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I was encouraged to see Secretary of Energy Spencer Abraham, in a major address this past Friday before the National Petroleum Council, go out of his way to draw special attention to "the looming challenges we face with respect to natural gas." In his remarks, Secretary Abraham noted that current stocks of natural gas in underground storage are "unusually low" due to a combination of cold weather in the Northeast and Mid-Atlantic regions this past winter and "declines in both domestic production and net imports." He went on to observe that (as discussed my article last week) storage at the end of March was at "the lowest level since 1976, when the Energy Information Agency first began keeping records," dropped to an all-time record low of 623 BCf by the week of April 11th and "is still only half the level of a year ago." Secretary Abraham noted that, "to reach the desired storage level of 3 to 3.5 trillion cubic feet of natural gas by the end of October," (a level well above the target currently used by many analysts), we must inject "much more" into storage than has been typical in years past (when the average injection over the 30 –week Refill Season generally has been in the range of 60 BCf/week, with injections in May and June well above this level). He further emphasized that while a total of 72 BCf was injected into underground storage last week, "a hot summer would prevent the continuation" of these rates. He then directly undercut EIA’s most recent forecast for U.S. production for 2003 (which projects sequential quarter-over-quarter increases in production every quarter), stating that "we already know that increased depletion rates and less productive new drilling have led to a projected 2 percent decrease in supply this year." Secretary Abraham concluded by asking Bobby Shackouls, the incoming Chairman of the National Petroleum Council, to schedule a special June meeting of the Council to "identify actions that can be taken immediately to ease short-term supply constraints," and to develop recommendations for actions that can be implemented immediately "during the critical summer period." (The full text of the Secretary remarks can be found on Energy.gov) Recommended Near-Term Actions
Secretary Abraham's clear acknowledgement of the potential for an imminent natural gas crisis is certainly a step in the right direction. And his request for advice from the National Petroleum Council undoubtedly is not the last action he intends to take to address the urgent need to prepare for next winter's "looming challenge." The question that remains, then, is what specific actions should Secretary Abraham be initiating to attempt to: (i) minimize the severity of the price spikes that are likely to occur next winter; (ii) avoid potentially catastrophic consequences later this year to industries that rely on natural gas for manufacturing purposes and (iii) minimize the risk that Local Distribution Companies ("LDC's") will be unable to satisfy residential heating needs if this coming winter proves to be unusually cold? I believe there are seven specific actions Secretary Abraham should consider taking right now (i.e., even before the National Petroleum Council meets month):

1. Urgent need to establish new, higher storage targets for this year’s end-of-Refill Season storage levels. First, it is essential that the Department of Energy begin to work immediately with state regulatory officials, state governors, LDC's and suppliers, not only in the Midwest, Northeast and Mid-Atlantic states but in the Producing Region as well, to:

• Develop a consensus regarding the need to establish new, significantly higher end-of-Refill Season storage targets;
• Establish new state-by-state targets, both in the consuming states and in the producing region;
• Develop a specific plan for ensuring that these targets are met;
• Identify major obstacles to successfully implementing this plan and develop a strategy for overcoming these obstacles; and
• Assess whether action should be taken immediately to expand the amount of storage capacity available in future winters.

As noted in last week's article, last year, by late October, the amount of working gas in underground storage reached 3,172 BCf (i.e., 112 BCf above the 5-year average of 3,060 BCf). Nonetheless, storage was drawn down to record low levels and prices reached an all-time high in a winter in which temperatures nationwide were 3% below historical norms. (Secretary Abraham appears to be unaware that last winter’s colder-than-normal weather in the Northeast was more than offset by milder-than-normal weather in the Midwest and the remainder of the U.S.) Remarkably, however, despite this dramatic recent experience, most analysts -- and some state regulators and LDC's – still take the position that storage will be adequate if stocks are rebuilt to 2,700 – 2,800 BCf (i.e., 400 – 500 BCf below the level that proved to be inadequate last winter) -- or, alternatively, at least matches the 5-year average level of 3,060 BCf (i.e., still well below the level that proved to be inadequate last winter). As explained in last week's article, merely rebuilding storage to levels that match the 5-year average of 3,060 BCf (let alone to a paltry 2,700 – 2,800 BCf) potentially could have disastrous consequences this coming winter – even if temperatures this coming winter merely match historical norms, but especially if next winter proves to be as cold as the most recent colder-than-normal winter (i.e., the winter of 2000/2001). Last week's "Shock and Awe" article explores this issue in considerable depth; I won’t repeat this discussion here. It is important to keep in mind, however, two key points:

