Not many years ago, the spread between summer and winter natural gas prices was 20 to 50 cents per MMBtu. Recently, however, the spread between March 2006 prices on the Nymex and the futures price for February 2007 widened to $3.50. It's precisely that kind of volatility that's driving developers of gas-storage facilities to undertake massive expansions of existing storage and finance new projects. "Gas storage is becoming more valuable," observes one such developer. That's true for gas producers, marketers and end-users, and for investors as well. Indeed, in March, EnCana Corp., once the owner of the most independently held gas storage capacity in North America, sold substantially all its gas-storage interests for about US$1.5 billion to the Carlyle/Riverstone Global Energy and Power Fund. The reason gas storage is so valuable: if a gas marketer or producer can inject substantial volumes into storage during periods of weak demand and low prices, then sell those volumes during peak-demand periods at much higher spreads, it's significantly enhancing its income stream. Tightening North American gas supplies, less reliable industrial base-load demand and the rise of more variable, weather-sensitive, power demand, are going to further fuel gas-price volatility. That, in turn, should make having access to gas-storage capacity even more valuable. Another factor driving storage value is the capacity shortage that exists in that space, as it relates to meeting future demand. One estimate this decade by the National Petroleum Council suggests that as much as 700 billion cubic feet (Bcf) of new gas-storage capacity needs to be developed in the U.S. between now and 2025 to cope with the 30 trillion cubic feet (Tcf) of annual domestic demand expected by then. Currently, domestic gas consumption is around 55 billion cubic feet (Bcf) per day, or 22 Tcf annually. For gas-storage developers, the timing couldn't be better to literally start building for the future. Although storage operations may be anywhere from 50% to 100% more profitable than they were in 2001, the earnings potential of these facilities is likely to increase further. Hot product "Underground gas storage is the hottest product in this industry right now, with the demand for it being driven by the volatility in natural gas prices," says H. Dean Jones II, co-president of Owensboro, Kentucky-based Boardwalk Pipeline Partners and president of Texas Gas Transmission LLC. Boardwalk Pipeline Partners LP (NYSE: BWP) is a master limited partnership engaged, through its subsidiaries Texas Gas Transmission and Gulf South Pipeline LP, in the interstate transportation and storage of natural gas. The general partner is 100% owned by Loews Corp., and it went public in November 2005, led by Lehman Brothers and Citigroup. "Five years ago, the spread between winter and summer gas prices was 20 to 50 cents; now we're seeing spreads of $1 to $2, and even higher," says Jones. "So there's enough price volatility that underground storage makes sense-for marketers, local distribution companies (LDCs) or producers-because it can be more than paid for by the variability in winter-to-summer gas prices." Gas storage is like a financial option for marketers, he explains. "If you own capacity in a storage field and want to store gas, that in essence is a put. Then if there's a subsequent price spike in natural gas prices, you have a call option on pulling gas out of storage to take advantage of that increase in price." How good are storage economics today? The Texas Gas Transmission president points out that five years ago, the Boardwalk subsidiary wasn't always able to capture its maximum allowable FERC (Federal Energy Regulatory Commission)-approved rates for storage. "Today, while we can only charge that maximum, the market would be willing to bear a higher rate. That's evidence that the value of natural gas storage has gone up." To better take advantage of that enhanced value, and industry demand for more storage capacity, Texas Gas this past November placed in service a roughly 8.2-Bcf storage expansion in its Midland, Kentucky, field. The expansion, completed at a cost of about $23 million, added to Texas Gas' working gas capacity of 55 Bcf. But that proved an inadequate response to demand. Based on an oversubscribed round of bids for storage this January, Texas Gas plans to file with the FERC for a second, $36-million expansion at its Midland and Hanson fields, this one for about 9.3 Bcf of added gas storage, expected to come online in November 2007. "Through that expansion, we'll be able to withdraw an additional 100 million cubic feet per day of gas from the fields, which will add another $7.5 million to our annual revenues," says Jones. Prospective customers Judging from the increasing demand for capacity from traditional gas-storage customers-utilities, LDCs and merchant