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Dynegy-El Paso Deal Breaks Even So far This Year

Dynegy-El Paso Deal Breaks Even So far This Year

With San Juan Basin-Southern California border (bidweek) basis averaging double what it was last year through November-36 cents/MMBtu compared with 18 cents-and rising, Dynegy's $70 million deal for 1.3 Bcf/d of El Paso Natural Gas' firm pipeline capacity is looking better all the time for the company, Dynegy President Stephen Bergstrom said in an interview with NGI.

Bergstrom doesn't deny the El Paso deal is responsible for driving up the value of transportation to the California market and widening the basis. The capacity Dynegy purchased was going for about 8 cents last year. Now it's valued at about 32 cents/Mcf, excluding variable costs, while Dynegy is paying only 12 cents in demand charges. But Bergstrom said the value of capacity last year was driven down to artificially low levels because California regulators forced the LDCs to dump all their unused capacity on the market. "When capacity gets rationalized in an unfractured market, you're going to get more of a true reflection of the value of the capacity."

Dynegy made $7.6 million on the pipe during the third quarter, but most people may not know those profits offset a corresponding $7.6 million loss during the first and second quarters.

"They look at the spreads and say 'gee you've got to be making a boatload,' but what they don't look at is that we paid a lot of money in the first six months of the year when there wasn't that much demand," said Bergstrom. "Now we're just starting to get to a point where demand is picking up so that we can start making some of that back, let alone get a return on the risk investment that we did make."

He said gas volumes transported on Dynegy's El Paso capacity have ranged from a low of about 400 MMcf/d to a high of about 1 Bcf/d. "[I]t's all over the map depending on demand. We still like the deal. We think it makes sense. But through about September we were about break even on our costs. We're encouraged that as we get into winter we think we're going to do pretty well, but remember we put a $70 million bet down over a two-year period. We've got to get $70 million back before we start making anything. Everyone kind of forgets that we don't have rate base on that $70 million. If the demand is not there and the spread is not there, we eat the whole thing."

The $70 million Dynegy paid is broken up into $28 million in the first year and $42 million in the second year. "That's a little over a million each month [next year], just in demand charges."

"The demand looks pretty good. The last three months, we've been averaging 750 to 800 MMcf/d. We think storage looks a little lean out there. And when Northern Border comes on in the next few weeks, we think you'll see gas get pulled out of [California] to go to the Midwest and the demand for U.S. transportation, i.e., El Paso, will be stronger than what we've seen in the past," he said.

"Our view is when Border comes on you're not going to have enough gas out of Canada to feed both the Northern Border expansion of 750 MMcf/d plus the TransCanada expansion of 400 MMcf/d starting Dec. 1. Our view is something has to give. Some capacity is going to go unutilized and if you look at variable costs, there's a higher variable cost to California than there is to Chicago," he said. "We think supply will migrate to the Chicago market, particularly in the wintertime, and come out of California. If you're a customer in California, then you have to go to El Paso to either buy gas or buy capacity because you can't compete with the Chicago price."

The San Juan-SoCal border basis spreads this winter and next year are going to be determined by the amount of snow this winter in the Pacific Northwest, which will fuel hydro electric generation in April, May and June, and how cold the winter is-how much stored gas is used, he said.

Bergstrom said the forward basis market is offering only the "high 30s," 30 cents/Dth for transportation from the San Juan Basin to the Southern California border. "When you go back and look at the [San Juan-SoCal border basis this year], you scratch your head and say why would the forward market be high-30s when the last three or four months has been mid to high 40s. That just tells you there's not a lot of liquidity out there because it should be [high-40s]. But the forward market doesn't really represent what the current market dynamics are because there's just not that much liquidity in the San Juan-to-SoCal spread."

The lack of forward market liquidity is partly the result of power grid design. Many of the new owners and suppliers of generating capacity in California have no reason to "forward buy gas," said Bergstrom. "I don't see the generating guys [signing a lot of long-term supply agreements]. Fuel is a pass through on those must run [power generation] agreements so there's really no reason for guys like Williams, Duke and HI to forward buy gas. When they need it they just buy it on that day and it's a pass through. They really have no risk."

The daily and monthly basis spreads have been wide but the spreads don't mean anything unless you move volumes, he noted. "Everybody else is full. Transwestern is full, Kern is full, PGT is full and our capacity is the swing capacity into California."

But Bergstrom remains confident that over the long-run Dynegy's El Paso contract will bring in a respectable rate of return. He said Dynegy does plan to extend the two-year contract, which ends in January 2000. El Paso also would like to extend it, he said, because it transfers a tremendous amount of risk. "We have a lot more capability of managing it because A) we're not an affiliate, and B) we have such a large position in California. We still think that we'll get a reasonable return."

Rocco Canonica

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