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March 2008

Vol. 13, No. 11 Week of March 16, 2008

Chugach Electric faces big drop

Southcentral Alaska electric utility tells Regulatory Commission of Alaska all of its gas supply contracts will expire by 2011

Alan Bailey

Petroleum News

The much talked about “cliff” in future Cook Inlet gas supplies came to the forefront again on Feb. 29 when attorney Eric Redman and Suzanne Gibson, Chugach Electric Association vice president of corporate planning and regulatory affairs, gave the Regulatory Commission of Alaska an update on Chugach’s fuel supply situation.

Chugach supplies 55 percent of the power in the Alaska Railbelt and generates 93 percent of that power from natural gas. The remainder of its power comes from hydroelectric plants, Redman said. He said that Chugach’s current gas supply contracts date back to the 1980s and that all of the contracts will terminate by 2011.

“So we have no gas at all beyond those dates,” Redman told the RCA commissioners. “… We have been negotiating with the (gas) producers for more than two years. We haven’t reached agreement on the new contracts.”

Cheap gas

In the past the Southcentral utilities have enjoyed cheap gas while the gas producers have benefited from a market for stranded Cook Inlet gas. In fact, the supply contracts negotiated in the 1980s included Chugach commitments not to replace for the most part the use of gas by other energy sources, Redman said.

That’s a very different situation from the Lower 48, where the high price of gas makes that fuel inappropriate for the generation of base electric load, he said.

“In the Lower 48 utilities use gas almost exclusively for peaking and maybe for shoulder load. They don’t use it for base load,” Redman said.

Base load in the Lower 48 comes from coal, hydro and nuclear power, with wind power also becoming important — the Alaska Railbelt also needs to diversify.

“(But) we don’t have any significant alternative to gas in the short term,” he said.

In addition, a 20-year-old Chugach power supply agreement with Golden Valley Electric Association to displace oil-generated electricity in Fairbanks is running into the Cook Inlet gas supply crunch.

“From Chugach’s point of view we’ve reached the end of the road at the moment with the viability to go on displacing oil generation in Fairbanks,” Redman said.

And problems with Cook Inlet gas deliverability have already forced Chugach to curtail its supply to Golden Valley on occasion.

“During the first week of February we were unable to sell power to Golden Valley using gas we are contractually entitled to, due to inadequate deliverability,” Redman said. “… Golden Valley had to self-generate far less efficiently at a cost of $190 per megawatt hour.”

Gas supplies

Chugach is using about 28 billion cubic feet per year of natural gas, with the Beluga power plan on the west side of the Cook Inlet generating the bulk of the utility’s power, Redman said. Overall Marathon provides about 52 percent of the gas for Chugach, with ConocoPhillips, Chevron and some other producers supplying the remainder of the gas.

The gas prices in the Chugach supply contracts have been linked to a basket of three different hydrocarbon products, including Texas crude oil, Redman said. That linkage to oil prices used to stabilize the gas pricing, but in recent years the price of oil has skyrocketed, he said. Prices remained relatively flat until 2000 but have escalated by almost 250 percent since then, Gibson said.

And those escalating gas prices have forced Chugach to look into upgrading its aging power plants. Chugach’s “heat rate” — the amount of gas consumed per kilowatt-hour of electricity generated — is much higher than it would be in the Lower 48, Redman explained.

“Now with the gas prices much higher we have to invest in more efficient generation,” Redman said.

Chugach Electric, Municipal Light and Power and Homer Electric have announced plans to build a new 260-megawatt, gas-fired power station in Anchorage. And that new plant should bring substantial savings in fuel costs, Gibson said.

At the same time, the Cook Inlet does not have a properly functioning, competitive gas market, Gibson said.

“A competitive market is made up of many buyers and many sellers that actively engage in negotiations which result in transactions and price change points,” she said.

Future pricing

When it comes to the future pricing of Cook Inlet gas, Chugach fully understands that the gas producers need to make returns from Cook Inlet gas development compete with returns from gas developments in the Lower 48, Redman said. But the problem Chugach faces is how to transition through the replacement of the electric utility’s entire gas supply.

“We and the producers are stuck trying to get to the other side of the stream,” he said.

The Henry Hub Lower 48 market price that is used as an index for the 2001 Unocal gas supply contract with Enstar Natural Gas, Southcentral’s main gas utility, does not represent an average Lower 48 price, Gibson said. More than two-thirds of the daily published Lower 48 prices fall below Henry Hub, she said. And there are other possible pricing models.

Compared with prices in the first quarter of 2008, projected electricity prices in 2010 could increase by 10 percent using the current Chugach gas pricing model, by 35 percent using a composite gas price index and by 40 percent using a Henry Hub index. And that would have an impact of $40 million to $140 million per year on Southcentral disposable income, she said.

Gibson also said that Chugach is seeking different gas pricing than what Enstar pays for its gas, because Chugach experiences a much lower swing in seasonal demand than Enstar. In 2007, for example, Enstar’s peak winter gas day was more than 10 times its low summer gas day, while Chugach’s ratio was less than two, she said.

“Prices that would represent Enstar’s level of service would not be acceptable to Chugach,” Gibson said.

The export of LNG at Nikiski on the Kenai Peninsula presents another complication in the Cook Inlet gas supply equation — Chugach has opposed the extension of the Nikiski LNG export license unless the gas producers reach agreements with Chugach for future gas supplies, Redman said.

“We’re entering into a very complex and probably very difficult time with Cook Inlet gas,” Redman said.

Decertification?

Commissioner Janis Wilson expressed concern that utilities might come to RCA perhaps a couple of days before falling over the gas supply cliff. In the interests of timely action, would it be helpful if the commission expressed an intent to begin decertification of Chugach at the end of the 2008, if the utility had not secured new gas supplies by then, Wilson asked.

No, that would not help, Redman responded. Chugach could have a contract tomorrow, but that requires agreement.

“We are all going to need a cool nerve. … Decertification could be potentially disastrous for the utility,” he said.

And what if Chugach were in the Lower 48 and had the same gas supply problems, asked Commissioner Anthony Price.

“If we were a similar sized co-op in the Lower 48 generating 90 percent of our power from gas, we’d be bankrupt,” Redman replied. “… At current gas prices you cannot run your base load on gas.”






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