marketers-plus companies looking to acquire storage capacity that hadn't used such capacity in the past, there's clearly a need for incremental gas-storage capacity in the U.S., concurs Edmund Knolle, chief operating officer of Falcon Gas Storage Inc. in Houston. Privately held Falcon Gas has more than 22 billion cubic feet (Bcf) of working-gas storage capacity at its Hill Lake and Worsham-Steed storage facilities in northern Texas. It's also developing the MoBay Storage Hub, a high-deliverability, multi-cycle storage project in southwest Alabama which will ultimately have up to 50 Bcf of working-gas capacity available to serve markets in Florida, and the southeast and northeast U.S. "We're looking at firm gas prices going forward, driven by long-term demand growth and diminishing gas supply, until meaningful LNG imports hit the beach in 2010 and beyond," says Knolle. "Currently, because of the recent warm winter, we have plenty of supply, so we're going to get a big contango curve-low prices now, high prices in the future-which creates even more economic incentive to store gas, if one can find the storage capacity." On top of this, today there's a supply-security issue during the summer because of the hurricanes of the past several years, and the possibility of high peaking events caused by supply disruptions from storms. Taken together, all these events have increased market volatility and made the economics of gas storage more attractive than in years past. "In terms of market-base storage rates-demand charges for firm storage services-we've seen between 2001 and 2005 an average 75% increase in rates at Hill Lake," he says. In response to these market dynamics, Falcon last fall boosted its gas injection/withdrawal capacity at Hill Lake from 150 million cubic feet per day to 300 million. Currently, it's in the process of preparing applications to FERC and the state of Alabama to convert its producing fields near Mobile Bay, Alabama, into the MoBay Gas Storage Hub. "The original scope of the project called for 12 Bcf of storage capacity by late 2007, but based on market demand, we may elect to increase the hub's capacity by another 15 Bcf by early 2008-and possibly increase it to as much as 50 Bcf thereafter," says Knolle. Although now backed by Arcapita, a private-equity merchant bank based in Atlanta, London and Bahrain that has invested $35 million in Falcon, the gas-storage provider had been backed by private equity from Dallas-based Energy Spectrum Capital through July 2005. Private-equity funding "Beginning in 2001, we helped Falcon Gas acquire, develop and expand its Hill Lake storage facility for high-deliverability, multi-cycle service," says Sidney Tassin, president of Energy Spectrum Capital. "With the $30 million of private equity we provided, we also helped the company acquire its Worsham-Steed storage facility." Backing Falcon made sense to the firm. "We had some previous experience financing gas-storage facilities in Canada where, as a joint-venture partner, we invested $10 million in the Alberta Hub Natural Gas project in 1997, alongside subsidiaries of Texaco and Dominion Resources," Tassin explains. "Even that far back, we saw gas storage as an increasingly valuable component of the North American natural gas infrastructure." Since then, gas supply and demand patterns have changed, with more supply beginning to come from remote places and more demand coming from gas-fired generation plants, he notes. "Also, we now have a very strong summer consumption pattern that we didn't have before. In addition, we're seeing people active in gas marketing, trading and hedging using gas storage as a component of their strategy-so the importance of gas storage today goes well beyond the physical requirements of utilities or LDCs." Since 1996, Energy Spectrum Capital has committed $600 million to the midstream space and spent more than $500 million. Currently, it has about $60 million available to fund gas-storage projects. Risky business High natural gas prices in recent years have caused gas-feedstock end users like ethanol and ammonia plants to emigrate from the U.S.; that, in turn, has resulted in a less reliable base load for gas at the very time variable power demand is on the rise. The upshot: high gas-price volatility. In such an environment, gas storage becomes more important, says Paul Ziff, chief executive officer of Ziff Energy Group. The Houston- and Calgary-based international energy consulting firm provides analysis of the North American natural gas industry, including gas supply, transportation, gas storage, regulatory affairs and gas-pricing forecasts. "With the huge spread in winter-summer Nymex gas prices-recently $7.50 near term and $10 for next January-producers, marketers and end-users have a very strong incentive to store gas," explains Ziff. "However, high gas prices have made it more