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California crisis adds uncertainty to summer natural gas prices
Ann de Rouffignac OGJ Online May 15, 2001—U.S. natural gas prices were volatile last year and are expected to seesaw even more this summer. The uncertainties, heightened by fears the government will intervene in the California gas market, result in little agreement among gas price forecasters. Most analysts expect gas prices to remain under $5/Mcf in May and early June, but they disagree about what will happen next and why. Will prices begin soft, rebounding with a vengeance later this summer, or just even out the rest of the year? While some forecasters think prices will top out at $6/Mcf, a Midwest manufacturing concern suggests prices could jump as high as $7.50/Mcf this summer, making decisions about when to lock up supplies a tough call. The perennial wild cards complicating gas price forecasts include weather, industrial demand, supply increases, and storage rates. But this summer California remains a bigger question mark than usual. What happens there could reverberate throughout the market. In addition to the normal market risks, some observers have added regulatory risk. Most analysts expect California prices to remain higher than prices nationwide, unless the Federal Energy Regulatory Commission intervenes. Marshall Adkins, analyst with Raymond James & Associates Inc. in Houston, believes prices will come down sharply in May and June. He calculates supply exceeds demand by 5-6 bcfd. Some of the slack has come from fuel switching, some from industrial demand drop off, and some from increased supply. He looks for a major "whipsaw" in natural gas prices this summer. Prices will be driven back up in July and August to about $6/Mcf and will average about $5/Mcf for the year, Adkins says. "Our assumption is that about 40,000 Mw of new gas-fired generation capacity will be added to the grid during the summer," Adkins says. "This will add, on average, about 4 bcfd of consumption." But later in the summer consumption will be even higher because of peaking plant demand. Ron Barone, analyst with UBS Warburg in New York, agrees near-term prices will continue to weaken in because of significant storage injections and cooler temperatures. Barone is forecasting a significant "pullback" in price to the low $4 level in June, much lower than his earlier June projections of $5.20/Mcf. George Littell, a partner with energy consultants Groppe, Long, Littell, Houston, says gas prices will continue to moderate through the summer. "A lot of people only think about the weather," says Littell. "There's fuel competition. A lot of older power plants are switching to burn oil. Concern about the summer is keeping prices up for now. But as the summer goes on, fuel switching will increase." For example, one of Littell's clients in Arizona managed to get oil shipped by rail to the West diverting it from its originally scheduled delivery point in the East. It cost the company $8/bbl for rail transportation but at the price of natural gas in the West, the oil (including transportation) was a bargain, he says. Littell expects summer prices to hover between $4.60-$4.75/MMbtu as such demand responses keep the lid on prices. Don't bet on it, says Peggy Claytor, energy purchasing manager for Timken Co., a large Midwest bearings and steel manufacturing concern. She says the manufacturing sector has done all the fuel switching it can in response to high natural gas prices. If there is going to be a demand response this summer, it's not going to be more than what was experienced last winter. Claytor doubts fuel switching will be able to ward off $7.50/Mcf prices in the dead of summer. "Last winter feedstock operators were shut down and processors switched to fuel oil for their boilers. That was as good as it gets," Claytor says. "To hang anyone's hat on more industrial demand response is ludicrous." Other observers disagree. "We expect prices to come down on average for the year," says Judah Rose, senior vice-president ICF Consulting of Fairfax, Va. "There will be some pressure in late summer but the price will be lower on average for the year." Rose also expects large gas consumers to manage their storage better this year. High prices kept big natural gas consumers from injecting gas into storage last summer. They bet prices would drop following the summer run up in demand and storage could be then filled for the winter.
They bet wrong. There was a run on gas as power producers scrambled for gas supply and distribution companies desperately filled storage for the winter. Prices spiked. Rose doesn't believe market participants will make same mistake twice. As companies steadily fill storage this year, the price of gas will even out, he says. Analysts at Purvin & Gertz Inc., Houston, however, predict the natural gas market will remain firm in the $5-$6/Mcf range throughout 2001, mostly due to concerns about rebuilding storage at the same time power generators require more gas during the summer. Rose says additional supply is finally reaching the marketplace. Gas production for the first quarter of 2001 was 2.5% higher than for the comparable period last year, according to the US Energy Information Administration. "We believe that production should continue to rise due to higher drilling rates," the report says. A 'weather casino' David Pursell, vice-president of upstream research for Houston's Simmons & Co. International, says he's been surprised by the magnitude of the supply response. "This means there is available gas to inject into storage creating a little negativity for traders who will think that demand has retracted more than expected," he says. He says prices will stay well above $5/Mcf barring weather uncertainties. "The gas market is just a weather casino," Pursell says. Indeed, Energy Security Analysis Inc., Wakefield, Mass, says a hotter than normal summer could mean prices will jump to $8-$9/Mcf range. But a normal summer will keep prices in the $5-$6 range, says Mary Menino, manager of North American natural gas for ESAI. It is predicting a normal summer. But all bets of moderation are off when it comes to gas prices in California. "California will be a debacle again," says Adkins. "Hydro is not available and gas will be feeling the strain to produce power. There will be a shortage situation for both gas and power without incentives to conserve." At the root of California's gas travail is the shortage of intrastate pipeline capacity, limiting the ability to distribute the gas that interstate lines bring to the state. "California prices will remain above the other areas. [Pipeline] expansions are not expected yet and we don't see a reduction in bottlenecks," Menino says. ESAI also says recent FERC regulations for California gas generators will pressure prices even higher. An Apr. 26 order forces generators to stay on line at full operating capacity and sell all available capacity into the market. Any gas generator that hasn't already locked in gas contracts on a forward basis will be forced to purchase gas on the spot market to keep their units running as ordered by FERC, says Menino. "It's downright ugly in California and gas is part of the problem," says Gordon Allott, vice-president, business development, with KWI North America, risk management consultants in San Francisco. "All the power plants will be turning hard this summer. That will strain what is already a limited gas capacity." EIA predicted the California spot natural gas prices will exhibit "significant volatility" relative to the rest of the country. California spot prices averaged about $13.30/Mcf in April, 2.5 times average prices in the rest of the country. Prices are 50% higher in southern part of the state than in the north, according to EIA. Without new pipeline capacity in the ground, ICF's Rose doesn't foresee much improvement in California either. But prices could moderate, he says. Prices may come down to about $10/Mcf from the $14 experienced in the first 4 months of the year. Market fundamentals point to higher prices. But confounding the market, sources say, is that some large marketers and traders are betting that gas basis, or the difference between the cost of gas at the producing points and delivered price into California, will be sharply lower this summer. These sources say these sellers are betting against the market because of fears FERC may intervene. FERC will hold a hearing on the California market May 24 that could set the stage for an order limiting gas prices this summer. The volatility in the California gas market makes planning particularly frustrating for industrial users, says Brennan Higgins, group manager, Summit Energy Services Inc., Louisville, Ky. Industrials don't know whether to lock in gas at the best price now or wait, assuming that the government will act to cap prices. "It's not a happy time for people who have to buy gas in California," Rose says.
-- Martin Thompson (firstname.lastname@example.org), May 16, 2001