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Arledge: Gas' Role in Power Generation in Doubt

Arledge: Gas' Role in Power Generation in Doubt

Energy traders would do well to fasten their seatbelts for the continuing convergence of natural gas and power if the prediction of Coastal Corp. CEO David A. Arledge is correct. Increasingly, the price of gas - the second most volatile energy commodity - will be linked with the price of power - the most volatile energy commodity, Arledge said.

For gas players made squeamish by memories of last year's chart-busting power price spikes, there is some consolation: gas prices will fall prey less and less to the vagaries of OPEC and the world oil market.

"One thing is clear. The North American natural gas business has moved away from its historically close relationship with oil. As gas consumption and electric power plants grow, the price of gas will become more closely tied to the price of power, with profound implications for all participants in the gas value chain," Arledge said last week at the Cambridge Energy Research Associates Executive Conference in Houston.

The future of gas demand relies heavily on the development of gas-fired power generation. Gas has become the fuel of choice for new generation, but Arledge views much of the proposed power development as highly speculative and a potential threat to profitability. "With most IPP (independent power producer) development in Asia suspended for the foreseeable future, it appears that a lot of developers have put down their passports and come back to the U.S. hoping to develop power projects in conjunction with our deregulating electric market here. In Texas, the upper Midwest and the Northeast, it would appear that capacity of proposed new plants far exceeds even the most optimistic projections for new demand. What is true in any other business will be true in electric generation. When intense competition collides with over-capacity, profits become an endangered species." Arledge predicted 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 to meet the challenge. "For example, U.S. producers added less than 1 Bcf/d of deliverability over a three-year period '95 to '97, and that's despite record levels of gas-directed drilling and strong price signals. That was a period in which independent producers were financially strong, well-funded and active. The sobering reality today is that at current oil and gas prices, most independents don't generate sufficient cash flow to replace existing production."

Also suggesting a tough road ahead for gas producers, last week in Houston CERA released findings that North American gas production capacity will weaken this year by roughly 500 MMcf/d due to cutbacks in drilling and exploration brought about by low oil prices. "We had previously expected a gradual increase in U.S. gas supply but several factors have reversed the outlook," said Robert Esser, CERA senior consultant and director for global oil and gas resources. Factors cited by Esser include accelerating decline rates in Gulf of Mexico production on the Continental Shelf that are offsetting new supply coming from the deep-water. Also cited was a 33% decline in overall gas-related drilling and a 70% drop in oil-related drilling.

"At Coastal we reached the conclusion some time ago that getting anywhere close to a 30 Tcf market by 2010 will require significant increases in gas supply from the deep-water gulf of Mexico and Canada, particularly from western Canada. We do expect growth in the Rockies and South Texas. But gains in these areas may be offset by declines in the shallow water Gulf and the Midcontinent regions over the next decade."

Arledge noted Coastal has been positioning for increased imports from Canada, taking a 14.4% interest in the Alliance Pipeline, for example. "Our decision to enter the Alliance Pipeline project and our intent to enter the Canadian upstream this year reflects our view that producers' netbacks will improve when Alliance goes into operation. When netbacks improve, Canadian producers will respond. They have in the past each time new pipeline capacity has been built."

Liquids Threatened

As gas supply is pulled up by demand, midstream gathering and processing players are at risk for getting squeezed by the growth. "Unfortunately, rising gas demand could be as much a curse as a blessing for gas processors in the future. When we talk about a 33% increase in gas demand, we're talking about a similar increase in NGL production from the gas plants. The market for gas is likely to be there, but the question is what about the market for NGLs. If it's not there, processing fundamentals appear bleak."

While gas processors might shudder at the thought of more liquids supply, gas pipelines, such as Coastal's, are licking their chops thinking of the growing demand. Citing a recent study by the Interstate Natural Gas Association of America, Arledge said pipelines are expected to invest $30 to $32 billion dollars over the next 12 years to support a 30 Tcf market. "That's a lot of investment, but it is very similar to the average annual investment by the industry over the past 15 years."

However, pipeline risk and rates of return need to come into better balance for the pipeline infrastructure to be built, Arledge said. Commoditization of pipeline capacity has benefited producers, shippers and end-users, "but all participants in the gas chain have a vested stake in the pipeline industry's willingness to invest to assure adequate capacity exists for future market growth." Arledge said he believes the Federal Energy Regulatory Commission is aware of the need for long-term contracts to support pipeline construction. "And I also further believe [FERC commissioners] are willing to consider the view that return levels must be made consistent with the new risk profile." Arledge said he thinks the industry, including FERC, sees no need for mandatory capacity auctions. "You're not going to be able to make 20-year investments on the basis of one-day contracts."

Joe Fisher, Houston

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