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Vine ---------------------- Forwarded by Vince J Kaminski/HOU/ECT on 06/02/2000 08:06 AM --------------------------- webmaster@cera.com on 06/01/2000 10:04:21 PM To: vince.j.kaminski@enron.com cc: Subject: US Gas Markets Reach New Heights: Where Will It Stop? - CERA Alert ********************************************************************** CERA Alert: Sent Thu, June 01, 2000 ********************************************************************** Title: US Gas Markets Reach New Heights: Where Will It Stop? Author: N. American Gas Team E-Mail Category: Alert Product Line: North American Gas , URL: http://www.cera.com/cfm/track/eprofile.cfm?u=5166&;m=1221 , The US gas market enters the month of June with prices at the highest level since deregulation. At the Henry Hub prices have surged to between $4.30 and $4.40 per million British thermal units (MMBtu)--up from less than $3.00 per MMBtu in April. Behind this has been a building and serious shortfall of supply, the result of disappointing gas production levels and surging gas demand for power generation. The gap between these two forces has been met through storage inventories, with injections so far this spring running between 1.5 and 2.0 billion cubic feet (Bcf) per day below last year's pace. The weak injection rate so far this season reinforces the pressure--last week's injections of only 8.0 Bcf per day compare with last May's injections of over 10.0 Bcf per day. If this trend were to continue throughout the summer, gas inventory levels would not meet minimum acceptable levels for next winter's heating season, which CERA believes to be between 2.65 and 2.7 trillion cubic feet (Tcf) of working gas in storage by October 31. Indeed, injections for June to October must ramp up to an average of 8.1 Bcf per day, 0.4 Bcf per day higher than last year's rate, for inventories to approach 2.7 Tcf, a level that still exposes the market to shortage late next winter. Even reaching this level will be a challenge and will require that demand be priced out of the market. This growing realization has sent the market into a panic. Although the forces that have pushed the gas market to this level are not a surprise--indeed they have been building for over a year--the resulting price level is shocking nonetheless. It highlights the challenge of pushing prices high enough to choke off demand and to free gas supplies for storage. Unlike years past, the gas market pressures this year come at a time when there is little flexibility in energy markets overall. Indeed, power markets are headed into the peak summer months with generation capacity still largely constrained in most markets; this is likely to result in a higher incremental call on gas than ever before--with only limited ability to switch to alternative fuels. At the same time oil prices remain above $30 per barrel, making the cost of switching particularly high. All these forces combine to suggest that the current market pressure is far from an aberration--and it raises the question: "Where will it stop?" There are breaking points in the market that are currently being tested--many of them involving industrial and feedstock uses of gas. Few of these currently cost below $4.00 per MMBtu, and many are currently above $5.00 per MMBtu. How high prices go and how long they stay there depends very much on the strength of the underlying market pressures. We expect to see the following reactions: * Power generation: incremental gas-to-residual fuel oil switching. The Atlantic Coast dual-fuel market is already providing the first demand response to higher prices. Given the late May climb in gas prices relative to residual fuel oil prices, a significant portion of the 1.5 Bcf per day dual-fuel market has switched from burning gas earlier in the month to burning residual fuel oil. This summer, CERA expects virtually all logistically and environmentally feasible dual-coal load to burn residual fuel oil. This will result in an incremental 600 million cubic feet (MMcf) per day loss of gas demand from these plants relative to last summer (and relative to early May). However, to keep that load burning residual fuel oil, gas prices will have to sustain premiums of $0.05 to $0.25 per MMBtu above 1% residual fuel oil prices at New York Harbor to price out switchable capacity in the Northeast. Premiums to Gulf Coast residual fuel oil will be required to price out Florida and Mis! sissippi/Alabama switchable capacity. Despite this fuel switching activity, CERA expects overall gas demand for power generation to climb by 3.0 Bcf per day from May into June as overall power demand increases. * Reductions in ammonia production. CERA expects a loss in gas demand for ammonia production, even with the recent strength in ammonia pricing. Ammonia prices have softened somewhat from their highest levels of a few weeks ago, but were still at $165 per short ton over the past week. At these price levels, US ammonia margins began to disappear as gas moved above $4.00 per MMBtu at the Henry Hub. Given the strong gas prices, CERA expects a sustained period of negative ammonia margins. Last summer when ammonia margins disappeared, a sizeable portion of the North American ammonia production capacity closed; at its most extreme in August, gas demand for ammonia was down by 0.4 Bcf per day. This demand reduction is likely to be repeated for much of this summer. The closing of ammonia capacity should lend some support to ammonia prices. Last summer in response to ammonia closures, ammonia prices climbed by about $15 per short ton. This feedback effect would keep a tight balance on! price. For example, raising the ammonia price to $180 per short ton allows the industry on average to maintain a margin until the Henry Hub price reaches $4.50 per MMBtu. There are limits, of course. Ultimately, high gas prices will not shutter the entire