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An evolving utility gas price situation Southcentral natural gas pricing moving towards consent decree standard, while legacy contracts have softened price rises ALAN BAILEY Petroleum News
The price of gas from Alaska’s Cook Inlet basin, a critical factor in heating and electricity costs for Southcentral Alaska businesses and residents, has had a turbulent history in the not too distant past. But some price trends have been emerging, in part because of a gas-price consent decree agreed to in 2012 between the state of Alaska and Hilcorp Alaska, the largest gas producer in the region. The consent decree has set something of a marker for the price of new large-scale, guaranteed supplies. But supply contracts pre-dating the 2012 agreement follow a variety of pricing formulas. And some new contracts, especially for short-term interruptible supplies, have pricing a little below the consent decree levels.
Unique market The Cook Inlet gas market, isolated by many miles from markets elsewhere, dominated by a relatively small number of gas producers and with relatively low levels of local gas demand, is unique. The gas business started in the 1960s with the discovery of some major gas fields as an offshoot of oil exploration in the Cook Inlet basin. While a fertilizer plant and a liquefied natural gas export facility were built on the Kenai Peninsula to monetize the newly discovered gas, utility gas became the prime means of heating buildings and generating power for Southcentral residents. With an excess of gas available, utility gas prices were low and indexed to the price of oil, with the gas sold under the terms of long-term supply contracts.
In the 1990s, as gas supplies tightened and the possibility of gas supply shortages loomed on the horizon, Cook Inlet gas producers started seeking higher prices in new supply contracts. Gas prices elsewhere in North America were rising because of a general tightening in the gas supply situation: Cook Inlet gas producers argued that gas development projects in Cook Inlet needed to compete for capital funding with projects elsewhere and that gas development in Alaska was relatively expensive. The subsequent fights over regulatory approval of new gas supply contracts were sometimes referred to as the Cook Inlet Gas War.
Particularly contentious were attempts to link Cook Inlet gas prices to gas market prices in the Lower 48, a price indexing mechanism that many people saw as a certain route to escalating Alaska prices. In 2001 the Regulatory Commission of Alaska approved a gas supply agreement between Unocal and Enstar Natural Gas Co., the main Southcentral Alaska gas utility, with pricing indexed to the Lower 48 Henry Hub market. But in 2005 the commission rejected a similar contract with Marathon. In 2009 Cook Inlet gas producers rejected a commission proposal for a price cap, if Cook Inlet gas prices were to be indexed to North American gas markets.
Gas shortage concerns But concerns about the impact of North American gas prices on Cook Inlet prices proved unfounded - later in the 2000s the shale gas revolution in North America triggered a gas glut and a subsequent collapse in gas prices. Then, amid concerns about potential gas shortages in Southcentral Alaska, and with the utilities investigating the possibility of importing liquefied natural gas into the region, state legislators enacted generous tax incentives for Cook Inlet natural gas exploration. New companies entered the Cook Inlet gas industry and the gas supply situation started to turn around.
A major breakthrough came in 2011 when Hilcorp purchased Chevron’s Cook Inlet oil and gas assets, with Hilcorp subsequently purchasing Marathon’s Cook Inlet assets. The company embarked on a major program of field development, a program that subsequently rectified the utility gas supply situation, assuring adequate supplies for several years into the future. A number of other companies also pursued Cook Inlet oil and gas exploration and development.
But, concerned about Hilcorp’s near monopoly in utility gas supplies, in 2012 the state of Alaska negotiated a consent decree with the company, setting maximum gas prices through to early 2018.
So what does all of this mean in terms of current utility gas pricing?
A mix of contracts The Hilcorp consent decree, with a price cap of $7.13 per thousand cubic feet this year, rising to $8.03 per mcf in 2018, has become the benchmark for prices in new gas supply contracts. But recent contracts tend to supplement older contracts, leading to overall gas pricing that represents a blend of multiple agreements.
Take Enstar, for example. In a May 2015 Regulatory Commission of Alaska filing, Enstar estimated its weighted average cost of gas as $6.47 per mcf for 2015-16. That average cost derives from a variety of individual gas supply agreements.
In one of these agreements, a contract with Hilcorp dating from April 2014, the gas prices exactly matching the caps in the consent decree. That contract guarantees annual gas volumes ranging from 14.5 billion cubic feet to 20.4 bcf from April 2015 to March 2018.
