GAS ECONOMICS How El Nino affects the US natural gas industry

Could plate tectonics in Eastern Pacific drive El Nino events?

The unusually mild winter of 1994-1995 caused considerable distress to the US natural gas industry. Gas prices collapsed during late 1994, triggering a slump in corporate earnings and stock prices. Another round of layoffs, restructuring, and mergers swept through the gas sector during 1995. The winter of 1994-1995 was an El Nino winter. Could El Nino be part of the problem?

Cross-disciplinary investigation of cyclicity in El Nino events, natural gas prices, and gas company earnings reveals a surprising trend: there have been four moderate-to-strong El Nino winters during the past fifteen years. Three of these winters (1986-87, 1991-92, and 1994-1995) have occurred since natural gas prices were deregulated in 1985 (Figure 2 [47526 bytes]). The El Nino events coincide with low or collapsed Henry Hub spot gas prices (Wilson, 1996, Flis, 1996). They also correlate with downsizing and corporate restructuring experienced by the author during his career in the gas industry.

Corporate earnings are shown in the 12-year chart inFigure 2 [47526 bytes]. Professional investors and readers of Peter Lynch's Beating the Street will probably recognize these charts.

Figure 3 [53033 bytes] shows a sector chart for US domestic oil companies which includes composite stock price, dividend and earnings data for eight large independent oil and gas companies - each with significant revenue from natural gas production. Recent El Nino events are superimposed on the chart. Stock prices are vertical bars; earnings per share are shown by the heavy black line with dots.

The earnings collapse in late 1985 and early 1986 coincides with falling world oil prices. The other earnings declines coincide with El Nino events - especially the 1991-1992 and 1994-1995 declines, when oil prices were relatively stable. The highest earnings occur during non-El Nino years. These correlations can be repeated with charts for individual petroleum companies, depending on a company's oil and gas price sensitivity and success at hedging. El Nino cycles correlate with profit cycles in the natural gas industry.

What is El Nino?

El Nino is "the second biggest climate driving force next to the change of seasons" states J. Laver (NWS-CPC, 1995). The event begins in the eastern Pacific Ocean, where a large pool of unusually warm water develops near the equator. The water temperature changes are described as sea surface temperature anomalies (SST).

Barometric pressures change and the easterly trade winds, which normally blow across the Pacific toward Indonesia, weaken or reverse direction. These pressure changes are shown by the Southern Oscillation Index or SOI (barometric pressure at Tahiti minus Darwin pressure) and by wind vector maps.

As El Nino develops, unusual westerly winds push warm, wet air into Ecuador, Peru, northern Mexico, California and Texas. Jet stream winds may shift in the Pacific Northwest (Wallace and Vogel, 1994). Long distance weather changes attributed to El Nino include:

• Unusually mild winters in British Columbia and the northern Rockies

• Heavy rains in California and floods in Texas

• Droughts in Australia and Japan

• Failure of the monsoon rains in Indonesia and India

• Variations in the Nile River runoff in North Africa

• Decreased hurricane activity in the Gulf of Mexico.

El Nino events have occurred at frequent but irregular intervals for at least the past 500 years (Quinn et al, 1987). During recent decades, El Nino events have occurred every two to eight years.

Why does El Nino occur?

Climatologists and oceanographers are collecting data with instrument buoys and satellites (Wallace and Vogel, 1994). Sophisticated computer models have been developed linking oceanic and atmospheric systems. Once a "hot spot" with high sea surface temperature develops, the transfer of heat and water vapor from ocean to atmosphere and the changes in barometric pressure can be explained.

Predictive models are gradually being improved and evaluated with forecasting skill ratios. But, there is still considerable controversy about why El Nino events get started. Kelvin waves, solar heating, and greenhouse effects are being debated. Some experts suggest that the wind changes the sea temperature. Others say that the SST anomalies drive the winds.

As noted in a recent article about recent El Nino modeling by Dr. Nicholas Graham at Scripps Institute: "...the obvious question: what warmed the tropical ocean? "I have no idea," Graham admits (Monastersky, 1995).

