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Apache: Natural Gas Market Broken, Needs Repair
The roller coaster ride of natural gas prices over the past year and a half is clear evidence of a market in need of federal repair, Apache Corp. said last week, adding that an Enron-Dynegy merger would exacerbate the existing market malfunction.
The large independent producer believes gas prices are out of control with companies, such as Dynegy and Enron, working to increase price volatility, which undermines the drilling plans and budgets of production companies. Alarming some observers, Apache said the federal government needs to step in and reimpose price controls on the market or require that all gas futures trades be backed up by physical gas.
Apache is cutting its drilling budget for next year by 70% to $300 million in capital expenditures because of the sharp decline in gas prices from $10 last winter to less than $2 in September, and because of the increase in drilling costs and the uncertainty in the market.
Apache spokesman Tony Lentini noted that with the rig count in rapid decline there is the beginning of a whole new volatile price cycle being created. “It would be a real shame if we don’t look at the underlying fundamental problem with the natural gas market, which is dramatically broken,” he said. “We have the same thing being set up in the electricity market, and it really needs to be dealt with. It’s undermining the security of supply.
“The changing price has become an end in itself,” said Lentini. “It disrupts the supply process. It gets us in constant boom and bust cycles that are really bad for the country.”
Apache doesn’t believe natural gas is inherently volatile because demand for it is seasonal and closely related to the weather. Instead, Apache thinks speculators have made it that way. “It wasn’t this volatile when it was regulated,” Lentini noted. “It hasn’t been that volatile really until the last few years. It’s all the people that were claiming they would make the market more efficient that actually have come in and made it a gambling casino. All they care about is how the price changes.”
They apparently include Dynegy Corp. and Enron Corp., two of the largest players in the futures and cash markets. “We would definitely be against [a Dynegy-Enron merger],” said Lentini, “because we think it would be bad for producers and consumers to have that much market concentration in the hands of two of the biggest players. It would create more market volatility,” which Apache sees as the real symptom of the market’s current problems.
“Our chairman Raymond Plank calls [the futures market and the cash market] a 150-pound tail wagging a 10-pound dog. We have 15 times more paper trading in the natural gas market than actual physical gas trades. What this does is exacerbate volatility. Natural gas is the most volatile commodity of them all — 10 times the closest competitor, which is crude oil. We’ve had 500% volatility this year. You can’t plan your drilling budgets when prices fall from $10 to $2 in one year.”
Requiring that all futures trades be backed up by 50-70% physical gas in the market would go a long way toward reducing that volatility, said Lentini, adding that Apache shares this view with consulting firm Simmons and Company.
David Pursell of Simmons confirmed his company has discussed such a market remedy, but he said raising margin requirements on financial players would be a much better way to curb volatility. “For an E&P company, the volatility of the market is very difficult.
“I don’t know that natural gas is inherently volatile,” he said. People make it that way, and the financial market is a major force in achieving that result. “You have a lot of financial leverage in the commodity market [that isn’t present in the stock market],” he noted.
“I would also argue that the market needs better data than what we get from [the American Gas Association] on Wednesday. Department of Energy supply and demand data also is just abysmal.”
Apache, however, also has proposed the more drastic recommendation that the federal government should set a pricing band in the wholesale market with a floor price of $3/MMBtu and a ceiling of $5/MMBtu. “Let gas trade within that range, but don’t let it get out so far that it damages the whole infrastructure and the ability of the nation to produce gas,” said Lentini. “The point is the market itself, as it is working right now, ain’t working.”
Those so-called remedies alarm some observers. Tim Evans, a futures market analyst with Thompson Global Markets, suggests Apache Corp. send its CEO and employees “back to Economics 101.” One other consultant called Apache’s pricing band idea “absolutely crazy.”
“If the futures market is going to be limited to those who have physical gas positions, then liquidity is going to drop and volatility is going to rise even further,” said Evans. “The economic function of speculative activity — why it is a bonus to the market and the way in which it adds value to the economy — is by pricing in likely future events sooner than they would be priced in otherwise. They send an economic message to the marketplace.
“Last summer, for example, we weren’t putting gas into storage at a fast enough rate so the speculators were in there buying futures, giving us prices headed north early in May and June, sending this message that ‘hey folks we need more gas’ and telling consumers ‘hey you might want to find a way to use less.’ I see that as the market working. They are not telling us there’s too little gas when there is too much or there is too much gas when there is too little.”
Evans said the $10/MMBtu gas prices seen last winter were not an inaccurate representation of the fundamentals at that time. “At the time we hit that price, we had a year-on-year storage deficit of 760 Bcf. There was serious talk that storage could hit zero at the end of the winter,” he noted. “If prices are ever going to be $10, that’s it.”
It is true in “every single commodity market in the world” that the financial presence is greater than the physical presence, Evans added. “My argument to them is if you think $10 is too high, sell. If you think $2 is too low, then buy. But don’t cry about it being broken.
“It’s an opportunity for them. Earth to Apache Corp., this is a boom and bust business, and it is partly the producers fault that it is that way. Nobody forced them to go wild with drilling in the last year and a half. And nobody is forcing them to cut back that drastically now.”
Evans suggested that producers focus on investing in their business on a more even and consistent basis. “[That] would leave them, by the way, in a better position to take advantage of price spikes when they do occur, which in turn would give them the cash on hand to invest in the business when prices fell.”
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