North American gas firms chase partnerships to boost marketing

John Olson, Merrill Lynch & Co. Inc.
In 5 years, you won't recognize your gas company. The name of the game is: What'll it take you to switch from your local utility?

Anything goes

Anything that can be delivered to homes or businesses via cable/transmission wires, pipelines, or home computers is likely to be part of the expanded "one-stop shop" concept that gas companies-some in tandem with electric utilities-may offer to gain an edge in the fiercely competitive, retail energy market that is shaping up.

A "multi-marketing" approach is already offered in Midwestern, Rocky Mountain, and West Coast territories served by LDC/pipeline/gas processor KN Energy Corp., Lakewood, Colo., and its partner, PacificCorp Holdings Inc., Portland, Ore., parent of several West Coast electric utilities.

The companies recently joined forces to offer services as diverse as wireless Internet access, satellite television, and electronic shopping, in addition to gas and electric service (OGJ, Feb. 3, 1997, p. 22).

Eager to stake a position in an estimated $300 billion-plus/year retail gas/electric market-that's roughly triple the size of the market for long-distance telecommunications-gas companies are making strategic alliances and acquisitions at a phenomenal pace. A week rarely passes in which a new alliance of some sort isn't unveiled, and some weeks have brought news of more than one combination.

Four Houston-based gas concerns alone-NGC Corp., Enron Corp., PanEnergy Corp., and Coral Energy Resources LP-are branching out so rapidly that the market value of their strategic mergers, acquisitions, and other recent alliances now approaches $15 billion. Even after subtracting several giant gas-to-electric mergers within these four firms, remaining gas-to-gas combinations are worth more than $2 billion.

Other gas industry mergers and acquisitions total more than $22 billion in total value, with almost half-about $9.9 billion worth-in the gas-to-gas arena (see table, p. 21).

Not even included in this tally are a host of pairings between gas marketers. Some of the bigger ones include Coastal Corp., Houston, and Westcoast Energy Corp., Vancouver, B.C.; and a unit of Wickland Corp., Sacramento, joining forces with Mock Resources Inc., Irvine, Calif.

And the gas sector may be just warming up. By the end of first half 1997, for instance, NGC Corp. expects to have forged regional alliances with six electric utilities, following a recently disclosed $1.26 billion acquisition of big independent power producer Destec Energy Inc., Houston (OGJ, Feb. 24, 1997, p. 42).

Meanwhile, relative newcomer Coral Energy Resources LP is approaching some industry giants in the number and pace of acquisitions (see chart, p. 22).

Leading the charge

Gas industry concerns are leading the charge to diversify to meet the anticipated retail market for a host of reasons.

With a few notable exceptions, many analysts have noted, electric utilities are often poorly prepared to meet the challenges of a competitive market, with many still enmeshed in a world of regulated rates that guarantee healthy returns.

About a dozen savvy utilities have picked up premium gas companies, but most-strapped by huge stranded costs in outmoded generation plants, sluggish management, or other factors-haven't joined the race to market energy by the BTU.

The era of guaranteed profits for big utilities is disappearing fast, however, as more and more U.S. states deregulate final sales of gas and electricity. Residential customers are being given the option to pick the energy supplier of choice, just as they can pick long-distance carriers.

In the U.S., Iowa, New York, Maryland, and California are among the states experimenting with pilot programs that allow select numbers of residential customers to pick their natural gas supplier of choice. This effort dovetails programs opening the electricity market to full retail competition (OGJ, Feb. 3, 1997, p. 19). In the past, the U.S. has limited free choice of energy suppliers to large industrial and commercial customers.

This trend is growing outside the U.S. as well. Ontario has already opened its gas market to free choice of retail suppliers, and the U.K. is in the final stages of doing so for gas and electricity.

More markets are expected to open in time. A recent survey by the Energy Information Administration notes that most states without pilot retail programs have regulatory inquiries under way to examine the pros and cons of unbundling gas sales from transmission and distribution services.

Virtually every sector of the energy industry is involved in mergers and acquisitions of some sort, but the gas industry is following a different course from the rest of the pack.

Outside the gas sector, energy companies are usually consolidating as a means of honing their focus around a specific core business.

Unocal Corp.'s decision to focus exclusively on exploration and production by selling refining assets to Tosco Corp. is one example (OGJ, Jan. 6, 1997, p. 28). In a variation of this theme, Valero Corp. recently sold its natural gas assets to Pacific Gas & Electric Corp., San Francisco, so Valero could concentrate on refining (OGJ, Feb. 10, 1997, p. 24).

Combinations in the gas industry also are consolidating the number of companies, but the combined entities-instead of narrowing their focus-are branching out into a host of new enterprises, notably in retail gas marketing and other nontraditional services.

A number of factors positions the natural gas sector unusually well to experiment and explore new directions. For one, improving industry and market conditions, including rising demand, have left some gas concerns with the strongest cash flow they've enjoyed in years.

For another, the supply picture is bright, notably with major new gas developments in the Gulf of Mexico and off Nova Scotia.

Finally, the gas industry has more than a decade's worth of experience operating under deregulated markets. This makes gas companies with pipeline and producing assets particularly attractive for electric utilities eager to play the budding BTU market (OGJ, Dec. 9, 1996, p. 25).

But getting the attention of homeowners away from utilities isn't expected to be easy.

For years, the Canadian effort has literally involved door-to-door sales and aggressive telemarketing, but some homeowners were disappointed with slim savings, or unreliable suppliers, one source noted.

Suncor Energy Inc., Calgary, this month decided to play on name recognition-and the constant influx of customers-at affiliated Sunoco gasoline outlets. The focus of Suncor's pitch is supply reliability. "We own the well," touts a newspaper ad for Suncor's discount natural gas. A Suncor official said, "We had no idea this would generate such a large response."

