TOPICS > Economy

Soaring Natural Gas Prices

February 26, 2001 at 12:00 AM EDT


PAUL SOLMAN: Natural gas: For 20 years, touted as the cheaper, cleaner fossil fuel. The reason millions of homeowners switched to gas heat; why so many power plants are run on gas. But suddenly, gas prices have exploded. Consumers are burning with anger. California is nearly aflame — when it isn’t in the dark, that is.

Who to blame? For many, it’s the natural gas producers. But not, of course, if you’re in the belly of the beast itself, in Houston, Texas, home to the now-flush giants of the industry: Dynegy, Enron, and the biggest of them all, the El Paso Corporation. At its recent annual meeting with stock analysts, El Paso was trumpeting the results of recent acquisitions.

NORMA DUNN, Public Relations, El Paso Corporation: When we went public in 1992, we had total enterprise value of $2 billion. Today it is over $50 billion. That’s pretty exciting. This is the new El Paso.

PAUL SOLMAN: The show was high- tech and first class, climaxing with El Paso’s uplifting new corporate logo, here making its public debut.

SPOKESMAN: Vision, value, people, raised to the power of El Paso.

PAUL SOLMAN: But the next morning at 7 a.m., it was back to business as usual, with El Paso’s traders apparently at the mercy of the daily weather report.

MAN AT MEETING: High pressure’s got control of the southeast. Weak system here in the central plains, not behind it. The West has been pretty tranquil, too, but that’s all about to change.

PAUL SOLMAN: With its main business, pipelines, touching 20 percent of all the gas in America, El Paso makes most of its money on transportation fees. But it’s also a gas producer, where profits depend on prices, which in turn depend on which way the wind blows.

MAN AT MEETING: A trough of low pressure developed in the southwestern U.S., and it’s going to inject a storm system or two eastward.

PAUL SOLMAN: Now, we’ve heard about the drought in the Northwest. Less water for hydroelectric plants means more demand for gas-powered electricity. For gas producers, the good news is it would take Noah’s flood to turn things around.

MAN AT MEETING: What’s it going to take to get back to normal?

MAN AT MEETING: 40 days, 40 nights.

MAN AT MEETING: Yeah, 40 days, 40 nights.

PAUL SOLMAN: The bad news, however, was a new warming trend which threatened to lower short- term demand for home heating gas.

MAN AT MEETING: As we move and look at North American temperatures right now, all the cold air is, for the most part, bottled up in Canada.

MAN ON PHONE: How much were you able to sell so far?

PAUL SOLMAN: As natural gas prices rise and fall with the weather, traders like Foster Smith try to ride the waves.

FOSTER SMITH: Last Thursday, we had a shift to a more bullish situation, and…

PAUL SOLMAN: “Bullish” meaning…

FOSTER SMITH: Colder air.

PAUL SOLMAN: Bullish for the market…


PAUL SOLMAN: Because the price goes up.

FOSTER SMITH: Right, right. When we say “bullish,” we mean price going up. Now, from a consumer standpoint, that might be bearish to you, but it’s a different… Depends on which side of the phone you’re sitting on, I guess.

PAUL SOLMAN: For the past year, Houston’s gas giants have generally been on the right side of the phone, as the price quintupled from two dollars per thousand cubic feet to nearly ten dollars this December. But from the traders’ point of view, when prices peak at ten dollars, then plunge back to five, as in January, they’re as whipsawed as the rest of us. The week before we arrived, a forecast of bitter cold had sent prices spurting up again.

FOSTER SMITH: We basically traded from $5.70 up to $6.94 in two days, a pretty large move. We’re talking about, you know, a 20 percent move in two days, which… that would be like the Dow going up 2,000 points in two days. That’d be a talkable event.

PAUL SOLMAN: And when the forecast changed just over the weekend…

FOSTER SMITH: Prices came off almost immediately. We opened up at $6.20 yesterday, which was down almost 60 cents, and it went down to $5.70 in about 30 minutes. So we lost everything we’d gained in two days in about 45 minutes.

