Why energy prices are cooling off

The Katrina effect on energy prices finally appears to be fading.

The price of natural gas on the futures market is down almost 30 percent from early September when it rose sharply to reflect the damage done to scores of wells and pipelines in the Gulf of Mexico. At the same time, the price of home-heating oil has dropped almost 60 cents a gallon. And gasoline prices, which had soared to more than $3.00 a gallon, have now dipped to $2.15 a gallon nationally.

Lower energy prices will help almost everyone from industrial users to airlines to hard-pressed consumers just getting their first heating bills. It will give the economy a boost since high energy prices act as a tax on consumers. And it will take pressure off companies to raise prices - something watched carefully by the Federal Reserve Board in its battle against inflation.

"Lower energy prices will cushion the blow to the economy from the higher prices so far," says Anthony Chan, chief economist at JP Morgan Asset Management in Columbus, Ohio. "Psychologically, it helps the consumer and that means the hit to the economy will not be as great as feared earlier."

A major reason for the drop is a late December holiday gift from Mother Nature. Temperatures, after a cold spell earlier this month, are now almost balmy by contrast. But, it's not just lower demand. Energy supplies in the Gulf of Mexico have been slowly but steadily coming back.

For example, after hurricane Katrina roared through the region, some 75 to 80 percent of natural gas production was shut-in. Today, just 19 percent of natural gas production is still out of commission.

"Natural gas is closer to the end of the Katrina effect than any of the other energy products," says Mark Routt, an energy analyst at Energy Security Analysis Inc. in Wakefield, Mass. "And, lower natural gas prices help those who heat with electricity, as well, since many utilities use gas."

However, energy analysts are quick to warn that energy prices are volatile and can rise as quickly as they fall. "I wouldn't take the warm weather and the price drop as the reason to ... celebrate yet," says Tancred Lidderdale, an economist with the Energy Information Administration (EIA) in Washington. "There is still three more months of winter ahead of us."

The next few weeks will remain relatively mild, predicts Dale Mohler, a senior meteorologist at AccuWeather in State College, Pa. "The consumer should be happy because the heating bill won't take such a big hit for a little while," he says. However, colder temperatures will come back around mid-January, he predicts, and remain in place for two to four weeks. "After that it's a tough call, but we think spring could come early this year," he says.

Late next month, OPEC members will meet in Vienna to look at production quotas. Already there are reports that OPEC will cut production, perhaps by as much as one million barrels of oil per day, to try to keep prices from falling.

"In the second quarter of the year, demand is at its lowest," says Mr. Routt. "If they continued pumping when demand eases they could be accused of crushing the market."

Oil prices have remained below $60 a barrel for six months. Combined with lower demand for gasoline, this has helped bring down the price for motorists. Wednesday, GasPriceWatch.com reported the national average at $2.15 a gallon.

"While the price of gas didn't have an impact on the holiday season, mostly since prices at the pump came down, this is not to say higher heating costs won't affect post-holiday spending," says Scott Krugman of the National Retail Federation in Washington.

Last winter, natural gas users in the Midwest paid $851 for the winter. This year, the EIA is estimating it will cost $1,220, a 43 percent increase.

Frank Zaski, a retiree in Detroit, can relate to those higher estimates. He recently was at a Hanukkah party where his neighbors were comparing their heating bills. With houses ranging in size from 2,500 square feet to 3,500 square feet, the range for the bills ran from $249 to $460 for the most recent December billing period. "Last year, the biggest bill we received was $212," he says.

Mr. Zaski does not anticipate any short- term benefit from the falling prices, since the Michigan Public Service Commission, the state regulator, locked in his supplier's price at $10.10 per thousand cubic feet. This is still lower than the current spot price of natural gas. Like many other utilities, his supplier, Consumers Power, had bought and stored 85 percent of the winter supply last summer before Katrina hit.

Any short-term reduction in the price is also not going to help the needy, says David Fox, executive director of the Campaign for Home Energy Assistance, which is trying to convince Congress to increase the amount of money provided for the Low Income Home Energy Assistance Program.

"The money Congress has provided has not kept pace with inflation or the growth of demand, and the current level of funding is going to be inadequate no matter what the price," says Mr. Fox.