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Gas Industry Faces 'Winter of Discontent'

Gas Industry Faces 'Winter of Discontent'

The natural gas industry should be prepared to face customer uproar and attempts to impose price caps, similar to those seen this summer in San Diego, if the upcoming winter is cold enough and prices continue to hit new highs. That was the warning sounded by government and industry representatives at the crisis "summit" sponsored by the Interstate Oil and Gas Compact Commission (IOGCC) last week in Columbus, OH.

High-priced gas is a foregone conclusion for this winter, and there's not much the industry can do at this stage to forestall it. It's "like a hurricane coming. We can prepare for it, but we can't really change it fundamentally," said Thomas R. Robinson, managing director and director of research for Cambridge Energy Research Associates (CERA). Jerry Jordan, chairman of the Independent Petroleum Association of America, agreed that industry and consumers have little choice but to ride out the storm. "I believe that there is no quick fix, and that consumers, especially industrial consumers, .....need to sort of hold their breath [until we] get through this relatively short period of high prices."

Both Enron Chairman and CEO Kenneth L. Lay and Stephen L. Baum, chairman of Sempra Energy, whose San Diego Gas & Electric subsidiary has borne the brunt of the California debacle this summer (and whose prices were capped), believe there's a real potential for customer backlash if this winter proves to be a cold one. "Absolutely," said Baum. "Certainly, there could be some reaction," agreed Lay. "If we have a combination of cold winter with high prices, it could send bills up quite substantially" (see related story, this issue).

In this highly charged political year, producer, pipeline, LDC and consumer representatives already are bracing for the prospect of government intervention in the market in response to the higher winter gas prices, with some pointing to price caps as a possibility. Even FERC Chairman James J. Hoecker acknowledged that gas prices could be capped. "If there [is] not a sufficient price response in due course.....pressure to seek traditional regulatory solutions will inevitably mount. It will not matter then what anyone thinks the theoretical inadequacies of price caps might be," he told a group of more than 300 from the U.S., Canada and Mexico attending the "Governors' Natural Gas Summit" last Wednesday. In order to avoid price ceilings, "we must, therefore, be proactive in ensuring that markets continue producing benefits for consumers."

No one --- not even the consumer representatives at the summit --- favored outside action to restrain prices, but they believe there are other steps that utilities, state regulators and the federal government can take to lessen the price shock to consumers this winter.

Distributors and utilities have already swung into action by preparing their residential customers for the impending gas price increases, explaining the reasons for the higher prices, and apprising customers of budget plans and other price-mitigation measures. State regulators last week were urged to favorably consider price "smoothing mechanisms," similar to levelized price plans, to help soften the blow to customers. Moreover, industry executives said Congress could do its part by increasing federal funding for low-income gas and electric customers. Since more and more electricity is being fueled by natural gas, electric customers also are expected to feel the pain this winter. To provide relief in the long term, industry representatives unanimously called on federal regulators and Capitol Hill lawmakers to approve more gas transportation capacity, open more areas to exploration and drilling, formulate a "rational" energy policy and reform the alternative minimum tax.

How the gas industry addresses the concerns of residential customers this winter will be critical. "If we're not careful, we might lose the PR battle," warned Enron's Lay.

"While large industrial energy users have been well aware of the tight [gas] supply situation's impact on market prices for quite sometime, it is just now starting to hit the radar screen of residential customers and smaller commercial customers," observed Peggy Claytor, purchases manager-energy for steelmaker The Timken Co. "We may see protests or proposals, such as price caps [or] government regulation of prices, that promise quick fixes for fundamental problems." While such actions may have "political appeal in some circles." she said they not only "would fail to solve the underlying problem," but they might "exacerbate" it.

CERA's Robinson agreed. "Price is the symptom, not the problem. Supply is the problem. Policies that attempt to fix the symptom, in other words price caps, risk letting the underlying problem fester," he said. "Prices will moderate, maybe not in time for this winter, but for future winters," noted Robert C. Skaggs, president and CEO of Columbia's LDCs in Ohio and Kentucky. In the meantime, "our collective challenge is to resist tinkering with the market," and in some cases that means "getting the heck out of the way.....so that the market is allowed to work."

