by Arthur E. Berman
On September 29, 2006 spot
natural gas prices at the Henry, Louisiana Hub reached a 5-year low, closing at
$3.46 per million British Thermal Units (MMBTU), down 75% from the all-time
high price in October 2005 of $13.44/ MMBTU (Fig. 1). This abrupt departure from the steady
increase in price over the past six years could bring about a crisis in the
domestic gas and petroleum service industries.
Short-term volatility has characterized
natural gas prices since the mid-1990s following a period of relative price
stability. Prices rose from 2002 through
2005 but have fallen dramatically since the beginning of 2006. Industry experts are struggling to determine
whether recent declines in the price of gas since November, 2005 reflect an
adjustment or a longer-term trend toward lower natural gas prices.
The analysis that follows will
show that gas prices show a stronger correlation with the number of months
supply of natural gas in underground storage than with actual supply and demand
relationships. Current gas price trends
suggest that low gas prices should continue, perhaps for several years. This
will result in drilling and production curtailments which, in turn, will cause
concern about future gas supply. This, along with demand rebound because of
lower price, will allow gas prices to rise once again over the next several
years.
The Simple Explanation for Natural Gas Price Fluctuations
Natural gas price fluctuations
are commonly explained by weather patterns or random events such as hurricanes
or infrastructure malfunctions. For
example, short-term price anomalies in the winters of 1996 and 1997 (Fig. 1)
were explained by cold weather. The
biggest historical natural gas price anomaly occurred in October, 2005 when
spot gas prices rose above $13/MMBTU.
This was explained by hurricanes Katrina and Rita, which combined to
disrupt 650 billion cubic feet (BCF) of gas production, 18% of annual
production, in the (Energy Assurance Daily,
October, 2005).
The following winter of 2005-2006
was exceptionally mild and resulted in a decline in spot gas prices to
$8.72/MMBTU. This is the first clue that
the simple weather pattern explanation for gas fluctuations may be misleading
since weaker demand for heating energy did not begin to offset the lost gas
supply that resulted from the hurricanes a few months earlier.
In order to evaluate the
correlation between weather and gas price, it is necessary to calibrate temperature
anomalies with gas consumption. Maximum
seasonal variance in gas usage due to weather alone was the 0.17 TCF difference
between January consumption during the cold winters of 1994 and 1996, and usage
during the milder January of the intervening winter of 1995 (Fig. 2). The resulting difference in price was less
than $2/MMBTU.
In the case of the price drop in
2005-2006, it is interesting to note that the price of spot gas had already
fallen from $13.44 to $8.72 by January, 2006, before the winter heating season
had begun in earnest, despite the loss of 0.65 TCF in gas production, an amount
more than 3 times the magnitude of any seasonal variance in consumption.
Gas prices fell an additional
$2.00/MMBTU through the summer of 2006, which was the second-hottest summer on
record, second only to the dustbowl summer of 1936 (NOAA Website, 2006). This should have been a time of increased gas
consumption for cooling, probably comparable to an exceptionally cold winter.
Clearly, the simple explanation
for natural gas price and usage fluctuations does not tell the entire story.
Predicting Gas Prices From Recent Trends
There are many methods for
predicting future gas prices which, despite their uncertainties, are useful for
estimating how gas prices may behave in the nearterm. A simple approach is to develop a general
trend-line for the overall pattern of gas prices apart from events that produce
anomalous spikes (Figure 3). This method
predicts that overall gas prices will remain below $6/MMBTU until the spring of
2008, will not get to $7 until early 2009, and will not reach $8 again until
some time in the summer of 2009.
According to Simmons &
Company, an overall gas price of $6.60 is necessary to sustain profitable gas
exploration in the
at current drilling and equipment costs; both exploration drilling and
production of gas will substantially decrease with prices below $5.70 (Lyle,
2006). Based on that figure, favorable conditions for drilling and production
may not return until at least the end of 2008.
Supply and Demand Considerations
In order to objectively evaluate
the meaning of gas price fluctuation, and to specifically understand the
dramatic price decline that has taken place in the year since hurricanes
Katrina and Rita, it is necessary to review the basics of supply and demand for
natural gas in the United States.
gas consumption (demand) was in balance with domestic gas production until
1987. Consumption increased from 16.2
TCF in 1986 to a peak of 23.3 TCF in 2000 (Fig. 4). Since the mid-1990s, the United
States has had an average 2 TCF disparity
between domestically produced natural gas (marketed gas) and the amount of gas
consumed. Most of this deficit has been
filled from increased output in the United
States and from imports from
(Fig. 5).
North American natural gas