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Kelliher Underscores FERC Vigilance in Assuring Gas Prices Driven by Fundamentals

Against the backdrop of an expected increase in natural gas prices this winter, FERC is "acting to assure that prices are being driven by fundamentals, not by other considerations, such as market manipulation," FERC Chairman Joseph Kelliher said on Tuesday.

The staff at FERC's Office of Market Oversight and Investigations (OMOI) holds daily meetings "to review gas market activity in detail in order to understand the fundamental supply and demand factors that are driving prices. If they see anomalies, OMOI staff can initiate non-public investigations," the FERC chairman said in an appearance at the National Press Club in Washington, DC, addressing effects of the recent string of hurricanes on natural gas prices.

"The question isn't whether prices will be higher than they were before the hurricanes," he said. "They will be higher. What we view as what's at stake is how much higher will they go? We want to make sure that they don't go any higher than they would because of market fundamentals. We want to be in position to quickly identify market manipulation, if it occurs, to penalize it to a full extent authorized by Congress in the new Energy Policy Act."

Meanwhile, Kelliher noted that FERC is moving to reform its gas storage pricing policies "with a goal of providing a greater incentive to invest in gas storage facilities." He pointed out that since 1988, gas storage capacity in the U.S. has increased 1.4%, but demand for gas has increased 24%.

"Last year, we saw record levels of gas in storage and near record levels of price volatility," Kelliher said. "I think one inference you can draw from that is that we don't have adequate levels of storage capacity in the United States." FERC's "cost-based pricing policies on gas storage pricing go back to 1976. I think after 30 years, it's probably time to actually look at some reform to both our cost-based and market-based pricing policies," with the goal of increasing storage capacity, "in the hopes that will help limit price volatility in natural gas."

Kelliher was asked to comment on the idea of the U.S. setting up a natural gas reserve that would be similar to the strategic petroleum reserve (SPR). He said, "It might displace some of the private reserves. Maybe you'd see less gas in storage held by the private sector if the government assumed that role."

If there is "no change in the amount of gas in storage and the only change is some of it's owned by the government that used to be owned by the private sector, it's hard to see that's a good thing. Arguably, it's not a bad thing. It depends on the use of the gas in storage. How responsive is it to price? But I generally don't have a comment on the proposal to establish a government natural gas reserve."

A group of industrial energy consumers recently told the Bush administration that creating a strategic natural gas reserve similar to the SPR would not be a good idea in light of the limited amount of domestic gas supply currently available (see Daily GPI, Nov. 4).

At a later point, another reporter asked Kelliher whether it would make sense for the government to require gas producing companies to set aside a certain number of days or weeks of emergency natural gas in storage.

"Most gas in storage is owned by local distribution companies or gas utilities," Kelliher noted. "And they typically do exactly that. They don't react immediately to price. They're less price responsive than, say, marketers... [Utilities] tend to keep it in storage for a rainy day."

Kelliher noted that Hurricanes Katrina and Rita had "a very severe effect on our infrastructure and our supply." Noting that 20% of the U.S. gas supply comes from the offshore Gulf, "most of that production has been shut in during the past three months because of the hurricanes." If one looks at the cumulative loss of production during that three month period, "it represents over 12% of our offshore production."

Kelliher said that it's "clear that we cannot make up the loss of domestic production through greater imports. The U.S. is much more self-sufficient on natural gas than it is in oil, clearly. But our oil industry is oriented around imports. Our natural gas industry is not."

Canadian production is flat while Canadian demand is rising, he noted. "The Canadians are growing into their production, and at best we can expect flat import levels from Canada. In fact, I think imports are slightly lower now than they were a year ago."

Meanwhile, LNG supply currently is limited by liquefaction capacity overseas. The LNG import "chain" has four links -- overseas gas production, overseas liquefaction, the shipment and, fourth, regasification/LNG import facilities located in the U.S.

"There's been a lot of contested proceedings to site LNG import projects in the U.S." and that has created a "false perception that is the constraint on LNG imports." Kelliher said this is "demonstrably not true, because right now the current operating LNG import facilities are operating at less than half capacity. So they could double the imports without reaching capacity."

He said that if "you look at the LNG import chain, the most expensive part of it is liquefaction, so it's not really surprising that that's the area that's the weakest link right now in the LNG import chain. It's the one that's most capital intensive."

As to how much higher natural gas prices will rise this winter, Kelliher cited three variables -- the rate of recovery of offshore gas production, weather and, third, conservation efforts. "Those are the three key variables that have driven prices in recent weeks and they will through the winter heating season."

He pointed out that natural gas prices were increasing before Hurricanes Rita and Katrina. The fact that gas prices were high prior to these two hurricanes "hasn't been recognized sufficiently, I think." Domestic production "has been flat, imports have been relatively flat, Canadian production has been flat, demand is growing, so it's not surprising that prices would have been increasing fairly steadily in the past few years."

But there is some "good news," the FERC chairman said. Specifically, Kelliher noted that offshore gas production "has rebounded very impressively in the past few weeks. Three weeks ago, 54% of our offshore gas production was shut in...as of yesterday [Nov. 21], that number had dropped to 32%, so we've seen a very impressive recovery in the offshore gas production. That, to me, has a permanent positive effect on gas prices" in the heating season.

Another positive development is in the area of storage levels. Prior to Rita and Katrina, the U.S. "had relatively high levels of storage -- gas in storage -- they were above the five-year average and they continue to be above the five-year average."

A third bright spot is weather. "Until recently, we've had a spell of mild weather and that has had a significant impact on prices." But he also noted that weather is "a huge variable" when it comes to the direction of natural gas prices. If one were to compare this winter to last winter, "if this winter proves to be 10% warmer than last winter," Kelliher said that can "roughly offset the loss of domestic gas production caused by the hurricanes." In contrast, if this winter is 10% colder than last winter, "it can roughly double the price effect of the lost offshore gas production this winter."

As for conservation, Kelliher said "it's very important this winter that consumers appreciate that prices will be high in advance of consumption and that's something the Commission has spent a lot of time on." It's important for consumers to "appreciate that gas prices will be high and they change behavior -- they increase their efforts to conserve."

He said that state conservation programs "really are critical this winter." FERC last month looked at a number of state programs related to conservation and has "urged states to adopt best practices in their conservation programs."

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