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Natural Gas Industry Analysis
Robert E. Willett, editor/publisher
ORDER INFO | SUMMARY | EDITOR BIO | CONTENTS | CONTRIBUTORS | CHAPTERS THREE, SIX, NINE, TWELVE
Contributors
vii
List of Tables ix
Preface xi
Part 1: NEW RELATIONSHIP WITH ELECTRIC INDUSTRY
Michael R. Waller and Rodger A. Kershner 31. "Convergence": A Megatrend Based on a Marketing Opportunity,
2. Electric and Natural Gas M&A’s: Rethinking Underlying Strategies, Gerald Klenner and Marko Schulz 10
3. Gas Use in Electricity Generation: Increases Uncertain in
Northeast, Midwest,
Daniel
S. Arthur, Steven H. Levine, and Matthew P. O’Loughlin 24
4. Case Study: NYSEG, New York PSC Dealing Successfully with Unbundling, Michael I. German 50
5. Taking on Retail Standards Would Mean Big Changes for GISB, Rae McQuade 57
Part 2: MARKETERS AND MARKETS
Benjamin Schlesinger 636. Gas Marketing Shows Steady Growth, Power Marketing in Strong Start-Up,
7. Gas Contracts: Impact of Power Contracting Trends, Penelope B. Tvrdik 79
8. Spark-Spread Fundamentals Indicate Huge Volatility, Dependence on Gas Price,
Paul
E. Meyers, Anthony E. Bopp, and Rutherford ("Bo") Poats 87
9. Risk Management for Purchasing Managers after a Decade of
NYMEX,
Ruben Moreno
and Douglas F. McDonald 100
Part 3: INTERNATIONAL
Len Coad 12710. Canadian Resource Base to Be Challenged to Meet Growing Deliverability,
11. Outlook for Natural Gas and Power Industries in Mexico, Dana Contratto and Marcos Hasbun 141
12. Natural
Gas in East Asia: Supply Yet to Meet Demand,
Arlon
R. Tussing and John Tichotsky 150
Part 4: ANTITRUST AND FERC REGULATION: ORDER 637 AND BEYOND
Thomas J. Norris 18313. Federal Regulatory Policy in Gas Has Evolved to Looser Controls,
14. Rates Have Frequently Shifted Risks for Participants, Become More Complex, Richard G. Smead 198
15. Focus on Industrial Sector: the Quiet Giant, Edward J. Grenier, Jr. 210
16. Antitrust to Continue to Play Major Role in Gas Industry Competition,
Robert
C. Fallon and Deborah A. Carpentier 230
17. Recent Litigation Covers Variety of Lasting Issues,
Richard
G. Morgan, Elisabeth R. Myers-Kerbal, and Curtis D. Blanc 248
18. LDCs Managing Risks, Seizing Opportunities through Asset Optimization Deals,
M.
Lisanne Crowley 270
19. New Structure for Pipeline Industry Could Be Similar to Pre-NGA, Carl V. Swanson 282
Part 5: STATE REGULATION
Nancy S. Boyd 30120. Review and Outlook Concerning State Regulatory Trends – Consumer States,
21. Critical Issues in Consumer States Include Unbundling, Performance-Based
Regulation,
Karl McDermott 321
22. Producer-State Regulation: A Lighter Hand on Production, Walter Davis 344
23. Texas Act Could Affect Gas and Electric Restructuring Nationwide, Charles A. Moore 366
Part 6: THE WAY TO 30 TCF
James M. Kendell 38124. 30-Trillion-Cubic-Foot Gas Market Can Be Supplied,
Index 393
Gas Use in Electricity Generation: Increases Uncertain in Northeast, Midwest
Daniel S. Arthur, Steven H. Levine, and Matthew P. O’Loughlin
The future looks seemingly bright for natural gas. As has been heralded by the industry, several projections are for U.S. annual demand to reach 30 trillion cubic feet between 2010 and 2015, up from 21.4 trillion cubic feet in 1998. It wasn’t always that way, though, and examination of these forecasts reveal that 30 trillion cubic feet is by no means a sure thing.
