Natural gas price risk sharing an issue

Utilities not likely to guarantee take-or-pay price for Alaska gas

Larry Persily

Petroleum News Government Affairs Editor

Looking around for candidates to share in the financial gamble of a multibillion-dollar Alaska natural gas pipeline, it doesn’t appear likely that state regulators would allow gas utilities to take on much of the price risk.

Although long-term, take-or-pay contracts could protect gas producers and pipeline investors from the financial fear of low market prices, they also could put utilities in the position of paying above-market prices for Alaska gas in the future. That’s something that utility regulators, and consumers, don’t like.

But finding a way to spread the risk between parties is one of the key unresolved issues in getting North Slope producers to commit to the project.

An Alaska gas line moving 4.5 billion cubic feet per day would carry almost $5.8 billion worth of gas a year, at $3.50 per thousand cubic feet. And with the projected pipeline tariff possibly eating up two-thirds of the revenue — if construction cost estimates come true — the producers worry who will help share the risk during periods of low gas prices.

“You’re probably not going to see LDCs (local distribution companies) take a big share of the risk,” said Bill Garner, a managing director of energy investment bank Petrie Parkman & Co., in Houston. “Naturally, LDCs are a little gun-shy about signing these long-term contracts.”

Utilities aren’t necessarily required to obtain regulatory approval of their gas supply contracts but they do need approval of their rates, and consumers can protest if they believe the utilities are overcharging for gas.

“We know of a number of utilities that are discouraged (by state regulators) from signing long-term contracts,” said Michael Zenker, senior director for Cambridge Energy Research Associates’ North American Natural Gas Service.

Regulators may shift thinking, but it’s too early

Utilities have a responsibility to ensure that their customers have adequate supplies of gas, but it’s impossible to know how much gas might cost in the future and how much utilities should promise to pay for that supply. “What always happens to these deals is the market turns on you,” Garner said.

“Generally, it comes down to the prudency standard. Was it prudent to enter into the contract at that point in time,” he said. “The problem with prudency, it’s always second-guessed.”

Contracts for long-term pipeline shipping capacity are different than contracts to buy gas at a set price, said John Cita, chief economist for the Kansas Corporation Commission, which regulates utilities in the state. Signing a long-term deal for pipeline tariffs, or even for gas at prices tied to a floating market index, isn’t a problem compared to a long-term supply contract at fixed prices, he said.

“Gas LDCs in the Lower 48 have a responsibility to serve,” Cita said, but taking on the price risk for future gas deliveries could overstep that responsibility.

Utilities tried long-term contracts in the ’80s

The problem is utilities signed long-term, take-or-pay contracts during the time of tight supplies and high prices, only to see prices slide back to under $2 by 1986 and stay there until 1996.

“The price of gas collapsed and they didn’t want to take the gas anymore,” Garner said of utilities’ reaction to the market change. Utilities signed contracts stretching 10, 15 or even 20 years back in the 1980s, but the norm today is usually just one or two years, he said.

A utility could be forced to swallow the loss if state regulators reject its rates based on above-market gas prices under a long-term contract. “It’s almost a bet-your-company kind of decision,” Garner said.

Without utilities to take on much of the long-term price risk of an Alaska gas line, the great bulk of the financial hazard is left to the producers, possibly industrial users of the gas, and maybe marketing affiliates of pipeline companies. Federal law prevents interstate pipeline companies from owning the gas moving through their lines, leaving that role for their affiliated companies, Garner said.

Enbridge may want 20% stake in pipeline, but not nearly that much gas

Larry Persily

Petroleum News government affairs editor

“We potentially could take some shipping commitments, but not in that range,” Carruthers said May 31. “That’s way more than we could.”

A commitment by its marketing and distribution affiliates to take 20 percent of the gas from a project moving 4.5 billion cubic feet per day, as proposed by the North Slope producers, would mean signing up for more than $1.1 billion a year in gas at $3.50 per thousand cubic feet. Enbridge in 2003 generated about $4.8 billion in total operating revenue.

The problems for advocates of an Alaska pipeline has been finding not only long-term buyers for that much gas but working out the potentially costly issue of sharing the price risk.

The risk of construction cost overruns, permit or regulatory delays, and the fear that future market prices could fall short of a profitable return for producers — or perhaps even short of the pipeline tariff in a down market cycle — are all part of the equation, Carruthers said.

Enbridge has announced its willingness to work with the state and North Slope producers to put together a financially feasible project, and has gone so far as to apply to the state to negotiate a fiscal contract governing company payments in lieu of potential taxes on the project.

In looking to come up with its share of the money needed for construction, Carruthers said the company envisions using cash to cover 30 percent of its share and borrowing the rest. Enbridge, just as some of the producers, said the pending federal loan guarantee under consideration in Congress is key to a go-ahead for the gas line.