John Hopper, Falcon Gas Storage Co.
Conventional wisdom this past winter decreed that the gas industry was “running out” of storage inventory–the second time in three years such dire predictions resounded throughout the industry. As it turned out, we didn’t.
During last winter’s heating season, 2,536 Bcf of gas was withdrawn from storage, surpassing the previous record 2,300 Bcf withdrawal that occurred during the 1995-1996 winter. In the midst of this, however, gas prices went berserk, vacillating on the NYMEX futures exchange between a low of less than $4 per MMBtu in November at the beginning of last winter to a high of nearly $12 per MMBtu in late February. In some regional energy markets, cash prices in late February exceeded $50 per MMBtu. By early July, near-month NYMEX futures prices and cash prices had receded to more modest levels but still hovered around the $5 per MMBtu mark as uncertainty persisted over storage refills for next winter.
The extraordinary gas price volatility that prevails in the energy industry today is driven by an extremely tight gas supply-demand equilibrium. When Allan Greenspan gets into the act, you know that things have gotten out of hand. Or, have they really gotten out of hand? The answer depends on your point of view.
The perception is that strong draws on storage inventory throughout the winter months will present a significant challenge in refilling storage to the magic 3,000 Bcf level by the start of the ensuing winter season, supporting higher gas prices in a tight supply-demand environment. Yet, following the winter of 2000-2001 when we also were “running out of gas,” a total of 2,513 Bcf was re-injected into storage and the 2001-2002 winter season started with what turned out to be ample storage inventory (in excess of 3,100 Bcf). If the same refill level volume of gas is re-injected into storage this year, which seems probable now, we’ll start the coming winter with a storage inventory level that also exceeds 3,100 Bcf.
So, is there really a problem? Actually, there is, but it’s much more complicated than Greenspan appreciates. Except for a one-time increase in 2001, North American gas production has been falling steadily since its peak in 1996, but so has industrial gas consumption, bringing the two into balance on average during the year. Interestingly, no apparent solid correlation appears to exist between gas prices and gas consumption in the industrial sector, as one would expect: In all but one year (2001) since 1997, industrial gas consumption has either fallen or remained flat as prices have fallen, or has risen as gas prices have.
Of course, gas-fired electric generation is sensitive to gas prices–both in absolute terms and with respect to price volatility–sending a message to the gas-fired electric generation industry: Gas supply and demand are very tightly balanced–and virtually in real time. As a result, even relatively small changes in either supply or demand can precipitate significant movements in gas prices over short periods of time. In the current environment, very little margin for error exists on either side of the supply-demand equation, underscored by the events of this past winter when late season weather-related demand stressed the domestic gas supply and delivery infrastructure nearly to the breaking point and sent prices careening out of control.
But the issue this past winter was not and is not now the aggregate amount of gas supply available for consumption during the year. Rather, it is the amount of gas supply available to the market during periods of peak demand. This past winter revealed that we are short peak-day gas supply deliverability and no amount of increased North American gas drilling or additional LNG import facilities can fill the peak-day deliverability gap that exists today.
The problem is a lack of sufficient pipeline and storage infrastructure, not aggregate gas supply availability. Until this is addressed adequately, extreme gas price volatility is here to stay. Managing gas price volatility, however, is not as difficult as it’s been made out to be. Fundamentally, it’s a matter of obtaining access to gas storage capacity, injecting gas into storage from time to time during off-peak periods when prices fall, and then withdrawing the stored inventory when demand peaks and prices go back up again, avoiding the inevitable price spikes in this highly volatile market. Owners of gas-fired electric power plants with uncertain dispatch profiles and relatively high costs of gas supply could profit from learning how to do this.
Hopper is the president and co-founder of Falcon Gas Storage Company, one of the largest independent owners and operators of high-deliverability, multi-cycle natural gas storage capacity in the U.S.