First, I want to commend Senator Williams as the sponsor of Senate Resolution 75, and also commend Senator White and other members of this Committee for holding this important public hearing in Philadelphia where gas customers have recently borne the brunt of unprecedented increases in the price of their natural gas service. As you know, however, this problem was not limited to Philadelphia or even to Pennsylvania, but was a nationwide phenomenon, as wholesale gas prices literally spiraled out of control. Fortunately, last year's wholesale gas price increases were immediately followed by a rapid plunge in those prices which are already providing at least some rate relief to many Pennsylvanians, as we approach this winter's heating season.
The fact that wholesale natural gas prices have dropped in recent months, however, does not lessen the importance of this Committee's task under Senate Resolution 75. The natural gas price roller coaster on which Pennsylvania consumers have been riding for the last 18 months is not sustainable. As pointed out in Senate Resolution 75, urban and rural consumers alike were faced with impossible choices last winter when their gas bills reached ridiculous heights. The fact that gas prices appear to be going down this winter is a welcome development, but it does not assure that Pennsylvania households will not face another gas price crisis in the future. Moreover, for many Pennsylvania consumers the overall price they are paying for natural gas today is still higher than it was a year ago.
It is necessary to understand what happened in the wholesale natural gas markets last year and then to determine what Pennsylvania policy-makers, regulators, and retail gas distributors and marketers can do to keep the prices paid by Pennsylvania gas consumers at a more reasonable level in the future.
First, it must be recognized that the wholesale price of natural gas "at the wellhead" has been deregulated for many years. This has nothing to do with the recent enactment by the Pennsylvania General Assembly that opened a portion of the retail segment of our local natural gas utilities to competition. Wholesale natural gas prices were once regulated at the federal level, but now they are not regulated at all. Rather, the wholesale price of gas is set through the competitive market. In my opinion, that market has worked well over the years in assuring an adequate supply of natural gas at reasonable prices. In early 2000, however, the dynamics of the market changed dramatically.
Typically, gas supplies are plentiful in the spring and summer, and gas prices are low. The wholesale purchasers of gas take advantage of this fact by buying large amounts of gas and placing it in storage for the next winter heating season. In the spring of 2000, however, natural gas prices remained higher than normal, and the level of gas in storage became shockingly low. Gas suppliers deferred the purchase of gas for storage in the hopes that gas prices would go down, but instead those prices continued to climb.
One of the causes of the supply and demand problems of early 2000 was the fact that gas prices had been so low in prior years that many gas producers had stopped looking for or selling new gas. The problem was exacerbated by the emergence of an increased demand for natural gas for new electric generation units that are fueled by natural gas. These electric generating units operate during periods of peak summer electric usage when the demand for natural gas was traditionally low.
Prices rose steadily as the winter of 2000-2001 began to approach and then prices simply raced out of control. On January 4, 2000, the spot price of natural gas at the Henry Hub in Louisiana was $2.17 per thousand cubic feet (mcf). On December 29, 2000, the spot price rose to the absurd level of $10.87 per mcf. As these higher wholesale prices began to work their way into Pennsylvania retail bills, the impact was horrendous, leaving many people across Pennsylvania unable to pay their monthly gas bills. Many customers developed large arrearages or debts to their gas utility as their bills mounted up over the winter. In addition, in most of Pennsylvania, the increase in gas prices was coupled with colder than normal temperatures, particularly in the early part of the winter, which caused monthly bills (and monthly arrearages) to rise even higher.
At that point, however, wholesale prices began to drop. Gas producers expanded production and began drilling new wells at a rapid pace; the amount of gas in storage increased to normal levels and above; and wholesale prices dropped to the point where the reported Henry Hub spot price at the beginning of this week (October 1, 2001) was $1.82 per mcf. These wholesale price reductions, in turn, are now beginning to be reflected in the retail gas bills paid by Pennsylvania natural gas consumers. Substantial gas rate reductions from last winter's highs are now being seen across Pennsylvania, but in some cases, the overall gas prices being paid today are still higher than they were a year ago. Based on current projections, the lower wholesale prices are expected to continue through the next several months, though it has become extremely hazardous to try to predict the future of natural gas prices.