1. On average, temperatures the past 5-winters have been far below historical norms. If temperatures this coming winter are closer to historical norms or are colder than normal, there is every reason to expect that withdrawals will be far larger than the average for the past 5 years.
2. This is especially true since, over this 5-year period, supply and demand have not been stable. Instead, supplies available to the U.S. market (i.e., U.S. production + net imports) have deteriorating dramatically. By this coming winter, supplies available to the U.S. market are likely to have fallen by 5.5 – 6.0 BCf/day compared to the level of supplies available just 24 months ago – i.e, a cumulative decline of 2.0 TCf/year. At the same time, demand for natural gas in the generation sector and the power sector have continued to grow at a rapid rate. This decline in supplies inevitably increases – potentially quite dramatically – the amount of natural gas that must be withdrawn from storage during winter months, when the daily consumption rate is at its peak for the year.

As least winter's experience clearly demonstrates, therefore, unless winter temperatures this coming winter once again prove to be extraordinarily mild, storage levels that might have been perfectly adequate just two or three years ago could prove to be grossly deficient this winter, with potentially catastrophic impacts on the ability to maintain storage at minimal levels and the vulnerability of the U.S. market to unprecedented increases in prices.. These dramatic changes in the balance between supply and demand in the U.S. market, and their implications for storage requirements this winter, are not yet well understood by the market. At a minimum, however, they indicate that meeting or even exceeding 5-year average storage levels is no longer even close to being adequate – just as we learned (or at least should have learned) from this past winter's experience. (Yet, as of EIA’s most recent Weekly Storage Report, the amount of natural gas in underground storage still is 542 BCf below the 5-year average, with only 8 weeks left in the prime injection season (which ends in mid-July) and no more than 24 weeks (i.e., less than 170 days) before the first withdrawal occurs.) The magnitude of the shift that has occurred is worth underscoring – especially since much of the industry is still tracking storage relative to the 5-year average, based upon the (in my view, mistaken) belief that matching the 5-year average would equate to storage reaching acceptable levels. Over the past 5 years, withdrawals from storage during the winter heating season have averaged 1,981 BCf – i.e., 568 BCf below last winter's peak to trough withdrawal of 2,549 BCf. It is tempting, therefore, to assume that last year was the anomaly, and the 5-year average the likely future norm. Any reputable weather scientist, however, would blanche at this notion. Two of the last 5 winters, (i.e., '99/'00 and '01/'02), have been among the warmest on record. A third (i.e., the winter of '98/'99) also was extraordinarily mild – albeit slightly warmer than the winters of '99/'00 and '01/'02. A fourth (i.e., last winter) was closer to historical norms – but still 3% milder than climatologically normal weather. Only 1 of the 5 years that goes into forming the 5-year average (i.e., '00/'01) was colder than a statistically average – and even then not by remotely enough to balance off the impact of the 4 warmer than normal winters. Among weather professionals, even the most ardent proponent of the Global Warming thesis would argue that only a relatively small portion of this variance from historical norms was due to Global Warming. Instead, the primary causes were El Nino effects in at least 2 of the 5 winters and a nearly unique combination of localized conditions in the atmosphere during the '01/'02 winter heating season – none of which are likely to be repeated this coming winter. As explained in last week’s article, therefore, to account for the possibility of a colder-than-normal winter against the backdrop of these extraordinarily mild winters, it is necessary to add at least another 1,069 BCf to the 5-year average withdrawal – increasing the size of the potential withdrawal to at least 3,050 BCf (i.e., 1,981 BCf + 1,069 BCf = 3,050 BCf). The need to account for abnormalities in prior years' weather is not the only factor, however, that requires adjustments in the 5-year average figures. Instead, it is important to recognize that, during this same period, the supply/demand balance also has been changing rapidly, in a manner that increases significantly the size of the withdrawal in winter months. In addition, to determine an appropriate end-of-Refill Season target reserve, it also is necessary to add at least another 500 – 800 BCf (if not more) to provide a working reserve. By this coming winter, total U.S. production is likely to be at least 4.5 BCf/day below production just two years ago – a reduction in supplies of almost 700 BCf in the winter months alone. In addition, depending upon the severity of the winter, and the potential need to retain natural gas in Canada to meet Canadian needs, imports of natural gas from Canada also could decline significantly – potentially by as much as 1.0 – 1.5 BCf/day. At the same time, demand for natural gas in the power sector and in the residential sector is continuing to increase at a record rate. Further, while industrial use of natural gas has been declining during this period and imports of Liquefied Natural Gas ("LNG") are likely to increase modestly relative to last winter, the net impact of these improvements is not nearly enough to offset the factors just described. It is precisely due to these factors (i.e., impact of return to more normal weather + deterioration of the supply/demand balance) that withdrawals this past winter averaged 5.67 BCf/day greater than could be explained based upon temperatures alone. We expect the supply/demand balance to continue to deteriorate this coming winter – perhaps by as much as another 1.5 – 2.0 BCf/day. As a result, as explained in last week's article, even "filling storage to the brim" in both the U.S. (i.e., in the U.S., a little over 3,450 BCf), may not be sufficient to fully protect against the possibility of severe price spikes or even physical shortages of natural gas, at least if winter temperatures are particularly cold. We do not expect Secretary Abraham, any LDC or any state PUC or state governor to accept this conclusion based upon our analysis alone. Given the urgency of the potential crisis, however, and the clear empirical basis based upon last winter's experience for questioning whether 3,172 BCf (i.e., a figure well above the 5-year average end-of-season storage level) is even remotely close to adequate, we believe it is essential for the Department of Energy (and, if possible, the White House) to take the lead in attempting to rapidly reexamine what our storage targets should be for this Refill Season and developing a plan to ensure that these targets will be met. No set of recommendations developed in another 60 to 90 days will be adequate to protect the public interest if the industry still is aiming over the critical next 8 to 10 weeks to achieve refill targets that are far too low to protect against price shocks and protect public safety this coming winter. Even if these targets are subsequently revised, the time remaining in the Refill Season will be far too short to possibly make up the deficit in the short time that remains before the heating season begins again in mid-September and the weekly injection rate begins its inevitable decline. We recommend, therefore, that:

