June 23, 2004 - From the January, 2001 issue

Not All Utility Deregulation Is Failing! So Asserts SoCalGas Company

As California continues to convulse through an ever-worsening energy crisis, MIR has called upon Southern California Gas Company's Richard Morrow to shine some light (gas-powered) on the natural gas industry's side of the electricity production equation. As Vice President for Energy Transportation Services, Rick is responsible for the utility's largest customers: electric generators, wholesalers, and large commercial and industrial customers. He also manages pipeline capacity, distribution and customer operations. MIR was pleased to speak with Rick recently about the future of the natural gas marketplace, the factors that have led to the dramatic rise in prices since last year-and why full-scale re-regulation of the industry is apparently NOT the answer.


Rick Morrow

Rick, as Governor Davis grapples with the energy crisis currently facing California, can you give our readers an update of the natural gas side of the equation? Explain the forces at work in this marketplace so that our readers can better understand the crisis dynamic.

First, to provide some backdrop, the natural gas market is separated into two major groups. 1) Core customers: These include The Gas Company's approximately 5 million residential, small commercial and industrial customers. About a third of the gas that goes through our system is gas we've bought for these customers. 2) Non-core customers: These include electric generation companies, larger industrial and commercial customers, universities, hospitals, etc. For the most part, these customers are responsible for buying their own gas supply and simply use our transmission and distribution system for delivery to their facilities.

Over the past year, the natural gas situation in Southern California has changed significantly. This year, the wellhead price of natural gas across the U.S. has increased to approximately $8-10 per MMbtu (million British thermal units), compared to only $2-$3 per MMbtu a year ago. A national increase in the price of natural gas has impacted the supplies that The Gas Company buys.

The increase in the price of gas across the U.S. is largely due to a short-term imbalance between supply and demand. Several factors coincided, causing the market to get very tight and forcing prices up. 1) Because the cost of gas at the well head had been low-and it's been at record lows in recent years due to an abundance of natural gas available for the market-there hasn't been much incentive for producers and drillers to develop new reserves. 2) Demand for all energy, including natural gas, is up as the U.S. economy has flourished. 3) Demand for natural gas for electricity generation increased significantly this past summer to make up for low hydro output from the drought in the Northwest. 4) Demand for natural gas increased significantly this winter due to colder than normal winter weather across much of the U.S.

The response, of course, has been that a lot of companies are now busy developing new natural gas supplies to feed that market. The drilling rig count has gone up 30% to 40% from where it was a year ago. It will take some time before that gas actually flows to the market, but as the supply picture adjusts, we'll definitely see some softening in the market and reduction in prices. Fortunately, in Southern California, due to prudent buying decisions and the use of storage, the average price The Gas Company pays for gas for our core customers has remained considerably below the national average. Right now, our monthly price is around $6.50 per MMbtu, or about 65 cents per therm (the equivalent of 100 cubic feet of gas), compared to $10 per MMbtu nationally.

Last month, L.A. DWP's General Manager David Freeman told MIR, "At the heart of this crisis is the fact that we deregulated both the natural gas and electric power markets. And now, with either real or perceived shortages-it really makes no difference-consumers are bidding against each other for the available supply, and the price is going through the ceiling. This country can't afford to let the price of a vital commodity like natural gas go up and down like a yo-yo. We need stable prices at a reasonable level, and that requires regulation and price controls." Rick, how do you respond?

I agree that we need stable prices and minimal price volatility for our customers. But that doesn't mean we should re-regulate the natural gas industry or reinstitute wellhead price controls. The energy shortages of the 1970s can be attributed to price controls and we don't want to repeat the mistakes of the past.

The supply of natural gas has been largely deregulated at the well head for over 20 years. And it has worked extremely well producing adequate supplies at reasonable prices. The current short-term imbalance will be corrected.

In December, San Diego Gas & Electric (which is one of our wholesale customers and sister company) filed an emergency request with the Federal Energy Regulatory Commission (FERC) to temporarily reinstitute price caps (which had only recently been lifted) on the secondary market for trading interstate pipeline capacity. This capacity problem has contributed significantly to higher costs associated with getting gas to the California market. The Gas Company supports this request-and we've asked our customers to do so as well-to moderate natural gas prices at the California border until the market stabilizes.

What does The Gas Company anticipate as the future outlook for natural gas prices in Southern California over the next two years?

The Gas Company is not in the business of forecasting natural gas prices to its customers.

We do, however, look at forecasts prepared by others, including the financial houses that trade on the natural gas commodity itself. What those forecasts suggest is that the prices will taper off through this summer. A year ago, the prices at the California/Arizona border were around $2.50; today they're in the range of $12-15. And this summer, financial markets are indicating prices at the California/Arizona border to be between $7 and $8.50 per MMbtu. Keep in mind, gas prices are volatile right now and actual prices in the future will depend on many factors.

So, while we can't say exactly what the prices will be down the road, The Gas Company is doing everything it can to moderate the price impacts to our customers.

Commenting on the future of renewable power, David Freeman went on to say, "Green power is looking better than ever-with the price of natural gas, solar power is now competitive." What are the price points that are relevant here, Rick, in terms of the viability of green power for California?

Recent publications indicate that solar and wind power can be generated for 6 cents to 10 cents per KWh, which is very competitive with natural gas-powered generation if the price of natural gas stays above $10 per MMbtu.We've always supported green power and other alternative energy sources; they provide customers with options where it makes sense for them.