The East Pacific Rise

Some geologists and geophysicists have different ideas involving heat flow from hydrothermal plumes and subsea lava flows along mid-ocean ridges. There may be a plate tectonic drive mechanism (Shaw and Moore, 1988).

Dr. Daniel Walker at the University of Hawaii has been collecting seismic data in the Pacific Ocean for years, and notes that surges in earthquake activity near the East Pacific Rise (EPR) coincide with the onset of El Nino events (Walker, 1995; Walker, 1988). The northern East Pacific Rise extends about 3000 miles from Baja to Easter Island, and is described as an ultra-fast spreading center, with spreading rates of 11-16 cm/year in some segments. Roughly three to five ft of fresh lava are extruded every 10 years along this trend.

The crest of the northern EPR is not very deep: -1,690 to -2,650 meters (National Geographic Society - 1992). An inspection of the EPR during 1984 by the submersible Cyana (Renard et al, 1985) found semi-extinct black smokers venting 0C water (note - this was not an El Nino year). During April 1991, the submersible Alvin found fresh lava flows just two weeks old and a "tubeworm barbecue" where recently parboiled tubeworms lay rotting next to black smokers venting 400C low density water, hydrogen sulfide, metals and methane (Haymon et al, 1993). This was just after the start of the 1991-1992 El Nino event, and followed a pulse of increased seismic activity during February, 1991 (Walker, 1995).

In November, 1993, an oceanographic expedition cruised slowly along the EPR "yo-yoing" a logging tool up and down (Urabe et al, 1995). They concluded that 60% of the portion of the EPR which they surveyed was venting hot water in hydrothermal plumes. These observations followed a pulse of high SST during the summer of 1993 (Figure 2 [47526 bytes]).

• How much venting occurs during a severe El Nino?

• What happens to the hot water rising above the ridge, and how is it dispersed by currents?

• Could the hydrothermal plumes cause sea-surface temperature anomalies?

These questions cross several scientific disciplines and haven't yet been clearly answered. But, if hydrothermal activity is an important cause of El Nino, additional subsea instrumentation along the EPR (hydrophones, seismographs, temperature monitors, etc.) might provide an early warning system.

Affecting US climate

How does El Nino affect climate in the US? Climate changes attributed to El Nino events include strong westerly winds (blowing toward the east-northeast) which push warm, wet Pacific air across the western US. During El Nino years there are unusually heavy rains in southern California, Arizona and Texas (Diaz and Markgraf, 1992).

Shifts in the Asian jet stream pump mild air across the northern Rocky Mountains and southern Alaska. A well-documented and recurrent effect of El Nino is unusually warm, mild winter weather in western and central Canada (Diaz and Kiladis, 1992).

During the 1994-1995 El Nino, shifts in the jet stream and northeasterly flow effectively blocked arctic cold fronts from the western and north-central US. When arctic cold fronts are blocked, the result is mild winter weather in the north-central US.

Heating degree day tables provided by the NOAA show the relative severity of recent winters.Figure 3 [53033 bytes] shows heating degree-days (HDD) for the west and east north-central regions of the US (North Dakota through Ohio, including the energy-intensive Great Lakes industrial region).

HDD values approach zero every year during mid-summer, then peak during December and January. El Nino winters are noted on the graph. El Nino events correlate with winters having unusually low heating degree days. Also shown is a plot of US natural gas consumption. El Nino winters coincide with unusually low mid-winter gas consumption. The highest gas consumption occurs during non-El Nino winters.

Natural gas business

Each year, more natural gas is being used for different purposes, but gas is still primarily a heating fuel. Since deregulation in 1985, the price of natural gas varies in response to supply and demand. Supply depends on the strategies of hundreds of large and small gas producers, on gas storage, and on gas imports from Canada.

Demand consists of a base rate for year-around usage - currently about 43 Bcf/d of gas (Figure 4 [34663 bytes]). Base demand is rising at 3% per year as more customers connect to pipelines (Smith, 1995). The mid-winter surge is due to increased heating demand, and has recently peaked at 79-83 Bcf/d of gas, or about 40 Bcf/d above the base demand level.