• The Secretary of Energy appoint a senior level Task Force within the next 24 hours, with representatives from both inside and outside the Department, to prepare an initial analysis, to be completed within the next 10 days, of the storage levels that are likely to be necessary to protect the public interest this coming winter;
• As soon as the Task Force has completed its initial analysis, the Secretary personally take the lead in conducting a series of meetings and workshops with State Governors, State PUC's, LDC’s and suppliers, to be completed by no later than June 15th, with the goal of (i) forging a consensus among these parties regarding the need to establish new, much higher storage targets; (ii) establishing new, state-by-state targets; and (iii) developing an agreed upon list of action steps that will be taken by industry and at the state and federal level to attempt to meet these targets (including any required regulatory action, required legislation and/or other required action by state or federal government, to the extent such action is necessary to achieve the agreed upon targets).

I recognize that the time schedule just proposed is extremely ambitious and that the approach I have proposed is more than a little unorthodox – i.e., that the Secretary of Energy (or, ideally, perhaps even the President) take the lead in attempting to develop a consensus around what might prove to be largely a private industry and/or state-action oriented action plan, rather than a program mandated by the federal government.

It is critical, however, that we begin to recognize several factors:

• It is the middle of May. The amount of natural gas currently in underground storage as of EIA's most recent Weekly Storage Report stands at 900 BCf. We may need more than 3,400 BCf in storage to avoid potentially catastrophic impacts this coming winter and less than 24 weeks remain in the Refill Season.

