Putting out the fire: Can we quell the natural gas crisis?

Kathleen Davis, Associate Editor

Part two of a two-part series.

We’ve spent the summer mired in a “natural gas crisis.” Whether the predictions were real or imagined, too far-fetched or not dramatic enough for your tastes, the impact has been obvious: power utilities filing for rate increases based on the price increase for natural gas, the Secretary of Energy unveiling an educational campaign for power conservation, and Congressional hearings to tackle the one burning question of this debate–how can we solve the crisis?

Photo of gas pipes at sundown courtesy of Calpine Corp.
Click here to enlarge image

At the heart of any solution–even this one–is desire, and no one denies the basic need America has for more gas. It’s obvious that what we’ve got is just not enough, and probably won’t be enough for the future–especially given the number of merchant power plants scheduled to come online in the next few years that will rely completely on natural gas. In the end, there are two camps warring over a possible solution to this gap between producers and consumers. The first touts liquefied natural gas (LNG) as our potential savior. The second looks to old-school style domestic drilling. But, which is the true messiah of the natural gas crisis?

LNG or bust

LNG–natural gas compressed for transportation at 20-150 pounds per square inch (psi)–is so named for the cryogenic process that “freezes” the gas around —275 degrees Fahrenheit. (The freezing process itself is referred to as “liquefaction.”)

And, LNG is a growing business these days. Typical exporters like Algeria and the Middle East are being joined by Bolivia, Peru, Angola, Russia, and even Equatorial Guinea. While currently used to supplement domestic gas supplies here in the U.S., LNG has, in fact, grown by leaps and bounds–at least percentage-wise–in just the last year.

According to the Gas Technology Institute’s Colleen Taylor Sen, gas production rose only one percent in 2002 worldwide, but LNG shipments increased 4.3 percent in that same timeframe.

And, with the current natural gas crisis in the U.S., LNG could see another leap in that percentage, if its proponents can convince investors and the general public that LNG is the answer.

“I think the big answer–the most attractive one–is the introduction of LNG in this country,” stated James Macias, executive vice president for commercial operations at Calpine in an interview with EL&P. “There are huge amounts of worldwide [LNG] supplies, and just a small addition will go a long way to help dampen these price spikes.”

And Macias is not alone in his faith in LNG. This summer Cambridge Energy Research Associates (CERA) chairman Daniel Yergin stated that the U.S. will be importing a lot more natural gas to bridge the gap–up to 20 percent of U.S. gas supplies by 2020, Yergin added. (LNG provides about one percent today.)

“Fortunately, the world is awash in stranded gas [gas resources without nearby markets],” he said. “Momentum is building for LNG. Yet, while a robust build may be anticipated in new LNG regasification capacity in North America, there are several hurdles that stand before the realization of this new resource.”

And the biggest hurdle for increasing LNG imports is the obvious: There are very few places properly equipped to “park” and convert that LNG here in the U.S.

“There’s almost no infrastructure,” Macias said. “But, over the past two years, there has been tremendous activities and investment by strong companies. So, they’re working on it.”

Macias pointed out that he’s seen about two dozen LNG projects in the works from the East Coast, the Gulf of Mexico, the West Coast, Mexico, California, and even up into Canada, with what he deemed “tremendous muscle” behind some of these projects.

“I’m very optimistic that we’ll start seeing LNG terminals come online within the next coming years,” he added. “While they are not inexpensive, they are not overly expensive. In fact, an LNG terminal costs about the same as a new power plant.”

Developing new frontiers

On the other side of this debate is the idea of stepping up domestic drilling, and Macias stated that he already sees that happening.

“Rig counts are up,” he stated. “They were slow to respond to the market because they had been burnt in previous cycles [of price/supply spikes], but they are growing.”

Yergin, however, stated that growth in natural gas demand has so far resulted in disappointments in supply, which he believes signifies the “mature geology” of the North American basin. Already heavily drilled and explored, Yergin thinks it may simply be a matter of reaching the bottom of the barrel.

