FERGUSON: ENERGY MATTERS California Betting on Gas Prices

California is poised to gamble heavily that natural gas prices will fall and stay low for decades. By a decision to build more gas-fired power plants, consumers will be forced to pay the consequences if the gamble is lost. Is that a bet that consumers - or, more rightly, regulators in their stead - are willing to make? The Energy Information Administration released its preliminary 2005 U.S. natural gas data last week. The results were pretty much as I forecast a year ago, with major trends continuing despite a minor blip caused by hurricanes Katrina and Rita. Most striking was the continuing escalation in prices. The average 2005 gas price paid at the "wellhead" was $7.33 per million Btu, an increase of $2 (+37 percent) over 2004. If last year you bet that gas prices would fall in 2005, you lost big time. Don't blame the industry - the record price resulted in record drilling activity with 27,335 gas wells completed, up 21 percent. Don't blame hurricanes, either. Katrina and Rita reduced gas production in 2005 by 567 billion cubic feet. But total U.S. production fell by 662 bcf. In other words, even without the storms, U.S. gas production would have continued to drop. From its peak in 2001, U.S. gas production has decreased 4.5 percent in four years (-881 bcf), even after correcting for production lost to last year's storms. Consumption also fell, primarily due to storm damage to refineries in the Gulf region. Adjusted consumption was down 366 bcf (-2 percent). I was surprised that consumption did not decline by a larger amount, given the 37 percent increase in price. Evidently you can't rely on higher gas prices to reduce consumption. My outlook for 2006 is that the trends of the last few years will continue. Production will have difficulty increasing despite attractive prices and active drilling. Prices will remain strong and continue to follow oil prices. Consumption cannot grow without additional supplies, which appear unlikely. Some forecasters project that large amounts of liquefied natural gas will flood the U.S. market, depressing prices. This is unlikely to occur this year, since receiving capacity remains limited. I remain skeptical of future low-price projections, too. While world LNG production capacity is growing rapidly, so is global demand. The odds of a world awash in cheap gas appear poor. The uncertain future of natural gas prices poses a crucial policy question for California. Unfortunately, it's not getting much attention in a state that relies on gas for 40 percent of its electricity. Thus the question becomes: Should the state gamble that gas prices will fall by building more gas-fired power plants to supply electricity for its burgeoning population? The alternative is to increase reliance on renewable energy from wind, geothermal, and solar plants and use natural gas only for backup supply if needed. California's wind and geothermal resources could satisfy decades of future demand growth. It is already economically competitive compared to gas. Renewable energy development provides guaranteed stable prices indefinitely. Unfortunately, regulators continue to treat renewable energy as a boutique resource, shunting it into the "green ghetto" of the renewables portfolio standard. Utilities plan to continue increasing dependence on natural gas for electric generation. Because gas prices are passed directly through to consumers, utilities can afford to gamble on lower gas prices at no risk to themselves. But unless gas prices fall significantly and remain low for the lifetime of power plants, consumers will pay. The utility electric procurement proceeding at the California Public Utilities Commission is now under way. The only real question is whether California will continue to bet on gas prices. If so, it will build more gas-fired power plants. If it wants to stabilize electric rates, it will build renewable power plants instead. My guess is that the public would overwhelmingly choose not to gamble that gas prices will fall and would prefer stable electric rates instead.

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FERGUSON: ENERGY MATTERS California Betting on Gas Prices

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