A comparison of forecasts by vintage shows how the optimistic expectations of future demand unfolded throughout the 1990s. Figure 3-1 displays the Energy Information Administration’s Annual Energy Outlook ("AEO") natural gas demand forecasts for the year 2010 over the past decade. From a low of 21.3 quadrillion Btu’s in the 1991 forecast, expected demand for 2010 reached a peak of 29.6 quadrillion Btu’s in the EIA’s 1998 forecast. Much of the upward revision in year 2010 demand estimates occurred between the 1995 and 1998 forecast vintages, a period during which there was considerable movement toward deregulation of electricity generation in some regions, accompanied by increasing development of efficient gas-fired generation. More recently, EIA has scaled back its expectations, with its AEO 2000 forecast of year 2010 demand at 27.7 quadrillion Btu’s.
Motivated in part by these wide year-to-year forecast fluctuations, this chapter examines the future demand for natural gas in the Northeast and Midwest, with particular emphasis on the demand by electricity generators. We begin with a general discussion of natural gas demand for electricity generation and the reasons that demand is so uncertain. Next, we take a detailed quantitative look at gas demand by reviewing recent forecasts, first for the Northeast and then for the Midwest. Our approach involves analyzing and interpreting forecasts from two sources, EIA’s Annual Energy Outlook for 1997 through 2000 and the Gas Research Institute’s ("GRI’s") Baseline Projection for 1997 through 1999. We also examine two recently released studies: the National Petroleum Council’s ("NPC’s") Natural Gas: Meeting the Challenges of the Nation’s Growing Natural Gas Demand (Draft Report, December 15, 1999) and the Federal Energy Regulatory Commission Staff’s Staff Analysis of Natural Gas Consumption and Pipeline Capacity in New England and the Mid-Atlantic States (December 1999).
Our objective is to provide a better understanding of the key assumptions and beliefs that underlie the optimistic natural gas forecasts for these two active regions. Although our focus is on the Northeast and Midwest, our analysis can be generalized to identify the critical developments needed for U.S. gas demand to approach 30 trillion cubic feet by 2010 as opposed to 2015 or later. We conclude with a discussion of one of the significant challenges facing the Federal Energy Regulatory Commission in the natural gas arena, namely, the development of adequate pipeline infrastructure in the face of significant gas demand uncertainty.
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Figure 3-1—EIA Forecast of Natural Gas Demand for the Year 2000 |
Gas Demand for Electricity Generation
While future gas demand looks strong, it remains highly uncertain. The focal point of this uncertainty is the link between natural gas markets and electricity markets in North America. It is the increasing demand for natural gas by electric generation facilities that many industry observers believe will drive the market to the 30 trillion-cubic-foot level by 2010 or shortly thereafter. On its face, the rash of announcements by developers of new gas-fired generation facilities, such as 26.5
Gas Marketing Shows Steady Growth, Power Marketing in Strong Start-Up
Benjamin Schlesinger
This chapter presents a review of the status of energy marketing industry in terms of its participation, physical attributes, commercial trading mechanisms, outlook and trends. Marketers of both natural gas and electricity are included in the discussion.
SummaryAlthough mergers involving leading gas and power marketers captured headlines during 1999 and 2000, companies just off the top tier and in the middle of the pack gained in market share. Major diversified energy marketers, many expanded by mergers, continue to dominate commerce in the industry, particularly on the power side, but many smaller and midsize players continued to hold their own in 2000.
The continued movement toward retail energy marketing kept the numbers of gas marketers up, with the number of active gas marketers increasing from 288 in 1997 to 312 in 1998. Many new entrants came from the electric power generation and downstream petroleum industries. The gas market increasingly exhibited the evolution of mature niche players. Market shares of the leading 5, 10, 15, and 20 firms each declined slightly, consistent with a trend of recent past years.
Contract durations continued to shift toward shorter-term instruments, and reliance upon price risk management tools in futures and over-the counter markets grew as well. Trading levels rose at a number of market area hubs, particularly Chicago, New York, and New England.
The discussion of natural gas marketers in this sub-section is organized into the following topics:
In particular, major diversified energy marketers, many expanded by mergers, handled the bulk of transactions in 2000.Gas marketers dominated commerce within the gas industry, in both physical wholesale and financial markets. At least 80 percent of all gas supplies produced and consumed in North America passed through the ownership of gas traders at some point during 2000.
