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Electric Generation Sector Needs Long-Term Gas Strategies, Public Power Report Says

The goal of more stability in wholesale natural gas markets will require a combination of regulatory and market strategies that are not in place currently, according to a report issued last month by the American Public Power Association (APPA). More oversight of financial traders is among the recommended steps that are needed, the APPA report, "Long-Term Strategies Are Key in Achieving Stable Natural Gas Prices," concluded.

In the aftermath of last year's hurricanes and the devastation throughout the Gulf of Mexico, a relatively mild winter and high natural gas storage inventories have eased gas prices in the short term. "Continuing high storage levels should keep prices moderate in the short term," APPA concluded.

Moving to the long-term view, however, the APPA report cited a February Federal Energy Regulatory Commission (FERC) staff assessment that predicted the current relatively moderate wholesale prices are "about as low as they are likely to be for the remainder of the decade." APPA thinks the current general assumption that wholesale gas prices will stay high is based on what it called "the historical relationship of natural gas prices and oil prices," since the two fuels can be substitutes for one another at some power generation facilities and industrial plants.

Increased reliance on liquefied natural gas (LNG) imports and the globalization of the natural gas markets makes the U.S. supplies of gas much more "susceptible to supply disruptions and political instability in producing countries," the APPA report stated. Rising imports mean the nation needs what APPA called "new patterns of production" and new infrastructure development, and combining this with the increasing number of financial entities involved in wholesale natural gas markets, means continued added price volatility, the report concluded.

"Energy markets are too important to the national economy and consumer welfare to allow market distortions and excess price volatility caused by price manipulation," APPA stated in the report. "Regulators must develop better information on how energy markets work -- including identification of major participants -- and use this to better define the 'fine line' between illegal market manipulation and legitimate profits."

While qualifying that it was not suggesting "collusion or illegal behavior" had taken place, APPA cited an example a year ago when equity analysts at Goldman Sachs noted oil was into a "super-spike" price period, and they forecast prices moving from a high of $80/barrel to $105/barrel. Subsequently, financial publications reported that crude futures prices jumped up 2.6% that same day. "It is certainly possible that the forecast of $105 oil benefited Goldman Sachs' trading operation," APPA said in its report.

Longer term the higher natural gas prices will have an impact on electric generation throughout the sector -- not just the gas-fired units, the APPA report said. Coal and nuclear plants, which could sell their output far above their costs based on gas-fired generation prices, may be precluded in the short term by contracts and other obligations, but eventually they will be free to reap significantly bigger profits, the report concluded.

"[Coal-fired and nuclear] generation currently can take advantage of high market rates for electricity only to the extent that they have generation in excess of contracted amounts," APPA said. "[But] according to Merrill Lynch, companies, such as Dominion Power, Exelon, FPL Group and Ameren, have the potential for significantly higher earnings from their generating facilities if natural gas prices are still relatively high in 2007 when many transition rate plans and hedges end."

APPA's solution? "Strategic action" that results in more domestic U.S. gas production, sufficient new infrastructure, increased conservation and "adequate oversight of financial traders in energy markets," according to its 22-page report.

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