Carpe Diem: Meeting the Growing Demand
for Natural Gas
Remarks Of Thomas F. Farrell II
Chief Executive Officer
Dominion Energy
To The Interstate Oil & Gas Compact Commission
June 12, 2000
Thank you, and good morning.
Special thanks to the IOGCC for inviting me here to share
Dominion's perspective on the National Petroleum Council's 1999 report and the
challenge of meeting our nation's future energy needs.
I'm pleased that my own company contributed intellectual
capital to the NPC report. Our chairman, George Davidson, served on the Natural
Gas Committee that helped prepare it.
If you've been around the gas business, you probably know
George - or know of him. He was the chairman of Consolidated Natural Gas, which
merged with Dominion earlier this year to form the nation's largest fully integrated
gas and electric company.
The Council's report is thorough and thoughtful and makes
a valuable contribution to the forecasting research on natural gas demand over
the next 10 to 15 years.
Its findings also reveal an unprecedented opportunity for
the gas and electric industries to work together for mutual benefit and to collaborate
with regulators to remove barriers to the robust and efficient energy marketplace
we all wish to create.
The potential for such a dual-industry partnership has never
been stronger, and the need has never been greater.
The 1999 NPC report sees demand rising beyond 30 trillion
cubic feet by 2015 - a forecast shared by the American Gas Association and others.
That's an increase of more than 40 percent about the 1998 demand level, and
it raises several important questions:
Will gas supplies be adequate to meet dramatically higher
demand?
Will the pipeline infrastructure be there to deliver the product?
Will the industry rise to meet the challenge?
The questions are certainly easier than the answers. But as economist Paul Samuelson
once said, "Good questions outrank easy answers."
No easy answers exist when it comes to predicting the future
- particularly when you're dealing with an energy marketplace that's changing
rapidly and steadily.
I'm hopeful the industry can deliver on the challenge of
meeting the future demand for natural gas. And I'm optimistic about our prospects
- as long as we have supportive regulation that eliminates barriers to innovation,
technological advances and stable markets for converging energy services.
We can all take our cue from the old proverb that says, "Nodding
the head does not row the boat." Let's get the oars in the water and start
rowing the boat. There's no time like the present.
Gas has taken on savior status in the energy business, thanks
to a strong economy, competitive gas markets, environmental advantages and a
growing interest in gas as the preferred fuel source for electric generation.
Just look at General Electric's enviable situation. As the
leading gas turbine manufacturer, GE says it will ship 244 gas turbines worldwide
this year, up from 65 in 1998 - almost a four-fold increase. And the company
says it expects to ship 325 gas turbines in 2001.
Not since the Carter era has the gas industry experienced
anything like the present situation. Back then, both nuclear power and coal
were mired in problems. The outlook for gas was bullish, with demand for its
product accelerating and public policy supportive of competitive energy markets.
Unfortunately, the government imposed wellhead price controls
to remedy the problem. That only made matters worse as gas companies struggled
under massive take or pay contract settlements.
So by the time needed gas supply got to market in the early
'80s, a recessionary economy ended the gas industry's opportunity to shine.
Today's gas industry should be mindful of history. The circumstances
we face today demonstrate that opportunity does knock twice.
What makes today's situation different - and far more promising
- is the ongoing restructuring of the electric utility industry, which is stimulating
the gas business significantly.
The need for new generating capacity is lending support to
the need for new or expanded gas infrastructure in markets where the demand
is real.
In addition, with the increased interest in gas by electric
generators and other large users, the industry's traditional supply and demand
dynamics are shifting. That is, today's electric load growth is boosting gas
demand to the point where pipeline projects can be built in areas that otherwise
wouldn't support them.
This confluence of factors presents the gas industry with
new and exciting opportunities for growth.
We're all familiar with the Latin rallying cry "Carpe
diem."
I can't think of a more appropriate call to action for those
of us in the energy business. We should seize this moment. Let's find new gas
supplies and build the pipes and wires and gas-fired generation needed to serve
wholesale and retail markets.
According to the National Petroleum Council report and other
sources, today's 1,466 TCF resource base - excluding Alaska - is sufficient
to get the job done. The key question is this: Can the industry produce sufficient
supply and deliver it to market at competitive prices?
My answer is YES - if we focus primarily on the business
of meeting real market needs with the resource base that's currently open to
exploration - and achieve satisfactory economic returns while we're at it.