In other words, we currently are 2.5 TCf short of the minimum storage levels we need to protect public safety and avoid exposure to unprecedented price spikes this coming winter (i.e., a staggering, unprecedented deficit) and we have less than 170 days (i.e., a little over 4,000 hours) to try to eliminate this deficit. Further, the heart of the Refill Season – in which more than half of the injections for the Refill Season typically occur – is from late March through mid-July. We already are well into that period. So far, both on a cumulative basis, and looking at each week’s injections figures on a weather-normalized basis, we are pretty much tracking exactly last year's anemic injections – which were among the lowest ever – and falling far short of the 100 BCf/week + injections achieved during this time of year two years (which still would not be adequate to rebuild storage to adequate levels this year). This low trajectory for injections should not be surprising; it is more or less exactly what might be expected, given that over the past 15 months the U.S. has consumed 1.25 TCf more natural gas than the new supplies delivered to the U.S. market during this period. If we continue on this pace, the best we can hope for is end-of-season storage of approximately 2,300 – 2,400 BCf. – i.e., more than 1.0 TCf below our estimate of what we need to be safe going into next winter and 800 – 900 BCf short of levels that proved to be grossly inadequate last winter in a milder than normal winter. It is always possible, of course, that we will luck out, and that this coming winter will again turn out to be among the mildest winters ever. Even if it does, given the chronic undersupply condition in the U.S. market, we still probably will need to withdraw more than 2,000 BCf of natural gas from storage, and the pressures on the natural gas market in all likelihood will be even more severe than they were last winter, when the price of natural gas in the day ahead market at Henry Hub in the Producing Region and at City-gate locations at many major delivery points in the East reached all—time highs. At least in our judgment, any analyst who believes that matching 5-year average storage levels will be sufficient to restore equilibrium to the market doesn't yet understand how radically the market has changed over the past two years. Instead, except in a "we really luck out" with the weather scenario, we believe that if storage is anywhere below 3,300 to 3,400 BCf, as a bare minimum "safe" level, the U.S. market faces a potential disaster, in terms of exposure to unprecedented price spikes, potential harm to gas-sensitive industries, and even in terms of ability to meet essential winter heating needs if the winter is particularly cold. We are in a situation, therefore, in which we need leadership from the highest levels of government and need to set time schedules that, under almost any other scenario, might be considered impossible to achieve.

• At the same time, issues of political philosophy aside, precisely because the time available to ramp up injection rates is so short, any attempt to mandate action at the federal level almost certainly would be counter-productive (since it would distract attention from efforts that are more likely to be productive, given the short time remaining).

There simply is too little time available. What needs to be done is to bring all of the relevant actors together, provide them with relevant information and help to build a consensus and encourage immediate action by parties in a position to act. To the extent legislation or regulatory action is necessary, it should evolve out of a consensual process, in which the need for specific legislative action (i.e., provision for new federal or state funding or loan guarantees, to the extent such measures become necessary) or the need for specific regulatory approvals is identified and the interested parties join forces to expedite approval. There isn't enough time available for any other approach to work.

• Finally, it is also important to recognize that a national planning effort clearly is required. Historically, each LDC plans to meet the requirements of its own customers. To do so, it enters into a series of supply contracts of various durations and with various swing capabilities and also plans to inject certain amounts of natural gas into storage in order to ensure its ability to meet the total requirements of its customers, even in a colder-than-normal winter.

In most states, the results of this planning process are reviewed carefully by the state PUC, which ultimately retains approval authority over each LDC's plans. This process is the cornerstone of the planning process – and should remain so this year and in the future. Over the past two years, however, a new layer of complexity has been added. In the past, the major LDC's typically account for approximately 65 – 70% of the total amount of natural gas injected into storage. Gas marketers, pipelines, suppliers, storage operators, speculators and other market participants controlled the remainder. In the post-Enron, more financially challenged environment, however, this clearly is changing. The ability of the marketers to post collateral is greatly reduced (and the amount of collateral they are required to produce significantly increased, in part as a result of higher prices for natural gas). Liquidity has diminished dramatically, both in private markets and in the futures market on NYMEX – for in all but the nearest-term months. In addition, LDC's in the northern U.S. are not in a particularly good position to estimate the extent of the winter generation-related demand (which occurs primarily in other regions of the country), and therefore may find it difficult to assess the impact power sector requirements will have on total consumption of natural gas (and therefore total withdrawals from storage nationally) during the winter months. As a result, there is substantial reason to fear that, even if the LDC's meet their own company-specific storage targets for this coming winter, the total amount in storage by the end of the Refill Season – and therefore the total supplies available to the market as a whole – will fall far short of the levels implicitly assumed in each LDC's company-specific plan. These factors, as well as the need to better track imports from Canada and exports from Mexico, reinforce the need to address storage needs in a more sophisticated manner at the national level than has occurred in the past, as well as on an LDC-by-LDC basis at the state level. The U.S. has faced very few crises that potentially as severe as we may face this winter if temperatures are cold. And few have required action within such a severely compressed time frame. We have shown in the past two years, however, in response to the Al Qaeda attacks and in launching the war against Iraq, that when the need exists, we can move very quickly. I don't draw these comparisons lightly. The potential consequences for the U.S. economy if we are short 1.0 TCf of natural gas supply this winter are extremely severe and the time remaining to act grows shorter every day.

