Demand Drives Expansion of Gas Storage Role
The intraday peaking needs of natural gas-fired power generation and the promise of growing LNG imports will continue to influence the use and development of natural gas storage.
Gas storage was historically a component of the natural gas pipeline infrastructure and used to supply extra deliverability during peak demand periods in the winter. Most storage was single- cycle with gas injected in the summer for withdrawal in the winter. This seasonal gas storage is, in most cases, accomplished by using reengineered depleted oil and gas reservoirs. A small percentage also comes from depleted aquifer and leached salt domes that have been converted to gas storage.
Currently, about 7.5 Tcf of underground storage capacity exists in 391 facilities in the United States. Of that volume, approximately 3.3 Tcf is working gas.The rest is cushion or pad gas needed to maintain minimum pressures in the facilities.
The United States consumes more than 22 Tcf/year of natural gas, but demand is not constant throughout the year. During April to October, demand is slack and gas is injected, then redelivered during the high-demand November to March period. Gas is stored at locations serving different markets, making it more accessible during peak periods. Working gas in storage currently exceeds the amount of gas in storage at this time last year as well as the average amount of gas in storage over the last five years. However, gas prices are at an all-time high, and future winter prices relative to summer prices are in very steep contango. This indicates that the market perceives that there is a shortage of peak winter deliverability and that it will pay a large premium for injections into storage today for use this winter.
Some expect the gas market to exceed 31 Tcf/year by 2020. Growing LNG imports are expected to meet almost all of this demand. Increased LNG vaporization will require more storage to adjust the timing and location of required peak deliverability.
CHANGING MARKET DYNAMICS
The role of storage continues to expand to meet new demand. Still needed to meet peak-day demand in the winter, storage is increasingly meeting peak-day demand during summer months. Environmental constraints have caused natural gas to become the fuel of choice for electric generation, vs. coal, hydro and nuclear power. That creates new challenges for the gas pipeline industry. Pipelines were developed to transport natural gas at a constant volume each hour of the day (ratable flow). Since electricity cannot be stored, gas-fired electric generators (GFEG) only run when there is demand, which peaks seasonally in summer and winter and daily from early morning to late evening. GFEGs are easy to switch on and off, depending upon demand, creating a non-ratable flow pattern on the pipelines. Storage is the only effective solution to balancing non-ratable flow.
High natural gas prices have caused demand destruction in certain industrial markets, which normally take natural gas in a ratable manner.The shift in demand from ratable industrial load to non- ratable GFEG load has increased seasonal and daily gas flow volatility. Since natural gas pipelines can only handle a certain amount of load variation through pipeline linepack, storage is needed for seasonal and daily balancing.
Hence the need for high-deliverability, multi-cycle (HDMC) gas storage, which is designed to handle both seasonal dual-peaking as well as the intraday peaks GFEGs require. Most pipelines now have multiple dispatch or nomination configurations to handle up to four gas-flow cycles per day instead of the traditional single day-ahead nomination. HDMC storage facilities can react to gas flow changes and even switch from injection to withdrawal with less than one- hour notice. The GFEG market requires that storage facilities operate on a 24-hour basis to handle withdrawals during the day and injections at night.
FERC-regulated pipeline operators that have gas storage as a component of their operations may wish to upgrade and expand their facilities from time to time. But storage development is a capital- intensive business and regulated storage owners may be slow to react to the changes needed since they can only charge storage rates based on cost of service.
Independent storage developers are willing to develop gas facilities with the prospect of getting market-based rates. Due to geologic constraints, ease of permitting and less expensive acquisition of storage rights, most projects slated for development by independent storage developers are in the supply areas. Supply areas are effectively long gas, however, and do not necessarily need to enhance gas deliverability.
WHERE CAPACITY IS NEEDED
The need for gas storage capacity has always been associated with market areas. However, market areas can be demand centers or demand growth areas located in any region, including supply areas. Establishing suitable storage capacity in these areas is relatively easy due to favorable geology. Some rapidly growing demand centers in supply areas are the metropolitan areas of Dallas-Ft. Worth, Houston, Denver and Southern California. Demand centers not located near supply areas pose a more challenging problem due to the lack of acceptable geologic formations. Major demand centers in this category include New York, New England, Chicago, Phoenix/the desert southwest and Florida/Southeast.
Storage capacity also will be needed for ENG vaporization facilities. Most planned or permitted ENG facilities areexpected to be on the Gulf Coast, where geological forma-_ tions suitable for gas storage abound, making locating and permitting ENG storage facilities relatively easy.
The best type of storage for ENG vaporization facilities is depleted reservoir. ENG economics require that cargos be vaporized into pipelines immediately and continuously whether there is demand for the gas or not. As market demand slackens during spring and fall, the delivery of large amounts of ENG into the pipeline grid will force gas prices down during those periods.
