Consider hedges for volatile natural gas prices

With the fragile state of the current economic recovery, one of the last items for many companies to consider is making investments to hedge against rising energy prices.  However, for a variety of reasons, facilities that use natural gas for production would be wise to consider the risks of regulatory changes that may raise natural gas prices.

For many companies, one of the few bright spots in the past several years has been the decline in the price of natural gas. Natural gas is currently selling at less than half of its 2008 peak price, primarily due to the expansion of natural gas production from domestic shale reserves. While geologists have long known that the United States had rich reserves of natural gas tied up in shale, it is only within the past decade that a new process called hydro fracturing or “fracking,” has been deployed on a large scale by energy exploration companies to unlock those deposits and bring additional natural gas supplies to market.  As production has scaled up, prices have trended down and stayed down.

While many analysts see this trend as likely to continue for the foreseeable future, it is unlikely to last in the long term.  States and the federal government are moving to regulate development of new fracking wells, potentially slowing the increase of supply, at the same time that demand for natural gas is rising and will likely continue to do so. The resulting uncertainty creates a risk of upward price pressure on natural gas.

While a 2005 law essentially prevents federal consideration of the impact of fracking on groundwater, states have started moving on their own towards regulating the process.  Colorado and Wyoming have taken steps to require disclosure and recordkeeping by drillers, while New Jersey and New York have considered imposing a moratorium on the practice. The federal government is also taking action. EPA is evaluating the use of diesel fuel and its injection underground under EPA’s existing authority under the Safe Drinking Water Act, and has proposed regulations for air emissions from fracking operations. This increase in regulation, especially moratoria, may put a damper on the expansion of shale gas supplies.

At the same time, natural gas consumption by the power sector has risen, and will likely continue to rise.  The U.S. Energy Information Administration notes that while coal consumption to generate power declined by 6 percent between 2008 and 2011, natural gas usage increased 2 percent over the same period. The trend is likely to continue due to the approximately 23 gigawatts (23,000 megawatts) of coal fired generation currently slated for retirement. In addition, many industrial sources are considering converting boilers to natural gas in light of EPA’s proposed stringent regulations for new industrial boilers.

What this all means is that companies may want to take a second look at investing in energy efficiency and possibly even renewable energy projects. While "sustainability" can be a vague term, many sustainability projects incorporate an energy efficiency component, and pay for themselves on a three- to five-year timeline. In addition, some or all of the projects may be eligible for favorable state or federal tax treatment under the Production Tax Credit or New Market Tax Credit programs, which make project economics even more attractive to companies willing to invest in efficiency or renewable energy. While these tax programs are currently in place, it is always possible that these incentives could be scaled back as part of the future budget negotiations. The same may be true for energy efficiency programs currently offered through Wisconsin’s Focus on Energy program.

Like all good things, low natural gas prices, too, must some day come to an end, and the convergence of new state regulations on fracking and increasing demand for natural gas are likely to accelerate that timeframe. So while companies may have little concern about managing energy prices today, now may be a prudent time to investigate and pursue projects that will pay off over the next decade.

Peter Tomasi, a partner with Quarles & Brady LLP, specializes in environmental permitting and environmental litigation.

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