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Perspectives on a U.S. Natural Gas “Shortage”

9 June 2003

In their front-page article on Monday, June 9, The Financial Times rightly identified an important issue facing the United States—a shortfall in natural gas supplies.

On June 10, Federal Reserve Chairman Greenspan testified to Congress concerning the high price of natural gas and its potential threat to the U.S. industrial sector, stating, "In summary, the long-term equilibrium price for natural gas in the United States has risen persistently during the past six years from approximately $2 per million Btu to more than $4.50. The perceived tightening of long-term demand-supply balances is beginning to price some industrial demand out of the market. It is not clear whether these losses are temporary, pending a fall in price, or permanent."

While this is clearly a vital issue, it is also important to put the current shortfall in the proper context. U.S. consumers, both individuals and companies, are facing adjustments to a new long-term reality of higher natural gas prices, just as they faced adjustments required by President Reagan's removal of domestic oil price controls 22 years ago.

In recent years, growth in demand has not been matched by growth in the low-cost supplies that characterized U.S. markets in the 1990s. Now both supply and demand prospects have changed. Demand has grown, particularly for power generation. This has resulted from both environmental initiatives and from extraordinary technological developments that produced large efficiency improvements in the use of gas turbines for power generation. At the same time, low-cost supplies are being depleted both in the U.S. and in Canada, and recent drilling results in these areas have been disappointing. The United States will increasingly turn to higher cost sources including imported LNG, deep-water exploration, and remote reserves such as those of the Mackenzie Delta and Alaska.

Of immediate concern is the summer peak in power demand. If the summer is particularly hot and domestic production hits the low end of current estimates, there will indeed be a significant supply shortfall, intense competition among buyers, and with that competition, significant price spikes. Our analysis indicates that such high prices could knock up to a percentage point off our already modest third-quarter economic growth estimate of 3.5%—not exactly a "crisis," but certainly a cause for concern in an otherwise weak economy.

Yet a temporary return to lower prices is still plausible, albeit unlikely. A cool summer, a subsequent warm winter, and supplies at the high end of the plausible spectrum could produce substantially lower prices in the second half of 2004. This very uncertainty is one of the factors hindering development of the higher cost supply sources that ultimately will be required by the U.S. market.

It is important to bear in mind that given time, markets work. Looking beyond summer, a new and considerably higher gas price plateau is inevitable.

Global Insight expects spot gas prices at Henry Hub to average above $6 per million Btu for the remainder of 2003 and into 2004: prices could be as much as $2 higher if a combination of hot summer/cold winter and more pessimistic supply performance coincide. Even if there is some easing of these peak prices later in 2004 and beyond, average prices will almost certainly not return to earlier levels. Faced with these higher prices, many industrial adjustments will have to be made.

The new gas price reality and the policy decisions it may trigger will undoubtedly lead to critical financial implications for some, but the situation can hardly be termed a "national crisis" or even a "shortage." What is true is that buyers—particularly those in the chemical industry and in independent power generation—will not be able to acquire the quantity of gas they wish at the prices they wish to pay, or even at prices that will allow them to remain competitive in their markets, particularly during peak demand seasons.

Over the next year or two, the result will be higher, and more volatile prices, to be sure, but there are market-driven adjustment mechanisms even in the short term, e.g., more electric power from coal and oil, reduced production of domestic chemicals, and a commensurate substitution of imports. Consumers and companies will feel the economic pinch of higher prices; particularly, if we experience an exceptionally hot summer and a winter such as that of 2002-03, when average temperatures were 20% colder than the year before in the Northeast. Still, the United States faces neither the specter of economic recession—at least not solely due to gas prices—nor of freezing families unable to obtain gas to heat their homes.

Longer term, a host of adjustments will come into play. On the supply side, additional capacity for LNG imports through the existing four U.S. LNG import facilities will come on stream, and the natural gas industry will continue to push the frontiers of water depth and of new areas for gas development such as those cited above. One thing is clear—these new sources will cost more than traditional supplies, and that will drive long-term pricing to a higher level, which we expect to be on the order of 50% to 100% higher than prices that prevailed during most of the 1990s. As new supplies do come on stream, one calming feature should be reduced price volatility compared with recent years.

Given this new price plateau, demand adjustments will also take place. These adjustments will vary across regions of the United States and across industries, with power generation and chemicals perhaps the most affected. Some in those industries (and others) may find that their facilities are no longer financially viable at the new price plateau, and there will likely be another round of industrial restructuring not unlike others that have resulted from international differences in resource and labor costs—lest we forget, natural gas is still abundant and very low cost in other countries such as Trinidad, Qatar, and Iran, just as labor is abundant and low cost in China, Indonesia, and parts of Latin America.

From a policy perspective, the United States needs to carefully evaluate a series of trade-offs between environmental concerns and economic growth. The gas price experiences of the last two years are the first real tastes of the economic costs of a gas-based environmental strategy. Evaluating these trade-offs needs to be done with a level head and a clear understanding of those trade-offs. Global Insight has recently launched an in-depth study into one critical aspect of these trade-offs: which industries and regions of the United States will be hurt most by this new gas price environment and what will be the overall economic impacts at a regional and national level. This new study, "Demand Destruction: The Impact of Rising Natural Gas Prices 2003-25," will provide vital answers to fundamental questions that are critical if the kind of policy errors that have characterized some of earlier government efforts to correct or avoid an "energy crisis" are to be avoided.

About Global Insight's Energy Group:

Global Insight's Global Energy Group is recognized for its multi-fuel coverage, pricing analysis, comprehensive industry sector forecasts, and treatment of regulatory and competitive issues. With a staff of 25 divided between Lexington, London, and Paris, the Group's clients consist of most of the world's large power, gas, and oil companies, as well as many governmental agencies.

Global Insight has recently launched a major multi-client study on the very important issue of the impact of higher gas prices on U.S. industries and regional economies. This in-depth study, "Demand Destruction: The Impact of Rising Natural Gas Prices-2003-25," will analyze on an industry-by-industry and region-by-region basis, the long-term impacts of higher gas prices on the competitiveness and long-term prospects for major gas-consuming industries.

Global Insight also publishes a monthly update on the U. S. natural gas industry, its direction, the ramifications, and future outlook. Global Insight's North American Natural Gas Monthly report is available by subscription.

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