2. Potential need for Federal Emergency Management Agency (FEMA), the Department of Homeland Security and/or State Governors to Purchase Natural Gas on an Emergency Basis to Help Rebuild Storage to Adequate Levels. Given the severity of the current storage deficit, there is at least one action that the federal government should consider taking immediately: to step in and begin purchasing natural gas for injection into storage in any week between during the remainder of the prime injection season (i.e., between now and the end of July) in which injections fall below 130 BCf/week (i.e., the level of injections required during this period in order to rebuild the amount of natural gas in underground storage to adequate levels before the end of October). The effect of these purchases would be to create a federal Strategic Natural Gas Reserve, akin to the Strategic Petroleum Reserve. Unlike the Strategic Petroleum Reserve, however, there would be no need to create a separate physical storage facility to house this reserve. Further, rather than holding natural gas in storage indefinitely, the federal government could sell call options on the natural gas injected into storage for this coming winter, pursuant to a competitive bidding process, to make it available to end use customers and LDC's. In an ideal (i.e., which is to say, non-existent) world, in which politics were not an issue, and the only objective was to rebuild storage in an orderly and efficient manner, such purchases could be made directly by the Department of Energy, the Federal Emergency Management Agency ("FEMA"), the Department of Homeland Security or the Department of Defense. Special authorizing legislation might be required, although it is possible that at least some purchases could be made at the direction of the President under existing legislative authority. Given the politics involved, however (i.e., the perception that if the Bush Administration initiated such a program it might be trying to benefit the oil and gas industry), President Bush might understandable be reluctant to order any federal agency to make such purchases directly. At least one possible alternative approach, therefore, might be to shift the responsibility for deciding whether to make such purchases to state governors, by providing federal grants or loan guarantees to support such purchases, but leaving the decision as to whether to purchase additional quantities of natural gas for injection into storage up to each state. The ability to obtain federal support might be allocated based upon expected winter demand, expected total demand for the year or pro rata based upon population. The states, in turn, might be permitted to assign their rights to LDC's and/or to end use customers in each state. It is possible that states purchasing natural gas for injection into storage under this sort of arrangement might be able to put in place hedging arrangements (e.g., caps and floors), that might effectively limit their exposure (both upside and downside) at the time they liquidated any supplies they controlled. Once again, the approach being suggested is entirely unorthodox – and certainly not intended to be instituted on a long-term basis. Instead, it is intended purely as a pragmatic method to quickly increase the rate at which natural gas is injected into storage this year, during a period in which the amount of natural gas in storage is drastically below minimum required levels and there is virtually no time remaining to cure the current deficiency. The current cash price of natural gas is at an all-time high for the second half of May. But it is not high enough to bring about as much fuel switching or demand curtailment as needs to occur in order to avoid a disastrous run-up in prices later this year, when the severity of the current storage deficit will be too severe for any market observer to miss. Every week that goes by, therefore, without injecting significantly larger amounts of natural gas into storage (i.e, at a bare minimum, amounts well above the 100 BCf per week + injections that were typical this time of year two years ago) virtually guarantees an even more severe price run-up later in the summer and/or early in the fall, with a potentially crippling effect on the economy before the end of the year.

3. Need to immediately identify potential candidates for fuel switching in the industrial sector and the power sector and to identify obstacles that must be overcome to maximize the amount of fuel switching during the remainder of the Refill Season and/or the winter heating season. A third, critical task that the Department of Energy should attempt to undertake is to immediately: (I) inventory potential remaining candidates for fuel switching in the generation sector and the industrial sector; (ii) assess the likelihood that these facilities will switch fuels and the potential impact on natural gas consumption; (iii) for each facility that is not currently planning to switch, identify the primary factors that are deterring such switching; and (iv) identify what actions, if any, might be taken at the federal, state or local level that might increase the amount of fuel switching that occurs between now and the beginning of the winter heating season. Completing a comprehensive assessment of every potential fuel-switching candidate in the U.S., in both the generation sector and the industrial sector, might take several months, even on an expedited basis. There is no reason, however, why it should not be possible to inventory all of the generating units owned by integrated electric utilities, independent power producers, major public utilities, generation and transmission cooperatives, as well as all of the large industrial boilers that have not already switched fuels that are owned by major chemical companies, steel companies, paper companies, metal refineries and other major industrial users of natural gas within the next 30 days. The number of companies that own such facilities is reasonably small. Most have reasonably good data regarding their facilities, available from a single point of contact. Collecting this information will give a much better picture than exists currently from any public or private source regarding the extent of the fuel switching capability that remains in the U.S. and the major impediments to tapping that potential. Having this information available, in turn, is essential for three reasons:

• In the end, the primary reason why most analysts and many regulators do not yet have a sense of urgency regarding the current supply deficit facing the U.S. market is the widespread belief that there is still a huge amount of untapped fuel switching potential that is likely to captured rapidly, now that oil prices have fallen from last winter's near-record highs.

