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Vol. 13, No. 49 Week of December 07, 2008
Providing coverage of Alaska and northern Canada's oil and gas industry

No to RCA gas price cap

Cook Inlet producers decline to put Enstar natural gas contract prices below cap

Alan Bailey

Petroleum News

The game of poker over Cook Inlet natural gas prices continued Dec. 1 when Enstar Natural Gas Co. told the Regulatory Commission of Alaska that ConocoPhillips and Marathon Oil Co. have refused to amend new gas supply contracts with Enstar to set gas prices below a price cap specified by RCA in an Oct. 31 order. The commission had issued the order as a ruling in its review of Enstarís new contracts with the two Cook Inlet gas producers.

Enstar, the main Southcentral gas utility, has said that without the new contracts it will have insufficient contracted gas supplies to meet all of its customersí needs as from Jan. 1. The contracts would run from 2009 to 2013.

In an RCA filing Enstar told RCA that neither producer had agreed to pricing under the price cap. However, ConocoPhillips has agreed to supply gas to Enstar under its new contract with a gas price below Enstarís weighted average cost of gas from all of Enstarís existing contracts, rather than with a gas-cap-related price. But the amended ConocoPhillips contract would terminate at the end of 2010 rather than in 2013, Enstar said.

Enstar said that it is still trying to reach an agreement with Marathon that would be acceptable to the commission.

Wants approval

Under the terms of Enstarís gas tariff the utility can accept without RCA approval a new producer gas price, provided that price reduces Enstarís weighted average cost of gas, as is proposed in the amended ConocoPhillips contract. However, Enstar says that, because this is the first time that this particular provision of the tariff has been exercised, Enstar is seeking RCA approval of the precise terms of the price agreement.

ďSuch a ruling will provide the necessary assurance of cost recovery, which is an important factor affecting Enstarís financial health, especially in light of future capital expenditures for storage and pipeline projects and related financing requirements,Ē Enstar said.

Although RCA regulates Enstarís tariff, including the price that the utility charges its customers for gas, the commission does not regulate the Cook Inlet gas producers and the prices that they charge utilities. However, to stay in business Enstar has to pass through to its customers the price that it pays the producers for gas.

But because Cook Inlet producer gas prices are set through supply contracts with a small number of producers, there is no local spot market in gas to determine gas price levels. And, as gas supplies have tightened in the maturing Cook Inlet oil and gas basin, the determination of equitable utility gas prices has become a highly contentious issue.

2006 rejection

In September 2006 RCA rejected an Enstar contract with Marathon that would have filled Enstarís 2009 shortfall. That contract involved gas pricing based on a trailing average of Henry Hub market prices in the Lower 48. A contract with Unocal (now part of Chevron) approved by RCA in 2001 used a similar Henry Hub-base pricing model, but in the 2006 decision a majority of the commissioners said that the Henry Hub pricing was unjustifiably high for the Cook Inlet gas market.

Following the 2006 contract rejection, Enstar issued a request for proposal for gas supplies. Only ConocoPhillips and Marathon responded to that request ó subsequent negotiations between Enstar and these two producers resulted in the contracts that RCA adjudicated on in October.

The pricing in the new contracts used indexes based on baskets of North American gas price points. Price tiering within the contracts would increase the price paid for ďswingĒ gas during periods of high gas demand, during the cold Alaska winters.

In its October order RCA accepted the principle of indexing Cook Inlet utility gas prices to gas prices elsewhere in North America, to enable ďthe producers to earn market based rates.Ē The commission also agreed with the principle of tiering the prices to accommodate the complications of meeting peak demand.

But the commission said that price indexes involving trading hubs which are downstream of major gas transmission pipeline systems are inappropriate for determining prices in the Cook Inlet. In fact, there is a strong analogy between the Cook Inlet and production basins in North America, the commission said.

Price cap

So, the commission specified a price cap for the new contracts The price cap consists of a 12-month trailing average of daily prices from five North American production basin trading locations: El Paso, San Juan basin; Panhandle, Texas-Oklahoma; El Paso, San Juan basin; Kern River, Opal Plant; and TCPL Alberta, AECO-C. That set of price points is significantly different from the basket of price points in the new contracts and would reduce the contracted gas price ó the price formulae in the contracts included downstream trading hubs such as Chicago Citygate and PG&E Citygate.

RCA required Enstar to file amendments to the ConocoPhillips and Marathon contract by Dec. 1 ó hence Enstarís filing that has informed the commission of the producersí unwillingness to price their gas below the commissionís price cap.

The amended ConocoPhillips contract that Enstar has now submitted specifies a contract price that would be set each year at 5 cents below Enstarís weighted average cost of gas ó there is no price tiering for peak demand. The weighted average cost would derive from Enstarís determination of the gas cost adjustment that it plans to charge its customers for that year.

Enstar determines the gas cost adjustment prior to the beginning of the year by calculating a weighted average of the cost of its gas, using estimates of the volumes of gas that it expects to purchase through each of its supply contracts during the course of the year. Essentially Enstar multiplies the estimated volume to be obtained under each supply contract by the contract price, adds up the results of these calculations for all of the supply contracts and divides by the total estimated volume of gas to be purchased for the year.

Each contract has its own price formula. Depending on the contract, the price is indexed to a specific oil or gas market price over a specific time period.

$8.91 per mcf

And Enstarís has determined its weighted average cost of gas for 2009 for the purposes of the proposed ConocoPhillips contract to be $8.96 per mcf, thus resulting in a ConocoPhillips contract price of $8.91 per mcf.

Two of the contracts that contribute to the weighted average are long-standing Marathon, ConocoPhillips, Municipal Light & Power and Chevron contracts indexed to the price of light sweet crude oil futures. For the 2009 pricing, these legacy contracts use prices indexed to the average price of oil in the third quarter of 2008, a period during which oil prices varied between about $98 and $140. The oil price index resulted in contract gas prices of $9.08 per mcf for the Marathon contract and $11.20 per mcf for the other contracts.

However, Enstar expects that by far the biggest contribution to its 2009 supplies will come from the 2001 Unocal contract that is indexed to Henry Hub gas prices. The 2009 price for this contract is $8.46 per mcf, a figure that represents the weighted average Henry Hub price for the 36-month period ending on Sept. 30, 2008.

The upshot of all of this is that in 2009 the proposed ConocoPhillips contract would be priced a little above the trailing average Henry Hub price. The 2010 price would presumably depend on what happens to oil prices and the Henry Hub gas price in 2009, and the relative proportions of gas expected to come from Enstarís various supply contracts in 2010.

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