· Analyzing and forecasting the supply, demand and price of natural gas

· Analyzing the impacts of energy and regulatory policy on energy markets

We have done this work for natural gas producers, pipelines, local distribution companies, power generators, technology developers, the U.S. Department of Energy, the U.S. Environmental Protection Agency and other public, private and institutional clients. I have been at EEA for 15 years and have over 20 years of experience in the energy and environmental field.

My testimony today addresses two areas: our outlook on natural gas prices and current effects and trends related to gas prices in industrial and power generation markets.

Gas Price Outlook

EEA quarterly prepares a 20 year month-by-month forecast of North American natural gas supply, demand and price that we call our Gas Market Compass. Figure 1 summarizes our current view of the price for natural gas over that period. Our current outlook for gas prices (in constant 2003 dollars) at the Henry Hub in South Louisiana is about $5.75/MMBtu for this year, a little higher at about $6.00/MMBtu for 2005, then moderating somewhat to $4.50 to $5.00/MMBtu in the medium to longer term. We do not expect to see future gas prices returning to pre-2000 levels.

This outlook assumes significant development of new LNG import terminals in the U.S. and eventual gas imports from Arctic Canada and Alaska. It does not assume any changes in policies regarding where gas can be produced. Delivered gas prices will be higher in areas with local gas delivery constraints. Extreme weather also can cause temporary price spikes. Overall, however, we believe that the market will function and find ways to bring new gas to market. If that does not occur, we would expect gas prices to be roughly 50 percent higher than this forecast.

Effect of Current Prices and Trends in End Use Markets

Regardless of any changes in policy, there is widespread agreement that it will take a significant amount of time to get new gas supplies in place. In the interim, the most readily available option to stabilize gas prices is increased efficiency in direct gas consumption and indirectly through increased efficiency in electricity consumption. This was one of the primary conclusions of the recent National Petroleum Council study on natural gas, which stated that: “Greater energy efficiency and conservation are vital near-term and long-term mechanisms for moderating [natural gas] price levels and reducing volatility.”

Other studies have found similar results. A December 2003 study by the American Council for an Energy Efficient Economy (ACEEE) looked at the effects on gas prices of an aggressive application of energy efficiency and renewables. The study estimated that efficiency and renewables could achieve a 1.1 percent reduction in gas consumption within one year and a 5.5 percent reduction within five years. More importantly, EEA projected in this study that this level of demand reduction would result in a 20 percent reduction in gas prices. This non-linear result occurs because we are in a very steep part of the gas supply curve where small changes in demand can result in large changes in price. This can happen in a negative way during extreme weather or in a positive way when efficiency reduces demand.

EEA performed another study last year that looked at the effect of increased use of combined heat and power (CHP) to reduce gas demand. CHP, also known as cogeneration, is one of the most readily available and widely applicable sources of increased efficiency for generation of electricity and thermal energy for process heat applications. The study found that widespread application of CHP in regions of the U.S. that are heavily dependent on natural gas for power generation could achieve 4 to 9 percent reductions in gas consumption through increased efficiency. This study did not separately assess the effects on gas price, but based on studies such as the ACEEE study, this level of demand reduction could result in significant gas price reductions.

While one can forecast that increased efficiency would be beneficial, one might question whether these types of efficiency improvements are practically achievable after 30 years of industrial efficiency improvements, starting with the energy price shocks of the early 1970s. Support for this expectation was described in a February 17 article in the Wall Street Journal.

The article describes the efforts of the Owens-Corning company to respond to high gas prices related to its production of glass and mineral fibers. While the company is exploring increased imports of materials as one response, it is also increasing the efficiency of its operation in the U.S. The article describes Owens-Corning’s efforts at an insulation factory in Waxahachie, Texas, that was burning as much as $4 million to $5 million of natural gas a year. The company was able to make operational changes at incinerators and melters that cut gas consumption without sacrificing product quality. With these adjustments, natural-gas use in the third quarter of 2003 was 18% below the year before, even though production increased. The plant is reported to be approaching $1 million in annual energy savings and the company plans to replicate the changes in 10 other North American insulation factories and two composite-fiber factories by the end of this year.

While not every facility will be able to achieve such startling results, this example suggests that there is still a significant amount of low-cost efficiency improvement to be achieved. We have also heard reports of companies reinstating or increasing their ability to switch gas-fired equipment to alternative fuels, primarily oil. The ability to switch to alternative fuels for short periods of time, while it does not result in significant reduction in overall gas consumption, can serve as an important safety valve to reduce gas price volatility during periods of extreme weather or local supply constraints. Chemical producers are also emphasizing production from facilities that rely on petroleum rather than natural gas feedstocks. These examples illustrate that industry is actively and creatively adjusting to changes in the U.S. energy markets.

Power Generation Trends

Much of the concern over gas prices has focused on the recent wave of construction of gas-fired power plants. Despite this growth, gas-fired generation in the U.S. in 2002 accounted for a lower share of total generation (18 percent) than in 1970 (24 percent). Coal-fired generation in 2002 was 51 percent of total generation and almost 70 percent of fossil generation. Energy forecasts show coal-based generation continuing to increase.

Moreover, the effects of new gas power plant construction are more complicated than they may seem. Of 152 GW of new gas-fired generating capacity installed in the U.S. between 1999 and 2002, approximately one third consists of peaking plants that seldom run and use little fuel. In addition, much of the construction has been in the west and southwest where the new gas plants are competing with less efficient older gas plants. Because of the higher efficiency, the new plants have displaced the older plants and caused them to run less or be mothballed. The displacement of older gas plants with new gas plants results in more efficient use of gas. While gas consumption has increased due to increasing electricity demand, the effect of the more efficient new plants has been to reduce the amount of gas that would otherwise have been consumed. In these areas, the construction of new gas plants is actually reducing gas consumption. Figure 2 shows this effect in Texas.

Displacement of Older Gas Generation by New Gas Power Plants in Texas

The increase in gas prices has also spurred increased interest in the use of renewables, biomass and waste fuels, including agricultural biogases. While some of these fuels are already in use, others are only starting commercial application and the recent higher gas prices have made their use more competitive. We have seen reports of increased interest in use of wind energy, small hydro, landfill and digester gas. There is also great interest in using agricultural biogas that can be produced by improved handling and treatment of waste from very large livestock and poultry operations. This is an area in which we expect to see quite a bit of growth in the near future.

Conclusions

Natural gas prices have reached a new price level that is significantly higher than during the last 20 years. We do not expect to see a return to those historical lower levels. However, we also do not expect to see natural gas prices increasing to the extreme levels predicted by some analysts. Over the last two and a half years, U.S. gas markets have responded by initiating new LNG import and other supply projects. With an increase in LNG imports and future imports from Canada and Alaska, we see a mid- to long-term moderation to Henry Hub gas prices in the $4.50 to $5.00/MMBtu range (in constant dollars). If new supply options are not available, the prices could be 50 percent higher.

On the demand side, gas users are turning to energy efficiency, fuel-switching and alternative feedstocks to address higher gas prices. We are also seeing increased interest in renewables, waste and byproduct fuels. These market responses have helped to stabilize gas prices in the near-term. However, new sources of gas supply will be needed to meet future growth in gas demand without creating further upward pressure on gas prices.