Natural Gas Markets Update for the Ethanol Industry. Identifying Market Fundamentals and Managing Price Risk

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1 Natural Gas Markets Update for the Ethanol Industry Identifying Market Fundamentals and Managing Price Risk

2 Presentation Outline Natural Gas Market Update Demand Issues Supply Issues Implications for Ethanol Producers Exposure to Price Risk Costs for thermal processes Costs for electricity Risk Management Options Hedging Combined Heat and Power

3 Natural Gas Prices at the Wellhead have been High and Volatile Source: Energy Information Administration, Annual Energy Outlook 2004

4 Why? There has been a fundamental shift in the natural gas supply/demand balance that has resulted in higher prices in recent years. This situation is expected to continue, but can be moderated. Key Finding of National Petroleum Council Report to Energy Secretary Spencer Abraham (September, 2003)

5 Trends in Key Supply Variables Productivity of existing North American reserves is dropping. Access to new reserves is limited. The ability to increase imports is also limited.

6 Source: Energy Information Administration, 2004 Well Productivity: Wells located in mature basins are declining in output

7 Access to new reserves is limited: Many potential domestic reserves are off-limits to development Source: National Petroleum Council, September 2003

8 Available Reserves: Traditional Major Natural Gas Producing s and Pipeline Transportation Corridors in the U.S. Western Canada Sedimentary Williston Michigan Green River Powder River Denver- Julesberg Illinois Scotian Sable Island Uinta/Piceance Hugoton Appalachian Sacramento San Joaquin San Juan Permian Raton Anadarko/ Arkoma East Texas/ North Louisiana s 15,000 12,000 9,000 6,000 3,000 0 Black Warrior Capacity (in Million Cubic Feet per Day) as of June 2002 Gulf Coast South Texas = Direction of Flow = Bi-directional Source: Energy Information Administration, GasTran Gas Transportation Information System, 2003

9 Source: National Petroleum Council, September 2003 Import Limitations: Existing LNG terminal have limited capacity, new terminals must still be built

10 Trends in Key Demand Variables North America maintains a high level of utilization of natural gas. Reliance on natural gas for electricity generation is expected to grow

11 High Utilization: Natural gas consumption has grown from 21 tcf in 1990 to 26 tcf in Source: National Petroleum Council, September 2003

12 New Electric Demand: Most new generation capacity utilizes natural gas (primarily for environmental reason) Source: National Petroleum Council, September 2003

13 New Electric Demand: Electric generation represents the highest sector demand growth for natural gas History Industrial Projections 8 6 Electric generators Residential Commercial CNG vehicles Source: Energy Information Administration, Annual Energy Outlook 2003

14 New Electric Demand: 1997 Daily Gas Loads show dominant winter demand driven by weather. Source: National Petroleum Council, September 2003

15 New Electric Demand: Projected 2025 Daily Gas Loads demonstrate the impact of electricity generation Source: National Petroleum Council, September 2003

16 Implications for Ethanol Producers Short Term Higher and variable net operating costs for thermal operations utilizing natural gas as the primary fuel Negative impact on cash flow projections Creditworthiness Long Term Higher and variable net operating costs for electricity as natural gas pricing begins to drive electricity prices Negative impact on general asset valuation Increased perceived risk among investor community

17 Risk Management Options Commodity Hedging Execute purchases of natural gas and electricity when market prices are: Marginally competitive Meet internal cost goals Types of hedging: Physical Hedging Purchase natural gas and place into storage for use when spot prices are high Financial Hedging Purchase electricity and natural gas through futures contracts to fix costs for portions of projected loads Invest in CHP Assets Generate electric and thermal output simultaneously. Benefits: Higher level of reliability Greater efficiency of total energy portfolio Electric generation becomes an asset in deregulated markets Can serve as a type of physical hedge for electricity End user can choose between generating or purchasing from grid.

18 Conclusions Natural Gas prices are expected to remain high and volatile for the next several years Volatility is being driven by perceived supply shortages in the face of increasing demand. Electricity prices will eventually reflect natural gas price volatility. More electricity will be produced by natural gas-fired plants. Hedging allows market participants to mitigate price risk. Purchasing commodities must be a planned activity. CHP technologies Provides a more efficient use of total commodity portfolio.

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