The nation faces a number of negative conditions as the winter heating season begins: flat to negative natural gas production that is driving up prices, tight infrastructure capacity in certain regions (especially New England) and expected higher gas demand, FERC said in its “2004-05 Winter Energy Market Assessment,” which was released Thursday.

At the same time, there are a few positive signs: speculative trading does not appear to be affecting prices significantly, storage is at a record level (more than 3.3 Tcf) and liquefied natural gas (LNG) imports are expected to rise this winter, the 36-page report said.

“We don’t want to leave the impression that we see things negatively” this winter heating season, but the Commission will be monitoring gas market activity, including pipeline capacity utilization and regional prices, said Thomas Pinkston of FERC’s Office of Market Oversight and Investigation (OMOI) during FERC’s regular open meeting on Thursday.

“We began our market monitoring effort this winter with commodity markets behaving as one would expect under conditions of tight supply. Nevertheless, these conditions have created high price levels,” he noted.

The Commission estimated that the recent natural gas futures price average for the 2004-2005 November-March heating season was 80% above last winter’s average. Although prices have gone down a bit over the past couple of weeks, the futures price average still is 60% higher ($7.73/Mcf) than it was for last winter (just under $5/Mcf), Pinkston said.

“Despite record storage levels, market concerns about tight supply/demand balance appear to be driving prices. Constraints include the status of production, demand growth and weather,” the FERC report said.

“Uncertainty about production appears to be overcoming the beneficial effects of record storage levels” this year, it noted. Although drilling activity has risen, industry experts estimate that year-on-year production is likely to range from flat to a negative 5%. Meanwhile, FERC staff said residential and commercial demand and gas-fired power generation have risen since last winter. Weather will be the wild card this winter, it noted.

“Speculative trading appears less significant to price behavior than are supply and demand conditions,” the staff report said. “Speculative trading (as measured by non-commercial futures positions) does not appear to be sufficient to have caused much of the recent price movement.”

Regional markets, particularly the Northeast, could see sharp price increases if the winter weather turns severe. Demand in the region this winter is expected to increase by 0.6 Bcf/d, while only about 0.5 Bcf/d of pipeline capacity has been added, the FERC report noted. Customers in the region would rather pay premium spot prices for brief periods than add year-round capacity, it said.

“This is rational from an end-user perspective to often rely on paying high prices for very brief periods versus committing to year-round capacity charges,” Pinkston told the commissioners. For example, FERC estimated that it cost New England customers about $24/MMBtu (relative to Gulf purchases) to buy spot gas during a three-day period last January, while it would have cost them more than $70/MMBtu to reserve annual pipeline capacity and more than $35/MMBtu to reserve storage and downstream pipeline capacity.

Overall, Northeast gas consumption this winter is expected to rise by a hefty 5% to reach 12 Bcf/d over the 2003-2004 heating season, significantly outstripping the growth rate for gas demand nationwide this winter, the report said. U.S. gas demand is projected to rise by 0.6% (or 2.7 Bcf/d) during the heating season, FERC staff noted.

Analysts estimate that LNG will contribute 7-10% to the total gas consumed in the Northeast this winter, according to OMOI’s Christopher Peterson. Overall, the Energy Information Administration (EIA) projects that deliveries of LNG this winter will be up 8% over last year nationwide, contributing an additional 400-500 MMcf/d, he said.

Given that only three pipeline projects were completed in the Northeast this year, “financial markets anticipate transportation bottlenecks in the Northeast and minimal congestion elsewhere” this winter, according to the winter assessment. Forward basis anticipates congestion at Texas Eastern Transmission M-3 (Northeast) and Transcontinental Gas Pipe Line Zone 6 (New York City) compared to minimal constraints in the Midwest and West. “Tight capacity is typical of the Northeast. Cold weather could cause restricted pipeline flexibility.”

During the 2003-2004 winter, “severe weather caused generator outages and fuel scarcity in New England,” and this could be repeated again because of the vulnerabilities facing the region, according to the report. New England is heavily reliant on gas-fired generation. It’s located at the end of gas supply lines from the Gulf of Mexico, and it could face a reduction in supplies from Canada in the event of a regional freeze. The region also has less dual-fueled generation capacity than New York and has significant winter load, FERC said.

But new procedures have been implemented to reduce the risk of winter problems in New England and other areas of the nation, the report noted. During cold snaps, the New England ISO (ISO-NE) will alter bidding schedules so that power generators will know their power commitments in advance of natural gas trading and pipeline scheduling deadlines.

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