For reasons explained in my last article, while at least some fuel switching potential clearly remains, all of the evidence I've seen indicates that this belief is largely a myth and that even at prices in the $ 8.00 – 10.00/MMBTU range the amount of additional fuel switching or other "demand destruction" that is likely to occur is unlikely to be any higher than 1.0 – 1.5 BCf/day. Most facilities that are still burning natural gas already have demonstrated more than once their willingness to continue using natural gas at prices above $ 8.00/MMBTU. Further, many new generators that are technically dual-fuel permitted decided to burn oil for a day (in order to demonstrate that they were in fact dual-fuel capable) and then immediately de-commissioned the equipment needed to burn oil, in part because burning oil even for short periods will foul the pollution control equipment at the plant. Other facilities that burned oil in the past (both industrial facilities and generators) – even in large quantities, and even as recently as the winter of 2000/2001 – have since been permanently converted to natural gas or have decided based upon changes in environmental requirements and/or expectations of lower natural gas prices that they were unlikely to burn natural gas in the future and have removed oil burners or tank farms or both. Still others are subject to much tighter NOx requirements this year than they were just two years ago and/or can only burn natural gas after the end of the ozone season on September 30th. Other facilities have been required to give up their dual-fuel entitlement as part of recent permit renegotiations with U.S. EPA or the states. Whether or not the remaining fuel switching potential is as limited as I have suggested, however, there is an urgent need for much better information regarding the level of fuel switching that remains feasible. Until such information is available, we will continue to live – as we do now – in what in a sense is the worst of both worlds: regulators and LDC's will tend to discount the significant of the current storage deficit, because they assume (with little or no empirical evidence to support their assumption) that a flurry of fuel-switching will occur now that oil prices have dropped and developers are reluctant to ramp-up drilling (causing production to continue to decline) because they fear that fuel switching will quickly drive down the price for natural gas. Only by having a much better sense of what is or isn't feasible can we put this issue to rest and accurately assess what measures are or are not necessary to avoid a disastrous outcome this winter.

• Further, whatever fuel-switching potential remains, it clearly isn't yet being fully realized. This is precisely why, despite remarkably little heating load or cooling load, last week only 72 BCf was injected into storage. This is 30 BCf below the injection level for the same week two years ago and 50 BCf below the injection level required to rebuild storage to adequate levels by the end of the Refill Season in mid to late October.

It is imperative, therefore, that we understand as quickly as possible what the major impediments are to tapping whatever additional fuel switching potential remains, how much fuel switching reasonably can be expected at different price points and the steps that need to be taken in order to maximize the amount of additional fuel switching that occurs. Absent this information, it is inevitable that the end-of-season deficit will be far steeper than necessary, with the potential for unprecedented price run-ups before the end of the year.

• Finally, while I am opposed, on philosophical grounds to suggesting any type of mandatory fuel switching requirements at the federal or state level, I believe that merely identifying potential fuel switching candidates, and pin-pointing where the potential to reduce natural gas consumption during the remainder of the year is most readily available, may result in additional fuel switching occurring (either immediately, or at least more quickly than might otherwise occur if potential candidates had not been identified as part of a public process).

There are likely to be at least some facilities that are currently right on the cusp as to whether the economics currently support switching; identifying these facilities and highlighting the importance of switching fuels as part of a concerted effort to avoid a national emergency this winter may well be sufficient to induce the owners to switch fuels – in some instances even if there is a slight cost penalty in switching fuels. In other instances, identifying the facility might accelerate the planning process, and thus speed up the date on which a switchover occurs if and when the economics support a changeover. Finally, there are a number of power plants in which, from a fuel cost perspective, the economics may already support fuel-switching, but the owner is nonetheless reluctant to switch, since fuel switching would be likely to result in a significant increase in maintenance costs (which may have to be absorbed by shareholders) while any reduction in fuel costs would be flowed through automatically to ratepayers. In these situations, also, merely identifying potential candidates may be sufficient to facilitate a solution (e.g., action by the state PUC allowing the plant owner to net out any increase in maintenance costs against any fuel cost savings flowed through to rate payers, eliminating the disincentive that currently exists to switch fuels).

