Pessimists see an oversupply of storage and limited demand—fundamentals which they believe will hold down storage rates for the foreseeable future. They argue that storage has risen steadily over the past decade, pointing to data from the U.S. Energy Information Administration which shows that total working gas storage capacity has grown from about 3,899 billion cubic feet (Bcf) in 2000 to more than 4,300 Bcf today.

Demand for storage has fallen as a result of a decline in the volatility of natural gas prices. Also, pessimists point to storage rates, which have fallen from their historical highs in many parts of the U.S., as evidence that the need for additional storage is past.

Yet, natural gas storage operators are an optimistic lot, and point to other fundamentals that indicate that storage is indeed needed in strategic locations, such as the recent report from the Interstate Natural Gas Association of America that concludes almost 600 Bcf of new gas storage capacity will be needed in the next 25 years.

High pressure discharge lines at Canyon Creek compressor station.

Also, in its most recent "State of the Markets Report," the U.S. Federal Energy Regulatory Commission (FERC) reported that U.S. natural gas demand from power generators has grown more than 8.6%. The report notes that "natural gas is increasingly edging out coal as the most economical fuel for base load power production in more parts of the country for longer periods during the year." This additional demand for fuel has added between 1.1 Bcf and 2.8 Bcf per day on average to total U.S. natural gas demand over the course of 2010.

Gas demand = storage demand

Also, an increased demand for natural gas is expected to boost demand for storage. But, like real estate, location is key.

Mark Fiedorek, group vice president of Transmission & Storage for Spectra Energy Corp., says the additional supplies from unconventional natural gas sources have done the industry a great service, increasing supply and making storage operators bullish.

Although he says storage is still a tool for customers to manage volatile prices, and continues to be a key component for customers' desire for storage, the tool for managing risk is not the only driver of the demand for natural gas storage.

"We believe the need for storage on the grid is high," he says, noting that, historically, storage was viewed as mostly a summer-winter requirement. Operators would produce gas year round and store it in the summer for use in the winter when consumers needed it to heat their homes. This is still a significant portion of how storage is used today.

But the development of the electrical grid and the growth in natural gas-fired electricity generation changed the traditional perception of the need for natural gas storage. Instead of one peak during winter heating season, the market might see additional peaks in demand for electrical energy throughout the course of the year, depending on weather cycles.

"Now, there are going to be multiple peak events in the course of a year," he says. "You may get two or three or more annual peaks, and you will need a lot of gas in the ground and the ability to pull it out and deliver it in a timely fashion." These spikes in demand might last only two or three days, rather than an entire winter, and the market will have to respond to these changes, he says.

Fiedorek sees supply from producing fields and demand from end users increasing. The combination of the two makes Spectra Energy bullish about the future of the natural gas storage business and this optimism explains its commitment to expanding its current storage facilities.

But supply and demand will not grow in tandem—and demand in particular will become more volatile. When supply exceeds demand, the market needs efficient infrastructure for putting the excess supply into storage. When the reverse occurs, the market needs infrastructure which can pull it out of storage just as efficiently.

“If you’re in the right locations, connected to the right pipeline systems and the right markets, both demand-side and supply-side, the market will respond and customers will appreciate you.” — Mark Fiedorek, group vice president, Transmission & Storage, Spectra Energy Corp.

Balancing act

"That's the crux of what storage is all about: How to balance out the pipeline system between supply side and demand side. The additional (natural gas) supply is a good thing, but the demand for it is never even," he says.

When Houston-based Spectra Energy offers storage, it offers four parallel services: space, injectability, withdrawal capability, and reliability. "That's the package of services that Spectra Energy provides when we sell storage. At any point in time, the value of any of those items can vary."

Power generators need flexible storage to turn natural gas on and off as demand for electrical energy fluctuates day to day and even hour to hour. Such companies have assets which will be producing electricity for 30 years or more, so they need reliable supply of natural gas regardless of what the market is doing.

Spectra Energy owns both depleted-reservoir and salt-dome storage assets with a total capacity of about 300 Bcf, including a depleted-reservoir facility near the town of Accident, Maryland, and partial ownership of Oakford and Leidy storage facilities in Pennsylvania.

Specifically, through its Union Gas business, the company owns the Dawn storage facility, in Dawn, Ontario, the largest storage facility in North America. In total, Spectra Energy's depleted-reservoir working gas storage capacity is about 235 Bcf. Also, it has three salt-dome facilities, including the Moss Bluff facility in Liberty County, Texas, the Egan facility in Evangeline Parish, Louisiana, and the Bobcat facility in St. Landry Parish, Louisiana. The combined capacity of these salt caverns exceeds 65 Bcf.

Going forward, Spectra sought and received approvals to develop and operate a fourth salt storage cavern at its Moss Bluff facility and to expand capacity at the Egan facility in Acadia Parish, Louisiana.

The company's biggest expansion is at its Bobcat storage facility, about 45 miles northeast of Henry Hub in St. Landry Parish, Louisiana. The company will invest between $400 million and $450 million to add three more caverns to the facility and to increase its full capacity to 46 Bcf by the end of 2015. Once the Bobcat facility is fully developed, Spectra Energy's total North American capacity will be 335 Bcf.

