October 2009 Vol. 236 No. 10

Q&A

AGAs Chris McGill Speaks Out On Challenges, Price Volatility And The Role Of LNG In The Nations Energy Future

Chris McGill is the Managing Director Policy Analysis at the American Gas Association (AGA), which represents 202 local energy companies that deliver natural gas throughout the United States.

There are more than 70 million residential, commercial and industrial natural gas customers in the U.S., of which 92% – more than 65 million customers – receive their gas from AGA members.
During his 21 years at the association, he has served as Manager Gas Supply, Director of Gas Supply and Statistics and Director of AGA’s Houston Office – in addition to his current position.
McGill’s work is in the assessment of future supplies of natural gas, domestic production, underground storage, key pipeline transportation issues, winter heating season planning and other related topics. He is an active spokesperson on many natural gas supply topics, representing local gas utility perspectives to the industry, regulators, legislators and the public. He has authored numerous articles, energy analyses and issue briefs on these subjects, as well as having created and managed statistical time-series data focused on key industry benchmarks.
In these especially challenging times, McGill had much to say during an interview with P&GJ.

P&GJ: What issues are proving the most challenging for AGA members today?
McGill: Right now it’s the economy and its impact on our customers. Higher unemployment and reduced household incomes often translate into an increase in late payments by customers and a rise in uncollectibles. Other areas like residential building are also taking a toll. Consider that over half of new homes choose natural gas – but if new homes aren’t being built, gas utilities are not adding new customers which means our residential market base is shrinking. And shrinking markets and lower thermostats result in decreased natural gas throughput. But, there have been a few silver linings. Federal funding for the Low Income Home Energy Assistance Program (LIHEAP) has been at record high levels for the last couple of years and is on track to be fully funded at $5.1 billion for this upcoming fiscal year. Even fully funded, however, the program dollars are insufficient to help all those who would qualify for assistance in paying their utility heating bills.

An increasing number of natural gas utilities have had “decoupled” utility rates put in place in the last few years. These rates break the link between a utility’s earnings and its customers’ natural gas consumption. This approach allows the utility to be on the customer’s side in helping them reduce their energy consumption and bills. Today, 31 natural gas utilities in 18 states serving more than 20 million residential customers (almost one third of U.S. residential customers) have decoupled rates in place. Along with helping the utility help the customer, decoupled rates tend to protect utilities from earnings declines brought about by reduced natural gas throughput.

Also, as consumers recognize the economic and environmental benefits of natural gas, there has been an increase in homeowners converting from oil heat to natural gas heat.

While all businesses have found it more difficult to obtain credit, utilities generally have excellent credit ratings that have helped them better weather today’s financial turmoil.

P&GJ: What are some of the challenges that companies have faced in dealing with the price volatility over the past several years?
McGill: After a long period of relatively stable natural gas prices through the 1990s, the natural gas industry entered a period of price volatility beginning in the winter of 2000-01. During the past 18 months, the volatility has been particularly extreme, with spot natural gas prices exceeding $13 per MMBtu in early to mid 2008 and then falling to below $3 in August and September 2009.

Fortunately, most utilities have adopted programs to help mitigate the impact of this volatility on their customers. The most common practice to reduce volatility is for gas utilities to put natural gas into storage in the summer when prices are (usually) lower and then to deliver that gas to customers in the winter when spot prices are generally higher. In addition to doing this type of “physical” hedging, many companies engage in other price-hedging strategies, including financial swaps and call options, fixed pricing and advanced purchases at fixed prices.

It is hoped that the advent of natural gas shale production will help stabilize natural gas production, increase the production base and perhaps somewhat reduce price volatility over time. Price volatility is a normal characteristic of commodity markets in general — and certainly oil and natural gas markets over the past century. In a business where demand is largely driven by unpredictable weather and economic activity, price volatility will likely remain a fact of life.

P&GJ: Operators have recently curtailed production because of low natural gas prices. What impact does this have on the overall market?
McGill: To date, reductions in production have had almost no impact. Natural gas market fundamentals remain supply strong and demand weak among large-volume industrial users. Curtailment of production, which has been minimal, and reductions in rig count are rational supply-side responses to the current market. In the longer-term, price and other market signals will key producers to increasing their investments. It is likely, however, that demand recovery among large-volume customers is probably the most important factor in estimating when this may occur.

