New Gas Fields a Deterent for Long Term Contracts

By BEN CASSELMAN AND REBECCA SMITH

In a sign that low natural-gas prices are probably here to stay, big U.S. energy companies are pushing to sign long-term contracts with electric utilities and other customers.

Major producers such as Chesapeake Energy Corp. and Devon Energy Corp. are trying to reach multiyear deals—likely five or 10 years long—that would guarantee them buyers for their gas but would deny them the benefits from any sudden price increases.

For a decade, energy companies have shunned such agreements because they wanted to profit when gas prices soared, as they often did, especially in advance of rising winter demand for gas heat.

But huge new gas fields in Texas, Louisiana, Pennsylvania and elsewhere have led to a surge in U.S. natural-gas production, glutting the market even as the recession has sapped demand for all forms of energy. Prices have plummeted to less than $6 per million British thermal units, less than half their price in July 2008.

"The days of double-digit gas prices in the U.S. are over," said Chesapeake Chairman and Chief Executive Aubrey McClendon.

Gas executives, however, are finding that long-term deals are an unexpectedly tough sell. The same price stability that has made producers eager to sign contracts has made their customers reluctant, because they are less worried that prices will suddenly rise.

"Producers would like contracts, but as a buyer, I don't think we need them," said Steve Warnick, senior vice president of energy-supply services for NiSource Gas Distribution, a unit of electricity and gas distributor NiSource Inc. in Merrillville, Ind.

Low prices are good news for homeowners, who can expect to pay 11% less on average for gas heat this winter than last and who have also seen electricity prices fall. But producers have been forced to slash budgets and sell assets as their revenues have dropped.

Long-term contracts are common outside the U.S., where international shipments of liquefied natural gas are sold under contracts that often stretch 20 years or more. Long-term deals are also often used in the U.S. to sell coal; boosters of long-term contracts say they will make natural gas more competitive with coal, which is usually cheaper but emits more pollutants when burned.

Until recently, energy companies needed to hunt continuously for relatively small, short-lived gas fields, making it hard to guarantee supplies far into the future, and prices had generally been rising.

The new gas fields are changing the equation because they contain vast quantities of gas that is relatively inexpensive to pump and is expected to last for decades, making it easier for producers to make long-term commitments.

"There's certainly the potential for the natural-gas producers and the utilities to develop a new relationship that has not been possible historically," said Larry Nichols, chairman and CEO of Devon Energy.

Earlier this month, Exxon Mobil Corp. agreed to buy U.S. natural-gas producer XTO Energy Inc. in a $31 billion stock deal that was widely seen as an endorsement of the new gas fields' long-term viability. Exxon has experience with long-term sales contracts through its large liquefied-natural-gas operations overseas, and many experts think the company will pursue them in the U.S. Exxon hasn't discussed its plans.

Long-term contracts also face obstacles in markets where energy contracts are subject to government review. If market prices rise above the contract price, consumers benefit. But if prices fall, local gas and electric customers could be stuck paying above-market prices, a risk regulators would prefer to avoid.

"We'd have to go back to regulators and get approval," said Joe Hopf, who heads trading operations for Public Service Enterprise Group Inc., a New Jersey-based power company. The company is building three new gas-fired generating plants but has no plans to enter into long-term fuel-purchase deals, Mr. Hopf said.

Producers, however, remain optimistic. Devon's Mr. Nichols said he expects to see a gradual shift toward long-term contracts, beginning with some relatively small deals to test out the idea.

Smoothing out volatile prices makes sense for both producers and their customers, he said, adding, "The peaks are politically unattractive, and the valleys are economically unattractive."