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A continuing Cook Inlet gas-price saga There’s no competitive spot market but with pressure on supplies, prices are likely to continue rising for utility customers Alan Bailey Petroleum News
Decades ago, encouraged by exceptionally low prices for natural gas from the Cook Inlet basin, gas became the fuel of choice for heating buildings in much of Southcentral Alaska, while gas-fired generation became the favored source of electrical power. But the last 10 years have seen major increases in Cook Inlet gas prices. And, as prices have risen, so have people’s monthly utility bills.
Peaked in 2009 During the Anchorage Mayor’s Energy Task Force meeting on Oct. 2 Moira Smith, vice president and general counsel of Enstar Natural Gas Co., Southcentral’s main gas utility, commented that the price that Enstar pays for gas climbed steadily during the 2000s and peaked at $8.76 per thousand cubic feet in 2009, subsequently falling back to $6.32 in the fourth quarter of 2013.
And the price of gas to consumers has followed a parallel trend: A chart of historical gas prices on Enstar’s website shows prices, including the fees that Enstar charges for distributing gas to customers, rising from $4.41 per thousand cubic feet in 2003 to $10.46 in 2009 and dropping to $7.39 currently.
The historic substantial rise in gas prices is a reflection of tightening gas supplies from the Cook Inlet basin, Smith said, adding that, because of the terms of a consent decree agreed between Hilcorp Alaska and the State of Alaska, it is safe to assume that gas prices will rise in the future. Hilcorp is the dominant Cook Inlet gas producer.
But what exactly determines the pricing of gas from the Cook Inlet basin, and how has the current pricing situation arisen?
Glut of gas Most of the gas produced in the basin comes from large gas fields discovered in the 1960s during a search for oil at that time. In the early days of the Cook Inlet gas industry, with the oil companies happy to sell a huge excess of stranded Cook Inlet gas to local power and gas utilities at bargain-basement prices, the utilities established long-term contracts with gas producers. And, as was the habit at the time, the price of the gas was indexed to the price of crude oil.
Fertilizer and liquefied natural gas plants were also constructed on the Kenai Peninsula, to provide industrial outlets for some of that excess gas.
The Cook Inlet gas industry motored along happily until the 2000s, at which time declining rates of production from the by-then aging gas fields put strains on the supply side of the gas market. In 2007 the Kenai Peninsula fertilizer plant closed because of a shortage of adequate gas supplies. The liquefied natural gas plant cut back on its production, eventually becoming mothballed in early 2013.
The gas war Meantime, with their old gas supply contracts starting to come to the ends of their terms, Southcentral utilities started to seek new contracts to ensure continuity of energy supplies to their customers. And that led to an acrimonious battle over setting acceptable prices for the gas, in what one commissioner in the Regulatory Commission of Alaska characterized as the “the Cook Inlet gas war.” The Regulatory Commission of Alaska, or RCA, is the state agency responsible for regulation of the utilities.
The RCA, although it has no authority to regulate gas producers, does have to review and approve utility gas supply contracts, including the gas prices set in those contracts. But, all Cook Inlet gas having been sold through long-term contracts, there was no open or “spot market” in which equable price levels could be set using the traditional levers of supply and demand. And the sale price of exported Cook Inlet liquefied natural gas, a possible price indicator for Cook Inlet gas, was commercially confidential and driven by the economy of Japan, the destination of the product.
The need for new, and expensive, development and exploration drilling to bring online additional Cook Inlet gas resources required new contract gas prices sufficient to make a financial return on those drilling costs. At the same time, tightening gas supplies elsewhere in North America were driving up gas prices across the continent — Cook Inlet gas producers such as Unocal and Marathon Oil found themselves competing for drilling capital with regions where drilling for gas could be more lucrative than in Southcentral Alaska.
Henry Hub pricing In 2001 RCA approved a landmark gas supply contract between Unocal and Enstar, indexing gas prices to three-year trailing average prices in the Henry Hub gas market in the Lower 48. The concept was to link gas prices in Alaska to those in the Lower 48, so that Cook Inlet gas exploration and development could compete for capital with gas projects elsewhere.
