California's Gas Pains Are Hardly Natural By Allan Brady 12/13/00 12:00 PM ET

California is in the midst of an energy crisis. Over the past week, there was a stage 3 electrical emergency on Thursday, which resulted in service interruptions for some customers. Stage 2 alerts, where large industrial commercial users are forced to curtail usage, have become the norm in California. The causes of California's troubles are wide in scope, but perhaps the most salient culprit for the current crunch is the high price of natural gas. The price of natural gas in California is now selling at five times the industry standard Henry Hub price, the Louisiana delivery point for natural gas futures (see chart below). Nationwide, natural gas has been pushed skyward by low stocks, cold weather, and inflexible supply. California suffers from all these factors in addition to a host of others. This begs the following questions: why are prices so much higher, and will prices return to earth before the heating season comes to an end?

The most obvious reason for higher prices this year is the abysmal state of inventories, which are particularly low in the West. Nationwide, the amount of natural gas in storage is 17% lower than it was last year. For the West, stocks have dropped to 26% below year-ago levels. Unfortunately, the especially low inventories in California are symptomatic of other problems.

Demand for natural gas in California is driven, to a much larger degree than elsewhere in the nation, by electricity use. About 31% of all electricity produced in California comes from natural gas versus 15% for the U.S. as a whole. Understandably, the increased reliance on natural gas for electricity generation would make the state more vulnerable to low stocks. This year, however, a drop in production from other power sources is applying additional pressure on prices. A full 11,000 MW of power is currently out of service in the state, about 10% of total state generating capacity, and the availability of hydroelectric power across the West is poor due to low water levels. As a result, the production of electricity from natural gas jumped from 40,000 million kilowatthours to 57,000 million killowatthours (utility and nonutility generation) in the first seven months of the year. The pressure on natural gas as a provider of electricity has likely stiffened since July.

Deliverability is also a problem for California. While demand for natural gas has ballooned in the state, the system of interstate and intrastate pipelines has not grown nearly as quickly. This has left the market relatively isolated from supplies in the rest of the nation. The lack of adequate infrastructure limits the opportunities for arbitrage across regions and has kept prices high in California.

Also, the possibility that prices in California will fall back to normal this heating season, or at least move to their traditional place slightly above the national level, is unlikely. A period of unseasonably warm weather would help a great deal, but since such a weather event is not in the forecast, and electricity markets remain relatively hamstrung, Californians are in for an expensive winter. In the long term, rectifying the availability of pipeline capacity into the state will take years, as well as building up supplies to meet growing demand.

Moving forward, California will almost inevitably be more dependent on natural gas because of the phasing out of nuclear power and the state's avoidance of coal. All told, these concurring factors have quietly conspired to land a blow to California natural gas consumers, and the impact on the state's economy will linger.

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-- Martin Thompson (mthom1927@aol.com), December 14, 2000