“The most dramatic example of maturity is the offshore waters of the Gulf of Mexico, which accounted for 31 percent of U.S. gas in 1990 but today produces just 24 percent of the nation’s total gas,” he said.

Of course, there remain places that have not been explored, which seems to be the heart of this issue: Do we go into new areas, even previously “preserved” areas to satisfy our growing hunger for natural gas? Macias, for one, says, “Yes.”

“We need more frontier gas, more gas resources available, period,” he stated. “The traditional fields across the country are getting more mature, and we do need to open more access. And that access is more in the Rockies, Canada, Alaska, offshore.”

“Domestic drilling will win out [over LNG] in the long haul,” stated Terry Ray, vice president of energy information strategies and an analyst with the META Group. “Producers have strong lobby skills. The reserves are here. And, drilling reduces dependence on imports and should be more cost-effective in the long-term.”

“Also, it is unlikely that the amount of LNG available for import at reasonable prices will be sufficient in supplying a significant amount. In other words, domestic drilling will still be needed,” he added.

Ray also sees loosening environmental restrictions on drilling and pipeline construction as one possible answer to the crisis.

In fact, in the end, many analysts feel that a mix of expanded drilling and increased LNG infrastructure may be the final solution–a blending of the two camps. Macias stated that we could see a “significant increase in LNG” within five years, but, obviously, that leaves quite a chasm to leap over before LNG comes to our rescue–a chasm that may be filled by domestic drilling efforts here at home.

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Putting out the fire: Can we quell the natural gas crisis?

Kathleen Davis, Associate Editor

Part one of a two-part series.

This spring Secretary of Energy Spencer Abraham declared that we were in the midst of a natural gas crisis. And, like a bizarre game of inter-media “telephone,” this issue has grown by leaps and bounds. In a June article from The New York Times, writers booted Abraham’s statement up from a natural gas crisis to “the most severe shortage of natural gas in a quarter-century.” USA Today made the jump into potential power ripples with their screaming headline “Electricity costs near 20-year highs,” although they point out within the article that those are potential “mights” and “maybes” given how the “crisis” pans out.

Click here to enlarge image

But, the basics of this crisis and how we got here still seem to be mired in a gray area. Even the concept of a “crisis” has been called into question by some industry players.

So, months after Abraham’s speech the question remains: Are we having a natural gas crisis or not?

Where we’re at

Speaking at the June 26 Natural Gas Summit convened by Abraham, Cambridge Energy Research Associates chairman Daniel Yergin predicted that a sweltering summer could bring the natural gas crisis home to the average American, impacting residential bills along with power suppliers and industrial users.

“The price will also be paid by the over-all economy,” Yergin added. “It will negatively affect recovery and growth, which is why U.S. Federal Reserve chairman Allen Greenspan spoke out on the subject.”

Indeed, Greenspan has stated that the low number of nat-ural gas supplies is “a very serious problem.” But, when asked if there was something that the government could immediately do to solve this problem, Greenspan answered simply, “No.”

Additionally, not all agree that a “crisis” is where we are at. Even Greenspan himself has been careful not to use that precise label. Additionally, some gas storage companies and power producers who rely heavily on natural gas disagree with the categorization of “crisis” for the current situation.

James Macias, executive vice president and head of commercial operations at Calpine Corp., told EL&P that he would, instead, “categorize it as a challenge.”

“We have had some short-term volatility in the market, but all the indicators are moving in the right direction,” he said.

“I think the market overreacted, and prices are coming down,” he added.

However, Yergin told the summit that one only needs to look at the volatile price of natural gas to see that there is, indeed, a problem, although he admits that a lot of the nasty potential of this crisis depends entirely on Mother Nature.

Like Goldilocks testing the bears’ porridge, the possibility that the summer we are currently in could be too hot or that the upcoming winter could be too cold makes those who see this situation as a true “crisis” a little nervous. However, there is also a third possibility in both porridge and weather: It’s entirely possible that both could be “just right,” potentially leaving those heavily in the “crisis” camp looking a bit like the boy who cried “wolf.”