The number of active gas marketers increased from 288 companies in 1997 to 312 in 1998, with 63 new gas marketing companies added and 39 either ceasing operations, merging with other trading companies, or discontinuing gas trading. The increase was due in part to the formation of new retail marketing companies that have arisen in response to customer choice programs in various states, principally New York, Ohio, New Jersey, and Georgia. Still others are units of established companies that are new participants or were not listed the previous year. Finally, some of the new entrants reflect renewed overseas interest in North American energy marketing: Merchant Energy Group of the Americas is a unit of Gener S.A., a Chilean energy company and Tractebel Energy Marketing, a unit of the large Belgian energy holding company.
Gas marketing volumes continue to rise faster than end-use consumption. From 1994 to 1998, traded gas volumes more than doubled, while total consumption rose by 3 percent.
VolumesThe gas marketing industry remained as highly competitive and diverse as ever. Of 158 natural gas marketers reporting gas sales volumes greater than zero in 1998, the top 5 sold 16.4 trillion cubic feet, or 24 percent of the market; and the top 10 marketers sold 28.7 trillion cubic feet, or 43 percent of the market (Figure 6-1). The top 15 marketers sold 37.3 trillion cubic feet or 55 percent of the market; and the top 20 marketers accounted for 44.2 trillion cubic feet or 66 percent of marketed volumes.
Total reported physical gas sales volumes for all 158 gas marketers reporting positive sales in 1998 was 67.4 trillion cubic feet, representing an increase from 59.7 trillion cubic feet in 1997. Ultimate natural gas consumption in the United States and Canada during 1998 was 24.9 trillion cubic feet, according to the U.S. Energy Information Administration and Statistics Canada. Thus, at least 2.7 thousand cubic feet of gas changed ownership in physical markets for every thousand cubic feet consumed.
Risk Management for Purchasing Managers after a Decade of NYMEX
Ruben Moreno and Douglas F. McDonald
He introduction of the NYMEX Henry Hub natural gas futures contract on April 3, 1990, was a milestone event in the transition to open, competitive markets for the gas commodity and transportation. In the ensuing decade, trading in futures, options, and other "derivatives" has matured into a vital feature of the U.S. gas marketplace. The success of the NYMEX Henry Hub futures and options contracts is evident not only from the sustained growth in trading volume shown in Figure 9-1, but also in the credibility of contract prices and high levels of industry participation. Total daily volume exceeds seventy thousand contracts on active trading days, which translates into a market of roughly $1.75 billion in a given day.
Figure 9-1 -- Trading Volume for NYMEX Henry Hub Futures and Options
More specifically, the total of all natural gas futures contracts entered into and not yet offset by a transaction, delivery or exercise has steadily increased at roughly 12 percent or over thirty thousand contracts a year (Figure 9-2). Looking at the latest figures, the seasonality of the open interest is dictated by the futures contracts held by entities involved in the production, processing, or merchandising of the natural gas (commercial); and the noncommercial (or financial) counterpart to complement the market. During summer when storage build-up is in full swing, most of the futures contracts are held by commercials, while the noncommercials are naturally short on the contract.
Figure 9-2 — Commercial and Noncommercial Net Open Interest, 1993-2000
The future development of the industry will in part be shaped by further consolidation, convergence of power and gas markets at a financial level, the introduction of novel financial instruments, and possibly new regulatory initiatives patterned after approaches used for financial sector supervision.
The goal of this chapter is to provide a road map to assist prospective users in navigating the complex, and occasionally treacherous, landscape of gas derivatives trading. Its primary focus is on the practical use of derivatives to manage price risk, from the perspective of a hands-on fuel-purchasing manager at a gas-fired power generating plant or industrial facility. The first two sections describe the various types of gas derivatives and how different traders both within and outside the gas industry typically use them. A section that examines price- risk management applications in more detail follows these sections. This section uses simulation results to contrast the performance of "passive" and "proactive" hedging strategies. The chapter concludes with a discussion likely future developments.
Types of Gas Derivatives
Derivatives are simply financial instruments that derive value based on the market price of another asset. There are three broad categories of derivatives relevant to gas markets:
Natural Gas in East Asia: Supply Yet to Meet Demand
Arlon R. Tussing and John Tichotsky
East Asia is potentially one of the world’s great new energy frontiers. China, Japan, South Korea, and Taiwan alone contain a quarter of the world’s people and one-fifth of the global economy and have recently been accounting for almost half of the world’s increase in primary energy demand. Between 1988 and 1998, the growth of energy consumption in the latter three economies averaged 3.4 percent a year while the rest of the world was averaging only 0.7 percent.
