Natural gas prices defeat hopes for cheap, plentiful energy in the west

At the time of the California energy supply crisis of 2001, a number of Western states were net exporters of electricity. They realized the Golden State would need much more electricity than it could supply itself. As a result, "a whole bunch of new power plants and extensions of old power plants were constructed elsewhere in Western states," says research economist Dawn McLaren of the W. P. Carey School of Business. "Everybody was planning to construct a power plant." But the new plants were built to utilize generators fired by then-cheap natural gas. Today, thanks to the ravages of hurricanes Rita and Katrina and other factors, the spiraling cost of natural gas has created a whole new set of energy worries for consumers in the West.

The recent spike in natural gas prices is the latest shock to consumer wallets, but it is not the only one. Electricity prices, especially for homeowners in the West, will rise higher as well, says Dawn McLaren, a research economist at the W. P. Carey School of Business.

In fact, the spiraling upward of heating fuel and electric costs are not unrelated. And in a weird twist of fate, the genesis of today's difficult natural gas environment and eventually higher electric rates began five years ago when California suffered through a summer of rolling blackouts and supply shortages, reports McLaren in the April 2006 issue of the Western Blue Chip Economic Forecast.

At the time of the California crisis, a number of Western states, such as Arizona, were net exporters of electricity. When they looked across the border at Calfiornia, they realized the Golden State needed more electricity than it could supply itself, explains McLaren. Since power plants could not be built quickly enough in California, thanks to tough regulatory restrictions, "a whole bunch of new power plants and extensions of old power plants were constructed elsewhere in Western states. Everybody was planning to construct a power plant."

Time of the essence

Utility companies believed, McLaren continues, that time was of the essence and the quickest way to get a plant built and running was to put in a natural-gas driven generator, which takes only two years to build. Coal and nuclear power are other possibilties, but considering environmental and anti-nuclear factions, it would take years just to get past the approval stages.

These new power plants increased the existing demand for natural gas. Consumption of natural gas had been rising since the mid-1980s, from under 17 million cubic feet to more than 22 million cubic feet by the turn of the millennium. After the 2001 California energy crisis, the upward curve of natural gas consumption spiked past 23 million cubic feet, declined and then spiked again.

More importantly for the consumer, the residential price of natural gas (on a seasonally adjusted basis) began rising, but only slightly from the mid-1980s to around 2000. Then things changed quickly. Between June 2003 and May 2005, prices rose from about $10 to $12.59 per thousand cubic feet, according to the Energy Information Administration.

Demand for natural gas as an alternative fuel had been climbing while prices had been steady. "We were cruising along, but the new power plants put extra pressure on prices bcause not much changed in regard to supply," McLaren says. Then in 2005 came hurricanes Rita and Katrina, which damaged pipelines and production facilities in the Gulf of Mexico. Since the hurricanes, the media has tended to focus on the jump in oil prices, but McLaren points out "our natural gas supply was hit hard."

The Mother Nature factor

In 2005, the residential price of natural gas (seasonally adjusted) took another great leap upward, spiking from just $12.46 per thousand cubic feet to $17.07 per thousand cubic feet. Thanks to the pipeline damage wrought by the hurricanes, says McLaren, "we have supply shock in addition to increased demand, and that's what's pushing up prices. It has become a real problem."

That natural gas situation has now affected the electric markets. In 2000, only 9.8 percent of Arizona's total electricity generation was by natural gas, reports the Energy Informaton Administration. By 2004, that number vaulted to 27 percent. Other Western states were in similar straits: Idaho, 2.5 percent of total electric generation by natural gas in 2000, 15.7 percent in 2004; Colorado, 16.2 percent in 2000, 22.5 percent in 2004; Nevada, 35.7 percent in 2000, 43.5 percent in 2004; California, 49.6 percent in 2000, 51.6 percent in 2004; and Oregon, 17.6 percent in 2000, 26.2 percent in 2004.

Succinctly put, more electricity is being produced through natural gas generation at a time when the cost of natural gas has taken a tremendous jump in price.

Consumers feel impact

Has the consumer felt the effects from the change to natural gas in electric power generation? In the West, only slightly, but it depends on where you live. Again, according to the Energy Information Agency, the percent change in retail electricity sales on a kilowatt-hour basis from November 2004 to November 2005 was up 5.8 percent in Texas, 5.2 percent in Nevada, 4.4 percent percent in Arizona, 4 percent in Wyoming, 3.9 percent in Washington, but less than the U.S. national average of 3 percent in New Mexico, Colorado, Utah, Montana, Oregon, California and Idaho.

The problem with forecasting electricty rate increases is that state regulations impede the natural flow of demand and supply factors. "What happened in California five years ago was that as prices skyrocketed, electric companies could not pass those costs on to consumers," McLaren explains. "Now mechanisms are in place across different states in different ways to to be able to pass on those costs." In Arizona, for example, electric companies will have to prove they have been paying more for their input so they can charge more for their output.

"This will all be delayed depending upon how each state handles rate increases," McLaren adds, "and no state wants to get into the same situation as California." Arizona Public Service, as an example, has a fuel adjustment clause that allows for alterations for over or under of fuel costs, comparing actual costs to what is allowed in its rate structure. This is typically done early the next year. "It takes about a year to start recovering fuel costs that had been incurred the prior year," says Pete Ewen, chief economist with APS.

In January, the Arizona Corporation Commission (ACC) granted Arizona Public Service an increase of just under 5 percent on average bills. The actual increase amounts to four millionths of a dollar per kilowatt hour in what the commission calls a Power Supply Adjustor. (The PSA is a way for the utility to recover part of the money it has already spent to purchase power and natural gas to serve its customers).

According to testimony from several participants in the commission's two day session, current APS rates are calculated using natural gas and fuel costs stemming from as far back as 2002, an ACC release reported. In 2002, the price per unit of natural gas averaged $2.64 (San Juan Basin). By contrast, the 2005 average was $7.18. Natural gas prices were a significant factor behind the APS application.

"Natural gas prices have about tripled since 2002 and will go higher in 2007 and 2008," Ewen stresses. He adds: "APS applied for an $80 million surcharge back in the summer of 2005. In that January action APS was denied that surcharge, but the ACC accelerated the annual 'Adjuster.'" Subsequently, two things happened: APS filed a surcharge application to get the balance of 2005 costs that were not collected, and S&P downgraded APS's credit rating.

"That has prompted the company to apply to the commission for emergency rates that would essentially alter what we can recover from changes in fuel costs in 2006," says Ewen. "The surcharge request has been bundled in with that request." So far, no resolution, but it could be coming in the weeks ahead.

"When power companies in the West reacted to the California crisis, they tried to do so in the quickest way possible," McLaren concludes. "They didn't think about natural gas supplies."