Questions abound about future of America's favorite fuel -- natural gas

Posted: Sunday, March 25, 2001

WASHINGTON-- For a decade natural gas has been the fuel to love. It's clean, plentiful and found close to home. Most important, it was cheap.

No longer.

As natural gas prices have soared to as much as five times what they were 18 months ago, consumers -- from the elderly trying to heat their homes to executives who are shutting down chemical plants because of high gas prices -- are wondering what happened:

Are producers profiteering? Maybe. At the very least, they're raking in billions of dollars.

Will the high costs, which have eased in recent weeks, rebound this summer and into next fall? Supplies remain tight. If the summer is a hot one, prices could again soar.

Can future production meet growing demand? Most experts say there's plenty of gas; developing it will depend on price and building new pipelines.

Should the government reimpose price controls? A few advocates say yes; the Bush administration and most economists, no.

Government regulations produced ''a couple of real disasters'' -- gas shortages in the 1970s and a gas ''bubble'' of too much supply in the early '80s, says Paul MacAvoy, a Yale economist who has followed the industry for 30 years. Despite greater risks of occasional price spikes, MacAvoy argues, a free market provides lower prices and adequate supplies in the long run.

President Bush's energy plan, expected to be unveiled next month, will stress expanding natural gas production and building new pipelines, but experts agree it will be years before those efforts significantly influence the gas market. Meanwhile demand for the fuel will continue to rise, especially for generating electricity.

It may be some time, perhaps never, before prices again will be as low as they were over a 15-year period covering the late 1980s and all of the 1990s, energy economists say.

During that stretch the wholesale price of gas hovered around $2 per 1,000 cubic feet. After accounting for inflation, natural gas prices actually declined by almost a third between 1985 and 1999, according to the American Gas Association.

Then in the first six months of last year, the price doubled, then doubled again. By Christmas and into the new year it had spiked to nearly $11 for the same 1,000 cubic feet. It's been even higher in power-starved California, prompting charges of price manipulation by suppliers and pipeline operators.

As the surge in gas prices drove up home heating bills by 50 percent or more in many areas, businesses and industrial plants saw energy costs cut into profits. Some chemical plants using natural gas as a feedstock have seen foreign competitors grab business because of the high U.S. energy costs.

Redland Brick Inc. of Williamsport, Md., has seen the cost of firing up its kilns at four plants soar. An expected energy bill of $4 million is twice what it was in 1999, says James Vinke, the company's president.

In recent weeks, wholesale gas prices have begun to fall back to about half what they were in December and early January, but at $5 per 1,000 cubic feet, they remain more than double what they were in the winter of 1999.

''The length of time that gas prices have remained so high is unprecedented,'' the government's Energy Information Administra-tion said in its latest energy forecast. It predicted prices will not ease much this year or next.

Energy experts say prices could just as easily spike again if supplies lag and demand jumps over a hot summer or unusually cold weather next winter. Stocks in storage are unusually low for the end of winter, raising some concerns if demand this summer is strong.

''It is becoming clear with each passing month that we grossly underestimated the demand pressure facing natural gas,'' says Matthew Simmons, a Houston-based investment banker and energy analyst who frequently has warned of an impending natural gas crisis.

Simmons helped craft a National Petroleum Council report at the end of 1999. It predicted that over the next 15 years natural gas demand will increase by 40 percent to 31.5 trillion cubic feet annually. With power plant construction at a fast pace, that demand now could come in five or six years, says Simmons.

While the council, an advisory panel to the government, said enough gas exists to meet the demand, it warned that production will have to increase dramatically, including in some areas that long have been off limits or restricted for environmental reasons.

Ironically, the report assumed that even with higher demand, prices would stay under $3 per 1,000 cubic feet, saying that was enough of an incentive to spur development.

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Of all fossil fuels, natural gas is a natural.

It is by far the cleanest. Compared to coal and oil, natural gas emits far less smog-causing and toxic air pollution or heat-trapping greenhouse gases when burned. Environmentalists embrace it as the transition from fossil fuels to solar technology or hydrogen fuel cells that are still decades away from wide use.

Natural gas also is plentiful. An estimated 2,449 trillion cubic feet of reserves in the United States and Canada is enough to meet today's demand for 100 years. And there is no worry about cutoffs from unfriendly nations halfway across the globe.

Nevertheless, the price explosion of the last year has prompted more than a few energy experts to wonder, only half jokingly, whether the OPEC oil cartel had captured the natural gas market.

Industry representatives and federal regulators scoff at suggestions of price manipulation and collusion, although the red-hot, and severely constrained California market has fueled suspicions of abuses and gamesmanship there. California regulators, for example, argue that pipeline companies have hoarded gas to boost prices, claims the companies have heatedly denied.

Nationally there are thousands of producers, marketers and middlemen. While controls on wholesale prices disappeared entirely in 1989, the federal government still regulates interstate transport and most states regulate retail prices.

''I don't think you can manipulate this market. There just are too many players,'' says Paul Wilkinson, a vice president of the American Gas Association, which represents local utilities that are having to deal with both higher wholesale costs and the ire of their retail customers.

Still, the run-up in oil and gas prices produced astounding profits last year.

According to the Energy Department, the 37 leading independent oil and gas companies saw profits in 2000 soar nearly 400 percent to $3.2 billion, most of it from natural gas. Earnings from U.S. oil and gas production among major multinationals jumped 155 percent to $22.2 billion, about half from gas.

Barrett Resources Corp., a Denver-based gas producer, earned $68.1 million last year, more than three times its 1999 income. In recent days its financial strength and its status as a leading lease holder for Rocky Mountain gas fields have made it the target of a hostile $2.2 billion takeover attempt by Shell Oil Co.

