Statement of Bruce D. Heine, Assistant Vice President,
National Fuel Gas Distribution Corporation, Buffalo, New York

Testimony Before the Subcommittee on Oversight
of the House Committee on Ways and Means

Field Hearing on Energy and Prices, Mayville, New York

March 5, 2001

An unprecedented rise in the cost of natural gas along with colder-than-normal weather this past year has caused consumers' bills to increase significantly over last year. Exhibit No. 1 shows the components of our average annual rates. The increasing purple line represents the gas cost element of a customer's bill while the slightly decreasing red line represents the utility cost of service component. The green line is the sum of these two components. This clearly shows it is the cost of gas supplies driving the increase in rates.

Why are natural gas prices so much higher recently as compared to previous years?

Natural gas is a deregulated commodity and is traded on the NYMEX Futures Exchange. The price is based on the value traders place on the gas at a specific point in time and, in most recent months, such prices have been at historically high levels with extreme price volatility. This rise in commodity cost directly relates to the increase in residential charges shown in Exhibit No. 1. This year follows a period of oversupply when drilling was down due to relatively low gas prices. Supplies have been steadily declining and even though National Fuel's market requirements have been somewhat stable, demand has grown elsewhere in the United States, especially as natural gas is used for electric generation. Factors outside our control and outside our geographic region affect the marketplace where we purchase the commodity. The problem of high prices is not just a New York and Pennsylvania issue, it is a problem that is being felt nationwide. Exhibit Nos. 2 and 3 illustrate these factors. Exhibit No. 2 shows the decline of natural gas deliverability over the past 5 years. In 1996 the total deliverability from the U. S. was 53 Bcf/day. Today it is around 51.5 Bcf/day. This represents a 3% decline. Meanwhile, Exhibit No. 3 shows how natural gas demand nationwide has been on the increase. A healthy economy and deregulation has fueled the demand for natural gas. Most forecasts now predict the demand for natural gas to reach 25 Tcf by 2005. Another factor that has had a significant influence on prices this past winter is the national storage inventory level. Going into the winter of 1999/2000 storage levels nationwide were higher (3.0 Tcf) compared to this past winter when they were at 2.7 Tcf. This is most likely due to the increased electric generation load over the summer. Now that prices have risen in response to the supply and demand shifts, drilling activity has picked up again. Both large producers and smaller independent drillers now have the incentive to get the gas production back to the level where it can meet the growing demand. Most experts believe the market price of natural gas will level off as additional supplies come to market.

How is National Fuel affected by rising natural gas prices?

It is important to realize that National Fuel does not benefit from higher natural gas costs. The price we pay is passed along to the customer, dollar for dollar, without markup. National Fuel has taken steps to manage gas costs while ensuring reliability of supply. We've balanced our purchasing portfolio between storage gas, fixed price gas, and market-priced mechanisms. Hedging strategies such as this do not necessarily reduce prices but do soften the effect of price volatility. National Fuel's storage contracts act as a natural hedge against rising prices and also provide a very reliable source of gas because it is stored directly in the market area. Exhibit No. 4 illustrates our winter commodity supply mix and how it is balanced between storage withdrawals, fixed price and market-priced gas that includes the index term, local and spot gas. This type of diversification helps to mitigate the effects of volatile prices.

Where does National Fuel's gas supply come from?

We purchase gas supplies from the southwestern United States and Canada. Storage gas also makes up approximately a third of our supply during the winter months. The majority of gas supplies for sale to customers of National Fuel are brought to National Fuel by seven (7) major upstream interstate pipelines that traverse our market area. These pipelines are: Tennessee Gas Pipeline Company, Texas Eastern Transmission Corporation, Transcontinental Gas Pipeline Corporation, Dominion Transmission Inc., Columbia Gas Transmission Corporation, Empire State Pipeline and National Fuel Gas Supply Corporation. Most of these are shown on Exhibit No. 5. It is these pipelines that transport the supplies we have under contracts in the production area. We always prepare for a winter that is 10 % colder than normal, and maintain enough gas in storage and through gas supply contracts to assure that level of available gas supply. In addition, local production accounts for around 30% of the total volume of gas moved through our system. Although it is closer, locally produced gas is not cheaper than other sources of supply. Local gas is also sold at market prices and is usually purchased directly by local industry.

How does National Fuel keep our natural gas purchase prices as low as possible?

National Fuel follows a least-cost gas purchasing strategy. We constantly evaluate different sources of supplies, pipelines and storage contracts to make sure we are using the very least-cost, reliable options available. We work with the Company's Rates and Regulatory Affairs Department to make sure our pipeline supplier rates and services are prudently priced and in our customers' best interest. State regulatory commissions review all of our contracts and purchases related to gas purchasing. However, with gas prices rising, it is more difficult to keep gas supplies at the low cost level we've experienced in the past. As far as the commodity price is concerned, we can't influence it--the market price is controlled by the forces of supply and demand. Historically, our most important opportunity and unique asset in keeping costs low and maintaining reliability is our storage, which is physically located in National Fuel's service territory. This allows us to purchase and store a significant amount of natural gas in the summer when, prices have traditionally been lowest. Then we can draw gas from storage in the winter, when demand and prices are generally higher. We continue to evaluate new storage options as opportunities arise. Because National Fuel relies heavily on storage, upstream capacity is not sufficient to meet customer requirements on cold days. For this reason, storage must be reserved through the early part of the winter to retain a volume of gas in storage that is sufficient to provide delivery of gas from storage necessary on the design peak day. In addition it is also necessary to reserve sufficient delivery from storage to meet cold days late in the winter period. Since there are many changing variables such as weather, price forecasts and market requirements, a linear program model is used on a continuous basis to prescribe the least-cost mix of gas supplies from pipeline and storage sources that should be utilized to meet National Fuel market requirements.

What will the future bring?

Our customers need to know that supplies of natural gas are adequate. Rising prices, while they hurt in the short run, have encouraged greater exploration and production for new natural gas resources. There are more rigs drilling for natural gas than ever before, and many experts believe these new supplies will help moderate prices later this year. Exhibit No. 6 shows the number of drilling rigs active in the U. S. and Canada. As you can see, it has gone from 800 rigs last January to approximately 1,150 currently nationwide. This is encouraging.

Also on Exhibit No. 6 is the latest price forecast from the Petroleum Industry Research Association ("PIRA"). This is somewhat encouraging since it shows prices leveling off between $4.00 and $4.50 per MMBtu, which is a considerable break from the $10.00 price we saw in January.

National Fuel has been serving northwestern Pennsylvania and western New York for over 100 years. As an active part of the community -and as gas customers ourselves- we're working to keep costs down by strategically acquiring and managing our natural gas supplies.

Though the colder winter weather and price increases are putting pressure on all of us, we are committed to providing our customers with the quality and service they have come to expect. Our mission is to continue to provide a reliable source of gas at the most reasonable price possible.

I would like to thank you for the opportunity to present this information to the Committee.

Exhibit 6