In this issue:

> Converging Challenges Test Natural Gas Operators
> LNG Update – A Growing but Complex Role in U.S. Supply Mix
> Gas Storage Value Proposition for Power Generators

Converging Challenges Test Natural Gas Operators
by Rod Walker and Lee Van Atta

Natural gas operators face a barrage of challenges in the current marketplace that threaten time-tested assumptions and put new wrinkles in the decision making process. As these elements continue to increase in importance over time, operators will need to respond effectively in order to maintain an offensive posture and meet the challenges head on.

Volatile Natural Gas Prices

While the DOE has shown that the volatility of natural gas prices has eased over the past few years, worrisome fluctuations are expected to continue as pressures from all sides create market instability. Now, more than ever, natural gas prices are linked closely with oil prices and natural gas is expected to increase in response to surging oil prices. Some of this pressure is a result of traders making a connection between energy commodities and traditional investments—such as stocks, bonds and currencies—and actively using energy commodities as a hedge against dollar depreciation.

What's more, difficulties in building new coal-fired power generation capacity are driving electric utilities back to natural gas-fired power generation, leading to greater competition for natural gas supplies. Additional demand-side pressure is related to the growing ethanol production, since natural gas is used in most ethanol plants.

On the supply side, U.S. natural gas prices face pressure from more costly, non-conventional domestic gas production, declining Canadian gas production, and lower exports to the U.S., not to mention ongoing uncertainty about the level and timing of LNG imports.

However, this environment of rising and highly volatile natural gas prices also presents utilities with opportunities. For example, gas system operators can mitigate exposure by re-evaluating their risk management approaches and further integrating hedging portfolios with a direct linkage to rates and customer impact. For suppliers, high natural gas prices drive a number of new pipeline and storage projects, presenting the opportunity to enhance utilities’ supply portfolios.

Increased Regulations

The natural gas industry has witnessed increased regulatory requirements each year since the late 1990s following pipeline accidents in New Mexico and Washington State. The latest regulation, Distribution Integrity Management, is expected to be adopted by the Pipeline and Hazardous Materials Safety Administration in 2008. Related to Transmission Integrity Management, this regulation would represent a significant human resource and financial burden to already challenged operators―especially to operators of smaller systems.

The burdens associated with regulation make it critical for utility operators to keep a pulse on current and future regulations, while effectively maintaining compliance within the utility. Internally, gas system operators can monitor regulation updates and changes through the Pipeline Safety Community portion of the Pipeline and Hazardous Materials Safety Administration website and through the local state public utilities commission websites. While compliance functions can be performed internally, utilities often opt to reach out for the assistance of an objective consultant to remain advised of regulations and ensure compliance.

Staff and Organization Structure Demands

As never before, natural gas system operators struggle with expanded responsibilities, regulation compliance, budget constraints, and expertise shortages. Today’s utilities now face the added challenge of staff limitations brought about by aging workforce. According to the U.S. Department of Labor, approximately 40 percent of the utility workforce is set to retire in the next five to seven years which will leave the gas industry in a difficult position. Aligning organizations to meet ongoing business and technical demands – while attracting and retaining talent from a smaller pool and transferring knowledge to younger employees – takes dedication and focus. This is doubly true because the task is often charged to an area of the company that has traditionally played a smaller role in the strategic direction of the company.

One tactic utilities may use to help minimize the impact of this trend is identifying critical positions in which employees are eligible for retirement in the next three to five years and interviewing these individuals on key job aspects to gain that knowledge for future reference. Taking this a step further, the key staff members are asked to author “Standards of Practice” for their positions to capture vital “know-how” for specific tasks. These can take many forms including traditional written documents, videos and even audio podcasts. Many gas system operators seek the advice of management consultants to help direct the effort and alleviate the pressures of larger tasks. The goal centers on enhancing organizational capabilities and performance without expanding staff.

It is also important to budget time for experienced employees to mentor new staff. Although some perceive this as an unnecessary expense, it often makes sound business sense over the long term. The payoff often comes years later once the experienced employee retires and new staff step in to assume and appropriately perform vital tasks.

