COMMENT U.S. NATURAL GAS INDUSTRY UNDERGOING IRREVERSIBLE CHANGES

Vinod Dar
Dar & Co.
Washington

In 18-24 months the wellhead price of U.S. natural gas will be much higher and never look back.

Next year gas demand will surge and keep going into the millennium.

This is a wonderful time to buy the common stocks of gas companies because the cash flow multiple is so low compared with the general market averages.

Gas is unique.

History is bunk.

Since 1983 those pronouncements have been made with quotidian monotony by leading industry executives and Wall Street analysts.

Of course, in 1983, the natural gas spot price in the Gulf Coast had dipped to the absurdly low level of $3/MMBTU, and everyone knew gas should sell at a premium to oil. Today, spot gas prices are struggling to stay above $1.30/MMBTU and everyone knows gas will eventually, one day-maybe - sell at parity with oil.

In a linear, static world doubtless the wisdom that the golden age of gas is always 2 years away would be quite true. Unfortunately, the world of competition, capital markets, consumer needs, public policy, and technology is far from static and never linear.

TRANSFORMATIONS

Four great transformations are converging to change beyond recognition or reversibility the U.S. natural gas enterprise (see table).

The revolution in world capital markets, government control, and information technology are causing a dramatic change in the value added role of intellectual capital in the U.S. gas business and in the reconstitution of the entire gas industry.

What is happening in the gas business is not an isolated phenomenon, and hence in the minds of many executives and their Wall Street boosters a regrettable but purely temporary dislocation of the familiar. Rather, it is a manifestation of endemic global change.

The basic principle of economic activity now, in the U.S. and abroad, is vigorous capitalism.

In the U.S. the three remaining bastions of socialism in a generally free economy are natural resources-particularly gas, electricity, air, water, public land, and the electromagnetic spectrum-the inner city and the Indian reservation.

In natural resources the invisible hand of the market is slowly but firmly replacing the palsied, visible hand of government.

THE NEW ORDER

It is impossible for an individual or a firm to completely forecast what the four great transformations will lead to. Some outlines of the new order, however, are beginning to emerge. The merest sketch of the outline would include:

Natural gas will increasingly become an intermediate fuel and electricity will gradually but inexorably drive other fuels out of end use markets, including personal transportation.
Electricity is the only final energy form compatible with our rapidly evolving information, biotech, and molecular engineering economy. It is universal, versatile, convenient, and quiet and clean in its consumption.
Pipelines of the new economy will pump voice, text, data, and images and be fueled by electricity-not hydrocarbons.
The inflation adjusted price of natural gas at the wellhead in 2000 may be no higher than in 1990 and could be lower. The nominal price of gas in 2003 may be lower than the nominal price in 1983.
Finding and production costs of natural gas will decline steadily in real terms as the productivity of the E&P sector soars.
The E&P sector generally will be divided into four categories: pure science driven explorationists who find and flip reserves for a large profit, pure natural gas "manufacturing" companies who concentrate on low cost extraction of gas via sophisticated technologies including automated drilling and robotics and make a plump margin at even $1.50 gas, divisions of fully integrated, nonregulated, multibillion dollar gas and electric companies (a new breed only just being born), and the subsidized U.S. E&P arms of global oil and chemical majors, electric and gas utilities, financial trading companies, and an assortment of Pacific Rim conglomerates.
The regulated segments of the gas business-interstate pipelines and local distribution companies-will find their cost of capital rising sharply as capital markets systematically and severely ration credit and equity to such companies.
Moreover, there will be far fewer but much larger regulated entities, especially in the LDC segment where regional hub and spoke companies subject to multistate regulatory oversight will emerge.
Within 5 years a secular glut - with episodic scarcity - of long haul gas transportation capacity will be evident, reaching even New England and Florida. Consequently, the price of firm transportation capacity will be quite volatile and, in real terms, fall noticeably.
During one of its cyclical price declines, shippers with long term, high priced, firm capacity will renege on their demand charges and chant "So sue me" to the pipelines. They will use many of the same arguments to walk away from 15 year transportation contracts that pipelines employed when they forsook take or pay contracts with producers, especially independents, in the 1980s.
Within 10 years, most homeowners and small businesses will buy gas and electricity directly from niche or integrated gas and electric merchants who will offer gas/electric credit cards, probably in an alliance with a financial services, or entertainment/information services, or telecommunication services company.
Information about gas will be far more valuable than gas itself. The culture of the successful gas/electric enterprise of tomorrow will reflect this compelling fact. The business culture will embody a collegial entrepreneurship organized around a "society of the mind" rather than corporate bureaucracy organized around a rigid hierarchy that characterizes most large energy companies today.
The combination of independent gas fired power generation, pervasive demand side management, and open access wholesale and retail electricity wheeling will gradually force electric utilities to eliminate power generation assets from their rate base altogether and concentrate on being electric service companies, moving aggressively into the electric refueling business via construction, ownership, and management of "power ports" for electric vehicles.

The four transformations under way cannot be reversed or even substantially delayed.

Certainly, they can be denied by those who feel threatened by systemic change. The King Lears of the gas industry continue to rail against the elements, howling imprecations at the skies while the winds of change blow unabated and indifferent to high abuse.