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09.04.2014
Gas price dynamics in the USA
A couple of demand and supply factors should be considered when the natural gas price is analyzed
AUTHOR: Lyudmil Milanov, energy consultant

Natural gas is of a great importance for the economy of the US. It is a primary energy source and around 25% of the supply comes from natural gas. That’s why the gas price plays an important role in the economy. Its prices are mainly a function of the market demand and supply. Because there are limited short-term alternatives to natural gas consumption and production, even a small change in the demand or supply can cause a significant change and a dynamic move in the price.

A couple of demand and supply factors should be considered when the natural gas price is analyzed:

  • The weather
  • The gas transportation infrastructure
  • The economic growth
  • The prices of the alternatives
  • The amount of gas produced

The weather

The chilly weather that affected a large swath of the country is one of the main reasons for the natural gas soar earlier this year. For the first time in nearly four years the monthly data from the Energy Information Administration (EIA) showed that Henry Hub (the most active and publicized gas market center in North America) prices rose above $5 per MCF. As it can be seen from the statistics, the Feb. 2014 price was $6.00 per million Btu (MMBtu) ($ per MMBtu multiplied by 1.023 = $ per Mcf) which is the highest price since Nov. 2008.



Residential and commercial end users also consume natural gas for heating, which places upward pressure on prices as demand increases. The snowstorms that hit parts of the country  in the beginning of 2014 plus the coldest winter temperatures in 2 decades are the reasons for the single digits on the Fahrenheit thermometers. The record-low temperatures have led to a surge in power demand causing rise in the price of the gas because the supply could not react that quickly to the higher demand.



As it can be seen on the graph above, the equilibrium position for the demand D(1) and supply S(1) was 1 with price P(1) and quantity Q(1). Due to the low temperatures there is an increase in the demand for natural gas and the demand curve shifts to the right due The new demand increases from D(1) to D(2) showing that buyers now intend to purchase a higher quantity than before.  As a result the equilibrium position changes from 1 to 2. Equilibrium price also increases from P(1) to P(2) and equilibrium quantity increases from Q(1) to Q(2).

The gas transportation infrastructure



Another reason for the dramatic rise in prices is the shortage of natural gas pipeline capacity in some parts of the US which creates bottlenecks when the demand is high. The pipeline capacity constraints during periods of high natural gas demand can result in a distinct price separation among regional markets.

For example The Transco Zone 6 NY that serves New York Metropolitan area hit price of more than $120/MMBtu for a day in January 2014.


source: http://www.quandl.com/WSJ/NG_TRAN6-Natural-Gas-Transco-Zone-6-NY

By comparison , the highest price at Henry Hub for a day in January was only $5.66/MMBtu.
If we take a look at the New England region the situation is pretty similar. There were a couple of severe price jumps in between Nov 2013 and Mar 2014.


 
Economic growth

The economic growth has a big influence over the natural gas markets. When the country experiences economic growth, the increased demand for goods and services from the commercial and industrial sectors generates an increase in natural gas demand. This is particularly true in the industrial sector, which is the leading consumer of natural gas, as both a plant fuel and as a feedstock for many products such as fertilizer and pharmaceuticals. The increased demand can lead to increased production, and, in general, higher prices. Declining or weak economic growth tends to have the opposite effect.



As it can be seen on the graph, the GDP percentage change is positive the last couple of years but the gas price was not that high. In the current situation the economic growth is not that important factor for the gas price increase last months.

Prices of the alternatives

The large-volume gas consumer can switch between different fuels depending on their price. When the prices of the substitute fuels fall, the result is that the demand for gas also falls because consumers are switching to the cheaper fuels. And the opposite, if the price of oil or coal is increased, the consumers are increasing its gas use and the natural gas demand is increased.

In the current situation, the prices of the alternatives did not play that important role because the high demand for natural gas was mainly from the residential users.

The amount of gas produced

Most of the natural gas consumed in the United States comes from domestic production. U.S. dry production started increasing since 2006. In 2013 it reached its highest recorded annual total of 25,616,403 MCF



The main factors for the increases in production are the new found gas formations, the more efficient, cost-effective drilling techniques, notably in the production of natural gas from shale formations.



As it can be seen on the graph above, the equilibrium position for the demand D(1) and supply S(1) was  with price P(eq)1 and quantity Q(eq)1. Due to the high production there is an increase in the supply of natural gas and the supply curve shifts to the right due The new supply increases from S(1) to S(2) showing that now consumers intend to purchase a higher quantity than before.  As a result the equilibrium position changes. Equilibrium price decreases from P(eq)1 to P(eq)2 and equilibrium quantity increases from Q(eq)1 to Q(eq)2. 

The last couple of years the bigger production caused a decrease in the price in the long term but factors like the cold weather increased the price in the short term.

Forecast

The natural gas consumption will decrease in the next couple of months because the weather is getting warmer. The high demand from the residential, commercial and electric power sectors will decrease and the natural gas price will decrease too. The possibility of hurricanes should also be considered as a factor which will affect the production and could cause higher price for a couple of weeks. 

The production of natural gas is expected to grow in the next years. The new found gas formations, the new technologies used, the more efficient, cost-effective drilling techniques, notably in the production of natural gas from shale formations are the reasons for the increase of production and supply. The abundant supplies are expected to keep the gas price low.



In the same time the low prices and the expected retirement of some coal plants will lead to higher consumption in the power sector which may lead to a temporary price increase.

Growing domestic production over the past several years has displaced some pipeline imports from Canada, while exports to Mexico have increased. Over the longer term, the EIA Annual Energy Outlook 2014 projects the United States will be a net exporter of natural gas beginning in 2018.

As a conclusion, the increasing natural gas production will keep the price at low levels if there are no major events that can affect the price.




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