"If you're in the right locations, connected to the right pipeline systems and the right markets, both demand-side and supply-side, the market will respond and customers will appreciate you," says Fiedorek.

Meanwhile, the development of new technology has not led to any abrupt changes in the natural gas storage industry, but there have been some more gradual evolutions that have changed the dynamics of the industry, he says.

For example, new technology in 3D seismic imaging has allowed reservoir storage developers to get a better view of where the best locations for storage are and to better pinpoint the location of injection and withdrawal wells to enhance the capabilities of the reservoir.

In addition, during the past 10 or 15 years, advances in high pressure gas technology have allowed operators to enhance the utility of leached salt caverns. This has given them the ability to store gas at higher pressure, again enhancing the capabilities of the caverns.

Storage rates

Despite better technology, storage rates have come off of historical highs as little as two years ago. As supply increased with the shale-gas boom, and demand fell due to a slowing economy, storage margins have narrowed.

However, several factors suggest increasing storage margins in the near term as the economy regains its growth momentum, natural gas power generation becomes a greater proportion of the total generation fuel mix and the supply-demand balance becomes tighter.

Jeff Foutch, a co-founder and managing director of Houston-based Peregrine Midstream Partners LLC, agrees that the pricing for storage has slipped, but stresses that there are still opportunities for operators who can offer reliable services from strategic locations.

The additional natural gas supply from the shale plays in the U.S. has flattened the forward curve for prices and reduced the summer-winter price spread that previously created a strong demand for natural gas storage, he says, and the overall effect is that there is more gas supply available to the market. But producers and other market participants aren't willing to pay as much as before to store it.

"The numbers that are coming in from people who want to buy storage are a lot lower than they used to be," he says. "We may need to accept lower returns for the foreseeable future."

In the short term he expects to see fewer projects, because the industry tends to run in cycles. After a period of slow growth, the industry might need to catch up when demand and volatility return to their previous levels. "Those people who are able to continue developing storage or have storage will benefit then."

Looking forward, Foutch says there is not enough storage in place to handle the increased output expected from unconventional gas sources.

"We see new supplies in areas where there is not enough storage in place to keep them. There is so much more gas coming on to the market that you will need a place to put it during off-peak periods. So I think there is still a need for more storage in locations which make sense," he says, adding that greenfield projects in south Louisiana may not make sense right now.

“The numbers that are coming in from people who want to buy storage are a lot lower than they used to be. We may need to accept lower returns for the foreseeable future.” — Jeff Foutch, managing director, Peregrine Midstream Partners LLC

Profitable strategies

So how will traditional natural gas storage operators adapt to the changing price environment? During times of higher volatility and greater basis spreads, producers and merchant companies frequently paid $0.20 per million Btu per month to store natural gas, but they will not likely renew their storage agreements at that rate, he says.

Peregrine builds facilities in areas with depleted reservoirs, which cost anywhere from $6 million to $10 million per Bcf to build, compared with salt storage projects which cost as much as $20 million per Bcf. The lower upfront costs make them more competitive as storage rates come off.

"We don't need 20 cents a month to justify a project," says Foutch. "We will be less affected by lower storage rates."

Although volatility in natural gas prices has fallen off over the past two years, there is no consensus in the industry about the role that an increase in storage facility has played. Some believe it can and has reduced volatility, but Foutch believes the growth in storage over the last decade has a relatively small effect.

"Storage is a small percentage of the overall deliverability of the market, so it doesn't have a huge effect of lessening volatility," he says. He believes there are two other causes of lowered volatility. One is the additional gas supply from increased shale gas production. The other is the decline in gas demand caused by the recession.

Yet, as the economic recovery slowly takes hold, the market should see some incremental demand return, bringing with it some additional volatility to the market. The increased volatility should lead to a modest recovery in storage rates, he says.

Also, for Peregrine, size matters, at least when it comes to the balance sheet. The size and type of storage facility have a huge influence on its costs of operation, says Foutch. Smaller gas storage facilities generally have higher per-unit operating costs, so investors want to design a project that is large enough to get economies of scale in operating costs. Some of the smaller projects could struggle in the foreseeable future with storage rates that are lower than their historical norms.

The larger salt-dome projects can operate at high turn rates and are more expensive to develop, but their operating costs are generally lower. Salt-dome projects can turn their inventory as many as 10 times per year, compared with a depleted-reservoir facility, which usually turns its inventory one-and-a-half to three times per year.

"When such facilities operate long enough to recover capital costs, they are less affected by a decline in storage rates," explains Foutch. "Facilities still in the process of paying off initial capital expenditures are likely to struggle if contract renewals come in at lower rates."

Peregrine likes to look for opportunities to add ancillary services, such as load-following, above and beyond the standard long-term storage contracts that are common in the industry. In addition, Peregrine likes to build in areas where there is good liquidity and good volatility, both essential for long-term profitable gas-storage projects.