China is the world's most-populous country, and for two decades has been its fastest-growing economy in absolute terms. Despite prolonged economic stagnation, Japan has remained the world’s number-two economy by a wide margin, both in gross domestic product ("GDP") and in total wealth. Additionally, although South Korea is distinctly smaller than China or Japan, in the ten years 1988-98 its industrial growth was rapid enough to lift it from twenty-third to twelfth in rank among all nations in energy consumption.
Huge Potential Demand
East Asia’s per-capita production and use of natural gas lags far behind that of North America, Europe, or the rest of the world as a whole. Together, in 1998 the seven political subdivisions of Northeast Asia in Table 12-1 derived only about 6 percent of their energy from natural gas. This low share of gas in total energy contrasted with 26 percent in North America, 22 percent in the European Union, 58 percent in the former Soviet Union other than the eastern regions of Russia covered by this chapter, and 24 percent worldwide.
Table 12-2 shows Japan to be the largest natural gas consumer in East Asia and sixth in the world, with a total 1998 consumption of 70 billion cubic meters (2.5 trillion cubic feet), about the same amount as California, Canada, or Ukraine. Supply mostly took the form of liquefied natural gas ("LNG"), with only about 3 percent coming from domestic natural gas production (2.3 billion cubic meters), and about 6 percent from processing of petroleum liquids and coal for production of "town gas." Between 1988 and 1998, the growth of gas consumption in Japan averaged 4.8 percent a year.
China’s 1998 consumption was only about 22 billion cubic meters (773 billion cubic feet, or twenty-third in rank worldwide). This amount was miniscule, given China’s population land area: it was about the same in absolute volume as Pennsylvania or Michigan, and less than half that of Netherlands. Nevertheless, between 1988 and 1998 gas use was growing at an annual rate of 4.2 percent, supported almost entirely by domestic production, a rate that it will almost certainly match or exceed over the next decade.
Table 12-1 - Economies of East Asia and their Consumption of Natural Gas
China’s gas consumption, shown in Figure 12-1, is barely more than the sum of South Korea’s 16 billion cubic meters (552 billion cubic feet) and Taiwan’s 6.4 billion cubic meters (225 billion cubic feet) (Figure 12-2). Between 1988 and 1998, gas consumption in South Korea was growing at an average rate of 22.1 percent a year, the world’s highest. Taiwan’s average growth rate over the same years was number two globally at 18.1 percent.
Table 12-2 - East Asian Natural Gas in Global Perspective
Indigenous and International Gas Supply Sources to East Asia
In East Asia, the supplies are far from the population, which leads to high costs and thus opportunities.
LNG Imports versus Pipeline Transport
One answer to supply difficulties has been liquefied natural gas.
Daniel S. Arthur, Ph.D., is
an associate at the Brattle Group, Cambridge, Massachusetts. He is an economist
specializing in the areas of industrial organization, econometrics, and
international trade. His work focuses on antitrust and regulatory economics,
with experience in merger evaluation, ratemaking, market power analysis, and
evaluation of new pipeline projects.
Curtis D. Blanc is an energy attorney and an associate in the
Washington, DC, office of the law firm of Shook, Hardy, and Bacon, L.L.P.
Anthony E. Bopp, Ph.D., is senior economist for Pace Global Energy
Services, in Fairfax, Virginia, and teaches at the College of Integrated Science
and Technology at James Madison University, Harrisonburg, Virginia.
Nancy S. Boyd is a partner in the Des Moines law firm of Brown, Winick,
Graves, Gross, Baskerville and Schoenebaum. She was formerly a commissioner of
the Iowa Utilities Board.
Deborah A. Carpentier is an attorney in Washington, DC, who make a
specialty of antitrust and natural gas matters.
Len Coad is vice president North American natural gas and electricity
for Canadian Energy Research Associates, Calgary, Alberta.
Dana Contratto is a partner at the Washington, DC, law firm of Crowell
and Moring.
M. Lisanne Crowley is a partner in the Washington, DC, law firm of
Crowell & Moring, L.L.P.
Walter Davis is an attorney in Austin, Texas, who makes a specialty of
producer-state regulation.
Robert C. Fallon is an attorney in Washington, DC, who make a specialty
of antitrust and natural gas matters.
