Return just isn't there for gas pipeline

July 18, 2009 

My June 21 column argued that there was no serious chance of an "open season" in 2010 when potential natural gas pipeline owners and North Slope gas producers may attempt to come to terms.

A few readers have countered by pointing out that in early June, Exxon Mobil agreed to partner with TransCanada Corp. on its proposed pipeline, suggesting that this greatly improves the prospects for a successful open season next year. Their argument seems to be that if the largest corporation in the United States wants to join up, then prospects must be very good.

I readily admit that Exxon's partnership with TransCanada improves the long-run prospects for a number of reasons, not least of which is that Exxon owns something like one-third of Prudhoe Bay's natural gas reserves.

But someone is going to have to show me where the numbers that I am looking at change just because Exxon has partnered with TransCanada.

Here are those numbers, certainly not as good as those that Exxon and TransCanada are privy to but probably in a small ball park, unless, of course, the publicly available information is greatly distorted.

The "givens" are:

• $30.22 billion in construction costs for the portion of the project/pipeline running from the input to a North Slope gas treatment plant to Alberta.

• Daily throughput of 4.5 billion cubic feet (bcf) of gas per day increasing, possibly, to 5.9 bcf per day.

• A 15 percent required rate of return on investment.

• A 20-year amortization period.

Given those assumptions, the tariff required to amortize construction costs on the part of the $30.22 billion project comes to about $3.90 per thousand cubic feet (mcf) of natural gas at a 4.5 bcf per day throughput. If throughput is raised to 5.9 bcf, the required tariff is reduced to about $2.80 per mcf.

Other assumptions include (sources upon request):

• The sum of field amortization costs, annual operating costs and fuel and maintenance costs comes to 70 cents per mcf.

• The Canadian tariff from Alberta to Chicago comes in at $2 per mcf.

• State and local taxes equal 50 cents per mcf.

• Provision for shutdowns and cost overruns is set at 40 cents per mcf

• A minimum $2 per mcf net wellhead price is required. Wellhead is the value gas producers get for their production -- the market price minus the costs itemized above to get the gas to market.

Under these conditions, the minimum price that the gas must fetch at Chicago is $9.50 per mcf at a throughput of 4.5 bcf per day, and $8.40 per mcf at a throughput of 5.9 bcf per day.

According to the U.S. Department of Energy, the average city gate price for natural gas in the United States in April was $5.76 per mcf. That yields a shortfall of between $2.64 per mcf and $3.74 per mcf. With the world economy in the doldrums is there any realistic expectation that prices will rise by 50 percent or more in the next several years?

Of course, Exxon and TransCanada could lower their required rate of return from 15 percent to, say, 10 percent. That would bring down the minimum Chicago price to something between $7.50 and $8.20 per mcf, leaving a smaller shortfall but a shortfall nonetheless.

I am ignoring higher valued gas liquids, but even so, it is hard to see how what we have been told to date adds up to a doable project. Show me where I am wrong.

David M. Reaume is a Washington state-based economist who was based for many years in Juneau. His opinion column appears every fourth Sunday.

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