As natural gas prices continue to stay north of $5.50, industry watchers are not sure whether the market is just reaching the peak of another cycle or whether these levels actually are sustainable over a longer term. Consultants at Arlington, VA-based Energy and Environmental Analysis, Inc. (EEA) believe there has been “fundamental shift in the gas market paradigm that is likely to be with us for the next two years or more.”

While acknowledging that the 2002-2003 winter has been much colder than last year and that the $5.50-$6.50 range is “quite high” by historical standards, EEA noted that it’s not the highest that prices have been in recent years. “Remember the $8.50 dollar bidweek prices in January 2001? So, maybe this is just another cycle on the gas price roller coaster,” the consulting firm said in its Monthly Gas Update.

“Or is it?” The group noted that many East Coast pipelines, such as Transco, have had days of near-record throughput and a number of local utilities in the eastern United States have reported record send-outs. “These factors have kept the balance in the gas market extremely tight. That said, it really hasn’t been all that cold, at least not throughout the entire United States. While many of the East Coast LDCs are experiencing weather that is 5% — or more — colder than normal, warm weather in the western states has more than offset the cold weather in the East.”

According to population-weighted heating degree day data through the week ending Feb. 8, this winter has been 3.1% warmer than normal, as defined by the average of the last 30 years.

Regarding the supply side, EEA said it would be months before there is even the possibility that increased drilling activity would be sufficient to raise deliverability by any “significant amount.” As January prices soared in 2001, the rig count followed suit. However, drilling activity currently remains modest at best and rig operators in trade reports and at meetings are talking about a bottom to the trough but not an upcoming strong rally.

The storage situation is tight as working gas levels are down significantly from last year, EEA noted. While attempting to refill storage this spring and summer, the industry will also have to put up with an additional 3 Bcf/d in gas demand for new gas-fired generation.

Despite the high prices, EEA thinks industrial gas users will stick around. The group said it does not believe that industrial demand “will go quietly into that dark night” so long as the economy continues to grow and manufacturing activity picks up.

Noting that higher gas costs can put pressure on profits for most manufacturers and cause certain industries, such as ammonia and methanol, to cut production, EEA said that gas costs, as a percent of total costs, are small for most industries. Inventories and consumer demand are larger drivers for most industrial output.

“All of this leads EEA to conclude that current prices are not at the top of the cycle,” but rather entering a new “paradigm,” or a step change upward, the group said.

High world oil prices are a contributing factor and EEA noted that probably won’t change in the near-term because of the situation in Iraq. In the firm’s base case, it assumes that refinery acquisition costs of oil will trend slowly downwards, stabilizing at $24/bbl by Jan. 2004.

“Given all the factors, we believe that the forecast risk is for even higher [gas] prices than shown in our base case,” EEA added. “Options for large amounts of incremental supply — LNG terminals, frontier gas, etc. — are on the horizon, but they cannot be developed in time to affect prices in the next 24 months.” The firm added that project timetables have grown longer as many energy companies have had to trim capital budgets to manage credit risk. Large LNG players, such as El Paso Corp., also have started to back away from the business entirely despite earlier rapid development plans.

Over the next two years, the group sees only two options to increase gas supply — increasing LNG imports or increasing deliverability through aggressive drilling programs. LNG Imports may increase in 2003 with the additional capacity from the 0.4 Bcf/d Elba Island Terminal in Georgia, which was reactivated in July of 2002, and the planned reactivation of the 1 Bcf/d Cove Point Terminal in Maryland, scheduled for the spring of 2003.

The group noted that total imports into the Lower 48 are still dependent on LNG supply, tanker availability, and competition from other countries. “There is evidence to suggest that some spot LNG supplies are currently being diverted to higher priced foreign markets,” EEA said. “However, increased LNG potential is modest in the very short run. At full capacity, the two reactivated terminals plus the existing terminals of Everett in Massachusetts and Lake Charles in Louisiana would only be 0.8 Bcf/d above our base case projection. This assumes that LNG spot supplies and available tankers could and would be diverted to the U.S.”

The group said its base case already includes an increase in deliverability from LNG and increased production of 1 Bcf/d over the next 12 months and 2.5 Bcf/d over the next 24 months. “We are concerned that any delay from producers in the response to the market signals will push prices to even higher levels.”

Classifying the natural gas market as being in a “somewhat perilous position,” EEA said there is a risk that a prolonged period of high gas prices could elicit a “regulatory backlash” that could damage the gas commodity marketplace. “Even if ‘a self-inflicted wound’ in the form of regulatory intervention is avoided, a prolonged period of high prices risks permanent long-run demand destruction as energy intensive industries move offshore. It’s not a pretty picture if you are a gas consumer or regulated company in the energy industry, but we are just telling it like we see it.”

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