The difference in HDD between a cold winter (1990-91 or 1993-94) and an El Nino winter (1991-92 or 1994-1995) is about 12-20%. Due to alternative fuels and fuel switching, not all of the peak in HDD translates to gas demand. The difference between peak gas demand in recent cold winters, versus mild El Nino winters, has been about 4 Bcf/d of gas. This is about 5% of the total gas demand or about 10% of the peak demand minus the base level. This 4 Bcf/d gas difference between cold winter and mild winter demand is about half of 1995 Canadian import pipeline capacity of 8.1 Bcf/d of gas (Smith, 1995).

The three El Nino winters since 1985 coincide with low HDD totals in the energy-intensive north central US region. North central region HDD and US gas demand show parallel trends. El Nino winters coincide with significantly reduced peak gas demand. Henry Hub spot gas prices collapsed or were unusually low during the 1986-1987, 1991-1992, and 1994-1995 winters. Prices fell, corporate earnings slumped, and stock analysts were disappointed. Layoffs, restructuring and mergers followed as poor earnings were reported during subsequent quarters and pressure was applied to corporate management to restore profitability. Some companies tried to restore profits by increasing production in spite of lower prices, flooding the market. Others decided to shut in wells, cut costs, and wait for prices to recover.

Hurricane activity

Another important effect of El Nino events involves hurricane activity in the Gulf of Mexico. Research by Dr. William Gray has shown that hurricane activity in the Gulf is influenced by three factors (Gray, 1995; Investor's Business Daily, 1995):

• Quasi-biennial Oscillation in the tropical Atlantic

• El Nino-Southern Oscillation cycle

• African rainfall.

During El Nino events, the easterly trade winds weaken and African rainfall is reduced, along with the monsoon rains in India. Remember the droughts and famines in Ethiopia? Meanwhile, westerly winds blowing across Mexico and Texas restrict hurricane activity in the Gulf.

Hurricane activity is typically subdued during El Nino years. But after El Nino events fade away, hurricane activity is likely to be more intense (Hurricane Andrew in 1992; Roxanne and Opal, 1995). So the probability of disruption of Gulf Coast gas and oil production due to hurricane activity is lowest during El Nino years, and increases after El Nino events fade away. This pattern can exacerbate the natural gas supply-demand cycles. Undisrupted, full gas supply is usually available from the Gulf region for mild El Nino winters. There is higher probability of gas supply disruptions after El Nino events fade away, just in time for the cold winters which follow.

Gas industry response

Should the gas industry pay attention to El Nino cycles? El Nino cycles appear to be deeply embedded in the supply and demand cycles of the US natural gas industry, as well as in agricultural economies around the globe. Successful prediction of the 1991-1992 El Nino enabled farmers in Brazil to change their planting strategies, switch crops, and avert economic ruin (Macilwain, 1995). Could the US gas industry benefit from El Nino forecasts?

Probably! Why did the gas industry go into the 1995-1996 winter with gas storage levels 11% lower than for the previous year (Smith, 1995)? Was industry looking ahead? Or looking backward at the previous mild El Nino winter? It was evident from NOAA's data that the 1994-1995 El Nino had faded away during the summer of 1995 (Figure 2 [47526 bytes]). Eastern Pacific SST turned negative during late l995 and a normal-to-cold winter was predicted for 1995-96.

Would a three-to-six month leading indicator showing the relative severity of upcoming winters be helpful to natural gas producers?

Strategy planning

How can El Nino cycles be used in strategy and planning?

• Understanding where we are in the cycle.

• Understanding the economic effects of previous El Nino events.

• Consider using cyclical, rather than linear or "hockeystick," gas price projections (Koch, 1996).

• Include El Nino events in long range planning scenarios.

• Anticipate when the next El Nino will occur.

Will the next event take place within three years, or ten years)? How would an oil and gas company adjust drilling schedules and fixed price versus spot gas sales allocations, if an El Nino winter is expected?

Figure 5 shows a possible scenario with the next El Nino arriving in 1998-1999, causing an unusually mild winter just as two new gas pipelines from western Canada are scheduled to open. Would the market be flooded with gas? Another possible scenario (more optimistic) is that the next El Nino will be many years away, and that a prolonged period of unusually cold weather lies ahead.