But as gas prices in the Lower 48 climbed, prices in the new Alaska contract also increased, becoming a major factor in that peak Enstar gas price of $8.76 in 2009.
Impacted by rising prices, people in Alaska questioned the indexing to Henry Hub, a market that has no obvious commercial connection with the Cook Inlet. In 2005, for example, a spike in Lower 48 gas prices following hurricane Katrina caused a knock-on price hike in the Unocal-Enstar contract, despite the hurricane sweeping through territory thousands of miles from Alaska.
Pricing impasse In 2006, amid the gas-price controversy, RCA rejected a Henry Hub-indexed gas supply contract negotiated between Enstar and Marathon. In 2008 Enstar went back to RCA with two new contracts it had negotiated with ConocoPhillips and Marathon, this time with prices indexed to baskets of North American gas price points. The commission responded to the 2008 contracts by requiring a commission-mandated price cap, based on a 12-month trailing average of prices in five North American basins. But the two Cook Inlet gas producers rejected this proposal, forcing the commission to allow the contracts to go into effect temporarily, to avoid a shortfall in Cook Inlet utility gas supplies.
In 2009 RCA convened a technical workshop to try to hammer out some kind of acceptable formula for setting Cook Inlet utility gas prices. But the major gas producers, citing concerns about anti-trust liability, declined to participate.
New precedent However, in September 2009 the commission set a new gas-price precedent by approving a gas supply contract between Enstar and Anchor Point Energy LLC, the operator of the North Fork gas field in the southern Kenai Peninsula. That contract included gas prices indexed to a three-month average of gas futures on the New York Mercantile Exchange, but with specified price floors and ceilings. And, starting in 2010, other new contracts with Southcentral utilities using a similar pricing formula were approved, thus demonstrating that the logjam in regulatory approvals had been finally been cleared.
Shale gas revolution Meantime, elsewhere in North America, in an entirely unanticipated turn of events, the advent of shale gas development involving the drilling of horizontal wells and hydraulic fracturing of gas source rocks upended the gas industry, ultimately creating a glut of gas and causing gas prices to plummet. In the aftermath of this upheaval gas prices in Canada and the Lower 48 remain below levels that are economically viable for gas producers.
The indexing of Cook Inlet utility gas prices to North American gas markets subsequently caused Southcentral gas prices to fall below their 2009 peak — the price in that Unocal contract with Enstar has dropped to just $4.06 per thousand cubic feet. And, with no new gas supply contracts on the horizon, Southcentral utilities started formulating emergency plans for dealing with pending gas supply shortfalls, including the possibility of importing liquefied natural gas into the region.
Hilcorp arrives In early 2012 Hilcorp, a newcomer to the Cook Inlet oil and gas industry, completed its takeover of the Unocal Cook Inlet assets, which had previously been purchased by Chevron. And in April 2012 Hilcorp announced that it was also buying Marathon’s Cook Inlet properties. But Hilcorp’s pending dominance of the Cook Inlet gas industry triggered an anti-trust investigation by the Federal Trade Commission and the State of Alaska, leading to the consent decree with the state as a condition for Hilcorp completing its Marathon Cook Inlet takeover.
Price ceilings set in the consent decree are higher than current spot prices for gas in Lower 48 markets and increase in annual steps from $6.60 in 2013 to $7.72 in 2017. The price ceilings, which now appear to be forming the basis of prices in new utility gas supply contracts that RCA is willing to approve, presumably represent a compromise between price levels that Hilcorp views as viable and that the state can accept as reasonable.
And a recent flurry of new utility gas supply contracts with Hilcorp, ensuring gas supplies through to end-March 2018, indicates that sufficient gas can be developed from the Cook Inlet fields until then with viable pricing. What will happen to gas supplies and, hence, gas prices after that time remains to be seen.
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