NATURAL GAS SUPPLY ASSOCIATION

The current run-up in natural gas prices, which is starting to be passed along to consumers, has generated a number of inquiries from the media and the public. Following is some information that puts natural gas prices into perspective.

Reliability

• Reliability is based on contracts. In today's gas market, customers reliably receive the gas supply and service for which they have contracted.

• Reliability of natural gas supply has been significantly enhanced by the increased reliance on competitive-market forces in the gas industry. Previously, when prices were completely regulated, demand outstripped supply. Today, competition in the natural gas market, as in other commodity markets, ensures reliable supply in several ways. For instance:

  - Short-term increased demand encourages industrial users to switch to other fuels, freeing up supplies for residential and commercial users unable to switch. The industry saw this market force at work last winter, when record cold east of the Mississippi did not affect supply availability for firm customers.
  

  - Producers can respond to increased demand through supply-increasing operational adjustments. For instance, a skid-mounted compressor moved into a field can significantly increase production in a matter of hours.
  

  - Long-term increased demand encourages producers to increase exploration and production activities that can bring more gas to market. Over the past year, for instance, natural gas drilling activity has risen markedly in promising areas such as the Gulf of Mexico.
  
  

• Competition in natural gas transmission has also increased reliability. As a result of changes in the marketplace, shippers frequently have several potential routes for reaching a given market. Thus, should high demand or operational issues make it difficult to get new supplies to market on one pipeline, shippers can frequently find alternatives.

• Reliability of natural gas delivery has been enhanced through the development of a reliability network, sponsored by the Natural Gas Council, which puts into immediate contact with each other those industry operations people best able to resolve problems such as unexpectedly high demand (usually related to cold weather) or temporary transmission interruptions.

Price

• Currently, spot market prices for natural gas at the wellhead (that is, "commodity" or "supply" prices) are higher than they were a year ago. The following are most frequently cited by analysts as causes of that rise:

  - The reality that November 1996 was 18 percent colder than average.

  - Speculation about a colder-than-average winter.

  - A belief that the amount of natural gas in storage is inadequate. Note that this contention is not supported by an analysis of storage data.
  
  

• Natural gas customers with long-term supply contracts for natural gas at fixed prices are not affected by short-term rises in spot-market prices. Customers relying on substantial spot-market purchases or on supply contracts indexed to spot-market prices are more likely to be affected. Similarly, residential consumers supplied by distributors with portfolios weighted toward spot-market or indexed supply contracts may see the current spot-market increase passed through on their bills at a later date. Should prices fall, these consumers would then likely see future bills reflecting the lower prices, whereas consumers whose distributors rely primarily on fixed-price contracts would be less likely to see a change in their gas supply prices.

• Residential consumers have benefited from relatively low gas commodity prices for many years. From 1987 through 1995, their price for natural gas unadjusted for inflation fell by nearly 16 percent; the inflation-adjusted percentage is much higher.

• There appears to be a widespread lack of understanding about storage reports and about the changing role of storage in a more competitive natural gas industry. Some relevant points:

  - Currently, the amount of natural gas in storage in the Northeast is not significantly different from the same period in past years.
  

  - The amount of natural gas in storage in the West is lower than during the same period in some past years because 1) high rainfall has produced a higher-than-normal potential for hydropower, which competes with natural gas in some markets, and 2) an excess of pipeline capacity into the West significantly reduces the need for storage.
  

  - National gas-in-storage averages are a less-than-useful indicator of supply reliability.
  

  - Previously, in the fully regulated gas industry, customers (including LDCs and industrial consumers) received "bundled" services that included storage; thus, for the most part, storage was a hidden cost. In today's more competitive industry, customers are re-evaluating their needs for storage as one method of controlling or reducing total fuel bills. Some appear to have implemented alternatives to storage, including gas peaking facilities (such as propane/air or LNG), switching to an alternative fuel, temporary facility closings, or limited purchases of higher-price spot-market gas. The effect of these decisions on the need for storage is unlikely to be understood fully for several years.
  

Large customers that contract directly for gas supplies--including many industrial and commercial customers as well as local distribution companies (LDCs)--have a number of financial instruments and risk-management strategies to achieve level prices, should they seek them, including price hedging, portfolio management expertise, and storage. As in other industries, costs are connected with virtually all risk-management strategies, and some may prevent customers from benefiting fully from low prices during periods when supplies are high and demand is low. Over the past decade, a high-supply, low-demand situation has existed that has encouraged many customers to depend on short-term contracts rather than implement risk-management strategies.

1/22/97

This page was last updated August 31, 1997