“The gas market is a very mature market,” Macias stated. “It’s a very capable market. It’s a very dynamic market. It responds to the supply/demand price signals.

“Gas prices have dropped about 20 percent over the past couple of weeks, and storage injection is very robust right now. I think the market panicked a bit, which is what shot prices up, but, in my opinion, we’ll see gas prices over the long-term stabilize in the $3.50 to $4.50 range,” he said.

How we got here

Yergin pointed out that he didn’t personally blame this situation on the open gas market, which began phased price deregulation back in 1979 and completed it with the Decontrol Act of 1989.

“This is not a failure of markets,” he said. “Rather it is the result of disappointing geological experience over the last few years, plus restrictions on exploration combined with a shift to new uses of gas that will certainly grow consumption.”

The chairman of the House Committee on Energy and Commerce, Republican Representative Billy Tauzin, however, has pointed fingers at federal policy for this “crisis.” In a June meeting of the committee, he stated that the government has been “the not-so-invisible hand on the market, increasing demand and all the while decreasing supply.”

Gas regulation started with the Natural Gas Act of 1938, but is was a Supreme Court decision in 1954 that began the price control process that the gas industry waded through for the next twenty years. Regional spot shortages began to pop up in the early 1970s, with natural gas demand peaking at an all-time high of 22 Tcf in 1973. Shortages continued throughout the 1970s, leading to more regulation.

When demand for natural gas began to drop, higher wellhead prices encouraged exploration. This created a bit of a “gas bubble” in the 1980s and most of the 1990s, with low to moderate natural gas prices. It seems, however, that the bubble has burst.

Carl English, president and chief executive officer of Consumers Energy, spoke of the precarious state of natural gas markets before the House Committee on Energy and Commerce on behalf of the American Gas Association.

“Today the balance between supply and demand has become extremely tight, creating a tightrope effect. Even small changes in weather, economic activity or world energy trends result in wholesale natural gas price fluctuations,” English stated.

Macias, however, stated that walking that tightrope is really nothing new.

“Every commodity is volatile, and natural gas is no different,” Macias said. “Demand fluctuates with the economy and with weather. Smart companies have to manage that volatility. Calpine certainly does. Now, I don’t want to say that we are ‘indifferent’ to gas prices, but there are reasonable steps that we take to help protect ourselves from volatility.”

What’s being done

And, whether or not you see what’s going on in the natural gas markets as a “crisis,” it’s obvious that volatility is everywhere. In July, U.S. Warburg predicted that peak U.S. power prices could jump 48 percent this year from 2002 numbers–a leap attributed almost entirely to natural gas prices. They also predicted that the ERCOT region of Texas would take the biggest hit, with peak prices rocketing up 74 percent.

Of course, what many in the power industry fear most about this crisis is not minor fluctuations in price. Instead, they cower at the potential return of the Power Plant and Industrial Fuel Use Act of 1978, which came about in the midst of the last major gas crisis and restricted the use of natural gas by power plants, and which President Reagan repealed in 1987.

The Electric Power Supply Association (EPSA) has sent a letter to Secretary Abraham in a preemptive move to counter the possibility that the dreaded Fuel Use Act will strike back. The letter states that all the EPSA members–who generate power from a number of different sources, not just natural gas, the letter is careful to point out–would “strongly oppose legislation or regulation that would prohibit gas use in new power plants.”

In fact, despite the volatility, Calpine still plans on going ahead with its long list of new merchant plants that will rely entirely on natural gas.

“There’s still a phenomenal amount of old gas-burning power plants that are not as efficient and have higher emissions. And, as long as those plants are out there producing power, Calpine will be out there trying to replace them,” Macias stated.

“Yes, right now the market is volatile, and, yes, there will be short term challenges,” he added. “But we all remember just a few years ago when gas was below $2, which was good for the consumption side of the equation. Right now, it’s reversed. But, it will reverse again.”

Macias, along with analysts from the META Group, will discuss how to manage volatility and weather the natural gas crisis in part two of the series, scheduled for EL&P’s September issue.