NEWSROOM

NCEP Releases Paper On Two Promising Natural Gas Supply Options

Tuesday, October 21, 2003
 

A bipartisan group of leading energy experts today released a study of two key U.S. natural gas supply issues, finding that an Alaska natural gas pipeline likely would provide significant economic benefits to the U.S. economy due to lower natural gas prices. The report by the National Commission on Energy Policy (NCEP), “Increasing U.S. Natural Gas Supplies,” identified and analyzed the market and regulatory conditions currently facing pipeline developers, and concluded that market barriers to the project and the substantial benefits likely to accrue from construction of the Alaska natural gas pipeline warrant limited government intervention —in the form of a tax credit—to help spur pipeline construction. Under the most likely natural gas price forecast, the study estimates a direct benefit to natural gas consumers of more than $100 billion over ten years and a net economic benefit of $40 billion over the same period.

“The analysis conducted for the Commission shows that consumers could benefit substantially from carefully crafted federal policies that enable construction of the pipeline sooner than private interests might choose to undertake the project on their own, given the size, risks and uncertainties associated with the project,” said Commission member Linda Stuntz. “The sheer size of the potential consumer benefit is important. But also crucial is the role that natural gas now plays in electricity generation, home heating, chemical and fertilizer production, and throughout the economy. “

The NCEP analysis found that the Alaska natural gas pipeline could reduce natural gas prices by roughly $0.50 per mmBtu or approximately 10 percent through 2025, resulting in direct net economic benefits averaging more than $4.0 billion per year. The Commission report examined the conditions surrounding development of the pipeline, including:

-- Substantial financial risk as a result of the magnitude of the project (estimated to cost approximately $20 billion) and the length of time needed to complete the pipeline, especially in the face of uncertainty over future prices and significant price volatility.

-- Inadequate risk management mechanisms in the market due primarily to the decline of long-term contracts in recent years.

-- Regulatory uncertainty regarding siting and permitting of the pipeline and uncertainty regarding royalty payments for Alaskan gas production.

“Three major factors make this project a particularly difficult investment ¾ the large capital costs of the project, the length of time needed to build the pipeline, and the fact that the pipeline can only serve the North American market,” said Commission member Andrew Lundquist.

Historically, natural gas producers and pipeline companies financed large investments through long-term “take-or-pay” contracts that ultimately shifted much of the investment risk to natural gas consumers. These contracts generally covered very long time spans, sometimes as much as 30 years. As natural gas markets have deregulated, however, contracting practices have changed significantly.

Over the past few years, many contracts have been renewed for periods as short as 3 to 5 years. While a 7 year contract might provide developers with adequate risk protection to begin typical pipeline construction, the Alaska pipeline will likely take 10 years to be completed. Pipeline developers would be required to find participants willing to sign contracts for transportation capacity 10 years or more into the future if they were to rely primarily on long-term contracting as a means of managing price risk. Changes in contracting practices over the past decade make this difficult, if not impossible.

The Commission analysis examines a tax credit for production should natural gas prices fall below $3.25/mmBtu, with the tax credit equal to the difference between the trigger price of $3.25 and the actual spot price. (The average price of natural gas over the last 12 months has been approximately $5.00/mmBtu, with a range of $4.00 to $9.00). The analysis indicates that under the scenario considered most likely, the tax credit is triggered only in 2015 when Alaskan gas delivered to the lower 48 reaches peak levels, with a total payout of $215 million. As prices adjust to the increased supplies, the tax credits are quickly paid back by producers the following year, and the net cost to the taxpayer is zero.

At the same time, the Commission acknowledges the legitimate concerns of local communities as they evaluate the implications of accommodating a major new industrial facility. Therefore LNG siting decisions should take full account of states' coastal zone management programs, and avoid marine sanctuaries, marine protected areas, sensitive habitats, and fragile resources like deep corals.

“Natural gas will be an indispensable, low emission fuel for decades to come, “said Commission Ralph Cavanagh. “Getting this huge Alaskan natural gas resource to markets will help ensure that natural gas can economically displace dirtier fuel sources, without degrading sensitive areas that should remain off limits to drilling...”

The Commission report also analyzed issues regarding liquefied natural gas, concluding that sustaining current and projected levels of consumption will require a greater reliance on natural gas imports even if Alaskan natural gas is available to markets in the lower 48 states. The Commission commended recent regulatory changes by the Federal Energy Regulatory Commission (FERC) to ease open access requirements for new LNG facilities, and believes more can be done to reduce the uncertainty to potential investors in this arena without sacrificing safety or environmental protection. FERC recently granted authorization for the construction of the first new LNG terminal in the U.S. in 20 years, which will be located along the Gulf coast in Louisiana. More facilities like this will be needed.

The Commission recommended that policymakers codify FERC’s recent policy changes regarding open access and reserve capacity for LNG re-gasification facilities. These policy changes will reduce uncertainty and ensure LNG investors that they will have the opportunity to earn adequate returns on their investment.

NCEP Commissioner Paul Joskow wrote a separate concurrence which is included in the paper; NCEP Commissioner Martin Zimmerman associated himself with that concurrence. NCEP Commissioner Archie Dunham also wrote a separate concurrence included in the paper.

The Commission currently has four additional major research projects on natural gas topics underway and plans to share the results of this work over the next few months. These studies are intended to complement the study recently completed by the National Petroleum Council and provide additional detail on four important issues ¾ 1) natural gas use in the industrial and electric power sectors 2) impacts of expanded LNG imports on U.S. energy markets 3) energy efficiency opportunities in new buildings and equipment and 4) retrospective examination of energy demand-side policies.