Climate bill section affecting gas processors would cut production, study finds

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

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

The study, which was commissioned by the American Exploration and Production Council, examined consequences of a provision inserted into S. 2191 which would require gas processors to buy cap and trade program emissions allowances for ultimate end-users. Sens. Joseph I. Lieberman (I-Conn.) and John W. Warner (R-Va.) introduced the original bill on Oct. 18, 2007.

Wood Mackenzie, an international energy research and consulting firm, concluded that up to 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 on 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 of Newfield Exploration Co. in 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 often are processors

The study built on data from previous third-party research which projected costs associated with gas processors buying emissions allowances for fuel they eventually put into the market for end-users. However, producers are often 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 emissions 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.

Wood Mackenzie said that the costs addressed in its study are in addition to the direct emissions 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 emission allowances.

Wood Mackenzie said that 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.

'A 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.

He 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 Wood Mackenzie 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 that Cambridge Energy Research Associates has said that approximately half of the gas which is currently consumed domestically comes from wells that were drilled in the last three and a half 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," Paul N. Cicio, president of the Industrial Energy Consumers of America, said on May 29. He said that US natural 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 for 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.

Contact Nick Snow at nicks@pennwell.com

More in Companies