Power Engineering - Gas crisis threatens jobs, production, homeowners' bills

WASHINGTON, D.C., June 26, 2003 - A hot summer could trigger a U.S. natural gas supply crisis that will be measured in the bills faced by homeowners, power suppliers and industrial users, and in the plants shut down, jobs lost, and production capacity exported, said Daniel Yergin, Cambridge Energy Research Associates (CERA) Chairman and Pulitzer Prize-winning author, at a June 26 Natural Gas Summit, co-hosted by Energy Secretary Spencer Abraham and the National Petroleum Council.

"The price will also be paid by the overall economy. It will negatively affect recovery and growth, which is why U.S. Federal Reserve Chairman Alan Greenspan spoke out on the subject," Yergin added.

"In some ways, this is similar to what happened in the early 1970s in the oil market, when the U.S. went from importing a little oil to importing a lot of oil. But this time it is with a different set of suppliers and supply arrangements, and without the geopolitical overlay." According to CERA, liquefied natural gas (LNG) could be providing as much as twenty percent of U.S. gas supplies by 2020 - compared to one percent today.

"Thirty years of experience, however, also alert us to the risks of political backlash when there are changes and turbulence in markets - and lack of understanding of what is happening. Call it the 'California Phenomenon,' in which finger-pointing and the search for villains work against market adjustment and cooperation and make a difficult situation much worse. Thus the need today is to understand the dimensions and linkages."

Crises from 1973 through the 2000-2001 California gas and power crisis highlight the same lessons, says Yergin.

"One of the most important is to identify in advance the measures that can promote flexibility and reduce rigidities and be prepared to act upon them if necessary - rather than having to scramble and coordinate in the midst of turbulence, acrimony and suspicion. Understanding what is in the tool kit is one of the prime needs."

The U.S. faces a natural gas shortage that is reflected in today's high and rising natural gas prices, and the prospect of much higher and more disruptive prices looms "if the summer is too hot or the winter too cold," Yergin told the gathering. These costs are already creating problems in key industrial sectors, but they could turn into a much greater burden if the weather does not stay mild.

"This is not a failure of markets," he said. "Rather it is the result of disappointing geological experience over the last few years plus restrictions on exploration - combined with a shift to new uses of gas that will certainly grow consumption."

The result is a mismatch between supply and demand, and prices are performing their essential function: signaling market needs and changing conditions to both producers and consumers.

"The current shortage will be resolved by markets - by investment, technology and adjustment - but there will be inevitable time lags," Yergin said. "It is essential to identify policies that facilitate the adjustment and do not retard it - that encourage flexibility, not rigidity - that apply the lessons from 30 years of energy policy."

Over the last few years, the growth in natural gas demand has collided with disappointments in supply, signifying the mature geology of the North American resource base. While technology has allowed for faster discovery and development of resources, most areas of North America already have been heavily explored and drilled. This was borne out by the step-up in exploration after the 2000-2001 price increases, which did not yield the anticipated results.

"The most dramatic example of maturity is the offshore waters of the Gulf of Mexico," said Yergin, "which accounted for thirty-one percent of U.S. gas in 1990 but today produces just twenty-four percent of the nation's total gas."

"There is another barrier to increasing supply, which is much debated: the controversial access question - the impact of closing off lands to exploration and development," said Yergin. "These include the waters of the eastern Gulf and the Rockies and, even more controversially, off the East Coast and West Coast of the United States."

He observed that there is much debate about the extent of resources that are no longer accessible. It is interesting to compare the United States in this regard to Canada and Norway, both highly environmentally conscious countries, which have thriving offshore gas production industries. Indeed, Canada is increasing gas production off its East Coast to supply adjacent New England."

The resource access issue highlights a key characteristic of the current gas dilemma that Alan Greenspan emphasized, says Yergin.

"Environmental policies - those that have favored natural gas almost exclusively for siting new power plants, and those that have closed off areas to exploration - have interacted with supply and demand to significantly accentuate the stringency in the market."

Yergin emphasized the impact near-term policy actions will have on natural gas prices.

"The chief goals of policy should include encouraging efficient use of natural gas during the coming, supply-constrained period, while fostering development of new, frontier supplies," he said. "Policies should promote demand and supply flexibility - to encourage new supply sources and make sure that prices play the important role of signaling when new resources are needed."

Conservation can play the biggest near-term solution to the supply-demand imbalance, dampening prices and the impact of the supply shortfall.

"One thing is clear: we are seeing a structural change in supply," Yergin said. This can be seen in two recent trends:

* Increased internationalization of the North American gas market. Canada is the U.S.'s largest (and growing) gas import source, while shipments between the U.S. and Mexico -
in both directions - are playing a more significant role.

* Increased integration of the North American market with other world markets. Waterborne imports of LNG into U.S. regasification terminals have risen substantially in recent years, sourced from areas such as Qatar, Oman and Trinidad.

The future - Frontier gas and LNG

Ultimately, the natural gas market must balance. Constrained supply will serve to limit demand growth, particularly in the industrial sector. But new frontier resources, such as imported LNG, gas from the Arctic, and associated gas from Eastern Canada, will be critical. But these supply additions will require large-scale capital investment for new facilities, requiring five years or more to develop.

"The shift to a new set of investment expectations, along with this time lag, points to a transition period during which the market will remain tightly balanced, but beyond which frontier resources will come into the North American market and restore balance. The pace and timing of these new resources will establish longer-term price levels in North America," said Yergin.

This presents a very important opportunity for LNG to play a growing role in the North American supply picture. The LNG industry has been steadily driving both capital and operating costs down, to the point where LNG is cost-competitive with many domestic natural gas resources.

"Fortunately, the world is awash in stranded gas (gas resources without nearby markets). Momentum is building for LNG. Yet while a robust build may be anticipated in new LNG regasification capacity in North America, there are several hurdles that stand before the realization of this new resource. The key uncertainty is whether or not the LNG industry can be ready when North American productive capacity begins to fall after 2007."

Cambridge Energy Research Associates is an advisor to major international companies, financial institutions and organizations, delivering strategic knowledge and independent analysis on energy markets, geopolitics, industry trends and strategy. CERA is headquartered in Cambridge, Mass., and has offices in Beijing, Calgary, Houston, Mexico City, Moscow, Oakland, Oslo, Paris, Sao Paolo, Seoul and Washington, D.C.

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