Energy traders would do well to fasten their seatbelts for thecontinuing convergence of natural gas and power if the predictionof Coastal Corp. CEO David A. Arledge is correct. Increasingly, theprice of gas – the second most volatile energy commodity – will belinked with the price of power – the most volatile energycommodity, Arledge said.

For gas players made squeamish by memories of last year’schart-busting power price spikes, there is some consolation: gasprices will fall prey less and less to the vagaries of OPEC and theworld oil market.

“One thing is clear. The North American natural gas business hasmoved away from its historically close relationship with oil. Asgas consumption and electric power plants grow, the price of gaswill become more closely tied to the price of power, with profoundimplications for all participants in the gas value chain,” Arledgesaid last week at the Cambridge Energy Research AssociatesExecutive Conference in Houston.

The future of gas demand relies heavily on the development ofgas-fired power generation. Gas has become the fuel of choice fornew generation, but Arledge views much of the proposed powerdevelopment as highly speculative and a potential threat toprofitability. “With most IPP (independent power producer)development in Asia suspended for the foreseeable future, itappears that a lot of developers have put down their passports andcome back to the U.S. hoping to develop power projects inconjunction with our deregulating electric market here. In Texas,the upper Midwest and the Northeast, it would appear that capacityof proposed new plants far exceeds even the most optimisticprojections for new demand. What is true in any other business willbe true in electric generation. When intense competition collideswith over-capacity, profits become an endangered species.” Arledgepredicted many power plant proposals will die on the vine.

Commenting on projections for a 30 Tcf gas market by 2010,Arledge said all segments of the gas industry face a tall order tomeet the challenge. “For example, U.S. producers added less than 1Bcf/d of deliverability over a three-year period ’95 to ’97, andthat’s despite record levels of gas-directed drilling and strongprice signals. That was a period in which independent producerswere financially strong, well-funded and active. The soberingreality today is that at current oil and gas prices, mostindependents don’t generate sufficient cash flow to replaceexisting production.”

Also suggesting a tough road ahead for gas producers, last weekin Houston CERA released findings that North American gasproduction capacity will weaken this year by roughly 500 MMcf/d dueto cutbacks in drilling and exploration brought about by low oilprices. “We had previously expected a gradual increase in U.S. gassupply but several factors have reversed the outlook,” said RobertEsser, CERA senior consultant and director for global oil and gasresources. Factors cited by Esser include accelerating declinerates in Gulf of Mexico production on the Continental Shelf thatare offsetting new supply coming from the deep-water. Also citedwas a 33% decline in overall gas-related drilling and a 70% drop inoil-related drilling.

“At Coastal we reached the conclusion some time ago that gettinganywhere close to a 30 Tcf market by 2010 will require significantincreases in gas supply from the deep-water gulf of Mexico andCanada, particularly from western Canada. We do expect growth inthe Rockies and South Texas. But gains in these areas may be offsetby declines in the shallow water Gulf and the Midcontinent regionsover the next decade.”

Arledge noted Coastal has been positioning for increased importsfrom Canada, taking a 14.4% interest in the Alliance Pipeline, forexample. “Our decision to enter the Alliance Pipeline project andour intent to enter the Canadian upstream this year reflects ourview that producers’ netbacks will improve when Alliance goes intooperation. When netbacks improve, Canadian producers will respond.They have in the past each time new pipeline capacity has beenbuilt.”

Liquids Threatened

As gas supply is pulled up by demand, midstream gathering andprocessing players are at risk for getting squeezed by the growth.”Unfortunately, rising gas demand could be as much a curse as ablessing for gas processors in the future. When we talk about a 33%increase in gas demand, we’re talking about a similar increase inNGL production from the gas plants. The market for gas is likely tobe there, but the question is what about the market for NGLs. Ifit’s not there, processing fundamentals appear bleak.”

While gas processors might shudder at the thought of moreliquids supply, gas pipelines, such as Coastal’s, are licking theirchops thinking of the growing demand. Citing a recent study by theInterstate Natural Gas Association of America, Arledge saidpipelines are expected to invest $30 to $32 billion dollars overthe next 12 years to support a 30 Tcf market. “That’s a lot ofinvestment, but it is very similar to the average annual investmentby the industry over the past 15 years.”

However, pipeline risk and rates of return need to come intobetter balance for the pipeline infrastructure to be built, Arledgesaid. Commoditization of pipeline capacity has benefited producers,shippers and end-users, “but all participants in the gas chain havea vested stake in the pipeline industry’s willingness to invest toassure adequate capacity exists for future market growth.” Arledgesaid he believes the Federal Energy Regulatory Commission is awareof the need for long-term contracts to support pipelineconstruction. “And I also further believe [FERC commissioners] arewilling to consider the view that return levels must be madeconsistent with the new risk profile.” Arledge said he thinks theindustry, including FERC, sees no need for mandatory capacityauctions. “You’re not going to be able to make 20-year investmentson the basis of one-day contracts.”

Joe Fisher, Houston

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