CERA: Press Release : Looming North American Natural Gas Crisis Demands Reinvestment, Reorganization: CERA & Accenture (July 12, 2004)

CAMBRIDGE, Mass., July 12, 2004 - Deeply rooted supply and demand trends, regulatory constraints and structural inflexibilities are driving the United States toward a crisis in natural gas similar to the crude oil crisis of the 1970s, according to a study released today by Cambridge Energy Research Associates (CERA) and sponsored by Accenture.

The study, "Charting a Path: Options for a Challenged North American Natural Gas Market," found strong parallels between today's U.S. natural gas industry and the oil industry of the 1970s, when oil production declined even in the face of high oil prices and a surge in drilling. “Despite historically high natural gas prices and near-record levels of on-shore U.S. gas drilling activity, gas production in the United States today continues to fall, and CERA expects ongoing declines of US gas production despite an outlook for continued strong drilling levels,” said Michael Zenker, CERA’s Senior Director, North American Natural Gas. This inability to grow supply, despite substantial investment, is at the core of the supply dilemma facing North America, he added.

The CERA study identified several options available to manage the situation, including reducing consumption of natural gas by encouraging fuel flexibility and the use of non-gas fuels in the power sector; promoting conservation through continuous consumer-education programs, and promoting new supply sources. “New supplies could come from speeding expansions of existing liquefied natural gas (LNG) facilities, encouraging new LNG facilities, boosting domestic supply by streamlining permitting for activity in areas already open for gas production and by applying flexibility in areas with various restrictions,” Zenker said.

“The real challenge to industry and policymakers is to work quickly to address this situation, and avoid finger-pointing which cannot ease high and volatile prices. Rather, critical decisions, some implemented for just a few years, could provide some real relief for consumers in the coming few years,” the authors concluded.

The report identifies areas of potential backlash as a result of a natural gas crisis. “A new market environment, defined by higher and more volatile prices, will likely pose serious challenges to many stakeholders as measured by: higher bills to residential and commercial users of natural gas, lost jobs as gas-intensive manufacturing capacity is exported, and utilities struggle to balance their energy portfolios,” said Ross Tokmakian, a partner in Accenture’s North American Utilities industry group. “Gas suppliers can anticipate a major backlash from consumers accustomed to a plentiful, relatively inexpensive fuel to one marked by uncertainty, volatility and record price levels,” he added.

Industrial firms in the U.S. have already been struggling with recent price levels. Some are anticipated to shutter plants in the face of seasonal prices rising to $6.50 to $8 per million British thermal units (MMBtu) while others will relocate outside the U.S. to take advantage of lower short-term energy pricing elsewhere. Residential and commercial customers will see higher bills, negatively impacting pocketbooks and the overall economy.

Natural gas provides nearly a quarter of U.S. energy needs, a level that is expected to grow as the latest of a large fleet of new, natural gas-fueled power plants becomes more highly utilized to meet a growing demand for electricity. North America added 200,000 megawatts of new power plant capacity in the past five years, equal to twice the amount of nuclear power capacity in the U.S. The vast majority -- 94% -- is fueled by natural gas.

Many power plants and industrial firms turned to natural gas as the result of 14 years of low and stable prices at the $2 to $3 per MMBtu range. However, in the past 20 months, the natural gas market has seen prices above $4 per MMBtu and regional daily gas prices that have broken new records of over $5 per MMBtu. CERA forecasts prices to average as high as $6.62 per MMBtu by 2007--even without a severe weather event that could further dramatically spike prices.

“A mix of short and longer-term strategic responses are available to industry and policymakers to mitigate the impact of higher prices on industry participants and their customers,” according to the study’s authors. Some measures, if implemented temporarily over just the next few years, could provide some real relief for consumers, they point out, including:

▪ Encourage LNG as a new supply source - Liquefied natural gas (LNG) is already the fastest growing source of supply to the North American gas market. By CERA estimates, North America alone will require about 11 Bcf per day of LNG supply by 2010, which would make LNG the third largest supply source for North America. The market is already moving quickly in that direction. About one year ago, 13 new regasification terminals were being proposed, now there are over 35 representing over 30 Bcf per day of regasification capacity. By comparison, the U.S. and Canada are expected to consume about 67 Bcf per day of natural gas in 2004.

However, translating these proposals into reality has been difficult. Policy makers, thus, should review the siting and permitting process for new LNG regasification facilities or risk facing a much longer-term tight market for gas.

▪ Adopt flexible land access policies - The natural gas resource base in North America has been exploited for many decades; the largest basins have been thoroughly explored and the largest fields are in decline. The number of wells producing gas in the U.S. increased from about 300,000 in 1999 to over 350,000 in 2001, but average productivity declined from 171 to 145 thousand cubic feet (Mcf) per day over that same period. Average well productivity is also declining in Canada.

U.S. land access will continue to be a key issue for natural gas production, especially in the Rockies, federal areas and offshore areas where there are known gas resources on lands currently restricted from exploration and production activity.

▪Redesign industry practices - Utilities can work with regulators to design flexible procurement practices that allow for some degree of price hedging and allow utilities to take advantage of favorable price opportunities when they occur.

▪ Re-examine short-term contracting bias – A growing volume of transactions for both natural gas and transportation have become shorter-term. Many of the new, non-utility power producers buy gas in the spot market and do not hold pipeline or storage capacity. In addition, regulatory commissions in some states have discouraged utilities from committing to long-term contracts. However, long-term contracts are essential to underpin investment in pipelines, storage fields and LNG projects. In addition, longer term arrangements can significantly dampen spot price volatility. Policymakers should work to align the need for long-term commitments necessary to underpin new natural gas infrastructure with state level regulation and the design of some power markets that do not support long-term contracts.

▪ Preserve availability of coal-fired capacity and dual fuel-capable plants - Restrictions on coal-fired plants mean that other plants must replace lost generation, exacerbating the high-priced, volatile natural gas market environment.

“Production and modification restrictions on coal plants should be weighed against additional demand pressures shifted to the natural gas market,” Tokmakian noted. Similarly the ability to shift gas-fired plants to residual or distillate fuel has provided an important demand buffer in the natural gas industry, one that has been eroded as environmental restrictions have limited their operation. Operating these plants on alternate fuels even for short periods of time, provides an important relief valve for gas demand during peak gas price periods. In addition, capacity or plant life extensions linked to environmental investments may now be more economically attractive in this higher price market – with the double benefit of addressing short-term price spikes and longer-term import dependence in an environmentally friendly manner.

▪Expand conservation & education - Industry participants should encourage consumer conservation through a variety of policies and incentives. In addition, the industry is poorly understood by policy makers, regulators and the public. The National Petroleum Council’s natural gas supply study is a good example of an industry effort to communicate the complexities of the current natural gas market. Education initiatives can mitigate a backlash against high and volatile prices.

Cambridge Energy Research Associates (CERA) is a leading advisor to major North American and international companies, financial institutions and organization, 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, Mexico City, Moscow, Oakland, Paris, São Paolo, and Washington, D.C.

Accenture is a global management consulting, technology services and outsourcing company. Committed to delivering innovation, Accenture collaborates with its clients to help them become high-performance businesses and governments. With deep industry and business process expertise, broad global resources and a proven track record, Accenture can mobilize the right people, skills and technologies to help clients improve their performance. With approximately 95,000 people in 48 countries, the company generated net revenues of US$11.8 billion for the fiscal year ended Aug. 31, 2003. Its home page is www.accenture.com.

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