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Buyers Be Warned: Natural Gas Prices Will Likely Heat Up This Winter By Christopher Edmonds Special to TheStreet.com Originally posted at 7:51 AM ET 9/11/00 on RealMoney.com If you use natural gas to stay warm, get ready to crack the piggy bank this winter.

As the price of natural gas futures hits all time highs -- the November contract traded consistently above $5 (per million Btu) on the New York Mercantile Exchange last week -- consumer angst has begun to show. And as gas prices have more than doubled since this time last year, politicians are looking to find someone to blame in an election year, with calls for federal assistance for low-income heating bills to calls for hearings looking to cast guilt. Governors Tony Knowles of Alaska and Bob Taft of Ohio held hearings this week in Ohio on the "natural gas crisis."

But political outcry isn't likely to change pricing, at least as we approach winter. "There is nothing between now and the beginning of winter to cause prices to come down at all," says one gas trader for a major energy firm. "The storage numbers alone are very bullish. I don't see a brake in this uptick until at least the end of the year."

Hot Air Rising A long, expensive winter for natural gas Key Hubs/Cities Spot Price Week Ago Month Ago New York City Gate $5.26 $4.92 $4.87 Henry Hub, Louisiana $4.88 $4.61 $4.45 Chicago City Gate $5.03 $4.71 $4.58 Katy Hub, Texas $4.94 $4.64 $4.45 So. Calif. Border $6.32 $7.23 $4.85 AECO Hub (Canada) $4.56 $3.55 $3.25 Prices as of September 6, 2000 Source: Energy Intellegence Group

And all the hearings and investigations won't change the facts: Winter stockpiles of natural gas are nearly 40% below average with little hope of catching up in the next 60 days. In fact, it is quite likely that stockpiles will slip further in the months leading up to winter, pushing prices even higher.

It's Not Just for Winter Anymore Historically, natural gas was a seasonal commodity, extracted and stored in the summer to meet heating demand in the winter. Not anymore.

In today's world of growing demand for electricity and the burgeoning business of merchant power plants -- primarily gas-fueled plants built to meet power needs during peak demand -- the nature of the gas business has changed. Once on a single-peak cycle, demand for natural gas now peaks twice: in summer as cooling demand spikes in the Southern states and in winter as heating demand ratchets up in the North.

That has a marked impact on typical winter reserves. "The wave after wave of merchant power plants coming on stream have sucked away a lot of the gas that would have gone into storage for winter use," says John Olson, director of energy research for Sanders Morris Harris, a Houston investment banking firm.

With winter stockpiling running nearly 1.1 billion cubic feet (bcf) per day below normal demand, gas for merchant power plants only exacerbates the problem. Olson says every 1,000 megawatts (MW) of merchant power capacity uses about 200 million cubic feet of gas per day. In Texas alone, 4,000 MW of merchant power is scheduled to come online in the coming months with an additional 5,800 MW scheduled for next year. "The gas-storage cycle is very tight," he says. "Combine that with demand from merchant plants, and you have a squeeze."

And, this year, the problem gets worse. Between now and November, nearly 18,000 MW of nuclear generation will be lost to plant servicing and refueling. And while electricity demand falls dramatically in the fall, most of the nuclear capacity lost is base load, generally requiring replacement. "If gas is used, that's 1 billion cubic feet in September, 1.6 bcf in October and 0.8 bcf in November," says Olson. "That also interferes with the injection [storage] cycle."

While there is a possibility that additional gas may arrive in the Chicago hub from Canada, that isn't likely to provide significant relief for already depleted reserves. "We could be pressed for adequate supplies in the coming months," says Charlie Sanchez, manager of energy markets for Gelber & Associates, a Houston-based energy-trading firm. "There is really no wiggle room, no room for error."

Adds the gas trader, "It's all about storage. We are only 66% full. You can't get to where we need to be for winter from here."

Will It Snow, Will It Snow, Will It Snow? While it is unlikely that natural gas prices will fall much, if at all, between now and the beginning of winter, once November arrives, gas prices will react to the thermometer's mercury. "Early on in winter, gas becomes purely a weather play," says the trader. "If you start seeing warm forecasts, prices could come off hard. However, if it's a cold winter, you could see a print [a natural gas trade] of $8 or $9 early on."

One reason for lower-than-normal prices in the past two years has been milder-than-normal winters. That is likely to change. "We aren't likely to see another overly mild winter this year," says David Salmon, president of Weather Derivatives, a Kansas City, Mo., meteorological consulting firm. "While temperatures won't be significantly below average, it will be colder than last year, closer to normal."

While not overly cold or severe, normalcy will present its own challenges. "If we have just normal weather this winter, you will see $6, $8, maybe even $10 gas," says Olson. "It won't stay at those levels, but the price will be stout."

And those who think the market will correct itself toward lower prices are living in the past. "The market has changed face," says Gelber's Sanchez. "Prices of natural gas will not give any reprieve in the coming months. A move back below $3.80 is far-fetched. With a base of $5.50 you could see spot markets trade to $10-$15."

As demand for gas grows, Olson sees a sustained trend toward higher prices. "Anyway you cut the deck, it doesn't look good for buyers," he says. "For 18 years we have had a buyer's market for gas. Now you are looking at least a 10-year cycle that is a seller's market."

If you want to keep warm, the conclusion is clear: Bundle up or pay up.

http://www.thestreet.com/comment/christopheredmonds/1071998.html

-- Martin Thompson (mthom1927@aol.com), September 16, 2000

Answers

I'm a bit surprised to see the expectancy of another rise from the current $5 to the $8-$10 range. That would be another, nearly, 100% price jump.

-- JackW (jpayne@webtv.com), September 16, 2000.

Up up and away!

-- RogerT (rogerT@c-zone.net), September 16, 2000.