Michael I. German is president and chief operating officer of New York
State Electric & Gas Corporation ("NYSEG") and senior vice
president of Energy East Corporation, NYSEG’s parent company. Prior to joining
NYSEG in December 1994, he was senior vice president of the American Gas
Association ("AGA"), directing the organization’s planning,
analysis, and financial activities. He joined AGA in 1978.
Edward J. Grenier, Jr., is a partner in the Washington, DC, law firm of
Sutherland, Asbill, and Brennan. He is also general counsel of the Process Gas
Consumers Group.
Marcos Hasbun is an associate with the Washington, DC, law firm of
Crowell and Moring.
James M. Kendell is director of the Oil and Gas Division at the Energy
Information Agency in Washington, DC.
Rodger A. Kershner is senior vice president & general counsel, CMS
Energy Corporation, Dearborn, Michigan.
Gerald Klenner is a principal at the Houston office of McKinsey &
Co.
Steven H. Levine is a senior associate at the Brattle Group,
Cambridge, Massachusetts. He works on consulting engagements in the electric
power and natural gas industries, with a focus on financial modeling, valuation,
regulatory economics, analysis of competition, and business strategy. He has
analyzed the competitiveness of natural gas markets in various regions of the
United States and examined the financial performance of U.S. and Canadian
pipelines. He has also forecasted electricity prices and performed valuations of
electric generation assets in property tax disputes and stranded cost
estimations.
Karl McDermott, who formerly was a commissioner with the Illinois
Corporation Commission, is a vice president with National Energy Research
Associates in Chicago.
Rae McQuade is executive director of the Gas Industry Standards Board,
Houston.
Paul E. Meyers is assistant vice president of Pace Global Energy
Services, in Fairfax, Virginia.
Charles A. Moore is a partner at the Houston office of the law firm of
Akin, Gump, Strauss, Hauer & Feld, L.L.P. where he is a member of the
Management Committee and the Practice Manager of the firm’s Energy &
Converging Industries Section. A former general counsel of the Federal Energy
Regulatory Commission, he has been involved in the energy and civil trial
practice for twenty-five years.
Richard G. Morgan is an energy attorney and managing partner of the
Houston office of the law firm of Shook, Hardy, and Bacon, L.L.P.
Elisabeth Myers-Kerbal is an energy attorney and an associate in the
Washington, DC, office of the law firm of Shook, Hardy, and Bacon, L.L.P.
Thomas J. Norris is a consultant with Pendulum Energy in Houston.
Matthew P. O’Loughlin is a principal at the Brattle Group, Cambridge,
Massachusetts. He consults to clients in the electric power and natural gas
industries on matters of business strategy, project and contract evaluation,
pricing and rate-making, and market assessment. He has extensive utility asset
and contract valuation experience in bankruptcy, tax, and arbitration
proceedings, merger evaluations, and "stranded cost" determinations.
His work has also involved examining the merits of several proposed energy
projects.
Rutherford "Bo" Poats is vice president of financial services
and risk management for Pace Global Energy Services, in Fairfax, Virginia.
Benjamin Schlesinger is president of Benjamin Schlesinger and
Associates, Bethesda, Maryland.
Marko Schulz is a senior engagement manager at the Houston office of
McKinsey & Co.
Richard G. Smead is a senior vice president of Colorado Interstate Gas
Company, a subsidiary of The Coastal Corporation. He is past chairman of the
Rate Committee of the American Gas Association.
Carl V. Swanson is president of Swanson Energy Group, Inc., an
independent energy economics consulting firm with offices in Wenham,
Massachusetts. He has been a consultant to industry and government for
twenty-five years, providing advice on investment, acquisition, market planning,
and business strategy decisions.
John Tichotsky is assistant professor of international development and
international trade, Alaska Pacific University, Anchorage, Alaska. He is also
research associate in economics, Scott Polar Research Institute, Cambridge
University, Cambridge, United Kingdom. He specializes in international
development and resource economics.
Arlon R. Tussing is professor of economics in the Institute of Social
and Economic Research of the University of Anchorage (Alaska). He is also
president of ARTA Inc., economic consultants, Seattle. He serves as an economic
and policy analyst in the fields of energy, public utilities, the environment,
natural resources, regional economic development, and corporate and government
finance.
Penelope B. Tvrdik is vice president, business development, for
Utilicorp United Inc. in Omaha, Nebraska.
Michael R. Waller is of counsel with LeBoeuf, Lamb, Greene & MacRae,
in Houston.
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