domestic ammonia industry, which uses approximately 1.6 Bcf per day in fuel and feedstock. * Ethane rejection. In previous gas price spikes or periods of low oil prices, processors have elected to leave ethane in the gas stream, providing an incremental source of gas supply. The observed difference in ethane production levels in recent years demonstrates a flexibility to add approximately 600 MMcf per day of gas supply, should extracting ethane from the gas stream become clearly unprofitable. Strength in oil and products markets this year, however, makes such an addition to gas supply highly unlikely. Last week (May 22-26) Mont Belvieu ethane priced above $5.50 per MMBtu (over $0.36 per gallon), with propane pricing over $0.54 per gallon. Given these products prices, gas prices of $5.00 in the Gulf Coast and $4.25 in the Rockies would be required before processors leave significant quantities of ethane in the gas stream. In addition, propane, the major alternate to ethane in the petrochemical sector, is currently in short supply. The result is that until world oil! markets loosen, allowing imports of propane, ethane is likely to follow gas upward, should gas even reach the ethane price. Unless gas prices rise significantly from current levels, or until oil markets themselves weaken, CERA does not expect ethane rejection to add much to gas supply this summer. * Methanol. Methanol margins are also suffering with current gas prices, even given recent healthy methanol prices. Methanol prices are being supported by the return of Asian demand; specific plant outages, including several ammonia feeder plants in Trinidad; and the late startup of several world-scale methanol plants, including plants in Trinidad, Saudi Arabia, and Iran. Although recent spot methanol prices have risen well above $0.60 per gallon, contract prices in the $0.50 range would imply production shutdowns when gas prices are above $4.00 per MMBtu. A significant portion of methanol plants having already shut down last summer, only a small incremental amount of gas demand is expected to be lost with further shutdowns in methanol production, perhaps 0.1 Bcf per day. * Fuel switching to distillate. With distillate prices well above $5.00 per MMBtu, distillate is not expected to provide a major source of demand relief unless the pressure intensifies extensively and prices spike further. For next winter, however, fuel switching to distillate could become an important force taking the pressure off gas markets--particularly on the East Coast. That said, distillate inventories are currently low. To the extent this continues through the end of the year, it would set up a repeat of what occurred last winter in the Northeast when prices in both distillate and gas markets spiked. In total there is certainly the potential to provide well in excess of 2.0 Bcf per day of cushion through a combination of reduced consumption and some localized ethane rejection in the Rockies and eastern Gulf--plus a marginal increase in liquefied natural gas (LNG) imports (up to 0.1 MMcf per day). But currently such a reduction in consumption would require an even greater increase in prices. For now the gas market appears to have reached a very tenuous resistance point in the $4.25-$4.50 per MMBtu range--a level that should result in "choking off" an incremental 0.8 to 1.1 Bcf per day of gas demand (relative to two weeks ago) from the combination of additional fuel switching to residual fuel oil and reduced feedstock demand for gas (see Table 1). However, as we move through June and into July even slightly warmer-than-normal temperatures could add an additional 1.0 Bcf per day of highly inelastic demand for power generation (relative to normal weather) and force prices ev! en higher to balance the market. CERA estimates that it would take prices in the $5.00 to $5.25 per MMBtu range to rationalize this extra demand--principally through a combination of ethane rejection and additional reductions in feedstock demand for gas. This deep a reduction inevitably would force price reactions in petrochemical markets--pushing gas prices up even further. There are also limited forces that could drive the market lower--and remove some of the panic. Mild temperatures through June would provide the most significant impact by allowing more breathing room for storage injections. Any movement by OPEC to increase crude oil output could also help lower the fuel switching threshold points. But even if both these forces were to act, we estimate this would move gas prices back down only into the $3.50 to $4.00 per MMBtu range. If prices fell any lower, demand would surge from a return of feedstock demand and fuel switching back to gas. For these reasons, CERA has raised its Henry Hub price outlook for the third quarter of 2000 to $4.18 per MMBtu, and the average for the year to $3.67 per MMBtu. **end** Follow URL for PDF version of this Alert with associated table. Please note: Should the above URL not work, please use the following: http://www.cera.com/client/nag/alt/060100_15/nag_alt_060100_15_ab.html ************************************************************************** CERA's Spring 2000 Roundtable event dates and agendas are now available at http://www.cera.com/event ************************************************************************** ********************************************************************** Account Changes To edit your personal account information, including your e-mail address, etc. go to: http://eprofile.cera.com/cfm/edit/account.cfm This electronic message and attachments, if any, contain information from Cambridge Energy Research Associates, Inc. (CERA) which is confidential and may be privileged. Unauthorized disclosure, copying, distribution or use of the contents of this message or any attachments, in whole or in part, is strictly prohibited. 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