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Wednesday, May 9, 2001

Natural Gas Prices Surge, Fueling Crisis

Power: Because gas is used by most generating plants, large markups could doom hopes of reining in costs.


WASHINGTON--Last week, bulk natural gas shipped by pipeline to fuel power plants and kitchen stoves in New York City cost 44 cents more at the city limits than it did at its point of origin on Louisiana's Gulf Coast.

Compare that with the same amount of natural gas piped to California, which on the same day carried a markup of $8.97 from its source in the Texas Panhandle to the state border. The amount in question, 1 million BTU or about 10 therms, is what a typical Southern California home uses in five or six days. Whether reported in insider jargon or printed on the bottom line of consumers' bills, the high price of natural gas is emerging as another key front in California's electricity crisis. Most power plants are fueled by natural gas, which was once cheap and abundant. High natural gas prices worry the Federal Energy Regulatory Commission, which fears that the big markups could doom its plan to rein in California electricity costs this summer, since generators will still be able to pass on fuel costs. "I have grown despairing that we can ever get the bids for electricity down until the price of natural gas goes down," said FERC Commissioner William Massey, who has been pushing for a more activist response to the West's power crisis. "The wellhead price is five to six bucks, and once it's delivered to California it's $14 to $16" per million BTU, said Massey, adding that the actual cost of transmitting that amount of gas is well under $1. "It's gas. All they do is stick in a pipeline and send it. It's not improved in any way." Amid allegations of price gouging, FERC has scheduled a special conference this month to consult with experts about reasons for the increase in natural gas prices.

The energy industry denies that market manipulation is to blame, citing strong demand instead. Independent economists say that some of the explanation may lie in low storage levels and regulatory and distribution problems within California. The price gap between California and the rest of the country began showing up last year--and is not expected to go away soon. To be sure, spot market prices for natural gas have risen considerably across the country--yet nowhere as dramatically as in California. In New York, bulk natural gas cost about 50% more this April than at the same time last year. In Los Angeles, the price rose by more than 320% in the same period, according to data published by Natural Gas Week, which tracks the industry.

California officials have lodged a complaint with FERC against El Paso Natural Gas, owner of the main interstate pipeline that serves Southern California, accusing it of using its market power to drive up prices. But the phenomenon seems to extend well beyond a single company or conglomerate. Prices for gas delivered to California on five major interstate pipelines rose significantly during the 12-month period ending last month. The smallest increase was 188%, the biggest was 280%. Natural gas prices may sabotage FERC's market-based plan to control electricity rates in California this summer. That is because, under the plan, power generators are allowed to recoup their fuel costs. In one example cited by Massey, fuel costs accounted for about 80% of the price of electricity during power emergencies in February. In response to complaints from Massey and fellow Commissioner Linda Breathitt, FERC last week announced plans for its conference of experts. "We need to find out what is going on in order to determine what we can do," Breathitt said.

The agency is also trying to increase the supply of natural gas in the state. On Monday, it granted approval for El Paso Natural Gas Co. to convert an existing oil pipeline to ship gas from Texas to the California border. Experts said it is unclear what FERC can do to limit natural gas prices in California. In a 1989 law, Congress lifted price controls on sales of natural gas at the wellhead. Whether the agency would have jurisdiction on subsequent sales of the commodity is legally uncertain. FERC's jurisdiction may depend on its ability to dissect and interpret many complex transactions. The portion of the price that represents the actual cost of physically transporting gas through an interstate pipeline is still regulated. The high markups are the result of trades between sellers and buyers of bulk natural gas. A FERC official said the agency estimates that because of the 1989 law, it might have jurisdiction over no more than 15% to 35% of natural gas sales.

California officials said FERC's policies are partly to blame for the problem. Last year, the agency deregulated the resale of certain transportation rights on gas pipelines as part of a two-year experiment. "The experiment has failed," said Rep. Henry A. Waxman (D-Los Angeles). "High natural gas prices are being manipulated by a small number of companies taking advantage of the fact there is no cap." The California Public Utilities Commission has singled out El Paso Natural Gas as a key contributor to the escalation in prices. In complaints filed with FERC, the commission alleges that El Paso contracted about 40% of its pipeline capacity to a related firm, El Paso Merchant Energy, which sells natural gas. By withholding space on the pipeline during crunch periods, critics allege, El Paso Merchant was able to drive up the spot market price of gas. "El Paso was always the swing supplier," said PUC lawyer Harvey Morris. "The other marketers looked at the price on El Paso and would undercharge by a penny or two. . . . The manipulation of California border prices drove all the other prices up."

But El Paso spokeswoman Kim Wallace countered that the company has been shipping more gas, not less, through its pipeline: "The electricity generation that is in short supply in California is what is driving the price up," she said. In other words, since power generators are able to get high prices for their end product, electricity, they are willing to pay high prices to ensure an abundant supply of their raw material, natural gas. El Paso Natural Gas' contract with its related company expires at the end of May. But no one is projecting that natural gas prices will drop when that occurs. PUC attorney Morris said the problem is that reserves of natural gas in the state are low because firms put off buying the commodity because of the high prices. The rush to fill storage tanks as summer approaches is certain to keep prices high, he said. "We have a new problem, but part of it is related to the old problem, because storage was not filled due to the exorbitant prices we have been experiencing," Morris said. However, several economists said the situation may be more complicated than that. Peter Fox-Penner of the Brattle Group said California puts a higher priority on storing gas for residential customers than for power generators. That policy may have the unintended consequence of creating shortages of natural gas for generators. "In recent years, gas use by power generators has escalated dramatically, and state policy is not designed to accommodate generators," he said. "Generators who are not confident they can get the gas they need would be willing to pay more."

Bruce Henning, an economist with Energy and Environmental Analysis of Arlington, Va., said distribution problems within the state contribute to the problem, particularly in Southern California. They range from the lack of pipeline capacity to contractual arrangements that set priorities for transporting gas.

Clearly, Henning said, the cost of producing and transporting natural gas is not the primary cause of California's high gas prices. Instead, suppliers are willing and able to charge as much as the market will bear. "It's based on what people are willing to pay, rather than what it costs to produce," he said.

-- Martin Thompson (, May 09, 2001

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