PAUL SOLMAN: In short, gas prices have become as volatile as the substance itself. But of course, no one’s worried about the gas producers, showered with profits as the price has geysered. In fact, for two days in December, gas going to California hit $50. How does a price go from four, five dollars, six dollars, even, per thousand cubic feet, to 50? I mean, what’s the mechanism by which that happens?

BO COLLINS: If you don’t have water to drink, on your first hour of not having water, what will you pay for it?

PAUL SOLMAN: Well, I start to…

BO COLLINS: You don’t care that much.

PAUL SOLMAN: Right, I don’t care.

BO COLLINS: In… 12 hours later, you’re a little thirsty; what’s the value of water?

PAUL SOLMAN: It’s getting there.

BO COLLINS: Two weeks later, if you’re still alive, you’ll probably give everything that you have in your bank account for that glass of water.

PAUL SOLMAN: So I understand that I’ll keep paying, but who has got the gas to jack it up?

BO COLLINS: Well, at some point… At some point, somebody takes the risk. They may not have the gas, but they take the risk that for $50, they’ll find a way to get it there.

PAUL SOLMAN: In other words, says trader Bo Collins, the prices for commodities we can’t do without surge when there’s a sudden shift in demand. When the supply is tight to begin with, as in California, the view from Houston is that speculators make matters worse. They jump into the commodity markets between producers and consumers and drive prices even higher. But California has a simpler explanation for $50 gas: Collusion. The state is suing El Paso and other big energy providers for conspiring to fix the market. El Paso won’t comment on the lawsuit, but Kurt Launer, a stock analyst, will.

KURT LAUNER: There’s no conspiracy. The market is too big. There are too many players involved in it. You’re talking about 22 trillion cubic feet of natural gas demand in the United States, and no one single producer comes up with more than one trillion cubic feet of that, so no one has more than a 5 percent market share.

PAUL SOLMAN: The merits of the collusion case will be sorted out later, in court. Meanwhile, the traders here will keep trying to get the best price for El Paso’s gas…

MAN ON PHONE: I have a 27-and-a-half bid.

PAUL SOLMAN: …Not locking in too much of their production at what might turn out to be a low price…

MAN ON PHONE: We have what?

PAUL SOLMAN: …But not locking in so little, they’re vulnerable to short-term downswings.

BO COLLINS: Don’t… Don’t outthink me.

MAN ON PHONE: No, that’s not what I’m saying.

PAUL SOLMAN: In fact, they’re hedging their bets here, minute to minute. El Paso has locked in 75 percent of its production at protected prices.

BO COLLINS: Buy them, buy them, buy them.

PAUL SOLMAN: So the folks here in Texas claim a big part of California’s problem is that when the state deregulated, it didn’t hedge its bets at all.

PAUL SOLMAN: If, a year ago, I’d said to you, you could lock in four dollars per thousand cubic feet for the next ten years…

FOSTER SMITH: People would have run at you and done it.

PAUL SOLMAN: Run at you and done it?

FOSTER SMITH: Sure. They’d love to have done it.

PAUL SOLMAN: In other words, says Foster Smith, if California had offered to buy gas long-term at four dollars as recently as last year, producers like El Paso would have jumped at the chance to sell it to them. Four dollars was a peak price. Ironically, however, the price shot so far up, the state has now stepped in to buy gas on long-term contract at even higher prices, which raises an economics question. Since prices are so high, and demand so strong, why hasn’t supply increased, as theory would predict?

LARRY STRAHAN: You see any natural gas drilling going on?

PAUL SOLMAN: Larry Strahan was a pipeline inspector when we first met him in 1992. Back then, energy prices were so low, drilling rigs lay idle off the Gulf Coast. Today, these rigs can’t be pressed back into service to increase supply since, after years of low prices, they were sold for scrap. Now, we’ve heard about some increased drilling; 1,100 rigs are now operating, double the number just a few years ago. But, says Strahan…

LARRY STRAHAN: So we’ve got 1,100 rigs. Compare that with 4,500, to achieve the level we were at in 1983. Try that. I mean, to catch up, it’s going to take us two years from the day we start drilling to go online with the natural gas we have.