expensive for the developers of those types of storage where significant base gas to operate the facility is required. So while storage has become more economically attractive for developers, it has also become riskier from a cost perspective." Adding to this risk is the growing volume of LNG (liquefied natural gas) coming into the U.S. This presents several challenges for storage developers because the characteristics of LNG storage are much different than with traditional storage. "The gas injection is going to be more interrupted and will go through many more cycles because of the sporadic nature of ship landings," says Ziff. "Also, injection rates are likely to be considerably higher, so there are tolling and pipeline-usage issues, as well as the type of storage facilities needed to handle LNG." Together with Den Norske Veritas and Sutherland Asbill & Brennan LLP, Ziff Energy has just formed LNG Solutions Group, which will provide integrated business solutions covering every aspect of the LNG value chain. Says Ziff, "Part of our effort will be to advise on the nature of LNG supply, the type of contract terms that would be appropriate, and the risks involved with LNG-because you have to be looking at what's happening around the world, not just in North America." Leveraging skill sets Last August, Houston-based Plains All American Pipeline LP (PAA) and Seattle's Vulcan Capital agreed that PAA/Vulcan Gas Storage LLC would acquire all the equity of Connecticut-based Energy Center Investments Corp., an indirect subsidiary of Sempra Energy. Energy Center Investment's principal assets are the Bluewater Gas Storage facility in Michigan and the Pine Prairie Energy Center, a gas-storage development project in Louisiana. The Bluewater facility's working capacity is expected to reach 24.5 Bcf in 2006; the Pine Prairie gas-storage project, which should be operational in mid-2007, will be developed as a 24-Bcf, high-deliverability, salt-dome storage facility. This facility is expected to be an active participant in the Gulf Coast gas distribution system which should benefit from the development of future LNG facilities. PAA/Vulcan's cost to purchase Energy Center Investments, complete construction of the Pine Prairie project and purchase the base gas is estimated at $590 million. The unlevered rate of return is targeted at 12% to 15%. "The gas-storage business is very compatible with, and complementary to, PAA's proven business model [crude oil storage and transport] and consistent with our strategy of economically leveraging our asset base, knowledge base and skill sets," says Greg L. Armstrong, chairman and chief executive officer of Plains All American. As U.S. demand for natural gas continues to grow, outpacing the growth in Lower 48 production, foreign sources for gas and LNG will become increasingly important to meet excess demand, adds David N. Capobianco, managing director of Vulcan Capital. "Given the increasing volatility in the timing of gas supply and the seasonal nature of demand, gas storage will be critical to maintain market equilibrium." Salt-dome project Mark D. Cook, a principal in Houston-based storage developer SGR Holdings LLC and a vice president in subsidiary SG Resources Mississippi LLC, agrees. The National Petroleum Council, he notes, has indicated that as much as 700 Bcf of new gas-storage capacity needs to be developed in the U.S. between now and 2025 to cope with the huge 30 Tcf of annual domestic demand expected to be in place by that time. Like Ziff, Cook also observes that a lot of industrial base-load demand has been taken out of the market while the building of more power plants and bigger homes is contributing to the growth of a highly weather-sensitive and variable gas market. "All this, coupled with diminishing domestic gas production, is putting increased pressure on storage to balance out supply and demand and lessen gas-price volatility." Gas-price volatility recently reached a point on the Nymex where the spread between March 2006 prices and the futures price for February 2007 gas was $3.50, says Cook. "This is an indicator that the market believes there's not enough gas storage around, and why storage is becoming so valuable-since only those with storage capacity can take advantage of such wide spreads." This January, SG Resources Mississippi started construction of Phase I of the Southern Pines Energy Center, a new Mississippi salt-dome, gas-storage project. Construction began following $115 million of debt financing from CIT Financing in New York and the sale of a 40% equity interest to an entity owned by Arc- Light Capital Partners LLC, a Boston-based energy investment firm. Initially, the Southern Pines Energy Center will provide 8 Bcf of storage capacity, beginning in the summer of 2007. Phase II development, once approved by FERC, will add another 8 Bcf of storage capacity.