Despite a reduction in short-term or seasonal risks associated with gas commodity price spikes, Northern States Power still believes there is continued exposure to significant price spikes over the longer-term horizon.
“The ability to export natural gas, the potential increase in gas-fired generation as coal-fired and other generation is retired or converted to gas, and future economic conditions create uncertainty and the potential for future commodity price increases,” said the utility. “In light of these uncertainties, we propose to make a separate filing requesting approval of any potential long-term (five to ten years) hedging opportunities in a separate docket.”
Northern States Power, doing business as Xcel Energy (NYSE: XEL), on Oct. 23 filed a natural gas price volatility mitigation plan update with the Minnesota Public Utilities Commission. The comments were a result of a Sept. 25 meeting with the Minnesota Department of Commerce–Division of Energy Resources. The utility has a pending request, filed May 25, for approval of a four-year extension of variances to Minnesota rules to allow it to recover the costs of financial instruments purchased to limit the impact of natural gas commodity cost volatility on customers through the Purchased Gas Adjustment (PGA) clause.
“Natural gas prices remained low by historical standards throughout 2011,” the utility noted. “On the demand side of the market equation, the U.S. economy continued to grow at a relatively slow pace. The quarterly growth rates for the second and third quarters of 2011 were 1.3 percent and 2.5 percent, respectively. On the supply side of the market equation, natural gas production levels reached new all-time highs. The slow economic recovery kept demand for natural gas in check. The result of muted demand and record supply was that gas commodity prices remained low throughout this past year.”
Despite essentially flat demand, marketed production of natural gas continued to increase. According to the U.S. Energy Information Administration, between January 2008 and November 2011, natural gas production levels in the Lower 48 states increased by 12.92 Bcf/day, the utility said. Gas production has been growing steadily since 2005, primarily because of the boom in horizontal drilling of shale gas formations. In addition, many producers were able to supplement natural gas revenues with the sale of natural gas liquids. Diversified producers benefited from the production of associated gas, which is natural gas that is produced in conjunction with crude oil at a presumed zero cost. The result was a reduced break-even price point for producers, which kept natural gas production levels high even as natural gas prices fell.
The winter of 2011-2012 was one of the warmest ever-recorded (going back to 1895) in the United States, the utility added. According to the EIA May 2012 Short-Term Energy Outlook, the very mild winter contributed to natural gas working inventories that continue to set new record seasonal highs, with April 2012 ending at an estimated 2.61 Tcf, about 46% more than the same time last year.
In response to the sluggish economy and robust production levels, natural gas prices remained low throughout 2011, with the December 2011 Henry Hub NYMEX contract rolling off the board at $3.36/MMBtu, which was $0.15/MMBtu lower than the November 2011 settlement and $0.90/MMBtu lower than the December 2010 settlement. On April 19, 2012, the front month futures price hit a low of $1.91, Xcel noted.
The average NYMEX natural gas futures for the 2013-2014 heating season are trading at $4.225/MMBtu and $4.64/MMBtu for the 2014-2015 heating season, the company said. The September 2012 forecast from EIA is calling for Henry Hub natural gas prices to average $3.44/MMBtu in 2013.
In addition, the current U.S. economic picture looks very similar to 2011, with an expected annual growth rate in Gross Domestic Product of roughly 2% and an unemployment rate hovering at around 8%, Xcel wrote.
EPA’s forced shutdowns of coal plants will boost gas demand
On the demand side, the electricity sector will be the primary driver increasing demand for natural gas. The U.S. Environmental Protection Agency is implementing several new air-quality rules, which will lead to the retirement of a fair amount of aging coal-fired generation, Xcel noted.
“At last count, there are nine new environmental rules that have been or will be introduced by the EPA over the next 18 months, even after removing the Cross-State Air Pollution Rule (CSAPR) that was recently stayed by the courts,” it added. “Of the proposed EPA rules, [the Mercury and Air Toxics Standards (MATS)] will likely prove the most costly for electric utilities and will likewise have the most significant impact on early coal unit retirements by making those units no longer cost-effective to operate. This will result in the construction of additional natural gas generation, or conversions of plants from coal to gas (as occurred under the Company’s MERP imitative). Eventually, this situation will lead to natural gas having an increased market share in terms of fuel for electric generation.”
Xcel’s $1bn voluntary Minnesota Metro Emissions Reduction Project (MERP) initiative involved significantly reduced air emissions from three Twin Cities-area coal plants – High Bridge, Allen S. King and Riverside – while increasing electricity output by around 300 MW. The MERP proposal was authorized in 2002 by the Minnesota commission. King was rehabbed under MERP, while High Bridge and Riverside were converted to natural gas.
While the use of natural gas as a substitute fuel for coal-fired generation does significantly improve air quality at the generator, natural gas production is not exempt from environmental regulation, Xcel added in the Oct. 23 filing.
“As natural gas production from shale and tight sand projects has risen, so have the concerns relative to the environmental impact of hydraulic fracturing. Environmental groups, politicians and local residents are concerned over the impact of fracking on water quality. The EPA is currently studying this issue. It is likely that there will be a movement to either ban fracking (as has already happened in France), or increase the regulation of such activities. The potential for decreased access or increased regulation poses a threat to current projections for natural gas supply production. Increased regulation would likely tighten the supply and demand balance and result in higher natural gas prices over the long term.”
Although record-high storage levels, resilient gas production and lower demand due to current economic conditions have put downward pressure on gas prices over the past two years, the possibility of significant price fluctuations remains, Xcel warned. “Several factors affect the wholesale natural gas market. Three important drivers are: 1) extreme weather events; 2) the impact of an ongoing shift in drilling patterns to focus on oil and liquids rich production areas; and 3) the potential implementation of a variety of environmental regulations. Any combination of these three factors (or a spike in oil priced due to some sort of international conflict) could combine to modify the current supply/demand imbalance. This uncertain supply and demand picture underscores the need for continued price volatility mitigation efforts. Therefore, the goals of the Company’s gas price mitigation efforts will be similar to those of previous years’ plans.”
In conclusion, the overall goal of Xcel’s Gas Price Volatility Mitigation program is to reduce the exposure to and magnitude of upward gas prices fluctuations for the 2013- 2014 heating season at a reasonable cost to customers, the company said. To accomplish this, the company is implementing a strategy that will protect up to 50 of the winter requirements from significant exposure to gas price fluctuations. Also, in order to keep hedging costs within the maximum hedging budget for the utility of $14m, with $6.85m allocated towards the use of financial hedging, a mix of hedging instruments will be utilized, with these instruments include combining costless collars with a put option, “at-the-money calls” and “out of the money” calls.