PAUL SOLMAN: Houston gas analyst Barbara Shook has another explanation for why supply has not kept up with demand.

BARBARA SHOOK: The prospects are probably not there. More wells have been drilled in the United States than the whole rest of the world combined. The good things have been taken already. So the wells that are being drilled are discovering smaller and smaller volumes of reserves.

PAUL SOLMAN: This fact would mean higher drilling costs, and therefore higher prices for the foreseeable future, until, that is, another sector of the Houston economy responds.

MICHAEL ZEITLIN: We have a lot of natural gas, so the question is… It’s not, do we have the resource? It’s there. We have to drill for it.

PAUL SOLMAN: Where some see the world of energy as a range of insurmountable obstacles, Michael Zeitlin sees a market opportunity. His company, Magic Earth, is pioneering computer imaging technology to help find the gas in them there hills as quickly and cheaply as possible. It’s a far cry from what prospectors had to rely on until recently.

MICHAEL ZEITLIN: This is the way we used to interpret the data.

PAUL SOLMAN: So this was essentially a cross section of the earth?

MICHAEL ZEITLIN: This is like a cross section.

PAUL SOLMAN: The point of the cross section was to reveal promising folds of rock that might contain oil or gas deposits.

MICHAEL ZEITLIN: And as the gas is generated, millions of years ago, gas being more buoyant that oil, even, and more buoyant than water, certainly, tends to want to rise up, and gets caught there because the rocks above it are impermeable. You know, you can’t flow through those cap rocks.

PAUL SOLMAN: It’s awfully hard, says Zeitlin, to find such deposits by cross section alone. His software integrates thousands of cross sections to create a 3D picture, like an ultrasound. Here: A 25-square-mile section of West Texas, one mile deep, that a prospector drilled into a few years ago, using the old paper charts. The red line is where they thought they’d smell gas.

MICHAEL ZEITLIN: And they said, that’s a prospect. By God, we’re going to drill. And it’s other people’s money, so what the hell?

PAUL SOLMAN: The prospector drilled, but the well was dry. Magic Earth, however, took the same spot, sliced through it at a variety of angles, even revealed what geological structure it was part of.

MICHAEL ZEITLIN: What does that look like, Paul? You look at that; what’s it starting to look like to you. If you…

PAUL SOLMAN: Like a Chinese dragon.

MICHAEL ZEITLIN: Well, that’s partially true. But if you’re in an airplane, 30,000 feet up, what does that look like? I’ll give you a hint. You’re flying over areas where there are lots of… lots of rivers. Does that help you?

PAUL SOLMAN: So a riverbed.

MICHAEL ZEITLIN: That’s an ancient riverbed.

PAUL SOLMAN: A riverbed is just the sort of place that gas collects, if hard rock forms over it. But in 25 square miles, with just individual cross sections, the surgery is hit and miss.

MICHAEL ZEITLIN: Oh, they were so close. Oh, they were so close. They missed it.

PAUL SOLMAN: Does this technology mean that supply will be able to respond more quickly to demand?

MICHAEL ZEITLIN: Absolutely. Absolutely. I think that by this time next year, just in one year from now, we’re going to be drilling many more prospects that have been identified with this technology, that’s going to put more natural gas into those pipelines and make it available.

PAUL SOLMAN: And therefore, the price will come down sooner.

MICHAEL ZEITLIN: The price will come down sooner and will stay relatively constant.

PAUL SOLMAN: Until prices do come down, though, Houston’s gas industry will reap the windfall profits. No wonder, then, that stock analysts were bullish on natural gas at El Paso Energy’s annual symposium. No wonder the rest of us are wishing for a way, short of buying natural gas stocks ourselves, perhaps, of hedging our bets on a market that’s become merciless largely because we’ve become so dependent on what it’s trading.