Friday, April 7, 2017

Natural Gas Prices

In the January-February 2014 time frame in the United States (US), the natural gas (NG) price spiked above $5 per thousand cubic feet (MCF).   Both for a long-term period (months) before and after this January-February 2014 US NG price spike, prices trended in a range significantly below $5 per MCF.  The reason for this price spike was an extremely cold period across the US caused by a southward shift of the North Polar Vortex.  Record-low temperatures were recorded in many parts of the US during this period.  More than 200 million people were affected. With this unexpected cold increase, NG demand for heating greatly increased, without a corresponding increase in NG supply, resulting in the price spike.

This cold weather affect on the price of NG prices is an example of one of the most common of determinants affecting NG prices – the weather.   The tables below identify and explain the results of several determinants (factors) that affect NG demand or supply, which in turn affect the NG price.

demand determinant table (all change over time)

e.g., colder and warmer weather increase demand
fuel competition
e.g.,  cheaper NG can move energy users from more expense energy
higher populations increased demand
more income means more energy use, such as NG
NG price increase/decrease
lower prices can increase energy use
foreign demand

supply determinant table (all change over time)

interfere with production
NG storage levels
higher levels, higher supplies
pipeline-transport improvements
improvements lead to greater supplies at customer locations
gas drilling-production rates
increases supplies
improved technology
increases supplies
adverse issues at production
decreases supplies
NG price/decrease changes
higher prices incentivize for more supply
increases supplies

The above tables indicate than many determinants affect NG price.  NG price is, in fact, primarily a result of the affects of these determinants on demand and supply

For example, fracking in shale gas fields (a supply gas drilling-production rates determinant) has greatly increased NG supply in the US compared to supply in the rest of the world.  This increased supply has resulted in a significant decrease in price compare to other areas in the world.  This increase in supply is reflected on the demand-supply curve graph by a shift of the supply curve to the right.

As the US NG price significantly decreased, NG became much less costly than competitive energy sources (a demand determinant – fuel competition) and, as a result, electricity providers moved to the use of NG as an energy source.  This greatly increased US NG demand and interactions between demanders and suppliers, affected the price offered by the NG suppliers.  The settled prices between the demanders (the electricity providers) and suppliers (those holding NG supplies) will initial be in a non-equilibrium state over a short time, but fairly soon with many (large) market participants negotiating prices, the price will stabilize to a market equilibrium (clearing) price. Now with greater demand, the demand curve shifts to the right.  The eventual market-determined price (and quantity supplied and demanded) will be shown on the demand-supply curve graph as the new point of intersection of the two curves. An important suggestion in this analysis is that usually the supply is the predominant determinate of changes in demand-supply equilibrium prices.

One conclusion I have reached from considering the many price determinants given in the tables above is that several determinants can be present at any one time making confidently predicting an equilibrium price very difficult.  This is especially true, it seems to me, over the short term, e.g., over a several-month period.  So, a prediction of future price trend will be limited to how US NG price will change, not over the short-term, but over a long-term, e.g., over the next five years.

I will use four demand determinants (weather; demographics; income; and exports).  And I will use two supply determinates (gas drilling-production; pipeline-transportation) and expectations in changes of these determinates in forecasting a future US NG price. 

Demand Determinants:

1.      Weather.  Reliable climate scientists predict global temperatures over the next several years will increase. Because of this, less energy should be needed, since less energy is required for cooling than for heating.  Raising temperatures suggest a decline in NG demand.

2.      Demographics.  Populations are expected to greatly increase globally, but not much in the more developed countries.  So a small population increase in the US likely will have little effect on NG demand.

3.      Income.  Incomes are increasing significantly globally but not so much in the US.  Income changes in the US will likely have little effect on NG demand and price.

4.      Exports.  With increasing capabilities of transporting NG by sea and across borders and because of lower US NG prices due to supply, export demand should greatly increase.

Supply Determinants:

1.      Pipeline-transportation advances.  Increases in pipeline capacities and capabilities are being made and this likely will result in more NG supply to meet new demand.

2.      Gas drilling-production rates.   Existing US fields are likely to have been mostly discovered and drilling rates not likely to greatly increase.  Therefore, a significant increase in US NG supply from this determinant is not likely over the next five years.

My conclusion from the above determinant analysis is that supply will show increase long-term over the next five years but the increase is limited.    The likely demand determinant potentially affecting price significantly over the long-term is exports.   Therefore, I would expect to see some movement of both the supply and demand curves to the right, resulting in limited price increases over the next five years.

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