As important as it may be for the gas industry to gain greater
access to currently restricted lands and rights-of-way, we have to ask: Is that
feasible as long as the existing resource base is sufficient to meet projected
demand?
I ask the question to point out that issues requiring changes
in public policy - such as the access issue - are long-term challenges, and
while important, should not divert the industry from focusing on its fundamental
mission - meeting real, near-term market needs and enhancing shareholder value.
Government intervention and government solutions didn't work
in the 1970s, and there's no reason for the gas industry to go down that path
again.
The access issue is comparable to the electric industry's
dilemma over nuclear waste disposal. The political challenge far outweighs the
technical one, with public perception driving the machinery of policy.
I'm not proposing to raise the white flag on the access issue
or on any other meaningful public policy concern facing the gas industry. I'm
merely cautioning against paying an undue amount of attention to the side show
and not enough to the main event.
As the nation's largest fully integrated gas and electric
company, Dominion intends to be in the center ring under the Big Top. We're
committed to helping meet the natural gas challenge at every point along the
energy production and delivery chain - from the wellhead to the end user.
Our E & P unit - Dominion Exploration & Production
- is active in both onshore and offshore oil and gas development, from western
Canada to the Gulf of Mexico. And we're going to do our share to recover the
reserves needed to meet future demand.
I would characterize our supply-side outlook as cautiously
optimistic.
We agree with the NPC assessment that most of the new supply
is going to come from the Rocky Mountain Basin and deepwater Gulf of Mexico.
We also think Canadian resources will play an increasingly important role.
The NPC report forecasts onshore production from non-conventional
sources, such as coal-bed methane, at 9 TCF by 2015. That level is attainable,
but in order to get there the industry must have an extension of Section 29
production tax credits beyond the current 2002 limit.
Extending these tax credits would provide industry with the
incentive needed to expand drilling to include marginal wells - not only in
the Rockies but also in Appalachia and other areas.
Advanced drilling technologies and efficiency improvements
in both onshore and offshore rigs will help ensure expansion of the existing
resource base, while reducing environmental impacts at the same time.
We think the NPC projections may underestimate the total
number of new rigs needed to reach 25 TCF in supply by 2010 and 27 TCF by 2015.
It's unclear at this point whether the number of wells drilled
annually and the level of drilling efficiency will increase enough over the
next 10-to-15 years to compensate for the anticipated 25 percent reduction in
operating rigs.
What is clear is that new exploration and production, particularly
offshore, is going to require significant capital investment and higher operating
costs for new rigs.
But if wellhead prices remain above $3 per million BTUs,
the industry has a strong incentive going forward to expand its drilling fleet
to produce the needed supply.
In fact, a recent study by Washington Policy and Analysis
indicates the prospects are good for meeting demand in 2015 with wellhead prices
in the mid-$2 range, adjusted for inflation.
Financial incentives, technological advances and short-term
gas prices aside, the biggest challenge in the E& P area may well be achieving
more consistent levels in drilling programs, given the industry's historical
boom/bust cycles.
The industry's traditional approach has been to ramp up production
when prices are high and cut back when prices fall.
Admittedly, it's going to take a healthy dose of discipline
and a strong stomach to do otherwise.
The industry should adopt as one of its primary goals greater
long-term price stability - even if it has to live with continued short-term
volatility in wellhead prices.
With prices in the $3 to $4 range, it's tempting to be unhedged.
But for a company like Dominion, whose shareholders look for steady, long-term
growth rather than short-term swings, an active hedging program is the best
way to promote long-term earnings stability.
Are there other ways to encourage the industry to seek more
stable prices? As usual, the question is easier than the answer.
Fortunately, consumers are largely insulated from big swings
in wellhead prices thanks to today's more sophisticated risk management strategies
and improved technologies.
But an environment of increased long-term price stability
would benefit the industry in many ways. For one, it would help mitigate the
projected shortage of skilled workers in the offshore business, which the NPC
report discusses in some detail.
This is a serious concern for those of us engaged in exploration
and production. Unfortunately, there's no silver bullet that's going to remedy
the problem overnight. Workforce shortages are part and parcel of the ebb and
flow of the business cycle, and it's up to industry participants to offer highly
competitive wage scales in order to attract good talent.
Turning to the pipeline business, Dominion's gas transmission
operation is called Dominion Transmission - formerly CNG Transmission -- and
is headquartered in Clarksburg, West Virginia. We are well located to serve
the large gas-using markets in the Northeast, Mid-Atlantic and Midwest - the
region we've targeted for growth.
