Causes and Anticipated Impacts of Rising Natural Gas Prices

1. Causes and Anticipated Impacts of Rising Natural Gas Prices Bob Gray, Arizona Corporation Commission 602-542-0827 bgray@azcc.gov

3. Source: Energy Information Administration

4. Source: U.S. Energy Information Administration

5. Western U.S. Natural Gas Infrastructure

7. Upward Pressure on Natural Gas Prices • Note: Wellhead natural gas prices were deregulated by the federal government in the 1980s • Continued fundamentally tight supply-demand balance in natural gas markets • Fast growing demand from electric generation sector • Flat domestic production despite high rig counts • High oil prices - the entire “energy basket” has risen • National economic strength • “Demand destruction” in the industrial sector has reduced demand flexibility

8. Upward Pressure on Natural Gas Prices • Hot summer weather – since April 1st, cooling degree days are 4 percent higher than normal and 12 percent higher than 2004 • Coal and nuclear power plant outages • Coal delivery disruptions from the Powder River basin, impacting electric generation • Low hydroelectric resources in the Pacific Northwest, impacting electric generation • Active hurricane season, including Cindy, Dennis, and Katrina • Arizona utilities face significantly higher pipeline transportation costs beginning in January 2006 as a result of the El Paso pipeline rate case

9. Impact of Hurricane Katrina • Most Gulf of Mexico oil (95%) and gas (88%) production was shut in by the hurricane. The Gulf of Mexico accounts for 19 percent of U.S. natural gas production, with additional production in nearby on-shore locations. • The Henry Hub facility, the basis for NYMEX natural gas futures trading was shut down briefly • Production is gradually being restored, but some estimates indicate that full production may not be restored until well into 2006 • The full extent of damage is not yet known, with on-going assessments regarding the undersea pipeline system, processing facilities, drilling rigs, and platforms • Natural gas futures prices in near term months jumped 20 percent in reaction to the hurricane and remain higher than pre-hurricane levels ($11.65 to $12.50 in upcoming winter months as of 9-6-05) • The full extent of Hurricane Katrina’s impact on the natural gas market is still a matter of much speculation

10. Reasons for Optimism • Natural gas storage inventories remain higher than the historic 5 year average, though the surplus is shrinking • In time new liquid natural gas import facilities should provide greater supply flexibility to the historically isolated North American natural gas market • Eventually an Alaskan natural gas pipeline will likely help support current domestic production levels • The recently approved Energy Bill may provide some increment of assistance over time to meeting natural gas needs • Mild weather?

11. Energy Information Administration Short Term Outlook – 9-7-05 • Provides three scenarios reflecting fast, medium, and slow recovery from Hurricane Katrina, focusing on the medium recovery scenario • Projects an average San Juan spot market price of $7.40 per mcf in 2005 and $7.14 per mcf in 2006 • Projects an average Henry Hub spot market price of $8.82 per mcf in 2005 and $8.42 per mcf in 2006 • Projects end of October storage inventories 270 bcf below last year, but 50 bcf above 5 year average • The outlook for the coming winter is for energy expenditures for natural gas to increase 24 percent

12. Arizona Circumstances • Arizona natural gas prices are generally lower than national prices, but are still likely to be significantly higher than historical norms • Arizona utilities engage in varying levels of hedging their prices, reducing the cost swings consumers might otherwise see • UNS Gas and Southwest Gas have both hedged approximately 50 percent of their winter natural gas supplies for the upcoming winter, but the rest of their supplies will be subject to market conditions • As of September 2005, UNS Gas’ tariffs reflect a cost of gas (both commodity and pipeline transportation) of $0.68341 per therm. Southwest Gas tariffs reflect a cost of gas of $0.63419 per therm. • Most additional electricity demand in Arizona is met with natural gas generation, suggesting that high natural gas prices will exert upward pressure on electricity prices in Arizona • Arizona’s lack of natural gas storage facilities reduces the ability of Arizona utilities and others to adjust to changing natural gas market conditions and prices

13. Arizona Natural Gas Costs and Utilities • Most Arizona natural gas and electric utilities have adjustor mechanisms which allow them to pass through natural gas and (for electric utilities) other specified costs to their customers, pursuant to the provisions of each utility’s adjustor mechanism • Natural gas costs incurred by utilities that have adjustor mechanisms are passed through on a dollar-for-dollar basis. These utilities do not earn any profit on the natural gas costs passed through the adjustor mechanisms.

14. Summary • Current natural gas prices are at record levels for summer months • Even before Hurricane Katrina, there was upward pressure on natural gas prices, with the hurricane only exacerbating the situation • While it is unclear how high natural gas prices may reach this winter and into the future, it appears likely that higher natural gas prices will play a significant role in driving the costs utilities incur and pass along to their customers