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GAO Tells Senate Panel High Gas Prices May Be Expected 'Every Year'

The trend toward higher natural gas prices in recent years has largely been due to market forces and weather disruptions, namely Hurricanes Ivan, Katrina and Rita in 2004 and 2005, an official with the Governmental Accountability Office (GAO) told a Senate panel that is investigating price volatility in the natural gas market.

"Other factors -- such as market manipulation -- may also have affected wholesale prices," said Jim Wells, GAO's director of Natural Resources and Environment, during a field hearing last Monday of the Senate Homeland Security and Government Affairs' Permanent Investigations Subcommittee in St. Paul, MN. He noted that the agency currently is exploring possible manipulation in the gas futures market and will report its findings later this year.

Susan Court, director of FERC's Office of Market Oversight and Investigations, also appeared before the panel. It "appears the prices are the cause of natural drivers in the marketplace," she said in her testimony, adding that the agency had not seen any evidence of manipulation this winter.

The GAO's Wells warned that high gas prices may be here to stay. "Many people may have to pay a larger percentage of their income for home heating and other uses of natural gas, such as electricity, not just this year, but every year. Some may not be able to afford it. Further, because some key industries have historically relied on natural gas prices to be competitive, we may lose some of these industries," he said.

"Natural gas has become an essential element in our national energy picture. Ironically, however, natural gas markets may be suffering from the growing popularity of this versatile fuel. Rising demand and tightening supply appear to have contributed to both the general rise in prices over the past several years as well as the price spikes, such as [those that] following the hurricanes in 2005. Moreover, the stage seems set for future price spikes if either demand is higher than expected or supplies are unexpectedly interrupted."

The investigation into gas prices by subcommittee Chairman Norm Coleman (R-MN) began in November after major energy producers reported record fourth quarter profits in the wake of Hurricanes Katrina and Rita.

A customer's sensitivity to high gas prices is determined by its exposure to wholesale spot markets, the GAO said. "Consumers who directly or indirectly buy their natural gas mainly from spot markets will see prices that reflect both recent price spikes and the longer-term trend toward higher prices," according to the agency's testimony.

"According to our preliminary work with the state commissions that regulate natural gas utilities, 10 states reported that at least some of the natural gas utilities they regulated were highly exposed to spot market prices. Furthermore, in a few states, some of the largest natural gas utilities projected they would purchase 70% or more of their natural gas supplies for this winter from the spot market," Wells told the Senate panel.

To minimize the effects of high gas prices, "utilities in more than half the states have hedged at least 50% of their supply for this winter by entering into long-term, fixed-price contracts and [using] other techniques," the GAO said. "According to the state commissions, 27 states reported that the utilities they regulate will acquire at least half of their expected winter natural gas needs at a known price, generally ranging from $7 to $10 MMBtu."

While a number of states have made advancements in the area of hedging, "some states and municipalities still discourage the use of hedging, according to the association that represents the public utility commissioners," the GAO noted.

Hedging provides a number of benefits if everything goes according to plan, but it also poses risks. "Storing gas for later use, for example, entails up-front costs such as the cost of placing it into and keeping it in storage. Market participants face risks if, for example, they purchase gas in advance under a fixed-price, long-term contract and prices drop. For that reason, some natural gas utilities may be reluctant to enter into long-term contracts when prices are relatively high, according to a trade association that represents municipal gas utilities," the agency said.

"Furthermore, absent specific PUC guidance to hedge purchases, gas utilities may have few incentives to hedge since they are generally able to pass along increased costs associated with purchases of natural gas [to their customers]. Moreover, some state regulators may not allow gas utilities to financially benefit from using hedging but hold them financially responsible if the hedge proves unnecessary."

The GAO reported that the run-up in gas prices has been "especially severe" on low-income customers. It noted that Philadelphia Gas Works billed $42 million more than it collected so far this winter, representing an increase of 2% in uncollectible heating bills this winter compared with last winter. In Kentucky, utilities this winter have witnessed the highest number of complaints and the greatest number of problems faced by consumers, the agency said.

Meanwhile, the federal government has provided only "limited assistance" with heating bills, the GAO noted. The Low-Income Home Energy Assistance Program (LIHEAP) currently serves only 20% of the eligible population, with average payments of $311 per family to help with projected natural gas heating expenditures of $1,568 this winter.

The high gas prices also are "adversely affecting" industrial consumers, and have been "particularly detrimental" to the fertilizer and chemical manufacturing industries, according to GAO.

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