Intervention by the federal government in the market this winter "will chill [capital] investment" for new facilities to produce and deliver natural gas, warned Williams Chairman and CEO Keith E. Bailey. However, he thinks state regulators can play a key role in helping consumers that will be "exposed most to volatility" this winter, which Bailey said will be those served by the "more traditional utilities." He proposed that regulators enact "long-term smoothing" mechanisms to control the flow of the higher prices to consumers.

Columbia's Skaggs expressed distaste for any kind of price "smoothing" mechanism. "Smoothing is fundamentally opposed to what [customer] choice stands for," he said, adding it could "undermine" choice programs. Timken's Clayton questioned how helpful retail choice will be for customers this winter, saying that locking in fixed prices may not be the most "prudent" move for residentials.

Bailey particularly cautioned "sophisticated" gas buyers within the industry not to "succumb to the temptation" to seek bail-outs from the federal government. "...[T]he market will respond. It already is responding.....My advice is to stay the course."

Most were quick to place the blame for higher prices on the tight supply, with CERA's Robinson estimating "we're close to 2 1/2 Bcf per day short on supply now." But Timken's Claytor saw another culprit. "In many ways, our dysfunctional electric grid and our failure as a nation to address this condition through meaningful action is contributing to high gas prices."

Assuming there's no outside intervention, Lay said industry experts expect wellhead gas prices to be high for the short term, coming down over next two to three years. "As long as regulators leave it alone, .....this market will come back into balance." Lay pointed out that even if the price to consumers hits $8.80/Mcf this winter, it would be just equal to the price level, adjusted for inflation, in 1986. Also, he noted the cost savings to customers since deregulation began in 1984 have been about $174 billion (see related story). But the savings to customers would have been a mere fraction of that if the price controls that were enacted under the Natural Gas Policy Act in the late 1970s were still in effect today, Lay said.

"I appreciate [what] the consumer will be facing" this winter, but in real terms energy is still considered the "best buy around," Robert Allison Jr., chairman of Anadarko Petroleum, told the group, pointing out how the percentage increases in prices for other basics such as houses and cars have been far greater over the past 15 years. The problem with energy prices is they have stayed low for so long.

In order to assure price relief in the long term, Congress should provide producers with access to "prime drilling lands" that are now off limits, Allison said, estimating there are 213 Tcf of reserves --- or a 10-year supply --- in the lower 48 states and offshore that are closed to producers. Specifically, natural gas and oil exploration and drilling are "off limits or significantly restricted" in 40% of the Rocky Mountain region and in the Outer Continental Shelf off the East and West Coasts, while more than 50% of the eastern Gulf of Mexico is closed to producers, according to Timken's Claytor.

"The big issue is access. All of the other problems fade and are insignificant compared to that. We need to educate our legislators on the state and federal basis to try and face this issue very quickly," said the IPAA's Jordan.

Given the long lead times required for new production to make its way to the market, Claytor said "any further delay [by Congress] in removing existing impediments to reserve development [will serve] to prolong the current tight supply situation." It was estimated that it takes 12 to 18 months for supply from new gas production fields to be felt in the market, 5-6 years for the effects of deep-water development to be realized, and will take 7-10 years for the construction of a pipeline from Alaska to the Lower 48 market.

Industry representatives unanimously called on FERC and Congress to actively encourage the building of additional pipeline capacity, particularly a new pipeline from Alaska. Williams' Bailey said the construction of new capacity to meet a 30 Tcf market in 2010-2015 will require a $25 billion investment on industry's part. That doesn't include the estimated $6-$12 billion that will be needed to build a pipeline to deliver Alaska's "very substantial resource base" to the lower U.S. market, he noted.

Leading off the gas "summit," CERA Chairman Daniel Yergin called the current situation a "shock," not a "crisis." A lack of reserves would be a crisis, but there are plenty of reserves. It's simply that demand has accelerated and bumped up against the "iron law of lead times." He said the entire industry would have to invest more than $500 billion over the next ten years, nearly double the level of the 1990s, to keep up with new markets.

Yergin called for the U.S. to coordinate supply development policy with Mexico and Canada. "This is not just a U.S. issue. And there will not be just U.S. solutions ---- there must be a continent-wide response."

Susan Parker, Columbus, OH

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