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Vol. 13, No. 45 Week of November 09, 2008
Providing coverage of Alaska and northern Canada's oil and gas industry

Gas price cap

RCA orders a market-based price cap for new Enstar gas supply contracts

Alan Bailey

Petroleum News

Two months after a long and contentious hearing over Enstar Natural Gas Co.’s new natural gas supply contracts with Cook Inlet gas producers ConocoPhillips Alaska and Marathon Oil Co., the Regulatory Commission of Alaska has issued a decision that may set a precedent for utility gas pricing in Alaska’s Cook Inlet for years to come.

In an order issued on Oct. 31, the RCA said that it will approve the new supply contracts, provided that the contract gas prices comply with a commission-mandated price cap. And in a statement accompanying the order, Commissioner Kate Giard described some of the perspectives on the imposition of a price cap for the Enstar contracts.

“Our goal was not to enforce bargain-basement prices on such a precious commodity as warm homes in the winter,” Giard said. “We did, however, remove the opportunity for windfall prices. … Our goal was to return Cook Inlet to balance and to craft a solution that ratepayers can afford and that our producers would be willing to take.”

Production basin average

The price cap will consist of an index calculated from a 12-month trailing average of prices in five gas production basins in North America. And prices would be inclusive of royalties and production taxes paid by the gas producers.

Enstar will now go back to the negotiating table with ConocoPhillips and Marathon, to try to agree on new contract terms that meet the RCA requirements, Enstar spokesman Curtis Thayer told Petroleum News Nov. 3.

“We’re just at the beginning of that process,” Thayer said.

RCA has given Enstar until 4 p.m. on Dec. 1 to file amendments to the new contracts.

When Enstar submitted its revised tariff under the new contracts to RCA in April, Colleen Starring, Enstar’s regional vice president, told the commission that the new contracts fill a gap of some 2.1 billion cubic feet in Enstar’s gas supply portfolio for 2009. Enstar, the local natural gas distribution company for Southcentral Alaska, only has contracted supplies to meet all of its customers’ needs until the end of 2008.

Enstar has since said that in the absence of new contracted gas supplies at the beginning of 2009 it might have to take actions such as curtailing gas supplies to some commercial customers.

Price pressure

But the pricing proposed in the new contracts proved a stumbling block in the path to regulatory approval of Enstar’s new tariff.

For several decades consumers in the Cook Inlet region enjoyed an abundance of cheap gas for heating and power generation, following initial development of the local oil and gas fields. However, since gas supplies started to come more into line with demand in the early 2000s there has been upward pressure on gas prices.

Because there is no spot market for natural gas in the Cook Inlet region, it has proved extremely difficult to assess an equitable price for the gas. Enstar and the gas producers have long argued that Lower 48 pricing is necessary in Cook Inlet to provide gas producers with an incentive to invest in new Cook Inlet gas exploration and development. Others have said that gas pricing should be more in line with production costs.

In September 2006 RCA rejected an Enstar contract with Marathon that would have filled Enstar’s 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 proposals for gas supplies. Only ConocoPhillips and Marathon responded to that request — subsequent negotiations between Enstar and these two producers resulted in the contracts that RCA has now reviewed.

The pricing in the new contracts uses indexes based on baskets of North American gas price points. Price tiering within the contracts would increase the price paid for “swing” gas during periods of high gas demand, during the cold Alaska winters. And in keeping with the State of Alaska agreement with Marathon and ConocoPhillips over the extension of the export license for the Nikiski liquefied natural gas terminal on the Kenai Peninsula, the contracts include provision for the curtailment of LNG production to meet any shortfall in the deliverability of gas to Enstar.

The contracts anticipate that by 2011 Enstar will establish gas storage facilities to reduce the need to purchase gas at the more expensive high-demand price tiers.

Price index

In its Oct. 31 order, RCA has accepted the principle of indexing Cook Inlet utility gas prices to gas prices elsewhere in North America, to enable “the producers to earn market based rates.” But the unwillingness of Unocal to offer new gas supplies to Enstar in 2009 suggests that the new exploration and development that were anticipated as a result of the Henry Hub pricing in Unocal’s 2001 contract “have not been fully realized,” the commission said.

