Spark spread sends natural gas flying

Natural gas prices continued to surge throughout the week with some experts predicting $5/MMbtu is not out of the question as competition between summer and winter needs intensifies. Gas for December delivery settled at $4.68/MMbtu Thursday on the New York Mercantile Exchange, which raised margins Friday for the second time in a month on its Henry Hub contract.


Ann de Rouffignac
OGJ Online

Natural gas prices continued to surge throughout the week with some experts predicting $5/MMbtu is not out of the question as competition between summer and winter needs intensifies. Gas for December delivery settled at $4.68/MMbtu Thursday on the New York Mercantile Exchange, which raised margins Friday for the second time in a month on its Henry Hub contract.

The previous high was $4.62/MMbtu in December 1996. The fundamentals of supply and demand suggest prices will remain high. Gas in storage is down 23% from year ago figures, according to the American Gas Association.

Meanwhile, high demand and the profit potential from power sales is also keeping the pressure up on natural gas prices. Electricity demand grew 5.4% in 1998, up from its 3.2% growth rate between 1994 and 1998, according to the Edison Electric Institute.

While power generators and storage operators are willing to pay almost any price for gas, some industrial firms have cut production in response to rising natural gas prices, and others are being wooed by energy marketers who want to buy up their cheap natural gas contracts.

�In some instances, the industrials are finding the value of their natural gas contracts are higher than the value of their manufacturing activities,� says Jeff Dietert, analyst with Simmons & Co. International, Houston.

High as gas prices have risen, experts says, there is still plenty of room left between gas prices and electricity prices for gas-fired generators to make money. So long as that's the case, many project gas prices could rise even more.

Electric power generation profits are governed, in part, by a so-called �spark spread.� The spark spread is the margin or spread realized by the power plant operator between the market price of electricity sold and the generator's production costs, including natural gas.

In some parts of the country, especially California, the spark spread has entered extremely heady territory. Last year about this time, the spark spread in southern California was about $16/Mw-hr. This year, it has reached $88/Mw-hr and that is in spite $4/Mcf gas, says David Garcia, analyst with First Union Securities in Houston.

In northern California, the picture is much the same. The San Francisco area recently experienced scorching triple-digit temperatures. Power traded at $663/Mw-hr on June 14, according to a recent report by Dietert. Forward on-peak prices for power at the California-Oregon border for the third quarter are in the $120/Mw-hr to $140/Mw-hr range.

Today�s spark spread is dramatically high when compared with last year�s spread of only about $20/Mw-hr, spiking at times to $30/Mw-hr at the California-Oregon border, according to Michael Carter, analyst with FT Energy�s RDI, Boulder, Colo.

Big spark spread in California
�We saw it [high spark spread] hit in California. They had early heat out there and the hydro[power] is in worst conditions than last year,� says Marc Chamberlin, vice- president of power trading at Dynegy Inc., Houston.

Chamberlin adds that electricity load growth in California coupled with little new generation supply coming on line is hitting California with a �quadruple whammy.�

Dynegy and Williams Cos., Tulsa, have about 5,000 Mw and 4,000 Mw of uncommitted capacity available in California, respectively, and stand most to benefit from the unusual market conditions, says Dietert.

�Williams beat their second quarter street estimates. I would suspect that power generation in California has a lot to do with it,� he says.

California was not the only region to experience lofty spark spreads recently.

In the New England Power Pool (NEPOOL), a gas price of $4/Mmbtu equals a $28/Mw-hr cost of producing power using gas turbines that require 7 Mmbtu to create 1 Mw-hr of electricity, says Marshall Adkins, analyst with Raymond James & Associates in Houston.

But the price in NEPOOL was well above $30/Mw-hr, spiking to $160 and hovering around $50-60/Mw-hr for the last third of May. Adkins estimates that even if gas prices doubled to $8/Mcf, power producers in NEPOOL could still make money.

Pressure on gas prices
�With electricity selling for at least $100/Mw-hr, there is a new class of [gas] buyers. These buyers are insensitive to price. They don�t care if they have to pay $10/Mcf,� says Garcia. �Higher natural gas prices are here to stay.�

What this means for natural gas prices is $4 gas is here to stay for at least a year and it may even go higher, some analysts say. Supply response from the exploration and production companies has been slow despite the huge price incentive.

Besides generator demand for gas, other price insensitive gas buyers include gas storage operators and residential and commercial gas suppliers.

�They have to have to have it. They don�t care what they pay,� says Adkins. He suggests that all of the above contributes to prices remaining in the $4-5 range�and that�s in a perfect world with no nuclear power outages and no hurricanes.

Impact of high prices
While gas storage players and generators are willing to buy gas at almost any price, industrial users have cut production because of higher gas prices. Dietert reported Terra Industries Inc., Sioux City, a fertilizer producer, reduced natural gas purchases significantly in June. Terra�s plants are running at reduced capacity levels, he says.

Luckier industrial concerns that bought forward and hedged natural gas prices for less than $3/MMbtu, including gas and steel companies, find themselves being wooed by large gas and power marketers. While Dietert would not identify specific companies, he says marketers are approaching these industrials to buy back the natural gas contracts at current prices.

Some glass manufacturers are reducing output in order to sell a portion of their hedged natural gas back into the spot market. And industrials with cogeneration facilities are selling more power into the grid to capture the high spot power prices.

Industrial demand for gas comprises about 40% of total demand for electricity in the US. As marginal industrial producers cut production, reducing gas demand, which may relieve the upward pressure on gas prices.

However, analysts anticipate that the lethargic supply response of gas producers, coupled with the soaring demand for gas-fired electricity, plus the need to fill storage for the winter, will combine to maintain the pressure on gas prices.

�Back in April we were calling for summer gas prices over $3.50 and not on a spike basis,� says Garcia. �It doesn�t surprise me they are at $4. That it happened in May sure does.�

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