Gas producer to share spark spread with power generator

EOG Resources Inc., one of the leading US gas producers, is forging a deal that guarantees future gas supplies to an independent power production facility in Texas for a share of the spark spread between the market price for that electricity and the cost for generation, primarily fuel.


EOG Resources Inc., one of the leading US gas producers, is forging a deal that guarantees future gas supplies to an independent power production facility in Texas for a share of the "spark spread" between the market price for that electricity and the cost for generation, primarily fuel.

The IPP locks in fuel supplies while EOG Resources gets a crack at the enhanced earnings of what promises to be a lucrative deregulated electricity market.

"As far as we know, this is the first deal of its kind. We're in the process of drawing up a contract like nobody has ever seen before," said Mark G. Papa, chairman and CEO of EOG Resources, at the annual energy conference Wednesday sponsored by Dain Rauscher Wessels Inc. in Houston. He would describe the IPP participant only as a large member of that industry.

The deal is being done "on a trial basis," involving supplies of about 25 MMcfd of gas "for 1 or 2 years," said Papa.

He said his company also has "a couple of deals working" in which IPPs would participate in purchasing gas properties that EOG Resources would then operate. Under those potential arrangements, Papa said, the IPPs would lock in existing reserves from those fields for future supplies, while EOG Resources would reap the upside benefits of additional reserves and production it would develop from those properties.

With domestic gas supplies tightening in the face of growing demand, Papa said, "IPPs are willing to pay a premium to lock in supply. They're more comfortable knowing they actually own the molecules of gas, rather than relying on delivery contract guarantees from middlemen like our former parent (Enron Corp.)"

He sees a growing trend for such innovative deals to lock in future gas supplies. "We want to get closer to these guys (IPPs). They're going to need us, and we're going to need them," Papa told reporters following his presentation.

"Domestic gas production has been flat or declining for seven straight years, since 1994. Domestic production decreased in 1998-1999, and it is expected to be down by 1.5% this year," he said.

Both Texas, which accounts for 30% of total US gas production, and the Gulf of Mexico, which supplies 28%, registered declines in 1998-1999. "The only state where gas production is going up is in Wyoming, which contributes 6% of US supplies," Papa said.

Meanwhile, he said, "Canadian production has been more tepid than most would have thought," despite a record increase in drilling activity in that country last year.

US drilling activity also has shown a strong increase with 1,012 rigs working last week, including 816 that were drilling for gas.

However, Papa said, "Once the rig count moves north of 600, the incremental future production per rig falls off by about half." That's partly because of the smaller reserves being targeted, he said.

The next big slug of new gas into the North American market won't come until pipelines are built to Arctic gas prospects in Canada and on the North Slope of Alaska. But that won't happen until 2006 "at the earliest," Papa said.

Alaska line

At that same conference Tuesday, Dave Welch, vice president of BP operations in Houston, said he expects a 4-bcfd pipeline to be built from Alaska's North Slope to tie in with the Canadian gas export infrastructure in Alberta Province "sometime in the next decade."

He said BP, the biggest oil and gas producer in Alaska, is appraising such a project and should issue a feasibility report within a year.

Other timeframe estimates for building a pipeline to tap the huge reserves of Arctic gas in Alaska and Canada vary from 2005 to 2010.

Meanwhile, some industry executives fear that rising market prices for natural gas will prompt federal officials to try to reimpose controls or to create another windfall profits tax or some other measure to punish the industry.

Papa said state governments, when told about the industry's gas production problems, seem willing to consider tax reductions and other measures to encourage production. However, he said federal officials have been adverse to opening up areas in the Rocky Mountains, Alaska, off Florida, and off and the Atlantic coast where exploration has been banned.

Access to gas-prone areas in the Rockies and off Florida would be a key factor in bringing new gas supplies to market over the next few years, Papa said.

Meanwhile, he said, EOG Resources has locked in 70% of its drilling and completion costs through 3-year contracts signed last year and is considering a possible 1 year extension.

The company's North American gas production is now "totally unhedged" to reap the full benefits of price increases�although at today's high price levels, Papa said he's watching that market closely.

EOG Resources also has revised some of its gas sales contracts to a daily vs. monthly basis to reap higher prices, he said.

At the start of this year, EOG Resources' production totaled 67 million bbl of oil equivalent, with gas accounting for 85% of that. Its reserves totaled 602 million boe, 88% gas.

The company has five prospects that it plans to drill within the next months, with potentials of 100 bcf of gas reserves each net to EOG Resources, Papa said.

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