MARKET ISSUES: Supply Outlook:
Tight Supply/Demand Balance in the Near-Term; Projected Greater Role for LNG to Meet Market Demand

The great interest in imported LNG arises as concern has been noted, particularly in the last few years, about a tight supply and demand balance in North America, as demand for natural gas rises but growth prospects for traditional North American supply basins are somewhat flagging.

The North American natural gas resource base is large and diverse, but access to some resource areas is limited and production in recent years has been relatively flat. In September 2005, the Potential Gas Committee (PGC) released its updated biennial report on long-range supplies of natural gas. The report indicates 1,308 trillion cubic feet in total natural gas supplies in the U.S. at the end of 2004. The PGC stated that its analysis “has shown a net increase in the nation’s natural gas resource base for the last 10 years, primarily as a result of new, unconventional natural gas plays and application of new drilling and completion technology.”

Nevertheless, even as drilling rates continue at high volumes, recent yields are essentially just holding the U.S. supply/demand balance in equilibrium, and the near-term outlook looks tight until new supply projects come online. The major growth areas in the near-term are considered the Rockies, deepwater Gulf of Mexico, and LNG; in the longer-term (the next decade), Arctic and Mackenzie Delta gas are assumed to be substantial resources.

Some interesting perspectives on these issues were provided in recent years by former U.S. Federal Reserve Chairman Alan Greenspan. Mr. Greenspan made these observations in 2003 and they crystallize the essential issues very well: “In the United States, rising demand for natural gas, especially as a clean-burning source of electric power, is pressing against a supply essentially restricted to North American production.” “Our inability to increase imports to close a modest gap between North American demand and production (a gap we can almost always close in oil) is largely responsible for the marked rise in natural gas prices over the past year.” There are still numerous unexploited sources of gas production in the United States. We have been struggling to reach an agreeable tradeoff between environmental and energy concerns for decades.” “Access to world natural gas supplies will require a major expansion of LNG terminal import capacity. Without the flexibility such facilities will impart, imbalances in supply and demand must inevitably engender price volatility.”

Price Volatility

The key variables in natural gas price formation include demand growth, state of the economy, production levels, storage levels, weather, and alternate fuel prices (mainly oil). 
 
In a December 2001 report, EIA observed: “The natural gas industry embodies a set of dynamics that could cause periodic cycles in investment, drilling, supply and prices. In the future, U.S. natural gas markets probably will exhibit a tendency toward cyclic supply behavior, which may be either exacerbated or moderated by random external events, resulting in rather large and unpredictable price swings.”

AGA has observed: “The wellhead price of natural gas was relatively stable during the 1990s – around $2 per million Btus (MMBtu) – because supplies of natural gas were plentiful. Since 2000, however, natural gas prices have bounced around between $2 and $10 due to weather changes (a record cold winter in 2000-2001, followed by a mild winter), increased use of natural gas to generate electricity and public policies that have made it increasingly difficult for energy producers to keep up with consumer demand.”

The last few years have seen unprecedented commodity price volatility for many energy forms including natural gas. In 2005, an improving economy nationally increased demand for natural gas, and a hot summer increased power plant demand for the fuel. High world oil prices also increased pressure on natural gas prices. The impact of the Gulf Coast hurricanes was one more extraordinary factor. Throughout the fall and winter of 2005, natural gas utilities actively communicated with their customers about energy efficiency and conservation measures as one essential element to help mitigate against this high price environment.

Industry observers expect that the supply picture will remain tight, and that a high price environment will likely linger, for possibly another few years - until substantial new supply volumes enter the national and regional markets – in the form most likely of new LNG supplies.

In April 2006, the U.S. Energy Information Administration (EIA) released its updated “Short-Term Energy Outlook” for U.S. energy markets. It notes:
	“Domestic [U.S.] dry natural gas production in 2005 is estimated to have declined by 2.8 percent owing mainly to the hurricane-induced infrastructure disruptions in the Gulf of Mexico. However, overall dry gas production is projected to increase by 1.8 percent in 2006 and 1.1 percent in 2007. Total liquefied natural gas (LNG) imports are projected to increase from their 2005 level of 630 billion cubic feet (bcf) to 770 bcf in 2006. LNG imports in 2007 are expected to reach 970 bcf.”
	“On March 31, 2006, working gas in storage stood at an estimated 1,695 bcf. Stocks are 411 bcf above 1 year ago and 629 bcf above the last 5-year average. Much of the current high storage level is accounted for by unexpectedly warm winter weather, particularly in January. Spot Henry Hub natural gas prices, which averaged $9.00 per mcf in 2005, are expected to fall to an average of about $7.50 per mcf over the next few months (from an average of about $13.44 per mcf in December). Thus, barring extreme weather conditions for the rest of the year, 2006 should bring a noticeable easing in spot natural gas prices, leading to an annual average decline in the Henry Hub price of about 10 percent. The respite is expected to be short-lived. Concerns about potential future supply tightness and continuing pressure from high oil market prices are keeping expected spot natural gas prices for the next heating season at high levels, with the Henry Hub spot price projected to again rise to just under $10.00 per mcf. The Henry Hub price is expected to average approximately $8.40 per mcf in 2007.”