EXECUTIVE SUMMARY

INTRODUCTION

Jensen Associates, Inc. has been asked by Northwest Alaskan Pipeline Company (NAPLINE) to analyze the marketability of "rolled-in" Alaskan natural gas and to establish its competitiveness both with other gas sources and with alternate fuels. It is important to recognize that this study was commissioned to review the commercial--as distinct from the policy--aspects of Alaskan gas utilization. As such, major national policy issues in the decision to develop an initially high-cost U.S. gas source, such as security of supply, balance of payments, and national cost/benefit relationships were deemed to be beyond the scope of this assignment. The study was to pay particular attention to the short/ medium term, defined as the period of construction and early operation of the pipeline. The period of major interest of this study, therefore, is the decade of the 1980s.

SUMMARY AND CONCLUSIONS

The market environment for natural gas in the United States has undergone a major structural transformation over the past decade. The industry entered the 1970s with a record of rapid and stable growth only to see its expectations falter in the face of shortages of low-cost conventional gas supply. It successively encountered the problem of shortage allocation, a search for gas supplements, a restructuring of the market through user conservation, major legislation which altered its regulatory climate, and, finally, a deterioration in the fortunes of competitive fuels, particularly, fuel oil. While forecasts of the future of gas markets made in 1979 bear little resemblance to projections made ten years earlier, we believe that it is possible to lay out the market prospects for high-cost gas supplements with greater confidence today than has been possible for several years. We believe the market prospects for Alaskan gas are excellent at the cost levels anticipated in this report.

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Several of the recent changes in the natural gas market environment have served to cast doubt on the prospective attractivenes of high-cost gas supplements. Demand is much less today than was anticipated even five years ago, since a substantial degree of user conservation has already taken place and more is expected. Natural gas prices have risen rapidly and still greater increases are expected as a result of Natural Gas Policy Act (NGPA) wellhead pricing provisions and the price implications of supplementary supply. But gas supply has also failed to live up to earlier expectations so that a shortfall of conventional supply still remains. More importantly, however, the Iranian revolution and the resulting OPEC oil price increases have signalled the end of an implicit policy whereby oil imports are used by default as the U.S. energy supply of last resort. As long as imported oil is constrained from displacing gas markets, we believe that the demand for gas supplements to augment conventional supply will remain strong.

Our projections are based on an anticipated excess demand for natural gas-a "gas gap"--over and above likely gas supply. Thus, despite our conservative projections of growth in demand (because of our expectation of continuing conservation), supplements are needed to offset expected continued decline in conventional supplies. Our estimates of potential demand, expected supply, and the resulting "gap" are summarized in Table 1. Even with Alaskan supply we expect a growing gap to 1990. In our view, the combination of accelerating oil prices with the various actions of administrative policy to limit oil imports will virtually insure that U.S. natural gas will retain markets which oil could otherwise serve. Thus, we believe the gas gap projection is realistic in the context of energy policies and economics of the 1980s and it virtually assures that Alaskan gas--rolled-in as permitted under the NGPA--will be marketable.

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b/

Includes some demand which switched on the basis of price.

Source: Jensen Associates, Inc.

I. THE MARKET FOR ALASKAN NATURAL GAS DURING THE 1980s

From the end of World War II until the beginning of the 1970s, the United States natural gas industry enjoyed a long period of rapid market growth in comparative stability. The 1970s have been a period of continuing market uncertainty for natural gas as it became the first of the major energy sources to grapple with shortage allocation and pricing in the face of limited supply. Two major changes in the structure of gas markets, first to shortage and then back to seeming surpluses, have been generally apparent since 1970. In our view, the gas industry entered still a third transition of market outlook with the Iranian revolution and resulting OPEC oil price response in late 1978. This new market environment for natural gas--the fourth discrete pattern in this decade-is based on a new political and economic urgency for the U.S. to minimize oil consumption and to utilize natural gas wherever it is the most reasonable alternative to oil. We see no real end to the emerging pattern of gas demand in excess of foreseeable supply as long as imported oil will be constrained from displacing gas markets. As a result, we believe that a strong market demand has been created for Alaskan gas, as well as for imported Canadian, Mexican, LNG and other supplementary supplies which help contain the growth of oil imports.

Our projections are based on the expectation of a "gas gap" or excess demand for natural gas above and beyond foreseeable supply. Market economists will argue that excess demand can only exist in the presence of price regulation since in a free market prices would rise to clear the market and eliminate the potential shortage. We cannot disagree with that premise but recognize that some form of residual price controls remain on natural gas despite the "deregulation" nomenclature applied to the Natural Gas Policy Act of 1978. However, it is important to understand that much of the clearing which would take place in the presence of full deregulation, or allocation-such as curtailment and prohibition of certain uses--without it, would result in increased U.S. oil demand. In our view, this clearing of natural gas markets in favor of oil was actually in the process of taking place in late 1978 with the relative price action of industrial oil and natural gas at that time;

it was reinforced by incremental pricing provisions of the NGPA which were, in part, designed to assure that such clearing would occur by the 1985 target date of new gas deregulation. This has now all been changed by the international oil crisis, precipitated by the Iranian revolution and confirmed by OPEC oil price action. If rapidly accelerating oil prices do not insure that U.S. natural gas will retain markets which oil could otherwise serve, the various actions of Administration policy to put a lid on oil imports will certainly do so. We doubt that any FERC administration of incremental pricing will be allowed to shed gas load in favor of oil on the basis of price alone. Thus, we believe that the projection of excess demand or a "gap" is realistic in the context of energy policies and economics of the 1980s.

Table 1-1 summarizes our projections of potential gas demand, gas supply, and gap for 1980, 1985, and 1990, compared to 1972 and 1977 actuals. Compared to 1972 the gas industry shed some load in plants which had switched to alternate fuels by 1977 and this demand is separately identified and forecast. Most of the industrial load not served in 1977 that was served in 1972 has switched to oil. We believe that the market pressures for this load to return to gas, as well as the market pressures for new industrial load to go to gas are strong. Compared to our total potential demand, we have a widening gap with and without Alaskan gas. The 1977 "gap" was in part a voluntary switching to other fuels, such as oil, at a time when industrial gas and oil prices were approaching historic parity levels. The projected "gaps" are in the face of an expectation of rising real prices for oil.

The four discrete periods of market structure for natural gas in the U.S. have each provided a different perspective from which to judge the outlook for high-cost gas. Since public perceptions of the nature of the gas market have not always kept up with the rapid changes which have actually occurred, gas policy arguments are frequently advanced which are no longer supported by the present reality of the marketplace. In order to understand why the present gas market outlook is strong, and should remain so, it is important to distinguish the characteristics of this market from the ones which preceded it.

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