We intend to expand our pipeline and storage business to
improve reliability and the efficiency of the natural gas infrastructure in
this energy-hungry region. And to do so, we are prepared to invest to meet demand
that stems from real market needs.
Let me emphasize that my company is not prepared to make
infrastructure investments that are ill-timed, uneconomic and unnecessary -
just to advance a policy agenda or strike a pose for regulatory reform.
In addition to planned expansions in the pipeline business,
our generation unit - Dominion Energy - is building new gas-fired merchant peaking
capacity to serve deregulating markets in the northeastern quadrant of the U.S.
We currently have about 6,000 megawatts of new gas-fired
capacity -- both simple-cycle and combined-cycle combustion turbines - announced
or under development along existing pipelines in West Virginia, Ohio, Pennsylvania
and Virginia. Those units will all be in service by 2004.
We're also in a joint venture with Peoples Energy of Chicago
to expand the 600-megawatt Ellwood merchant facility. When fully built out,
Ellwood will be a 2,500-megawatt facility - the largest gas-fired facility in
Illinois, capable of serving about one million homes.
And later this month, we will bring on line a 566-megawatt
combined-cycle facility in Batesville, Mississippi.
We're actively evaluating a number of other sites as part
of an ambitious capacity development program that will enable us to be a major
player in our target market.
Electric transmission is the remaining critical factor in
the integrated, dual-industry approach to meeting future energy needs.
As you may know, transmission issues are at the heart of
the current debate over federal restructuring legislation - a debate that seems
to have no end on such matters as federal/state jurisdictional concerns, the
creation of Regional Transmission Organizations, and FERC permitting requirements
and rate design, among others.
To move this process along, the electric industry needs to
step up and resolve outstanding issues regarding the creation of RTOs to ensure
open access to the grid.
Then, we hope FERC will come through with an electric transmission
expansion policy that builds on its Order 2000 by streamlining the project approval
process and offering pricing incentives to help attract needed investment capital.
The Commission's recent decision to approve a Hydro-Quebec
merchant transmission project between Connecticut and Long Island is a step
in the right direction - but it's only a step.
FERC needs more innovative pricing schemes to facilitate
expansion of the power grid, improve interties between electric reliability
regions, and allow for the development of efficient energy markets.
With so many electric transmission issues unresolved, the
gas pipeline industry has an excellent near-term opportunity to expand as more
and more gas-fired generation gets sited and built close to markets where it's
needed.
I want to end my remarks as I began them - by applauding
the National Petroleum Council for producing a report that provides important
insight into the challenges that lie ahead for both industry and the regulatory
community.
I also want to conclude with a few recommendations - some
of which are offered to my colleagues in the industry and some to the regulatory
community.
First, to members of the gas industry:
Carpe Diem. Seize this moment and make the most of the opportunity
that lies before you. To quote Thomas Edison, "Opportunity is missed by
most people because it is dressed in overalls and looks like work."
Competition may be the name of the game today, but nobody
wins without effective cooperation between industry and government -- especially
in the public policy arena, where sustained, open communication and a long-term
perspective are essential.
We especially need to get behind regulatory reform that provides
incentives to invest and eliminates disincentives that obstruct efficient market
performance.
Speaking to the regulators in the house, we need a FERC that
is flexible and industry-oriented. Chairman Hoecker's "FERC First"
restructuring initiative is an excellent start and should help create a converged
agency better equipped to address pressing industry concerns.
We also need ratemaking policies that allow market rates
of return on investment because today's projects -gas or electric - will not
get built at yesterday's cost of capital. Investors need a reason to jump into
this business, and today's returns don't provide the springboard.
Industry will do its part to build the pipes and wires needed
to deliver energy where it's needed - and we'll do so as responsible corporate
citizens.
For its part, FERC needs to recognize the importance of maintaining
the industry's financial integrity and offer incentives that more accurately
reflect today's shifting risk/reward balance.
The Commission also should work for more timely approval
of meaningful, economical projects - respecting environmental laws and the rights
of property owners - without giving in to the demands of niche landowners. Our
industry is simply too important to the nation's economy to be held hostage
by special interests.
The real meaning of light-handed regulation is enlightened
regulation - the kind that encourages infrastructure investment, promotes efficient
deployment of assets, and allows competition to harness industry's creative
powers in order to bring innovative energy goods and services to market.
