The natural gas market has been unusually if not eerily quiet this year. After shooting up to $10/MMBtu in December 2000 and then tumbling below $3/MMBtu in early 2002, prices have remained relatively stable throughout this spring, hovering slightly above the $3 mark. Between a nearly 20% drop in industrial usage—a reaction to the price spike--and an exceptionally warm winter, natural gas storage levels are now double what they were a year ago. U.S. demand is expected to rebound to over 22 trillion cubic feet (Tcf) this year, and may even eclipse the 22.5 Tcf mark recorded in 2000.

So is the coast clear? Is it safe for us to consign that nasty price spike to the dusty archives of academe and get after the Mirants, PG&Es and Calpines of the world to start building the merchant gas-fired generating capacity that they have permits for? About as safe as sleepwalking across an interstate highway during the afternoon rush hour.

Since 2000 the Public Service Commission of Wisconsin has permitted 1,600 megawatts (MW) of merchant gas-fired generating capacity, while even greater amounts have been authorized in states like California and New York. Trouble is, in this post-Enron climate of retrenchment and caution, there isn’t a lending institution on this planet that will finance a nonutility power plant that isn’t secured by a long-term purchase power agreement. Without utility commitments to accept their power, independent power producers (IPPs) have no market to sell into, and, not surprisingly, their stock prices have been taking a brutal pounding from unhappy investors.

Their current position represents a complete reversal of fortune from where things stood in January 2000, when IPPs, along with other “New Economy” high-flyers like the telecom industry and Internet start-ups, rode tall in the saddle as the bull market ascended to new highs. But all financial binges must come to an end, and when the revelers go home, someone has to come along and assess the mess left behind. As the speculative excesses of the late 1990’s gave way to the proverbial morning after, investors woke up to the realization that economic slowdowns invariably dampen demand for electricity. And, as several of these companies learned after restating their earnings, hell hath no fury like a misled investor. Indeed, with each successive downgrading of the IPPs’ credit ratings, their descent from Wall Street’s good graces seems to pick up speed. As a result, independent power producers are, almost without exception, unable to do anything with their power plant approvals, except perhaps to sell them to raise cash.

By the end of 2000 some 200,000 MW of new generating capacity had been proposed for construction, almost all of which to be owned by IPPs and fueled with natural gas. Now, with the merchant power sector imploding and the recent price spike still etched in our collective consciousness, it’s a safe bet that only a tiny fraction of that gas-fired capacity will come on line in this decade, if ever. The dream of many environmentalists, that these relatively clean-burning fossil units would displace older, dirtier coal-fired generators and improve air quality, is quickly receding in tandem with the IPPs’ declining fortunes.

No doubt the ongoing meltdown in the IPP sector is contributing to the easing of pressure on natural gas prices, as is the residual overhang in inventories following one of the warmest winters in recorded history. But today’s ample supplies are destined to be short-lived if recent trends in extraction volumes continue.

Noting a falloff in output in the first quarter, the U.S. Energy Information Agency (EIA) now projects that 2002 extraction volumes from U.S. sources will fall short of 2001 levels by at least 3%, and 2000 levels by about 2%. Yet, according to EIA projections, demand is creeping up to 2000 levels, indicating that unless new sources of natural gas are tapped into and brought to market in the next six to nine months, we will experience another round of price volatility.

The deeper one digs into the natural gas supply picture, however, the darker it gets. Despite the fact that gas drillers operating in the U.S. completed 30% more wells last year than in 2000, setting an all-time record, output increased by a paltry 1.8%. With spot market prices too low to sustain the drilling boom that peaked last July, gas well completions are expected to sink to about 13,000 this year, a decline of more than 40% from last year’s record total. According to a supply study conducted by Simmons and Company, which provides investment banking services to the energy industry, the decline in output caused by the reduction in drilling is likely to accelerate in the third and fourth quarters, and may exceed 5%. In a May 2002 speech to the International Workshop on Oil Depletion, company president Matthew Simmons said:

“Our firm has just completed an incredibly intensive supply analysis on 53 counties in the state of Texas. These 53 counties represent 66% of Texas’ gas supply. Texas represents 31% of total U.S. daily gas supply. Based on this study, I fear that U.S. natural gas supplies could fall as much as 10% in as little as six months from now. The drop could be close to double that amount by the time it bottoms.”

Even if the expected dip in this year’s output is no greater than 5%, “there is a good chance that the industry will not be able to get supplies back to the flat levels we enjoyed for the past eight years,” Simmons said. Those who share Simmons’ view that the U.S. natural gas industry has in all probability peaked and is now headed into irreversible decline are, truth be told, a small minority very much out of step with official predictions. According to Joseph Riva, a geologist who has written often about depletion issues, it is still the official view in this country that supplies of natural gas will increase throughout this decade, and much of that will come from untapped U.S. and Canadian sources.

In the course of exploiting domestic deposits of natural gas, energy companies tapped into the largest and most accessible fields first, then moved on to tighter and deeper pockets as depletion set in at the bigger fields. As we all know, the smaller and more inaccessible the deposit, the higher the cost of extraction on a per cubic foot basis. From the industry’s perspective, it’s all very well and good that most energy analysts forecast higher levels of natural gas consumption as the decade wears on, mostly to feed the merchant power plants that are on the drawing boards, but if drillers aren’t confident that future prices will justify venturing into a new field, then the resource will stay in the ground, rosy projections notwithstanding. Clearly, the official view of how the natural gas industry ought to behave is at considerable variance with current operational realities.

Another price shock in 2003 is a virtual certainty. What’s not certain is whether the U.S. economy can grow at the price needed to keep natural gas supplies from contracting. If that price turns out to higher than what the biggest industrial consumers can tolerate, they will switch to other fuels or shut down their operations faster than you can say Alcoa. If that happens, then the danger is that a rapid shrinkage in consumption will cause prices to plummet as dramatically as they did last winter, creating yet again an unfavorable environment for increasing gas well completions.

So, the $64,000 question is this: can the natural gas industry ever again settle into a price range that can stabilize supplies without causing an economic train wreck? Unless and until that question is answered in the affirmative, it is not possible to lend any credence to official projections that call for increased supplies of natural gas, many more gas-fired power plants, and vigorous growth in GDP along the lines of the previous decade’s expansion.

Natural gas is clearly not the fuel of the future. With that in mind, one can be forgiven for thinking that the merchant power industry’s collapse was a blessing in disguise.

Sources:

“Canadian Gas: Our Ace in the Hole?” Joseph Riva. Hubbert Center Newsletter #2002/2. Web address: www.hubbert.mines.edu

“Depletion & U. S. Energy Policy,” Speech, Matthew Simmons, Simmons & Company International, May 23, 2002. Web address: www.simmonsco-intl.com

“The Global Energy Scene,” Speech, Matthew Simmons, Simmons & Company International, May 21, 2002. Web address: www.simmonsco-intl.com

Energy Information Agency, U.S. Department of Energy, Monthly Energy Review – Natural Gas, May 2002. Web address: www.eia.doe.gov/emeu/mer/pdf/pages/sec4.pdf

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Petroleum and Natural Gas Watch is a RENEW Wisconsin initiative tracking the supply-demand equation for these imported fuels, and analyzing its effects on prices, consumption levels, and the development of energy conservation strategies and renewable energy alternatives.

For more information on the global and national petroleum and natural gas supply picture, visit "The End of Cheap Oil" section in RENEW Wisconsin's web site: www.renewwisconsin.org