High Anxiety over High Energy

Winter is long gone, and major hostilities in Iraq officially ended in May. Yet energy prices in the U.S. haven't fallen back as much as expected. Natural gas and oil are still pricey -- and appear likely to take a big bite out of profits in some industries for months to come.

In July, Federal Reserve Chairman Alan Greenspan said that high natural gas prices are putting big consumers like chemical, metals, and paper companies in "a weakened competitive position." The current price near $4.70 per million Btus is up more than 50% from a year ago. Oil is down from a war-induced runup but is still near $30 per barrel, far above the 10-year average of $21. The big reason: Fighting isn't completely over in Iraq, and looting and sabotage continue to disrupt rebuilding. "Exports from Iraq are way behind what any plans or schedules were," says Dennis Eklof, executive managing director for the Global Energy Service at Global Insight Inc.

There isn't much price relief in sight. The Energy Information Administration expects natural gas to stay near $5 per million Btus for this year. Andrew D. Weissman, chairman of Energy Ventures Group, believes a cold winter could drive prices up to $10 per million Btus. Plus, U.S. oil inventories are low: Companies keep holding off restocking in the hope prices will drop. Another disruption like the strike in Venezuela or conflict in Nigeria earlier this year could cause oil to shoot up.

Some sectors are really getting burned. For fertilizer maker IMC Global (IGL ) Inc., not only are natural gas prices up but ammonia, a key ingredient made from gas, has climbed more than 60% from a year ago. IMC recently locked in 55% of its gas needs for the rest of the year at $4.48 per million Btus. But its business model is built on gas at close to $4 per million Btus. Through June, AK Steel (AKS ) shelled out $40 million more to fuel its plants than it did the previous year. That contributed to a $78.2 million loss last quarter, compared with the year-earlier $16.2 million profit. And at Northwest Airlines (NWAC ), fuel costs rose faster than any expense except depreciation and amortization last quarter. Northwest lost $160 million, not counting federal security payments, the sale of a reservations system, and other special items.

The other side of the coin, of course, is that bottom lines will continue to fatten at energy-exploration and -production companies. Electric utilities that have electricity to spare could also benefit. If the mild summer turns hot, electric companies that own a lot of newer gas-fired power plants may find it cheaper to buy electricity from another utility than to increase output at their own facilities.

The oil market is skeptical of U.S. government claims that significant Iraqi production will come by August. But once oil does start really flowing, prices should drop. Natural gas is another story, though. North American supplies are fading, even as more homes use the clean-burning fuel for heating and utilities ramp up capacity with gas-fired power plants. Gas producers are building rigs and increasing their ability to import liquid natural gas (LNG). Even so, new supplies are barely offsetting eroding output from older fields. LNG could cover only 10% of U.S. demand by 2010, says Paul Horsnell, head of energy research at J.P. Morgan Chase & Co.

The few major gas users that can switch to another energy source must decide if a move is feasible financially and environmentally. If they can't? Says Horsnell: "The choices are starker: Absorb the higher costs, relocate to another country, or close down completely." For some companies, the natural gas dilemma is really heating up.

By James Mehring in New York, with Michael Arndt in Chicago

    Before it's here, it's on the Bloomberg Terminal.