Long-term contracts could make electric utilities more receptive to gas

The time might finally be right for natural gas producers and electric utilities to get serious about entering into long-term contracts, two different analysts said during sessions at the recent National Association of Utility Regulatory Commissioners (NARUC) conference in Portland, Ore.

Both National Regulatory Research Institute (NRRI) Principal Ken Costello and American Clean Skies Energy Policy Advisor Patrick Bean suggested July 22 that the natural gas and electric power sectors might be moving closer to an embrace of long-term contracts.

“For many utility executives, basic psychology—specifically, people’s natural aversion to loss—may explain part of the reluctance to make a larger commitment to gas-fired power” by electric utilities, Bean said. “Simply said, they don’t trust that gas prices will stay low,” he added.

Bean was highlighting key points from a June report titled “Power Switch: A No Regrets Guide to Expanding Natural Gas-fired Electricity Generation.”

Bean said gas producers have also been leery of long-term agreements, but for slightly different reasons.

Gas suppliers fear that they could miss future revenue or profit opportunities if they enter into long-term contracts to supply fuel at current, low prices. “For example, why would a gas producer want to sell any amount of gas for $5/MMBtu over the long-term if there might be an opportunity to sell it for $7/mmBtu on the spot market” within the next couple of years, Bean said.

Bean’s report outlines a case for risk sharing between gas and electric companies. This “hybrid” approach would provide a blend of fixed and market prices, Bean said. “By constraining fuel-price fluctuations the hybrid approach also reduces the risk that either party to the contract will default.”

Bean added: “To illustrate how a hybrid agreement might work, assume that a gas supplier and a generator contract for a defined volume of fuel based on a 50/50 split between fixed and variable (market) prices.” If the fixed price is $4 and the spot market price average is $6 over the term of the contract, this arrangement yields an effective price of $5/mmBtu.

Both gas producers and electric utilities have expressed some interest in long-term commercial arrangements, Costello said. The gas producers might see a long-term deal as a way to stabilize their cash flow and reduce the variability of the market. “Another factor supporting long-term contracts is the reluctance of some gas buyers to commit to investments that require the purchase of natural gas over a multi-year period unless offered a certain level of price and supply stability,” Costello said.

During the conference, gas pipeline officials stressed that they don’t like to build new pipes without firm customer commitments.

Costello says states have largely stayed on sidelines so far

There is currently a “mismatch” between the business day for the gas sector and the power sector, Costello said. This can often complicate fuel planning for gas-fired power units, some conference speakers said.

On the issue of long-term gas contracts, Costello said most states have tended to remain on the sidelines so far.

A recent survey conducted by the American Natural Gas Association (ANGA) indicated that most state commissions give utilities little guidance on pursuing long-term gas contracts, Costello said.

Some industry observers contend that unless state commissions become more proactive in promoting long-term deals, utilities will continue to rely heavily on financial hedging and other mechanisms to reduce price and supply risks, Costello said.

In the meantime, some gas producers are interested in looking to liquefied natural gas exports as a market boost to help make up for weak gas prices here in the United States, Costello said. The NRRI official said this has stirred up strong reactions in Congress and some energy policy circles.

The crux of the debate is whether exports would drive up the domestic price of natural gas to a level that would impose hardship on households and businesses in addition to making energy-intensive industrial firms less competitive. “On the other hand, LNG exports could transform the natural gas sector into a more vibrant industry, which could benefit domestic consumers in the end,” Costello said.

Current U.S. Energy Information Administration forecasts indicate that the share of total generation fueled by natural gas will rise from 24.8% in 2011 to 30.9% in 2012, while coal’s share of the market will drop from 42.2% to 36.2%, Bean said.

About Wayne Barber 4201 Articles
Wayne Barber, Chief Analyst for the GenerationHub, has been covering power generation, energy and natural resources issues at national publications for more than 20 years. Prior to joining PennWell he was editor of Generation Markets Week at SNL Financial for nine years. He has also worked as a business journalist at both McGraw-Hill and Financial Times Energy. Wayne also worked as a newspaper reporter for several years. During his career has visited nuclear reactors and coal mines as well as coal and natural gas power plants. Wayne can be reached at wayneb@pennwell.com.