Some ENG suppliers anticipate using salt dome storage for their storage needs. Salt dome storage economicsdictate that users must subscribe to very high inventory turn services, as high as 12 turns per year.That means filling and emptying each month. The monthly salt dome withdrawals would compete with ENG vaporization volurnes and compound the excess supply problem during slack demand periods. During peak demand periods, salt, dome storage would need to be refilled at high gas prices in order to maintain high inventory turns.
ENG suppliers need storage that can be filled during the slack periods, sometimes lasting several months, then emptied during extended demand periods. Depleted reservoir storage would allow a user to subscribe for a lower inventory turn service at a lower price than salt dome storage, enabling the user to inject continuously during slack demand periods and withdraw gas continuously during peak demand periods.
STORAGE VALUE PAST AND PRESENT
The value of gas storage is the sum of the intrinsic and extrinsic (optional) value of the forward natural gas price curve. In a contango market the value of seasonal storage is the net value of the difference between the summer price and the winter price, allowing for basis differentials, the cost of capital and transportation. The valuation of multi-cycle storage is more complex due to the addition of the extrinsic value, which is determined by valuing the forward volatility of the price curve. The extrinsic value of storage can be two, three, or even more times the intrinsic value.
Market Changes Have Reshaped Gas Demand Profile
Baseload Demand and Wellhead Supply Have Decreased While Variable Demand Has Increased
Rising seasonal forward price volatility has increased the value of storage over the last several years. This is due to the changing dynamics of the demand components of the market, such as more GFEG vs. baseload industrial demand, and to the shift in the supply- demand relationship from long deliverability (the “gas bubble”) to short deliverability.
Daily volatility has actually decreased slightly over the last few years due to better liquidity as large merchant players return to the market. But daily volatility is still quite large and contributes greatly to the increased value of gas storage.
Another value driver for storage is the increased intraday demand needs of the GFEGs. Since GFEGs at the margin typically operate only during peak periods, they must balance their daily fuel use. Daily power demand begins at about 7 a.m. and peaks around 6 p.m., declining considerably after 11 p.m. Most GFEGs at the margin only operate during this 7 a.m. to 11 p.m. cycle, actually burning the gas purchased for a 24-hour cycle during a 12- to 16-hour period.The solution is to inject the gas into storage during nonuse hours, then remove and combine it with the purchased gas during generation hours to aggregate the supply needed to operate the GFEG.
If a GFEG is going to consume 2,000 MMBtu/hour for 12 hours of the day, the GFEG purchases 1,000 MMBtu/hour (24,000 M MB tu/day) and diverts the flowing gas during the 12-hour non-generation period into storage. When the GFEG is operating, the gas is withdrawn from storage for 12 hours at 1,000 MMBtu/hour and combined \with the 1,000 MMBtu/hour of flowing gas to deliver 2,000 MMBtu/hour to the GFEG.
POWER DEMAND AND GAS PRICES
Daily cash prices are driven by the real-time supply-demand balance, while NYMEX gas futures prices are driven by the perception of what the supply-demand balance will look like at a later date. The forward NYMEX curve has begun to price in a summer seasonal increase due to the GFEG effect on summer gas prices. Several years ago, the forward curve did not display this summer effect because the GFEG was a smaller part of the demand equation. GFEGs are beginning to compete with seasonal summer storage injections, as they require gas injection and withdrawal flexibility only available with HDMC storage. This competition will drive up gas prices during the typical summer gas injection season.
The hourly pricing of power also affects gas prices. Since electricity cannot be stored, gas storage offers an option to the GFEGs. Storage can serve the intraday gas market and becomes an intraday call option or intraday put option, as the case may be, for intraday power demand. If storage is used as an intraday call option for the power market, the option value for the intraday call would be additive to the replacement cost of the gas. The replacement gas will be purchased in the forward market, driving up the forward price of gas. The storage option provider will charge a price based on the forward price of replacement gas plus the value of the intraday option. If the market is in contango, the gas replacement cost plus option premium can get very high. Likewise, if the market is in backwardation, the premium may be reduced to only the intraday option value. In some cases of steep backwardation, the gas replacement cost plus the intraday option value could actually be less than the spot price. In this case, the option provider would charge at least the spot price, keeping the difference as profit.
The North American gas storage industry is being driven by several new market dynamics. Expect to see growth in the development of new HDMC gas storage projects and expansion of HDMC gas storage facilities in the near term. The shifting dynamics of the industry require new technologies in gas storage and changes in the way the gas storage and pipeline business is conducted. Over time, this will lead to a more efficient and productive use of natural gas by power generators, industrials, and residential and commercial customers.
Jeffrey H. Foutch is the chief commercial officer and co-founder of Falcon Gas Storage Co. Inc. He can be reached at 713.961.3204; jhfoutch@falcongasstoragc.com
Copyright Hart Energy Publishing, LP Sep 2005