Shift to Alternate Energy Sources

As discussed above, market volatility, regulation compliance, and human resources needs can all present challenges to the natural gas utility. Further, with the surge in interest and demand for alternative energy sources, the natural gas industry faces new challenges in retaining its customer base because this new obstacle has presented itself at the interface of the utility and its customers. Marketing of the commodity has traditionally been focused on competitively pricing natural gas with alternative fuels. Since the commodity is no longer as price competitive, the industry has had to re-focus its strategy on communicating the benefits of natural gas relative to alternative fuels.

This transition has been slow to achieve desired results. Marketing staff in most gas companies still need to be trained on how to emphasize the benefits of natural gas while downplaying the role of cost in selecting it as a fuel. The industry is now beginning to lend more attention to this issue, which will help retain customers who may be considering the switch to alternate energy sources.

For more information on this subject, please contact us: Natural Gas Resource

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LNG Update – A Growing but Complex Role in U.S. Supply Mix

The much debated role of imported liquefied natural gas (LNG) in the U.S. supply mix is becoming clearer. LNG will be a growing source of supply for the U.S. but will arrive—or not—subject to the complex global market. As a result, Henry Hub prices will reflect a much larger set of price dynamics beyond North American supply and demand.

Last summer saw a dramatic increase in monthly U.S. LNG imports, while the increase in prior years was largely due to British Gas (BG) approximately doubling the amount of supply shipped through its capacity at Louisiana’s Lake Charles terminal.

Figure: U.S. LNG Imports Surged in 2007
LNG imports during the summer of 2007 spiked unusually high to more than double that of the preceding and subsequent months.

Source: Energy Velocity

As the leading player in the LNG “spot” market, BG sustains a strategic capacity position in both European and U.S. regasification terminals, allowing it to arbitrage Atlantic Basin LNG cargoes. Many other LNG players are attaining similar supply and terminal positions to execute like strategies. While a number of factors went into the 2007 increase in U.S. LNG imports, it appears the pattern will continue due to two fundamental factors:

• Most large European and Asian natural gas markets are even more seasonal than the U.S. market.
• Europe and Asia have little underground natural gas storage relative to demand. Therefore, European and Asian buyers make long term commitments to LNG to ensure adequate supply during peak periods, but have limited flexibility to take cargoes for future needs.

As the global market for LNG expands the role for the U.S., off-season cargoes will grow. Of course, this role as the world’s “market of last resort” is secondary in nature – in the event of tightness in global LNG supply, U.S. LNG imports will dry up rapidly, dawning highly uncertain projections for future imports.

It is likely, though, that the summertime influx of LNG into the U.S. will drive a need for more underground natural gas storage capacity. In addition, the U.S. market’s near-term competition with Europe and Asia for incremental LNG supplies will lead to higher Henry Hub natural gas prices. This is given the current oil price of around $100 per barrel and the high degree of oil-price linkage in European and Asian natural gas markets.

For more information on this subject, please contact us: Natural Gas Resource

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Gas Storage Value Proposition for Power Generators

A massive amount of underground natural gas storage capacity is under development in the U.S. and around the world. Driven by high natural gas prices and market volatility, valuations for natural gas storage assets have roughly doubled in recent years. To make sure these new storage facilities are fully utilized, many gas storage developers actively seek customers to sign multi-year contracts and/or align with equity investors.

Power generators can derive value from natural gas storage by physically moving natural gas in or out of the storage field, as this movement helps manage hourly balancing requirements. In the past several years, pipelines and local distribution companies have tightened requirements for shippers, requiring them to match the amount of gas removed from the pipeline with the amount put in. Under these new requirements, imbalances – such as those created by gas turbine operation – can expose power generators to large penalties imposed by pipeline system operators.

This marks a shift in the role of gas storage that has primarily been used in the past to help manage price risk and provide greater security of supply during peak periods. Both roles can be valuable to power generators. Gas storage can mitigate risk of supply interruption and provide assurance of supply to help limit the risk of offering firm power to the market. By lowering overall gas supply costs, or at least limiting upside price risk, gas storage can enhance spark spreads for power generators.

R. W. Beck has expertise in the technical and market aspects of natural gas storage and can assist clients to evaluate gas storage contracting and investment opportunities.

For more information on this subject, please contact us: Natural Gas Resource

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