P&GJ: Is there an ideal price range that you think would actually satisfy most everyone in the natural gas industry?
McGill: Local gas utilities are more tuned to future price stability and health in the overall natural gas industry for all parties, including residential and small commercial customers. Producers must get a price that meets their production costs and investment requirements as should pipelines for creating transportation infrastructure. The absolute dollar value is something that AGA does not pretend to predict. It should be fair and competitive with other market alternatives.

P&G: What were your thoughts on Potential Gas Committee’s recently released report on the nation’s natural gas resource base?
McGill: The Potential Gas Committee (PGC) from the Colorado School of Mines reported on June 18, 2009 the results of its latest biennial assessment of the nation’s natural gas resources. The report indicates that the United States possesses a total undiscovered resource base of 1,836 Tcf. This is the highest resource evaluation in the Committee’s 44-year history and, when combined with current natural gas reserves reported by the Energy Information Administration, offers a total gas endowment of over 2,000 Tcf – more than 100 years of gas supply at current production levels – with the ever-present shale-gas representing more than 600 Tcf of the total. The increase from the prior assessment at year-end 2006 was more than 500 Tcf or 35%. Most of the increase from the previous assessment arose from re-evaluation of shale-gas plays in the Appalachian basin and in the Mid-Continent, Gulf Coast and Rocky Mountain areas.

With that said, the current assessment assumes neither a time schedule nor a specific market price for the discovery and production of future gas supply. Estimates of the PGC are ”base-line estimates” in that they attempt to provide a reasonable appraisal of what is considered to be the “technically recoverable” gas resource potential of the United States. From AGA’s perspective, the PGC view of natural gas resources in the United States is the real deal. A public policy of permitting development of these resources under appropriate environmental guidelines, however, must be in place for it to happen.

P&GJ: What about the Boone Pickens’ energy plan?
McGill: Mr. Pickens has spoken of using alternative energy forms such as wind to generate electricity in order to free up natural gas resources for transportation fuel, particularly for long-distance, high-mileage trucking. AGA is not opposed to either idea and, in fact, has been supportive of source alternatives for power generation and transportation for years. We aren’t bashing anybody’s good ideas for energy security and reliability. We do believe that natural gas has to be a key part of any energy plan that addresses long-term energy and carbon-reduction strategies.

P&GJ: What impact do you see the global recession having on new construction and infrastructure projects planned by the natural gas industry?
McGill: While U.S. construction generally has suffered over the last year, there are three relatively positive developments in the natural gas industry.

The first is the industry’s traditional focus on safe and reliable service. This means that ongoing maintenance and line-replacement programs tend to move forward. A number of progressive public utility commissions have approved various types of regulatory tracking programs that encourage utilities to move forward with these types of maintenance and line-replacement programs by assuring that the utilities will be able to recover these costs in a timely fashion.

The second is the federal stimulus legislation that Congress enacted in February. While the American Recovery and Reinvestment Act (ARRA) does not specifically target natural gas construction and infrastructure projects, it has made funds available to states that in turn have made funds available for gas distribution pipeline projects. In New Jersey, for example, the state made available funds for accelerated capital investment projects. This funding is expediting gas distribution projects that might not have moved forward until some later date.

A third development is the construction of new pipelines to move natural gas out of the rapidly expanding new natural gas plays. As long-term natural gas production continues to expand in the Intermountain West and as more natural gas shale plays are developed, we would expect to see continued expansion of the nation’s pipelines.

P&GJ: What role do you see LNG playing in the nation’s energy future?
McGill: Liquefied natural gas (LNG) will compete as a potential supply of natural gas in the United States just as domestic production, gas from Canada and even future arctic gas may, if infrastructure is built. Clearly, the LNG world market has demonstrated significant complexity in the past five years with short-term and long-term expectations changing on the vagaries of price, geopolitical unrest and even earthquakes. We have no way of predicting the future role of LNG in the United States, only to observe that import capacity in the U.S. and North America, in general, is increasing as is world supply. At this time, the actual utilization of that capacity is unpredictable.

P&GJ: Do you see any problems on the horizon that could negatively impact the industry?
McGill: The big game-changer in the works is climate change and energy-efficiency legislation. Not only will it have an enormous impact on the utility industry, but that impact is likely to play out over many decades. Naturally, any major change could negatively impact the natural gas industry.

It may be that we will look back at climate-change legislation and see it as something that had many positive impacts on the natural gas industry. As the lowest carbon domestic fossil fuel with more than a 100-year supply, natural gas may well be the nearly perfect fuel for a society that is looking to reduce carbon emissions.