However, the gas utility also has several older contracts. A 1988 contract, originally with Marathon but now with Hilcorp, is indexed to oil prices. Gas pricing under this contract has ranged from a low of $1.32 in 1999 to a high of $9.08 in 2009. The current contract price of $8.80 is set to fall to $6.03 in 2016, presumably reflecting the current plunge in oil prices. The contract guarantees an annual supply of 5 bcf.
Another contract with Hilcorp dating from November 2000 is indexed to Henry Hub market prices and is thus impacted by low gas prices in the Lower 48. The 2015 price for this contract is just $3.57 per mcf, with a guaranteed annual volume of 10.5 bcf.
Enstar has two contracts with AIX Energy LLC for gas from the Kenai Loop gas field in the city of Kenai. The first of these contracts guarantees an annual volume of 1.8 bcf in 2015, with a pricing formula that results in a price of $7.37 per mcf in October 2015 rising to $8.78 in December. The second AIX contract, with a schedule of daily and quarterly volumes, is currently priced at $7.35.
A recent contract with Cook Inlet Energy LLC guarantees up to 2.5 million cubic feet per day at a price of $6.03 from the Kenai Peninsula North Fork gas field. A contract with ConocoPhillips relates to gas boiled off from the storage tanks at the Kenai Peninsula LNG terminal and has a price linked to Lower 48 gas prices. Another ConocoPhillips contract does not come into effect until 2016 and has prices set a little below consent decree levels.
Electric utilities Chugach Electric Association, the Anchorage-based electric utility, has contracts with ConocoPhillips, Hilcorp, AIX Energy, Cook Inlet Energy and Aurora Gas for the supply of gas for gas-fired power stations. According to a September 2015 Regulatory Commission of Alaska filing, the utility may obtain all of its gas from ConocoPhillips and Hilcorp in the fourth quarter of 2015.
Mark Fouts, Chugach Electric director for corporate planning and analysis, has told Petroleum News that the average price that Chugach Electric is paying for its gas in the fourth quarter is $4.24 per mcf, with a price range between supply contracts of $2.66 to $7.13. The lower end of that range represents the ConocoPhillips contract, a contract signed in 2009 with pricing indexed to a basket of gas prices in the Lower 48. The upper end of the price range comes from a more recent Hilcorp contract, with prices linked to the Hilcorp consent decree.
Municipal Light & Power, the other utility that supplies electricity in Anchorage, is in a somewhat unusual situation, in that it supplies its own gas with its own internal pricing, using its one-third ownership of the Beluga gas field on the west side of the Cook Inlet.
Homer Electric Association and Matanuska Electric Association, the two other Southcentral electric utilities, used to buy their power from Chugach Electric and, so, have relatively recent contracts for the purchase of gas to fuel power stations that they now operate. Homer Electric currently uses gas from a Hilcorp contract dating from 2011, with a price indexed to futures contracts in the Nymex gas market but with a price floor of $6.90 per mcf. The utility has recently signed a contract for the supply of gas by Furie Operating Alaska, starting in April 2016 at an initial price of $6.50.
Matanuska Electric Association has a gas supply contract with Hilcorp, using consent decree pricing currently set at $7.13 per mcf.
Utilities can also obtain gas from time to time through short term, interruptible contracts. Pricing in these contracts seems typically in the range of $6 to $6.50.
Other gas cost factors The prices quoted above relate primarily to the supply of base-load gas volumes at specified delivery points. Contracts typically specify elevated prices for the supply of gas at high rates during periods of peak demand. And the actual cost of the gas to the utilities normally incorporates the cost of delivering the gas by pipeline from the delivery point to the place where the gas is used. Several utilities also incur costs associated with the storage of summer produced gas for use in the winter, when gas demand is high - these utilities store gas in the Cook Inlet Natural Gas Storage Alaska facility on the Kenai Peninsula.
Although the price of gas indexed to oil prices or Lower 48 gas prices can fluctuate up and down, as oil and gas prices change, the Hilcorp consent decree pricing increases steadily each year through to 2018. However, a recently signed extension to the contract between Chugach Electric and Hilcorp has a price drop from $8.03 to $7.35 in 2018, suggesting that some softening of gas prices in the Cook Inlet may be on the horizon.
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