Gas marketing companies, a group dominated by a handful of giants such as Enron, Duke and Dynegy, also have reaped hefty rewards as the commodity often is traded several times as it flows from producer to end consumer.

Enron, based in Houston, reported a 160 percent jump in profits, or $1.6 billion total, in commodity sales and services last year with natural gas the largest and most profitable portion. Its gas transactions jumped 82 percent.

''It's basically economics ... supply and demand,'' says Paul Holtberg, an analyst at the Gas Technology Institute, a research organization funded by the gas industry.

That view is shared by many economists not associated with the gas industry, but there also are skeptics who contend the market is rife with manipulation.

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How did we get to this?

As the Y2K scare occupied the attention of many at the beginning of 2000, another storm was brewing. The demand for natural gas, especially by the electricity industry, was quietly increasing. But production, still hamstrung by years of low prices, did not react.

There had been a ''sense of complacency'' during much of the '90s, says the AGA's Wilkinson. It was a stable period with low prices, and natural gas was a fuel that would not ''stir up the environmentalists.''

Gas producers were getting by, although struggling. As demand inched higher, they boosted production from older wells using improved technology. But at $2 per 1,000 cubic feet there was no incentive -- nor access to capital -- to expand into new fields.

''We were staying afloat, but you had to be prudent, work hard and you had to tread water to stay even,'' recalls Robert Bayless, a second-generation operator of a small, family-owned Rocky Mountain gas producer.

In Washington, the Clinton administration continued to tout gas as the environmentally sound fuel of the future, promoting it to generate electricity and power alternative-fuel motor vehicles.

But there was little talk from either the White House or the Republican Congress on boosting gas production.

In the 1990s, the number of gas drilling rigs in operation plummeted. In early 2000 world oil prices took off, but gas producers were reluctant to commit to a boom. Exploration and development is expensive and they had been burned before.

As spring turned to summer in 2000, and many motorists complained about skyrocketing gasoline costs, some electric utilities began worrying about natural gas prices. Dozens of new power plants were started by new, independent generating companies and all used gas.

Last year electricity generation increased by 20,000 megawatts -- enough for 20 million homes -- and virtually all new capacity came from new plants burning natural gas. When air conditioning demands on the power grid peaked last summer, natural gas storage tanks normally filled in preparation for winter were drained. Combined with reports of lower gas production from the Gulf of Mexico's older fields -- prices took another jump.

Then came an unusually cold October and November and predictions of a colder than normal winter. That and California's power problems were enough to send natural gas prices into the stratosphere, past $10 on the spot market nationwide by Christmas and into 2001.

''None of the forecasters predicted such a sharp increase,'' says Jeff Brown, vice president of Beacon Energy, a consulting firm that tracks gas prices and production activities.

For some, the only explanation is manipulation.

''There's been a breakdown in competitive markets; they're not working,'' insists Charles Wheatley Jr., a longtime energy lawyer. ''As a result the (market) players can put prices to consumers that are way above any respectable cost.''

Wheatley represents a group of municipally owned utilities that has petitioned the Federal Energy Regulatory Commission to clamp controls on natural gas and cap its price at $2.74 per 1,000 cubic feet.

''No one has justified how high prices went this winter,'' says Jack Hilliard, general manager of a municipally owned utility in Florence, Ala., which in January faced a natural gas bill of $5.4 million, four times what it paid in the same month a year earlier.

Hilliard trekked to Washington recently to urge Congress to investigate ''a very real possibility of price manipulation'' in the natural gas industry. ''This is very suspicious,'' he said.

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If there's manipulation, it's not by Rob Bayless, 45, who with his 25 employees operates a small gas drilling company in Denver that was started by his father in 1958.

''Gas prices in the $8 and $9 range ... are way too high,'' he says. ''You don't want people mad at you.'' But Bayless doesn't want to go back to the $2-plus price of a few years ago, either.

He's seen the boom of recent months and he has seen the busts.

''This is a very capital intensive business whether you're drilling a shallow well for $150,000 or you're drilling a deep well for $2 million,'' he explains from his Denver office. ''For a company like ours, the big part of the challenge is (getting) capital. To expand ... you have to be making money.''

Bayless recalls the not-so-good days that were far too many in the late 1990s when the wholesale price of natural gas fell well below $2 per 1,000 cubic feet.

That's when Bayless bought some federal gas leases in the San Juan Basin of northern New Mexico, in western Colorado and in Utah. He didn't have any money to drill, but he bought them anyway -- for the future.

''With higher gas prices, now we can develop them,'' he says.

Bayless is not alone. The past year has seen a frenetic pace of gas drilling.

The number of drilling rigs jumped by 46 percent to about 900, the biggest such surge over a single year in a quarter century. But the amount of gas flowing into the market has not increased by much.

''We're drilling at higher rates just to get the same amount of gas out of the ground,'' says Skip Horvath, president of the Natural Gas Supply Association, a producer trade group.

Existing basins, which have relied for years on improved exploration and drilling technology to be productive, are producing less gas as they become depleted.

Gas coming from the Gulf of Mexico has been declining and the industry's push into deeper waters is not expected to make up for the reductions, says Richard Sharples, president of Anadarko Energy Services, a leading gas producer.

While energy companies are flush with cash, Sharples says aging rigs, a shortage of workers and restrictions on access to federal lands will continue to hamper domestic gas production.

The industry has launched an intense lobbying effort in Washington to open new federal areas for development both on land and in offshore waters, most of which have been off limits for years because of environmental concerns.

The Bush administration has made clear it wants to give the industry wider access. ''The notion that we can rely so heavily on natural gas, maintain restrictions on exploration and still enjoy low prices is a dangerous assumption,'' says Energy Secretary Spencer Abraham.

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