Oil and gas companies should routinely monitor El Nino indicators. The last El Nino arrived with early warning signs. If companies know what to look for, they might be able to spot the next one several months in advance, and plan accordingly. El Nino data and forecasts are available from the US NOAA and various commercial weather services.

This author will continue investigations of El Nino and correlative events and activities, and is considering starting an El Nino Watch service.

REFERENCES

Wilson, M., "Oh No, El Nino! A Correlation of El Nino Events and the Price of Natural Gas," The Outcrop - Newsletter of the Rocky Mountain Association of Geologists, Vol. 45 No. 1. 1996

Flis, L., "Using El Nino events in forecasting gas markets," Rocky Mountain Oil Journal, Vol. 76, No. 4, 1996.

Wallace, J., Vogel, S. "El Nino and Climate Prediction: Reports to the Nation on our Changing Planet; University Corporation for Atmospheric Research, Spring 1994, No. 3, 1994.

Diaz, H., Markgraf, D. (Editors), "El Nino, Historical and Paleoclimatic Aspects of the Southern Oscillation," Cambridge University Press, 1992.

Quinn, W., Neal, R., Antunez de Mayolo, S., "El Nino Occurrences over the Past Four and a Half Centuries," J. Geophysical Res., Vol 92, No. 13, 1987.

Monastersky, R., "Tropical Trouble - Two decades of Pacific warmth have fired up the globe," Science News, Vol. 147, 1995.

Shaw, H., Moore, J., "Magmatic Heat and the El Nino Cycle," Eos, Vol. 69, No. 45, 1988.

Walker, D., "More Evidence Indicates Link Between El Ninos and Seismicity," Eos, Vol. 76, No. 4, 1995.

Walker, D., "Siesmicity of the East Pacific Rise - Correlations With the Southern Oscillation Index," Eos, Vol. 69, No. 38, 1988.

National Geographic Society, June 1993, "Deep-Sea Vents: Worlds Without Sun; Map of World Ocean Floors - Pacific Ocean."

Renard, V. et al, "Submersible Observations at the Axis of the Ultra-fast-spreading East Pacific Rise," Earth and Planetary Science Letters, Vol. 75, 1985.

Haymon, R. et al, "Volcanic Eruption of the Mid-Ocean Ridge along the East Pacific Rise Crest at 9 45-52'N: Direct Submersible Observations of Seafloor Phenomena associated with an Eruption Event in April, 1991," Earth and Planetary Science Letters, Vol 119, 1993.

Urabe, T. et al, "The Effect of Magmatic Activity on Hydrothermal Venting Along the Superfast-Spreading East Pacific Rise, Science, Vol. 269, 1995.

Diaz, H., Kiladis, R., "Atmospheric Teleconnections associated with the Extreme Phases of the Southern Oscillation," in Diaz and Markgraf, 1992.

Weatherwise, Eastern Pacific Hurricane Storm Tracts - December, 1994," Weatherwise Magazine, April/May, 1995.

Smith, S., Bear Stearns Energy Perspectives - E&P Monthly Review, March 3, 1995 (a) and August 8, 1995 (b).

Gray, W., "LAD Multiple Linear Regression Forecasts of Atlantic Tropical Storm Activity for 1995: Experimental Long-Lead Forecast Bulletin," NOAA-NWS-CPC, Vol. 4 No. 2, 1995.

Other academic and event references can be provided by the author.

AUTHOR

Michael S. Wilson is a consulting geologist specializing in structural geology, analysis of pressure compartments, and natural gas exploration in the Rocky Mountain region. He holds a BA in Geology from Williams College and an MS in Engineering Geology from the University of Calgary. He was employed by Mobil Oil for 11 years on various exploration and production projects. He has been investigating the relationships between El Nino events, natural gas prices, and gas company stocks since the beginning of the last El Nino in late 1994. The author can be contacted at US (303) 674-1271.

Copyright 1996 Offshore. All Rights Reserved.