[Benjamin]

Sunday, May 7, 2006
Natural gas falls far short of power imagined

By Jeff Donn
The Associated Press

On the brink of the 21st century, a group of energy experts peered into the future of natural gas. What they saw was quite rosy, and quite wrong.

To satisfy growing demand, producers could crank out a third more natural gas over the next decade at "competitive prices." It could "power our economy" for decades beyond. Or so said the National Petroleum Council in its 1999 report.

But natural-gas prices soon headed skyward, with those charged by producers spiking late last year at nearly five times 1999 levels.

This past winter, though starting off warm, saw the average gas-heating household spend a record $867, a 17 percent increase, according to federal data. As for that predicted robust supply, the country's annual gas output has strangely slipped by 3 percent over the past six years.

Something is broken in the economics of natural gas, say industry insiders and observers. The bright dream of an economy built squarely on clean-burning natural gas is slowly deflating. Although the U.S. still derives almost a quarter of the country's energy from natural gas, the amount will slip in coming decades, federal forecasters now say.

"What's going on now is so dysfunctional, it is really remarkable," says industry consultant Jim Choukas-Bradley.

Retired Yale economist Paul MacAvoy says price jerks and fuel crimps could soon rival California's electricity nightmare of 2000-2001.

"Everything that has gone wrong in electric power is going to go wrong with natural gas, unless we do something," he says. "It's just a few miles down the road."

What's so wrong with natural gas?

The industry largely blames old fields and self-defeating government policy, and such explanations are widely accepted. The trouble is, they don't explain the breakdown very well.

Skeptics are beginning to suspect other powerful forces, ones at work within the industry itself.

Some consumers simply look to their gut and blame the industry.

After 26 years, retirees Anna and Frank Siracusa are selling their nine-room, gas-heated home in Methuen, Mass., for something smaller.

At age 72, they're tired of turning down the thermostat and piling on sweaters each winter.

"Someone is ripping us off," grumbles Anna Siracusa.

The level of discontent even makes the industry nervous.

Tired of criticism

"We're good corporate citizens. We'd like to have prices at a level where people and congressmen are not screaming all the time," says R. Skip Horvath, president of the National Gas Supply Association.

Industry leaders say they're trying to fix things, but declining gas fields and harder-to-reach new ones are limiting output.

"You've got to drill more wells, you've got to run faster, just to replace what has declined," says Bobby Shackouls, CEO of producer Burlington Resources and past chairman of the Petroleum Council.

While government policy turned less-polluting natural gas into the fuel of choice for new electric plants in the late 1990s, federal rules kept drillers away from vast stretches of public land, the industry complains. Then came last year's hurricanes.

However, most drilling restrictions were imposed years ago and added no new impediments to output during the price run-up, say federal energy officials. And the hurricanes only added the latest insult to a market with much bigger, older injuries.

Also, other trends should have cooled off prices. Yes, gas-fired generators did use almost 1 trillion more cubic feet of natural gas last year than in 1999.

But at the same time, factories cut back, using almost 1.5 trillion less, federal data show.

The country is not running out either. There's enough natural gas to last beyond 65 years — longer than oil, according to some forecasts.

Despite the federal barriers to drilling, the amount of economical, ready-to-capture gas — under existing wells within reach of pipelines — rose 15 percent during the four years ending in 2004, according to the latest federal data.

The American Gas Association, a group of utilities, has made a preliminary estimate of another 4 percent rise last year.

"There's a lot of natural gas in the world ," says Jerry Langdon, an executive at producer and marketer Reliant Energy.

Why, then, isn't it reaching users?

Despite their protests, maybe some producers aren't really trying, industry critics suspect. Many producers are the same companies benefiting from rocketing gasoline prices in recent years — familiar petroleum names like Exxon Mobil, Chevron, Shell and BP.

"As soon as companies that control the resource figure out how to keep prices high, they'll do it, and I believe that's what were seeing in gas," says Ezra Hausman, analyst for Synapse Energy Economics in Cambridge, Mass.

Some Midwestern cities are accusing producers of doing it by collusion.

In an antitrust lawsuit, they suggest producers have reached either a secret agreement or tacit understanding to bottle up production.

"I think the increase in prices is a designed thing," says Charles Wheatley, a lawyer for the 18 communities from Texas to Indiana suing five leading gas producers in federal court.

They haven't found a smoking gun. Yet some industry executives acknowledge in interviews that, during their 1999 sessions, members of the Petroleum Council talked privately of a supply-and-price crunch in the near future — purportedly as a result of external factors.

Why, then, didn't they warn people? Former council leaders indicated they wanted to keep pressure on demand.

"We needed to give comfort to our customers that gas was going to be available," says Joe Foster, a retired gas executive who was council chairman in 1999.

Shackouls, his successor, puts it this way: "We were doing it to grease our own wheels."

In the end, the council issued its reassuring report, and demand stayed strong.

Since the 1990s, the marketplace itself has increasingly set producer and pipeline prices under pressure from new hordes of traders, many betting on the future prices of natural gas.

In theory, traders would enable better deals through the magic wand of competition. And the theory seemed sound in the first years of market pricing, when supplies were robust.

During the production-pricing bind, though, something else appears to have happened.

Conditioned by an irrepressible string of price increases, futures traders — who contract for future gas deliveries at fixed prices — tend to settle at even higher fixed prices, many analysts believe.

Since the market uses these fixed prices as a reference point for its day-to-day prices, overestimates by traders can turn into self-fulfilling prophesies.

"One thing that's out there that I think is a bit of a negative is traders love volatility," says Reliant Energy's Langdon, who once worked for a predecessor to disgraced energy trader Enron.

Middleman role

Middleman traders — also children of deregulation — now sell much of the gas, taking their cut without producing or transporting it. They were supposed to bring better deals to buyers, but not everyone's sure they do — even setting aside market manipulations blamed on traders like Enron in recent years.

"I sometimes wonder if these are the prices that would really be arrived at, if the user of the gas was dealing with the producer of the gas," says Foster, the former Petroleum Council chairman.

Others harbor deeper doubts. Is real competition possible, they wonder, for a product that buyers absolutely need?

They're not like shoppers, after all, who can simply shift to a cheaper product on the store shelf.

"I think it is very difficult, if not impossible, to foster truly competitive markets when you're dealing with energy," says Tyson Slocum, a consumer advocate at Public Citizen.