4. Potential need to consider granting emergency waivers of restrictions on the number of hours for which fuel oil can be burned at certain facilities. During the remainder of the Refill Season, the potential for fuel switching undoubtedly would be greatly enhanced by eliminating or relaxing federal, state and local restrictions on emissions associated with burning oil. As the dimensions of the current crisis become more apparent, therefore, many in the industry undoubtedly will call for elimination of these restrictions. If the crisis becomes severe enough, it is conceivable this will occur (but not particularly likely – even under an extreme scenario). The opposition that will be engendered, however, will be ferocious. An alternative approach, therefore, that might have at least a somewhat greater likelihood of achieving benefits this summer, might be to focus on a much narrower set of waivers. This might include, for example, allowing waiver only plants that are technically located within ozone non-attainment areas, but are situated in locations such that the adverse impact of allowing a waiver is likely to be de minimus (especially if the waiver itself is narrowly drawn). Alternatively, waivers might be allowed only if there are offsets (but with the offset requirements applied somewhat more liberally), or only during days or weeks in which ozone conditions are moderate (e.g., September but not July) or only if the facility makes a firm commitment to install specified control equipment by a specified future date that would not otherwise be required for that facility (e.g., for some power plants, SCR). Even approaches along these lines undoubtedly will encounter fierce resistance; however, they might have at least some greater possibility of yielding results this year, when the crisis is most acute, and perhaps could be tied to federal funding to help support installation of control equipment at a future date.

5. Need to develop emergency conservation programs at both the state and federal level and speed-up installation of energy-tracking and control systems, particularly at commercial and industrial facilities. In terms of steps that can be taken with a potential near-term pay-off, emergency conservation measures clearly should be part of any overall program. Preparation to begin rolling out these programs on a major scale nationally needs to begin right now; the height of the summer cooling season is only about 8 weeks away and the winter heating season begins less than two months after the summer cooling season ends. Voluntary conservation efforts clearly will be part of what's required – particularly given the short-lead time available. In addition, we need to begin focusing systematically on the potential to dramatically reduce energy consumption in commercial office buildings, retail shopping malls and other retail stores – both on the natural gas side and on the electricity side. This is where the greatest low hanging fruit lies; most experts in energy management believe that a typical commercial user wastes 25 – 40% of the amount it spends on energy. Quite literally, U.S. businesses are throwing $ 25 –40 billion per year out the door. We can only begin to tap the potential to reduce consumption in this area between now and the end of this year – but we can at least start. We also can achieve significant gains by rolling out advanced, moderately priced energy information and control systems. Many businesses are able to track on close to a real-time basis how many paperclips they've ordered, but have little current information regarding their energy costs and even less ability to quickly adjust their consumption. During the remainder of this year, businesses that lack this capability may see their bottom line suffer very painfully – at a time when the stock market penalizes severely even small variances from expected earnings. The more quickly businesses develop the ability to track and control energy usage on a close to real-time basis, the better the odds that consumption of natural gas can be more quickly brought in line with the limited supplies likely to be available to the U.S. market.

6. Need to ensure adequate supplies of residual fuel oil, distillate and propane. As noted in last week's article, supplies of distillate currently are near record low levels, which may significantly limit the potential for fuel switching during the remainder of the Refill Season, to the extent additional fuel switching opportunities might otherwise still remain. Further, in prior winters, limited supplies and/or higher-than-normal prices for residual fuel oil and/or propane have limited the potential for fuel switching in the industrial sector and/or increased residential consumption of natural gas (for end users who have a choice of fuels). Since it will be absolutely critical to minimize natural gas consumption throughout the next 9 – 12 months (and in all likelihood, beyond), the Secretary also should begin assessing immediately: (i) factors that might limit supplies or increase prices for any of these alternative fuels; and (ii) steps that can be taken to assure adequate supplies.