We sincerely hope Mr. Freeman is correct and that renewable energy sources will play a larger role in our energy future. Natural gas, however, will continue to be one of the most economic energy sources and play a significant role in the country's energy future.

Rick, in September's "Energy Perspective," The Gas Company states: "[N]ational and State policies must adapt to changes in the market demand for natural gas. They must support increased production, provide adequate delivery infrastructure, and encourage energy efficiency." Rick, can you elaborate on that for our readers?

In terms of energy efficiency, The Gas Company has always offered its customers a very strong energy efficiency program, primarily focused on the residential and smaller commercial and industrial customers. We have many programs to make sure our customers are aware of the latest technologies-whether it's a business process overhaul or modification, or a hybrid (gas-electric) piece of equipment-to help customers manage their energy costs and improve productivity. In light of today's price increases, we're looking at ways to expand our energy efficiency programs to provide even more benefits to our customers.

In terms of capacity, we have ongoing discussions with several prospective customers that are considering installing new electric generation facilities on our system. Right now, our natural gas system is adequate to meet the foreseeable needs for the customers already attached, but as more gas-fired electric power generation gets approved and constructed, we will have to add the infrastructure to accommodate that.

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And how does that translate in terms of the legislation and regulation you're looking for out of the Federal and State governments to accomplish such goals?

To date, we have been able to keep up with changes in the market and have not proposed any legislation or regulation to streamline the building of new gas infrastructure. To increase the supply of natural gas, I don't think we need any new laws. While it may take several months before the new supplies get to the marketplace, the increased number of drilling rigs will add the necessary supplies.

In terms of installing infrastructure within The Gas Company's service territory, we are constantly evaluating our system to ensure its adequacy to serve the needs of our customers. The California Public Utilities Commission (CPUC) reviews the long-term plans in various regulatory proceedings.

Rick, with the expected increase in the number of in-State power plants coming on-line in the next couple of years, the demand for natural gas to fuel them will obviously increase. How might this affect the prices and delivery systems presently in place for natural gas in California?

As new plants get approved for siting and new infrastructure is necessary to serve them, there will certainly be cost consequences. While we do want to be able to serve all the needs of our customers, both existing and prospective, we also want to be careful not to overbuild the system. So we'll work with the prospective customers to ensure that the facilities installed are put to the best and most efficient use possible, and that our investment costs do not become unused or stranded.

Without knowing specifically how many new generation facilities will be installed, I don't know exactly what the cost impact will be. But as we work with the customers and the prospective generators, we believe we'll be able to come up with terms that make sense for all the parties.

Let me link you into the hearings that are about to take place for Presidential-elect Bush's Interior Secretary and EPA Director. Translate for our readers what will be important in these hearings. What will you be listening for in the way of orientation to these issues about production, transmission, and energy efficiency?

We need to look at regulatory refinements to the natural gas industry so that the kind of price volatility we've seen recently can be avoided, but not at the cost of stymieing the market's development. It's very important that we encourage economic growth in California and not make it prohibitive to do business here. To that end, I'm going to be looking very carefully that the policies and proposals being advocated both federally and statewide encourage reasonable, prudent, economic growth for the community and the businesses that serve it.

And what are you anxious about?

I get nervous sometimes that people will make rash decisions without thoroughly considering how it will impact the industry. Basically, I'm concerned that people might "throw the baby out with the bath water." The natural gas industry has worked very well for many years, and it would be a shame to throw that away strictly because of the experiences we've had recently with high gas prices.

Again turning to the electricity crisis, PG&E and Edison are nearly out of cash, and PG&E has just announced it won't be able to get any more natural gas on credit from its suppliers. How will this crisis bubble up, and what do you consider the appropriate political response to be?

The Governor and State Legislature are working on a proposal to solve California's energy crisis, one that involves the State in power purchases on behalf of the utilities. This seems to be a promising framework for a near-term solution. At its core, the electricity crisis is based on a fundamental imbalance in supply and demand. No major new power plants have been built in the State in more than a decade, while demand has soared. To be effective, any solution must address this imbalance by bringing new power sources into the State and promoting conservation.

Rick, every time you have a crisis like this, people look for villains. And State regulators have begun an investigation to find out whether power generators are engaging in a profit-making scheme called ‘bumping,' in which they privately sell off some of the natural gas supplies needed to operate their plants and thus artificially worsen the electricity shortage. Officials say that while it's not illegal, the public becomes the loser in this scenario by having to absorb the higher costs, while power companies profit both by getting top prices for natural gas and by inducing electricity shortages that bring lucrative higher power prices. Flesh out this process for us, and give us some insight into how real it is as an accusation.

Unfortunately, there seems to be a lot of speculation on all fronts, and people are indeed looking for villains, when what we really need to do is look for solutions.

If you were the senior adviser to the Governor of California, what would be an ideal scenario to work through the next two years in terms of regulation?

As I mentioned, we have to concentrate on finding a solution to the energy crisis, including providing additional generation in California and driving down demand where appropriate. Also, as politically painful as it might be, consumers need to see more of the actual cost of the electricity they're using. And we need to act with a sense of urgency and place these activities very high on the agenda.

On the gas side, we need to focus on making sure adequate infrastructure is in place to serve the needs of our customers in a cost-effective way.

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