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Date: Fri, 2 Jun 2000 01:03:00 -0700 (PDT)
From: vince.kaminski@enron.com
To: mike.roberts@enron.com
Subject: US Gas Markets Reach New Heights: Where Will It Stop? - CERA Alert
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Vine
---------------------- Forwarded by Vince J Kaminski/HOU/ECT on 06/02/2000 
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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**

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**************************************************************************
CERA's Spring 2000 Roundtable event dates and agendas are now available at
http://www.cera.com/event
**************************************************************************



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