As chief financial officer of DJ Resources, an oil and gas producer in the Rockies, I am forced to watch a ridiculous example of why America is losing its struggle for energy independence.
The promise of natural gas deregulation was that consumers in New Haven could purchase natural gas from producers in the Rockies, Louisiana or Texas and pay a normal transportation charge to move the gas to their homes. Deregulation was only partially accomplished. For much of the past month, natural gas cost New Haven consumers more than $7 per thousand cubic feet (mcf) while producers in the Rockies could only earn $2 per mcf, which does not cover the costs of production. This provides a windfall for traders and hedge funds but a loser for producers, pipeline operators and consumers.
Why is this happening? Insufficient pipeline capacity. There are too many gas molecules in the Rockies trying to make their way to major markets, so producers must bid against each other just to get them on the pipeline.
It’s not just in the Rockies. The same story plays out with gas produced in Texas (for less than $4 per mcf) and delivered in California (sold for more than $6 per mcf), as well as gas produced in Louisiana and delivered in New York, where the price difference often does not even cover the cost of transportation.
It happens year after year. Last year, the price of natural gas in the Rockies actually fell to one penny per mcf while prices in the Northeast were greater than $10 per mcf. This prompted the entertaining letters from Connecticut Gov. M. Jodi Rell and Chesapeake Energy CEO Aubrey McClendon, in which the governor attacked Chesapeake because it had cut back gas production — as the company has again done this year — given the lack of market access.
United States Department of Energy data confirms that producers added to domestic natural gas reserves at historic rates from the Powder River Basin in Wyoming, the Denver-Julesberg Basin in the eastern Rockies, the Barnett Shale in Texas, the Fayetteville Shale in Arkansas, the Antrim Shale in Indiana, the Mowry Shale in Wyoming, the Haynesville Shale in the Gulf Coast and the Marcellus Shale in the Midwest. But little is being done to expand pipeline capacity to take the new gas supplies to market.
The long-anticipated Rockies Express pipeline went into service last winter, and joyous producers received better prices at the wellhead for a few months. Now, a year later, the Rockies Express is full, producers are not able to sell part of their newly available production and consumers are again penalized by not having access to added supply.
But new pipelines will not be built unless we scrap our outmoded federal regulations that prevent pipeline operators and the investors who actually pay for the pipe in the ground from earning a proper return. Yale professor emeritus Paul MacAvoy has shown in his recent work that the Federal Energy Regulatory Commission (FERC) has failed to allow interstate pipelines to recover their cost of capital, therefore removing the incentive to expand established pipelines in the major producing fields.
Pipeline companies are restricted by caps on the tariffs they can charge for full contract service, and therefore, they limit capacity by building smaller pipes to maximize utilization — a kind of “make it up in volume” approach that one expects to hear from furniture dealers on the Post Road.
Pipeline companies cannot make the profits that would encourage them to build new lines that would be less than 100 percent utilized. There is no ability to increase deliveries when winters are colder or summers are hotter — the last minute, expensive but deregulated airline ticket does not exist in the natural gas industry.
These constrained supplies have led to wild price spikes between producers’ markets and consumers’ markets. The public remembers the infamous 2001 California energy crisis when cheap gas entered the El Paso pipeline in Texas and exited in California with a markup more than $10/mcf (equivalent to $60 per barrel of oil).
This occurs at least partly because the current regulatory regime at FERC rewards the gaming behavior of natural gas marketers and the hedge funds that trade in gas. For these foxes, FERC rolls the red carpet into the henhouse. Hearings were held, but the foxes have remained safely in the henhouse.
The solution is to remove FERC as an impediment to the expansion of the older gas pipelines. Safety regulation should remain, but public utility-style price control regulation must end.
To further our nation’s goals of reducing our carbon footprint and reducing reliance on foreign oil, building much more natural gas pipeline capacity from producers to consumers is the industry’s priority. FERC could encourage such activities by removing price caps and accelerating the acquisition of right-of-way — often just opening an existing trench and burying a new line.
Failure to act will lead to perverse outcomes. Price bubbles will continue on both the east and west coasts. Consumers will be denied access to our cleanest fuel. And producers will cut back exploration and production.
Ed Hirs is a 1979 graduate of Timothy Dwight College and a 1981 graduate of the School of Management.