Sunday, January 22, 2006
By TERRY MORLAN Columbian forecaster

It is not news that energy prices were very high during the last half of 2005. The price of gasoline is easy to see on the sign at the local gas station and it was higher recently than many of us can ever remember. The prices that we pay for natural gas and electricity are less visible, but the increase in our monthly bills will be evident this winter.

During the 1990s, the U.S. increased its reliance on natural gas. Homes converted from oil and electricity to natural gas for heating, industries also increased their use of natural gas, and most new electricity generation was fueled by natural gas. These trends were driven by the low cost of natural gas and its environmental advantages, but the low cost advantages have disappeared.

The increased price of natural gas has been driven by the fact that new supplies are lagging increasing demand. With lagging supplies, inventories of natural gas reserves have declined relative to consumption, creating a tight market with very volatile prices. Prices change dramatically with every piece of news that could affect natural gas demand or supply. For example, a forecast for a cold winter can cause natural gas commodity prices to jump. The damage from hurricanes Katrina and Rita to Gulf of Mexico natural gas and oil production and processing facilities had a huge impact on natural gas prices.

High natural gas prices have been unmitigated by the ability to substitute oil for natural gas uses because oil prices also have been high. World oil prices, which generally ranged between $15 and $30 a barrel from the late 1980s until recently, reached more than $60 a barrel during 2005. The high price of crude oil is partly due to inadequate investment in production capability in the Middle East. The prices of refined oil products, such as heating oil and gasoline, that consumers buy have been affected not only by high crude oil prices, but also by shortages of refining capacity.

Electricity prices are strongly affected by natural gas prices. As a result, wholesale electricity prices have been high since the hurricane season, although much lower than the electricity shortage-induced prices experienced during the electricity crisis of 2000 and 2001. Even coal prices have been affected by the high energy market.

Consumer Prices

Fortunately, consumers are somewhat sheltered from the volatility of energy commodity prices. Although gasoline prices vary day to day and week to week, natural gas and electricity prices to homes and businesses are moderated by local distribution utilities. These businesses make a practice of limiting the volatility of prices by buying energy supplies before the heating season or controlling price variation through hedging or other financial transactions. For example, NW Natural, which serves the Vancouver area, purchased a significant portion of its natural gas for this winter before prices jumped in response to the hurricanes.

However, utilities cannot shield consumers for long from higher natural gas and electricity prices. Even with the moderating effects of utility service, consumers will see significantly higher prices this winter. Energy bills will be larger and take a bite out of consumers' incomes and businesses' profits.

Looking Forward

Forecasting the energy outlook for 2006 beyond the current period is a real gamble. Prices are almost certain to continue their recent volatility. The fundamental conditions that lead to volatility and relatively high prices are likely to persist this year.

Periods of high prices will follow adverse weather events (or even weather forecasts), interruptions in refinery operations, changes in demand expectations, and other factors.

Given normal weather conditions, however, energy prices could be lower this year than in 2005. Prices for most energy commodities had fallen from their October highs by late November. Very high prices carry the seeds of their own destruction by reducing demand for energy and increasing the supply. Large increases in natural gas supply are not expected for several years, but some increases combined with substantial reductions in demand could bring prices down from their recent levels.

Many industry observers think that the natural gas market is experiencing a speculative bubble. If that is the case, the drop in prices could be large and sudden. But even so, the much lower prices likely would not persist for long.

Significant investments in Middle East oil production capacity, increased ability to import liquefied natural gas, new pipelines from Alaska and northern Canada, and development of more natural gas production capability will be needed to create significant increases in supply.

In the face of such uncertainty, consumers and businesses can protect themselves by investing in more efficient homes, cars, buildings, factories and equipment. Many Northwest electric utilities are following the recommendations in the Northwest Power and Conservation Council's power plan for the region by investing in energy conservation and building significant amounts of wind generation. Both of these strategies help reduce exposure to volatile and increasing fossil fuel prices.

These approaches also reduce the growth in natural gas and oil demand, which will help bring supply and demand into balance and limit price increases in the long-term.

The outlook for 2006

* Given normal weather, the likelihood of lower energy prices in 2006 compared to the very high prices in the fall of 2005 is possible.

* Many industry observers think that the natural gas market is experiencing a speculative bubble. If that is the case, the drop in prices could be large and sudden. Even so, lower prices likely would not persist.

* Many Northwest electric utilities are following the recommendations in the Northwest Power and Conservation Council's power plan for the region by investing in energy conservation and building significant amounts of wind generation.

ENERGY: What might happen 20 years from now

Sometime during the next 20 years we are likely to enter another cycle of higher energy prices that will induce a new round of changing energy uses and new technologies.

The world in 2026 is likely to look as different from today's world as today's world looks different from the world in 1980. Traditional fossil energy supplies are limited, but not so limited as to threaten global economic collapse. Through successive periods of shortage and high prices, the world will move toward new approaches to meeting our basic energy needs, and traditional fossil fuels will play a slowly decreasing role.

If the council's energy plan is implemented, by 2026 the region will be using electricity much more efficiently and wind generation will be a larger share of our electricity supply. Though oil and natural gas prices likely will be higher and continue to be volatile, the region's electricity consumers will be less vulnerable to these uncertainties.

At the Northwest Power and Conservation Council, thinking we can forecast the future with any certainty is folly. Looking forward that far requires dealing with uncertainty and developing strategies that make sense in an uncertain world. That is what the council's Fifth Northwest Electric Power and Conservation Plan does. (See www.nwcouncil.org.)

Natural gas, oil

The cost of natural gas and oil will be particularly uncertain 20 years from now. However, it is likely we are at the peak of an energy price cycle, similar to 1980.

High prices are likely to lead to increased investments in new technologies for providing energy and for using energy. Consumers will change their consumption patterns and new technologies will lead to more efficient uses of energy. These changes will lead to a fall in prices, but to a higher floor than the previous low energy-price cycle during the 1990s.

Certainly global warming, changing technology and changing industrial structure are among important factors influencing energy prices and use. Particularly important in Washington will be the change in electricity prices as the region outgrows the capability of its hydroelectric system. We have already seen the effects of this on the aluminum industry and other energy-intensive sectors.

By using electricity more efficiently, the region can limit the requirement for new more expensive forms of electricity generation and thus limit the rise in electricity prices.