WoodMac: Climate bill would affect gas processors, cut production

Global climate change legislation due to reach the US Senate floor as soon as next week could reduce gas supplies and greatly increase prices, concluded a study by Wood Mackenzie.

Nick Snow
Washington Editor

WASHINGTON, DC, May 30 -- Global climate change legislation due to reach the US Senate floor as soon as next week could reduce natural gas supplies and greatly increase prices, concluded a study by Wood Mackenzie Ltd., Edinburgh.

The study, commissioned by the American Exploration & Production Council (AXPC), examined consequences of a provision inserted into S. 2191 that would require gas processors to buy cap-and-trade program gas emission allowances for ultimate end-users (OGJ, Apr. 7, 2008, p. 80). Sens. Joseph I. Lieberman (I-Conn.) and John W. Warner (R-Va.) introduced the original bill Oct. 18, 2007.

WoodMac concluded that as much as 32% of the expected domestic supplies in 2012 and more than 45% in 2017 could be at risk if exploration and production companies are forced to bear the costs of those who ultimately burn the gas, AXPC said as it released the study May 29.

Supplies could be reduced by 5-14% even if half the costs are passed on to consumers, it added.

"This finding, stunning as it is, reflects the reality of a very sophisticated and reliable natural gas market that could be severely disrupted by wrong policy choices," said AXPC Chairman David A. Trice, who is also chairman and chief executive officer of Newfield Exploration Co. of Houston.

"Member companies invest all their cash flow and multiples of their profits to grow reserves of our cleanest fossil fuel and to increase production. These efforts are paying off. It is inconceivable that policymakers would enact climate legislation that could have anything even approaching the potential effects cited by Wood Mackenzie," he continued.

Producers as processors
The study built on data from previous third-party research that projected costs associated with gas processors' buying emission allowances for fuel they eventually put into the market for end-users. However, producers often are the processors, AXPC noted. Existing third-party processing agreements also probably do not contemplate processors' cap-and-trade program consumer allowance payments, it said.

Since producers' gas sales contracts are generally based on market indexes and similar consumer-driven price determinations instead of being tied to producers' costs, it is likely that a significant share of government-imposed consumer emission allowance costs would be paid by E&P companies in the near term as funds are diverted, contracts are renegotiated, and the markets adjust, AXPC said. Previous analyses of pending Senate climate change legislation used long-term market balancing models, which did not capture these potential near-term impacts, it noted.

WoodMac said the costs addressed in its study are in addition to the direct emission allowance costs associated with E&P and processing activity, which were addressed in an earlier study by ICF International for the American Petroleum Institute. That study's results, which API released on May 5, indicated that the Lieberman-Warner bill would raise the $25,000 estimated annual cost of operating a domestic gas well by some $12,500/year by 2012 and $25,600/year by 2030 because producers would be required to buy greenhouse gas (GHG) emission allowances.

WoodMac said it believes increased US reliance on gas to generate electricity will drive sharply higher prices in response to any threat to domestic gas supplies. "These higher prices would allow an adequate return once again for the development of at least a part of this production placed at risk. However, the speed of this market response, and the amount of production lost as a result, is uncertain. This uncertainty alone is likely to affect, for a time, producer capital budgets and the supply of a fuel on which the US will increasingly rely," it said.

'Good characterization'
Other trade associations said that the study's conclusions were significant. "We think it's a good characterization of the challenge we're facing. If the bill goes forward as it has been constructed with the point of regulation on the gas processors, they may have to absorb the costs instead of passing it on to the consumers. If that happens, it could be relayed upstream to producers," said Lee O. Fuller, vice-president of government relations at the Independent Petroleum Association of America.

Fuller told OGJ on May 30 that the Natural Gas Council plans to release its own analysis early next week on other impacts of the bill. "Basically, Congress would be creating policies to increase natural gas demand and reduce the ability to produce it. That needs to change," Fuller said.

Marc W. Smith, executive director of the Independent Petroleum Association of Mountain States in Denver, said on May 29 that the WoodMac study's findings validate IMPAMS concerns that a cap-and-trade emissions allowance program would severely disrupt the domestic gas market. "The Climate Security Act of 2007 would place an unbearable financial burden on natural gas producers, making it uneconomical to drill new wells. If we stop, or even slow down, natural gas drilling, we will see an immediate decline in supplies and a sharp spike in prices," he warned.

Noting that drilling new wells is critical to maintaining supplies, Smith said Cambridge Energy Research Associates has said that about half of the gas currently consumed domestically comes from wells that were drilled in the last 3 1/2 years. Gas drilling in the Intermountain West will need to increase by nearly 75% over the next 10 years to sustain current production levels, he added.

"At a time when more natural gas is needed to meet growing demand, including the global warming challenge, any supply reduction could result in an alarming increase in its price," said Paul N. Cicio, president of the Industrial Energy Consumers of America, on May 29. He said US gas production has been essentially flat since 2000, while demand is up 9.8% and prices rose 189% during that period, according to US Energy Information Administration and New York Mercantile Exchange data.

The ability of US basic industries to compete worldwide is directly linked to the relative price of gas domestically versus elsewhere, Cicio said. "The significant increase in the price of gas since 2000 has been a significant contributor to the loss of 3.3 million jobs, or 19% of all manufacturing jobs," he said.

The Gas Processors Association, a nonprofit industry trade group, released a list of issues it would expect to be addressed when considering potential climate change policy.

Since gas produces the lowest amount of greenhouse gas (GHG) emissions/unit of energy of any of the fossil fuels, GPA said, and because of its combustion efficiencies, low-carbon emissions, and plentiful domestic supply, "it should be the preferred fuel in any carbon reduction policy."

GPA also said, "Gas processing facilities should not be a point of regulation as it pertains to the reduction of GHG emissions because almost one third of all gas consumed in the US is currently not processed…and would thus bypass regulation. Should gas processing facilities remain a point of regulation," the group said, "it is likely a greater amount of gas would go unprocessed to avoid regulation because of the potential regulatory action imposed on gas that is processed."

GPA also stated that whatever framework is set to reduce GHG emissions—whether a cap-and-trade system or a straight carbon tax—it should be "fair and equitable."

Contact Nick Snow at nicks@pennwell.com.

More in General Interest