With San Juan Basin-Southern California border (bidweek) basisaveraging double what it was last year through November-36cents/MMBtu compared with 18 cents-and rising, Dynegy’s $70 milliondeal for 1.3 Bcf/d of El Paso Natural Gas’ firm pipeline capacityis looking better all the time for the company, Dynegy PresidentStephen Bergstrom said in an interview with NGI.
Bergstrom doesn’t deny the El Paso deal is responsible fordriving up the value of transportation to the California market andwidening the basis. The capacity Dynegy purchased was going forabout 8 cents last year. Now it’s valued at about 32 cents/Mcf,excluding variable costs, while Dynegy is paying only 12 cents indemand charges. But Bergstrom said the value of capacity last yearwas driven down to artificially low levels because Californiaregulators forced the LDCs to dump all their unused capacity on themarket. “When capacity gets rationalized in an unfractured market,you’re going to get more of a true reflection of the value of thecapacity.”
Dynegy made $7.6 million on the pipe during the third quarter,but most people may not know those profits offset a corresponding$7.6 million loss during the first and second quarters.
“They look at the spreads and say ‘gee you’ve got to be making aboatload,’ but what they don’t look at is that we paid a lot ofmoney in the first six months of the year when there wasn’t thatmuch demand,” said Bergstrom. “Now we’re just starting to get to apoint where demand is picking up so that we can start making someof that back, let alone get a return on the risk investment that wedid make.”
He said gas volumes transported on Dynegy’s El Paso capacityhave ranged from a low of about 400 MMcf/d to a high of about 1Bcf/d. “[I]t’s all over the map depending on demand. We still likethe deal. We think it makes sense. But through about September wewere about break even on our costs. We’re encouraged that as we getinto winter we think we’re going to do pretty well, but remember weput a $70 million bet down over a two-year period. We’ve got to get$70 million back before we start making anything. Everyone kind offorgets that we don’t have rate base on that $70 million. If thedemand is not there and the spread is not there, we eat the wholething.”
The $70 million Dynegy paid is broken up into $28 million in thefirst year and $42 million in the second year. “That’s a littleover a million each month [next year], just in demand charges.”
“The demand looks pretty good. The last three months, we’ve beenaveraging 750 to 800 MMcf/d. We think storage looks a little leanout there. And when Northern Border comes on in the next few weeks,we think you’ll see gas get pulled out of [California] to go to theMidwest and the demand for U.S. transportation, i.e., El Paso, willbe stronger than what we’ve seen in the past,” he said.
“Our view is when Border comes on you’re not going to haveenough gas out of Canada to feed both the Northern Border expansionof 750 MMcf/d plus the TransCanada expansion of 400 MMcf/d startingDec. 1. Our view is something has to give. Some capacity is goingto go unutilized and if you look at variable costs, there’s ahigher variable cost to California than there is to Chicago,” hesaid. “We think supply will migrate to the Chicago market,particularly in the wintertime, and come out of California. Ifyou’re a customer in California, then you have to go to El Paso toeither buy gas or buy capacity because you can’t compete with theChicago price.”
The San Juan-SoCal border basis spreads this winter and nextyear are going to be determined by the amount of snow this winterin the Pacific Northwest, which will fuel hydro electric generationin April, May and June, and how cold the winter is-how much storedgas is used, he said.
Bergstrom said the forward basis market is offering only the”high 30s,” 30 cents/Dth for transportation from the San Juan Basinto the Southern California border. “When you go back and look atthe [San Juan-SoCal border basis this year], you scratch your headand say why would the forward market be high-30s when the lastthree or four months has been mid to high 40s. That just tells youthere’s not a lot of liquidity out there because it should be[high-40s]. But the forward market doesn’t really represent whatthe current market dynamics are because there’s just not that muchliquidity in the San Juan-to-SoCal spread.”
The lack of forward market liquidity is partly the result ofpower grid design. Many of the new owners and suppliers ofgenerating capacity in California have no reason to “forward buygas,” said Bergstrom. “I don’t see the generating guys [signing alot of long-term supply agreements]. Fuel is a pass through onthose must run [power generation] agreements so there’s really noreason for guys like Williams, Duke and HI to forward buy gas. Whenthey need it they just buy it on that day and it’s a pass through.They really have no risk.”
The daily and monthly basis spreads have been wide but thespreads don’t mean anything unless you move volumes, he noted.”Everybody else is full. Transwestern is full, Kern is full, PGT isfull and our capacity is the swing capacity into California.”
But Bergstrom remains confident that over the long-run Dynegy’sEl Paso contract will bring in a respectable rate of return. Hesaid Dynegy does plan to extend the two-year contract, which endsin January 2000. El Paso also would like to extend it, he said,because it transfers a tremendous amount of risk. “We have a lotmore capability of managing it because A) we’re not an affiliate,and B) we have such a large position in California. We still thinkthat we’ll get a reasonable return.”
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