At the retail level, although competition for gas supply is permitted throughout most of Pennsylvania, the vast majority of residential consumers continue to be served by their traditional local natural gas distribution companies, and the retail prices that those customers pay are regulated by the PUC. Each natural gas distribution company (NGDC) purchases gas at the wholesale level and essentially passes that gas on to its residential and other retail customers at cost. That is, the NGDC's generally do not "mark up" or profit from the sale of the natural gas itself. Under Section 1307(f) of the Public Utility Code, which was enacted by the General Assembly in 1984, each NGDC's purchased gas costs are reviewed every year by the PUC and by other parties such as my Office. We work to ensure that the NGDC is serving its customers at the lowest reasonable price; that is, by purchasing its gas through a least cost gas procurement policy. As of July 1, 2000, PGW also became subject to the PUC's jurisdiction for purposes of reviewing its gas purchasing practices. I would note parenthetically that while my Office has many serious complaints about the rates and service provided by PGW, one of our complaints is not the Company's gas purchasing practices. On the contrary, up to this point we have found that PGW's gas purchasing practices have been sound and are not the cause of PGW's financial and service problems. It is my understanding that Mr. Bertocci of Community Legal Services will testify later this morning more specifically about the management and operational problems that have led his office and mine to oppose much of the recent PGW base rate increase request which was for expenditures other than gas costs.
I would also note that opening up the gas supply portion of Pennsylvania's natural gas distribution companies' retail sales to competition has certainly not been a cure to the volatility in the wholesale gas market. In fact, to my knowledge, no residential gas customers in Pennsylvania are being served by alternative competitive natural gas suppliers except in the service territories of three Western Pennsylvania gas utilities (Columbia, Equitable, and Dominion Peoples) that had substantial gas competition pilot programs in place prior to the enactment of our Natural Gas Choice legislation in 1999. Even if these competitive retail suppliers were active throughout Pennsylvania, however, they would have been subject to many of the same wild swings in wholesale gas prices that have plagued our regulated retail gas utilities.
So what would I recommend? In each of our recent purchased gas cost proceedings, our Office has recommended that the utility purchase more of its gas supplies at fixed prices, rather than purchasing all or most of its supplies under contracts that are "indexed" to the spot price of gas. We believe it is important for the gas utilities to have a diversified gas portfolio that allows the gas utilities the flexibility to take advantage of lower cost supplies when they become available, but also provides assurance that their overall gas supplies will not be subject to the kind of wild swings that we have seen in the last year and a half. We recognize that this means that at any given point in time, our gas utilities might not be paying the very cheapest prices that are available on the spot market that day, but it also means that they will not be as exposed to the horrendous risks that forced them to purchase gas last year on the coldest days of the winter at prices that could only be described as unconscionable. Our Office believes that these recommendations are consistent with the current Public Utility Code, especially in light of the amendment to Section 1307 that was made in the1999 Natural Gas Choice Act that allows utilities to include in their purchased gas cost recovery "costs paid for employing futures, options and other risk management tools."
Another important amendment that was added in 1999 was the requirement as part of the Natural Gas Choice Act that each natural gas distribution company file a "universal service" plan to assist low income and payment troubled customers to pay their bills and to conserve energy. Our Office has worked with each of the companies to develop these programs, which are now established throughout almost all of Pennsylvania.
One valuable addition that the General Assembly could make at this time would be to augment the utility and ratepayer funds that go into our gas low-income programs with some level of state funding. I testified in June of this year before the House Consumer Affairs Committee in support of House Bill 1433, which provides up to $3 million per year in state matching funds for electric and natural gas companies who contribute to hardship programs on behalf of their low-income customers. My major concern with House Bill 1433 was that the state matching funds only were provided in years in which the winter temperatures were at least 10% colder than normal. In my view, such assistance should be provided on a consistent basis every year. Nevertheless, I recognize that this legislation -- as well as more substantial state funding programs that have been proposed by others -- must compete with other state funding priorities. I would submit, however, that any state assistance that could alleviate some of the hardship that was faced last winter by so many Pennsylvania natural gas consumers would be welcome.
I would also reiterate that the programs that are most helpful to many low-income consumers involve not only assistance in paying individual monthly bills, but also enable customers to avoid high bills in the future through weatherization and other types of conservation and energy efficiency measures. One of these programs that has shown significant positive results is the PUC's Low Income Usage Reduction Program (LIURP). In my opinion, the best "hedge" for residential consumers against high energy bills in a volatile market is to use energy wisely. Programs such as LIURP, in my view, should be supported fully at all levels of government.
I hope this testimony has been helpful to you in your Committee's investigation. I would be happy to answer any questions you might have about my testimony or about any other related issues.