7. Need to identify and implement any measures that can be taken to expand supplies of natural gas between now and the end of the winter, to the extent such supplies realistically can be expanded. Realistically, given: (i) the lead time required to plan to develop new wells; (ii) the time required to raise additional funding and plan and schedule additional rigs and crews; (iii) the limited number of prospects in the current inventories of many developers; and (iv) the lag time between the completion of new drilling and the time when a typical new well is hooked up to the gathering system, tested and begins commercial production, the extent to which any significant increase in production can be achieved this year, beyond development efforts that are already planned, is minimal at best (i.e., in all likelihood, no more than, at absolute most, a few tenths of a BCf/day by the end of the year, beyond the development efforts that are already planned). Given the urgency of the current crisis, however, any discernible expansion in production (or at least slowdown in the rate of decline) is certainly desirable – and will help to accelerate the date by which the continuing decline in production from U.S. wells potentially can be brought to a half (i.e., potentially by the second or third quarter of next year). Thus, the Secretary should certainly begin exploring immediately all feasible steps that might be taken to increase supplies in the last two quarters of this year and early next year. These actions might include: (i) some form of federal loan guarantee, back-up purchase commitment or other mechanism to facilitate financing of additional drilling by small independent developers (who generally have been cut-off from many of their traditional sources of funding); (ii) exploring means to more rapidly increase imports of LNG; and (iii) looking at the potential to bring back into service moth-balled compressed natural gas plants (which can be used to convert natural gas liquids into CNG). While the potential impact of these measures is limited, they would provide at least some further benefit, in a market that, absent extraordinarily mild winter weather, even under a "best case" scenario, will make last winter's record-high prices look tame. Conclusion
The recommendations just offered are presented purely in the hopes of stimulating further discussion. None of the recommendations provides a "silver bullet" solution. At least in my judgment, there is no quick, easy solution; the "looming challenge" we face runs far too deep. Further, the recommendation that might have the most significant near-term impact – i.e., allowing the federal government to step in and immediately begin purchasing additional quantities of natural gas for injection into storage – in all likelihood would spark too much controversy to be aggressively pursued (despite the urgency of the crisis we now face). I don't pretend for a moment to have either the knowledge or the wisdom to develop on my own a comprehensive program to respond to an urgent national problem. Nothing would please me more, therefore, than if others respond to my initial suggestions by offering other, better developed and/or more creative proposals. We all share a common interest in trying to keep under control a problem which could have a devastating effect on the economy over the next 6 – 9 months, especially if the winter is as cold as the last recent cold winter (i.e, just three years ago in the 2000/2001 winter season). I’ll be more than satisfied if my contribution is merely to spur further discussion of what should be done next. I'd like to end on a strictly personal note: nothing of what I've said either in this article or in earlier presentations is intended to be alarmist. Instead, to the contrary, I am an optimist by nature. It makes me extremely uncomfortable, both personally and professionally, to be writing articles, presenting programs and making television appearances that sound a note of concern – as I have been doing for more than a year. This is especially true since I am convinced that, once the urgency and depth of the problem we face is fully understood, we will find solutions – and ultimately be stronger both as an industry and as a nation as a result. At the same time, however, I believe that anyone who looks carefully at the fundamentals of supply and demand of natural gas in the North American market, and expresses their views candidly, inevitably must conclude that the U.S. natural gas market has been operating in an extreme deficit position for more than a year. This deficit (i.e., over the past 15 months, more than 1.25 TCf) was temporarily masked by the storage surplus that developed late in 2001. This surplus, however, has now been entirely eliminated and replaced by all-time record storage deficit that will be nearly impossible to overcome in the short-time remaining between now and the end of the Refill Season in mid to late October – especially in an extremely undersupplied market, in which total supplies for the year are likely to fall far below EIA's most recent estimates of projected demand and the potential for fuel switching almost certainly is far more limited than many industry analysts recognize. As we head into this coming winter, therefore, with supplies of natural gas available to the U.S. market almost 2.0 TCf/year below 2001 levels, we face the likelihood of the most extreme supply crunch ever encountered in the U.S. market – with the potential for prices to reach unprecedented levels before the end of the year. We owe a debt of gratitude, therefore, to Secretary Abraham for not trying to duck these issues, and instead being forthright in acknowledging the urgency of the impending crisis. In response to his remarks, I've tried to offer a few initial thoughts regarding actions the Secretary of Energy can take immediately to attempt to reduce the severity of the potential supply shortages and price shocks we face over the next 6 – 9 months, both in the natural gas market and in regional electricity markets. In subsequent articles, I will try to offer, in the same spirit, recommendations for intermediate term (i.e., 1 – 4 year) and longer term (i.e., 5 – 10 year) actions to address an ongoing crisis that I believe is virtually certain to have far-reaching impacts on the U.S. economy – not just this coming winter, but at least for the remainder of this decade, and perhaps for many years thereafter.