Anchorage Daily News

Two months after a contentious hearing over Enstar Natural Gas Co.'s new contracts to buy Cook Inlet natural gas from Conoco Phillips Alaska and Marathon Oil Co., the decision state regulators made might set a precedent for how local utility gas is priced for years.

The Regulatory Commission of Alaska said its new order, issued Oct. 31, will approve the new supply contracts, provided that the gas prices comply with a commission-mandated price cap.

"Our goal was not to enforce bargain-basement prices on such a precious commodity as warm homes in the winter," said Commissioner Kate Giard in a statement accompanying the order. "We did, however, remove the opportunity for windfall prices. ... Our goal was to return Cook Inlet to balance and to craft a solution that ratepayers can afford and that our producers would be willing to take."

The price cap will consist of an index calculated from an average of prices in five gas production basins in North America over the previous 12 months.

Enstar will now re-negotiate with Conoco and Marathon to meet the RCA requirements, Enstar spokesman Curtis Thayer said.

RCA has given Enstar until Dec. 1 to file amendments to the new contracts.

Enstar submitted its proposal to the RCA in April. At the time, Colleen Starring, Enstar's regional vice president, said the new contracts would fill a gap of some 2.1 billion cubic feet in Enstar's gas supply for next year. Enstar pipes natural gas to Southcentral homes and businesses. It has supply contracts with a variety of different gas producers. It told the RCA it had contracts at that point for gas to meet all of its customers' needs only until the end of this year.

Enstar has since said that in the absence of new contracted gas supplies at the beginning of 2009 it might have to curtail gas supplies to some commercial customers or take other actions.

PRICE PRESSURE

But the pricing proposed in the new contracts proved a stumbling block before the RCA.

Consumers in the Cook Inlet region have enjoyed an abundance of cheap gas for heating and power generation for decades. But prices have been rising since the early 2000s as gas supply came more into line with demand.

Because there is no spot market for Cook Inlet natural gas, it has proved difficult to decide a fair price for the gas.

Enstar and the gas producers have long argued that the price should be tied to Lower 48 pricing to give gas producers an incentive to explore for and develop new Cook Inlet gas supplies.

Others have said that gas pricing should be more in line with production costs.

In 2006, the RCA rejected an Enstar contract with Marathon that would have filled Enstar's 2009 shortfall. That contract tied the price to an average of Henry Hub market prices in the Lower 48. A contract with Unocal approved by the RCA in 2001 used a Henry Hub-base pricing model, but in the 2006 decision most of the commissioners said that the Henry Hub pricing was unjustifiably high for the Cook Inlet gas market.

Now the RCA calls for tying the local price to indexes based on prices at certain North American sites that have similarities to the Cook Inlet market. The contracts also would increase the price paid for gas during periods of high gas demand during the cold Alaska winters. And in keeping with the state agreement with Marathon and Conoco over extending their federal license to export liquefied natural gas from their plant at Nikiski, the contracts call for curtailing LNG production if Enstar needs more gas. That LNG plant is a big consumer of Cook Inlet gas.

PRICE INDEX

In its Oct. 31 order, RCA has accepted the principle of indexing Cook Inlet utility gas prices to gas prices elsewhere in North America, to enable "the producers to earn market based rates." But Unocal's unwillingness to offer more gas to Enstar in 2009 suggests that the new exploration and development that were anticipated as a result of the Henry Hub pricing in Unocal's 2001 contract "have not been fully realized," the commission said.

Rather than pegging the Cook Inlet price to general prices in the Lower 48, the RCA picked a blend of prices from five gas-producing areas that also export gas:

El Paso, San Juan basin; Panhandle, Texas-Oklahoma; El Paso, San Juan basin; Kern River, Opal Plant; and TCPL Alberta, AECO-C.

"The trading locations were selected because they are net producing locations and export gas beyond their immediate geographic vicinity," RCA said. "They are located in the United States and Canada with geographic diversity to dampen risk. The trading locations are transparent with daily trading volumes. These factors work together to provide a meaningful cap that will help ameliorate any unreasonable terms within the GSAs (gas supply agreements)."

MARKET POWER

RCA said that it was imposing the price cap because of the gas producers' power in a market dominated by just three companies: Conoco, Marathon and Unocal. Enstar requires gas supplies and the amount of gas required by residential consumers for heating is insensitive to price, the commission said.

The commission said that certain terms within the contracts provide evidence of "an excessive degree of control" by the producers over the terms of the gas-supply agreements. Those terms include some control over Enstar's participation in the RCA review of the contracts and a requirement for Enstar to develop gas storage facilities, RCA said.

And in its contract with Enstar, Marathon has, in effect, excluded the possibility of a small third-party producer supplying gas to Enstar, by requiring all suppliers to be able to meet all levels of gas deliverability, including gas needed required for the coldest winter days, RCA said.

The commission wants this section of the Marathon contract changed.

Producer bargaining power also results in part from the fact that Conoco and Marathon own the LNG plant, the commission said.

"The Cook Inlet market is vertically integrated, with the producers as their own best customers through the medium of sales to the LNG export facility," it said.

And the commission said that the terms under which the U.S. Department of Energy recently renewed the LNG plant's export license had hurt Enstar's bargaining position.

"It is in the best interest of local utility ratepayers to require the producers to finalize contracts with the local utilities before receiving authorization to export natural gas," the commission said.

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