driving new exploratory developments in both California and in Western Canada, as well.

"I think there are going to be a lot of high-risk, high-reward type formations pursued in deeper horizons within the state," Linden says. "The direction of the drilling activity [in Canada] ... [is going the same direction as California]. ... The more sophisticated players are going deeper, they're going farther North, they're looking at new horizons. ... And this Temblor play in California is an indication of that. People have been drilling for oil and gas in California for 100 years. Who would have guessed that a one to seven tcf formation could be sitting down there? That's a huge financial windfall."

But that's all in the future, and Linden expresses grave concerns about the short-term. "I think there's going to be a huge economic dislocation. It's certainly going to be a drag on the economy, because this energy problem was not created overnight."

And again, electricity and gas are practically one-in-the-same. "The volatility that you're going to see at the California border in gas prices is going to be directly tied to power demand for the foreseeable future. Power price volatility is going to be very high, so gas price volatility is going to be very high."

Looking at the situation philosophically and with caution, Linden recalls that years ago, he thought he could predict the future, but says he has since grown wiser in dispensing advice."I now advise clients that they have to assume ignorance and uncertainty in all their business positions, and I certainly confess to my own ignorance and uncertainty in the current circumstances. ... That's my advice to everyone in California: Assume you know nothing."

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