Why Are Natural Gas Prices So High?

Consumers burning up over heating and electricity costs may be wondering how they got there.

According to the U.S. Department of Energy, Americans will pay $834 million to heat their homes this year — $300 million more than in 1999. The DOE also forecasts a 40 percent rise in natural gas prices and a 29 percent hike in fuel oil.

And while predictions of warmer weather are pushing the wholesale price of natural gas down for February, utility rates are still going up. Power companies in California, Ohio, Colorado, Illinois, Indiana and elsewhere have announced or are requesting rate hikes to cover increases in the wholesale price they’ve had to pay this year for natural gas.

The effects of the price rises ripple well beyond the higher costs for heating homes or burning lights. For example, because fertilizer plants have been forced to reduce their production, farmers will be facing higher prices this spring, and those increases will surely be passed on to consumers.

Here are some questions, and answers, about why prices have risen so far, and what attempts are being made to combat the problem:

How Close Are We to a Crisis? The United States uses about 20 trillion cubic feet of natural gas a year, and has 1.9 trillion cubic feet stored, with reserves estimated at 164 trillion cubic feet. Energy analyst Kyle Cooper, of Salomon, Smith Barney in Houston, says the price rise doesn’t mean that the United States is going to run out of gas, only that there’s less of it to go around this winter.

“We certainly need to begin developing more supplies, or we could hit a crisis, but I don’t think we’re there yet. It’s just tight, much tighter than it’s been before, and that does have people spooked about the ‘what-if’ possibility.”

The “what-if” involves a shortfall in the supply forcing a drastic rise in fuel prices, rationing or blackouts. While colder-than-expected weather (and the corresponding increase in gas consumption) cannot be predicted, natural gas holdings should be able to cover unforeseen circumstances.

If There’s So Much, Why Can’t We Get It? Oddly enough, one reason natural gas has become expensive of late is because it’s been comparatively cheap compared to other fuels.

With natural gas prices low, and with warmer winters cutting homeowner demand, producers in recent years have been slow to invest in the infrastructure to tap new natural gas sources. As the economy has grown, industrial use of natural gas has risen, and so reserves have been eaten into at higher rates, just when homeowners — blasted by this year’s storms — needed it most.

“After three years of a very warm winter, and very solid economic growth, the demand for natural gas has risen a great deal, and the supply really hasn’t risen very much. So it’s just a much tighter balance than the industry has been used to,” says Cooper.

In order to loosen things up, suppliers will have to tap more resources and build new delivery capacity, including pipelines.

If It’s Hard to Get At, Why Are We Trying to Use More?

Natural gas is transported by pipeline to urban areas or industrial centers. Although natural gas can be liquefied for easier transport by truck or ship, this process is more expensive, and therefore domestic sources for natural gas are preferable to imports. Approximately 13 percent of natural gas is imported, and only about 1 percent of North American natural gas is exported.

Oil, too, is easier to transport because it does not have to be converted to be shipped by tanker.

Still, natural gas does have some advantages when used by utilities to generate electricity: It costs about the same as oil, and is more expensive than coal, it is more energy efficient and is cleaner to burn. The reduction of greenhouse gases is one reason why natural gas use is promoted not only for power plants but for large vehicles as well.

The technology has improved, so that natural-gas-fired power plants are now cheaper to build and maintain than coal-burning plants.

Approximately one third of California’s electrical energy is generated by natural gas, and that figure is expected to rise to 38 percent by 2009. Nationwide, natural gas produces roughly 10 percent of electricity used (more than hydroelectric, wind and solar combined), and that figure will increase, as the majority of new plants in development will be gas-fueled. Globally, natural gas use is expected to increase more than 76 percent over current levels by 2015.

And it’s a major source of home heating. More than half of all new homes are heated by natural gas. Nationwide, the percentage of homes using gas varies widely, from 3 percent in Maine to 76 percent in Illinois. Those states with a higher proportion of gas-heated homes (such as California, Utah or Colorado) have consequently felt the pain of a spike in gas prices more than others.

If Deregulation Was Supposed to Reduce Rates, Why Are Bills Higher?

Twenty-six states, plus the District of Columbia, have deregulation plans pending, and they are keeping a watchful eye on California’s experience to decide whether that is a road to ruin.

In 1996 California passed legislation that was designed to help deregulate the state’s electric industry, the fifth largest in the world. Among other provisions, it mandated a 10 percent rate reduction and a cap in charges (the state’s energy prices were at that time 50 percent above the national average). Under the plan, power generators would place bids for their price for producing electricity, allowing energy buyers to shop around. The state’s Power Exchange (PX) publishes its “spot market” rates hourly so consumers can shift their energy use to lower-priced periods.

What the new system prohibited, however, was for utilities — San Diego Gas & Electric, Southern California Edison, and Pacific Gas & Electric — to buy power from suppliers under reduced, long-term contracts, thereby raising the risk of spikes in energy prices when demand is higher, or when fuel supplies are interrupted. That scenario played out this summer (when shortages of electricity caused blackouts to some customers) and again this winter.

For example, in early 2000, wholesale electricity sold for an average of 3 cents per kilowatt hour. But prices shot up to 25 cents in December for the same amount of electricity. Deregulation is now being reexamined in California. Consumer activists, who had backed a failed 1998 ballot initiative (Proposition 9) to repeal deregulation, are vowing to try again in 2002.

Would Drilling for More Gas Hurt the Environment?

Now with the incentive of higher prices, there are already moves to increase domestic production of natural gas. In Ohio there may be at least 700 new wells drilled, reversing a 15-year trend of fewer and fewer wells. (When wells are drilled, oil and natural gas are generally found together. Decisions must then made about whether to take the natural gas for consumption.)

Independent, for-profit companies in Texas are already speculating that fuel prices will not drop too far, building 24 new generating plants, spending $10 billion in anticipation of energy deregulation in that state.

Campaigning on a priority of expanding domestic oil production, President-elect George W. Bush has said that he wants to begin drilling in about 1.5 million acres of the Arctic National Wildlife Refuge. But Federal wildlife officials claim the area in question — named a protected region by President Eisenhower — is a prime breeding ground, habitat and migration route for caribou, polar bears, snow geese and other wildlife. Environmentalists fear drilling in the ANWR would destroy a pristine wilderness, which has up till now been protected from oil exploration by legislation, a status Republicans in Congress have tried to reverse for years.

Alaskans themselves are divided by the issue, torn between the profits such drilling would bring and the need to conserve energy and protect the environment.

Proposals are on the table for a new gas pipeline in the far north. While representatives for Alaska, Calgary and the Northwest Territories debate their advantages (with costs ranging from $2 billion to $8 billion), construction of a gas delivery system for hundreds of miles raises serious environmental issues.

The state’s biggest oil producers are currently conducting a study of the best pipeline route for Alaska natural gas. Most analysts predict they will elect the so-called Alaska Highway route through that state, across Yukon and into northern Alberta, because most of the approvals for that line were granted in the late ‘70s. And because much of it follows the Alaska Highway, the right-of-way would be easily accessible.

ABCNEWS’ Kevin Newman and The Associated Press contributed to this report.