And, to limit the contract pricing, the commission has specified for its price cap a basket of prices in gas production basins rather than prices at trading hubs which are downstream of major gas transmission pipeline systems. The price cap is calculated as a 12-month trailing average of daily prices from five 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’s significantly different from the basket of price points in the new contracts and would reduce the contracted gas price — the price formulae in the contracts currently include downstream trading hubs such as Chicago Citygate and PG&E Citygate.

RCA said that there is a strong analogy between Cook Inlet and the production areas that the commission has selected for its price index — gas is exported from the Cook Inlet region through the LNG terminal on the Kenai Peninsula.

“The trading locations were selected because they are net producing locations and export gas beyond their immediate geographic vicinity,” RCA said. “They are located in the United States and Canada with geographic diversity to dampen risk. The trading locations are transparent with daily trading volumes. These factors work together to provide a meaningful cap that will help ameliorate any unreasonable terms within the GSAs (gas supply agreements).”

Market power

RCA said that it was imposing the price cap because of the gas producers’ power in a market dominated by just three companies: ConocoPhillips, Marathon and Unocal. Enstar requires gas supplies and the amount of gas required by residential consumers for space heating is insensitive to price, the commission said.

“The ConocoPhillips GSA price cap and the Marathon GSA price cap are required to help militate against the market power and resultant imbalance in bargaining power held by the producers over Enstar,” the commission said.

The commission said that certain terms within the contracts provide evidence of “an excessive degree of control” by the producers over the terms of the gas supply agreements. Those terms include some contractual control over Enstar’s participation in the RCA review of the contracts and a requirement for Enstar to develop gas storage facilities, RCA said.

And in its contract with Enstar Marathon has, in effect, excluded the possibility of a small third-party producer supplying gas to Enstar, by requiring all suppliers to be able to meet all levels of gas deliverability, including winter seasonal swing and needle peaking gas required for the coldest winter days, RCA said.

The commission wants this section of the Marathon contract changed.

Because, under the contract terms, neither Marathon nor ConocoPhillips is required to supply needle peaking gas after the first quarter of 2011, a third party supplier would end up having to provide more gas deliverability than either of the two largest Cook Inlet gas suppliers, the commission said.

“It is doubtful that an independent supplier can provide a higher level of deliverability than Marathon itself is willing to provide,” it said.

Producer bargaining power also results in part from the fact that ConocoPhillips and Marathon own the Kenai Peninsula LNG plant, the commission said.

“The Cook Inlet market is vertically integrated, with the producers as their own best customers through the medium of sales to the LNG export facility,” it said.

And the commission said that the terms under which the U.S. Department of Energy recently renewed the export license for the LNG terminal had negatively impacted Enstar’s bargaining position.

“It is in the best interest of local utility ratepayers to require the producers to finalize contracts with the local utilities before receiving authorization to export natural gas,” the commission said.

Tiered pricing

The commission has accepted the principle of unbundling the gas prices into different service tiers to accommodate seasonal swings in demand but does not like the way in which the tiers are determined in the contracts. In particular the commission questioned the way in which the cost of the gas storage required to support winter demand swings is hidden within the rates.

“We find that the evidence shows that the tier demarcations were producer-efficiency driven and then retroactively superimposed on Enstar’s seasonal demand profile,” RCA said.

However, recognizing the urgency of having Enstar’s new gas supply agreements in place by January 2009, the commission said that it will accept, subject to one minor modification, the proposed tiering arrangements as “an interim step” to achieving unbundled rates.

“We require the next GSAs filed by Enstar for our approval to be fully unbundled, including pricing for storage,” RCA said.

The commission also does not like the fact that, under the terms of the ConocoPhillips contract, ConocoPhillips could reduce its gas supplies to Enstar if the State of Alaska elects to take its gas royalties in kind, rather than as cash. However, the commission said that there is adequate evidence “in the record” that the new contracts would assure sufficient gas supplies for Enstar, even with the royalty-in-kind provision in play.

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