Sector Plays

[excel]

Reliance on natural gas sets off series of problems
09:03 AM CDT on Tuesday, August 19, 2003

By SUDEEP REDDY / The Dallas Morning News

It seemed like the perfect fuel for electricity generation. Natural gas was domestic, environmentally friendly and cheap.

But the nation's rapid shift toward natural gas in the last decade is coming back to haunt consumers and the economy.

The latest blow is expected this week as TXU Corp., the state's largest electric company, is set to receive a rate increase because of higher natural gas prices, which would send electric bills to record levels.

The problem's roots have been visible for years. Natural gas demand is rising quickly, due largely to a wave of new gas-fired power plants, and the commodity's supply has failed to keep up.

To make matters worse, an even deeper natural gas crisis looms on the horizon. Though last week's massive blackout drew widespread attention to transmission grids, fears about gas shortages have been at the top of the industry's list of worries for this winter – and years ahead.

To some experts, natural gas simply became too popular, not just for power plants, but also for factories, vehicles and a slew of other everyday uses.

"In one way, we have a disconnect," said Mark Baxter, director of Southern Methodist University's Maguire Energy Institute. "We're telling you it's efficient and clean. But we're telling people they can't drill for it" in many parts of the country.

Throughout most of the 1990s, natural gas prices hovered near $2 per million British thermal units. After spiking to $10 twice in three years, natural gas sells for about $5 per million BTUs today – double what it was a year ago.

This isn't the first time that consumers and policy-makers have struggled with a natural gas crisis. Before the 1970s, most Texas utilities generated all of their power from natural gas.

When commodity prices skyrocketed with the energy crisis of 1973, "we learned the folly of that situation," said Erle Nye, chairman and chief executive of Dallas-based TXU. "This state went from complete reliance on natural gas to a much more balanced portfolio."

Waves of coal and nuclear plants came online in Texas and across the country, bringing natural gas' share far lower than before.
But amid environmental concerns in the 1990s, gas-fired plants were the only new generation facilities receiving widespread support for permitting and financing.

Developers built power plants producing about 200,000 megawatts in the United States and Canada in the last five years, the equivalent of some 400 power plants, according to Cambridge Energy Research Associates. Ninety-five percent of those were fired by natural gas.

More than half of Texas' electricity came from natural gas in 2000, according to federal data. Nationally, natural gas fueled about a sixth of all power in the same year, with coal taking the biggest share followed by nuclear plants.

Though residential and business electric bills are generally higher in Texas due to greater consumption, in the 1990s the per-kilowatt-hour rates had been slightly below the national average.

The TXU rate increase, set to go before the Texas Public Utility Commission for approval Thursday, would send electric bills for about 2 million residential customers in North Texas to their highest points ever.

An average residential TXU customer who uses 1,000 kilowatt-hours of electricity each month would pay almost $101 a month. A year ago – before natural gas prices led to the first of three rate increases – that bill would have been about $83 a month, more than 20 percent lower.

Under deregulation, consumers can pay less by switching to competing providers. Critics of deregulation charge that the rates of incumbent utilities are higher than they would have been under regulation, but nobody denies that higher natural gas prices are pushing electric rates up for everyone.

Just about every state will feel the impact of higher electricity rates due to natural gas. A handful – Alaska, California, Maine and Rhode Island – also generate more than half of their power from gas, according to the U.S. Energy Information Administration.

Some Texas firms, such as those in the petrochemical or fertilizer industries that use natural gas as a feedstock, have been suffering for months. That sector of the economy is expected to face the greatest permanent damage from high natural gas prices, as factories move overseas to cut costs.

Other types of businesses consider electricity rates when building plants or relocating employees, and the effects of those concerns have yet to surface.

"It may be the case that our advantages in electricity may not be quite as strong as they were a few years ago, because we're competing against states for some of our growth that don't use as much natural gas," said Stephen Brown, director of energy economics at the Federal Reserve Bank of Dallas.

Perks from drilling


Texas' overall economy may not take as much of a hit as other states. As the nation's top producer of natural gas, the higher commodity prices can help Texas companies that drill and produce gas.
"Rising natural gas prices mean higher income for existing gas production in Texas," Mr. Brown said.

Most state officials haven't spent much time talking about higher electricity rates yet, said PUC Chairman Rebecca Klein.

"I think we're just learning the risk that gas dependency causes," she said. "I do hope that over the course of time that policy-makers take a look at the merits and demerits of Texas' being so dependent on gas."

Both the PUC and Texas Railroad Commission, which oversees the state's natural gas industry, plan to study the interactions between the gas and power sectors, in reaction to the February winter storm that depleted natural gas supplies and sent wholesale power prices soaring.
For a commodity so dependent on the weather, the storm exposed the difficult balancing act that the oil and gas markets face as they try to match supply with demand.

"A hundred thousand barrels over, and you've got a surplus. A hundred thousand under, and you've got a panic," said Boone Pickens, the longtime oil and gas producer who now runs Dallas-based BP Capital, an investment firm.

With so many new power plants trying to secure gas supplies to operate, shortages seem almost inevitable now. "Where's the gas going to come from?" Mr. Pickens asked. "They act like it's automatic that the gas is going to show up."

Today's impending natural gas crisis shouldn't be a total surprise. Prices spiked sharply in the winter of 2000, exposing for the first time in decades the nation's reliance on gas.

"The spikes that we had two years ago were a watershed event in that it showed how tightly balanced this market was," said Michael Zenker, a senior director at Cambridge Energy Research Associates.

Higher prices led to increased drilling by producers, and prices fell largely due to milder weather. But those lower prices led to another drop in drilling – and then a price spike earlier this year amid tight supplies.

After draining the nation's natural gas supplies, producers and utilities have been in a summer rush to store enough gas to meet the heavy winter heating demand. Supplies have increased, but the amount of natural gas in storage facilities is still 16 percent lower than it was a year ago.

Lasting effects


Most analysts expect high prices to remain for at least two to four years, as the effects of increased drilling hit the market and imports of liquefied natural gas, or LNG, start transforming what has been a largely domestic market. That means little can be done to prevent a fresh spike in prices this winter that would send electricity and heating bills soaring even more.
Lawmakers have expressed growing concern about the natural gas situation, calling on Alan Greenspan, the ever-influential Federal Reserve chairman, several times this year to highlight the issue and the impact on the economy.

And as Congress debates an energy bill to open up federal lands for drilling or encourage new energy sources, comparisons to the 1970s crises ravaging the nation's economy are not entirely forgotten.

"Every major energy policy in this country has followed an energy crisis of some form or another," Mr. Zenker said.

Some energy plans have already started changing due, in part, to higher natural gas prices. Three U.S. utilities are preparing applications to build the nation's first new nuclear reactors since the 1970s. Dozens of new coal plants have been proposed, including one by San Antonio's municipal utility. And wind power is becoming more competitive than ever.

"Diversity of fuel sources is absolutely key," said Mr. Nye of TXU. "You need to play all of the levers. ... Gas is a premium fuel, and you shouldn't put all your eggs in that basket."

But even with all of natural gas' faults today, experts say, there's little that will reverse the nation's growing dependence on the energy source.

"We're here to live with natural gas for a while," said Mr. Baxter of SMU. "I don't see it as a bad thing, but it's a short-term heartache for consumers."