Growth drivers

Also, the growth of renewable energy has also produced opportunities for flexible gas storage operators. Power producers will draw first from wind energy, which is cheap but unpredictable. When the wind dies, power producers fire up their gas turbines again. Each time the source of energy changes can mean natural gas flows in or out of storage, generating steady revenue for flexible players. "That is a valuable service," he says.

The effect of environmental regulations may also create opportunities for gas storage operators. If federal environmental regulations force power producers to turn away from coal, they will have to replace it with natural gas. An increase in the use of natural gas as a fuel leads to additional demand and volatility in the market.

Peregrine's growth strategy is to grow organically in markets it believes are underserved and to avoid developing assets in areas that have numerous other players, such as southern Louisiana.

"While at Falcon-Nortex Gas Storage, a company my partners and I co-founded, we felt North Texas was underserved in storage. I don't think people appreciated that Dallas-Fort Worth consumes as much power during a summer load as New York State in the winter," he says.

Going forward, Peregrine is developing its Ryckman Creek facility in the Rocky Mountains. The Opal hub in southwestern Wyoming has a larger take-away capacity than Henry Hub, but has no storage facility serving it right now, he says.

"We feel the Opal hub area is underserved by storage. It has a number of pipelines connected to processing plants that serve markets from the Pacific Northwest to southern California to the Midwest, and it needs the support storage would offer."

“We believe shale plays have accelerated the demand for natural gas storage for producers, local-distribution companies, power generators and industrial and residential users.” — Chris Kunzi, vice president and managing director, Ten Section Natural Gas Storage Project at Tricor Ten Section Hub LLC

Peregrine, through its subsidiary Ryckman Creek Resources LLC, is developing the project near Evanston, Wyoming. The $240-million plan is to convert an existing, partially-depleted oil and gas field into a new interstate high-deliverability, multi-cycle natural gas storage facility that will be the largest independently-owned gas storage project serving Wyoming's Opal hub area.

The facility will have 35 Bcf working gas capacity with maximum daily withdrawal of 480 million cubic feet. The project will include drilling new horizontal wells, constructing new pipeline facilities and upgrading an existing compressor station. Because location is key, the facility has interconnects with Kern River Transmission, Questar Pipeline and Overthrust Pipeline.

Customers seek flexibility

The need for reliable assets in strategic locations applies to the West Coast markets as well, says Chris Kunzi, vice president and managing director of Ten Section Natural Gas Storage Project at Tricor Ten Section Hub LLC.

Once complete, Tricor Ten Section Hub will be the first independently-operated natural gas storage facility in the southwestern U.S. The depleted-reservoir storage project is about 12 miles southwest of Bakersfield, California, near major western U.S. natural gas pipelines with more than 4 Bcf per day of capacity. The facility will be connected to the Kern River/Mojave interstate pipeline, with subsequent interconnections to the PG&E and SoCal intrastate pipelines.

The facility is designed to hold 22.4 Bcf of working gas (with 10.1 Bcf of base gas) and will offer customers four-turn, high-speed deliverability.

"This is 1 Bcf per day of solutions from a centralized interstate location," Kunzi says. "We believe shale plays have accelerated the demand for natural gas storage for producers, local-distribution companies, power generators and industrial and residential users," he says. "Because of its strategic location, Ten Section serves one of the largest, if not the largest, power generation growth regions in the U.S."

As in other parts of the country, reliability of high-speed natural gas deliverability is a huge concern to customers in the Western U.S., he says. "Having new storage infrastructure located within or near the market is extremely advantageous."

“There is significant market demand out there.” — Ryan Kunzi, managing director for corporate development, Tricor Ten Section Hub LLC

Like other storage operators, Kunzi is optimistic the increase in gas-fired electricity will mean an increase in the need for storage in strategic areas. "Those in high-demand, power-generation growth locations such as ours are doing well. Those in overbuilt locations, far away from customers and end users, are facing challenges," he says. "We believe we will see substantial growth in our business in the short term."

During Tricor's open season, it received solicitations for a total of 39 Bcf of storage capacity from potential customers. "There is significant market demand out there," says Tricor's Ryan Kunzi, managing director for corporate development.

Storage still plays an important role in lessening gas price volatility, but there is a value shift occurring to the spot markets as perceived production volumes vary versus actual, he says. Adding to this effect are hourly demand changes in power generation load, which has a similar effect increasing volatility in the spot market. "The flexibility of the operator to respond to real-time swings in demand creates value for both the shipper and the operator."

Also, although the long-term summer to winter spreads have fallen, they have not tightened in the West as much as they have in the Gulf and East Coast markets. "This creates a great opportunity for storage," Kunzi says.

Meanwhile, a recent Black & Veatch survey of utility operators shows that they are concerned about the aging infrastructure of their suppliers. This, coupled with the need for additional natural gas storage supplies, creates opportunities for operators to upgrade their current facilities or to build new ones. Newer facilities will have an inherent advantage over older ones, Kunzi says. "A lot of our customers want to make sure they can get quick access to their gas."