Sunoco customers can sign up at the filling station pump for home natural gas service at guaranteed savings of 10% monthly from utility rates.

Survival skills

Paul Ziff, president of Ziff Energy Group, Calgary, notes that it's virtually impossible for a gas marketer today to be profitable in this line of business alone.

"Gas marketing per se is a hard arena to make money in," Ziff wrote in a recent report by the consulting firm. "In the last few years, price volatility and better real-time electronic price reporting has led to an erosion in margins, from an average of 3¢/Mcf or more a few years ago, to only about 1¢/Mcf today, he wrote. "This explains why Enron shifted several years ago to capital ventures and international power projects.

"The other major change, which is still in an early stage, is electricity deregulation, which impacts the highest growth market for natural gas in the last 5 years and also marks the emergence of BTU marketing."

"Translated, this means that large sectors of the energy market are adapting to purchase various forms of energy, whichever is cheapest at the moment, rather than a specific type of energy as in the past. Both these trends lead to the 'cult of size' to achieve economies of scale and amortize significant costs."

Ziff notes that there are different strategies for gas marketers to survive today's tougher, more sophisticated market. Among them: "growing to critical mass," forming strategic alliances, relinquishing some functions to outside sources, or adopting a portfolio approach as aggregators of supply.

The only certainty, he says, is that "not to evolve one's strategy means the same fate as dinosaurs-the only question is how quick."

Risky markets

Despite huge upside potential, retail gas and electric markets are fraught with risk. Nobody's sure a significant number of utility and local distribution company customers will want to switch energy suppliers.

"Enron's going to lose $50 million this year setting up its retail operation, between advertising, staffing, and all that's involved," predicted Merrill Lynch analyst John Olson. Asked if the potential market was worth it, he responded: "That's the $64 million question."

Enron's foray into retail energy marketing and brand-name advertising is one of the more aggressive campaigns. Competitor NGC is taking a less costly, indirect approach to test the waters of retail marketing, without jumping in with both feet.

"AT&T kept about 67% of its customers after deregulation," said Steve Bergstrom, president and chief operating officer of Natural Gas Clearinghouse, NGC's gas marketing arm. "Even if a utility is not very good, it will probably keep about 50% of its business."

That's why NGC will continue its existing focus on wholesale customers, such as LDCs and large industrials. To tap the retail potential, NGC will take an indirect path by forging marketing alliances with utilities and LDCs in six regional U.S. markets that it plans to have in place by May or June.

"We believe the local guys will have a tremendous home field advantage," Bergstrom said of deals now being negotiated. While NGC isn't yet clear on who will play which roles, a company that knows gas and electric marketing has much of value to share with local distributors and utilities. Utilities and LDCs, in turn, can deliver reliability in service, the metering and distribution infrastructure, support personnel in the field, and much more.

Tom Robinson, natural gas director for Cambridge Energy Research Associates, says managing these combined mega-companies could prove to be a challenge. "Companies are building a network of alliances. It remains to be seen how well they all can be managed."

An overlapping presence in U.S. Northeast markets, and differing views on how best to serve it, for example, led to the breakup of a union between Pennzoil Co. and Brooklyn Union Gas Co. this past October.

Another risk factor, Robinson notes, is that nobody knows how fast the retail end of the gas market will grow. "If LDCs retain their merchant business but allow third parties to aggregate customers, conceivably the market could reach about $30-40 billion/year," Robinson estimated. But he cautioned: "It's unlikely to reach this level quickly."

Nevertheless, larger concerns aren't waiting until the retail market matures to make their debuts. Enron plans to spend at least $30 million this year on splashy print and broadcast media ads to get recognition beyond the oil and gas patch as a "brand name" supplier of energy. Many other companies are trying similar strategies on a smaller scale.

Gas market conditions

The gas industry, like its electric counterpart, has connections to millions of North American homes and businesses.

Combine a gas pipeline or LDC with an electric concern, and the joined unit can penetrate virtually every building in a given area. Gas companies have another trump card in making good connections: During the many years gas was a weak stepchild to electricity and fuel oil in many markets, the industry invested millions of dollars developing more efficient appliances and technologies to court customers away from other energy sources. The effort has gradually kept gas markets growing, even after severe image setbacks in the supply crunches of the 1970s and 1980s.

Continuing a long-term pattern, gas demand for the first 11 months of 1996 rose 3% overall from the same period in 1995, EIA said. But demand dropped in industrial and utility markets when prices rose, despite the overall increase in demand.

So-called "captive" residential and commercial users that can't switch fuels or supplies used 9% more gas in the first 11 months of 1996 than the same period of 1995, with consumption boosted by a cold winter heating season.

Yet high prices trimmed industrial gas use to a growth rate of 2% the first 11 months of 1996 vs. 5% for all of 1995. Utility consumption fell by 9% Jan.-Nov. 1996, after a 7% gain in all of 1995.

Industrial and utility customers with freedom to choose suppliers-and even fuel sources-react rapidly to price jumps, and this is a very real risk that energy retailers will face. If prices leap too fast during a cold snap, residential customers can switch, too-back to LDCs and electric utilities, just as many long-distance telephone customers have returned to local telephone monopolies for long-distance service, despite independent long-distance service firms' huge advertising budgets and telemarketing campaigns to lure them away.

Defining what it will take to lure energy users away from LDCs and utilities they have used for years is the challenge now being explored: Better prices? Better service? Satellite dishes and shopping services? Access to the largest number of prospects, through service stations or other means?

Only time will tell, but the competition is gearing up now to prepare to capture an estimated 35-50% of the market that may not stay with the local utility if an alternative is available.

Copyright 1997 Oil & Gas Journal. All Rights Reserved.