Natural gas is a lot like oil in gas form, but with some key differences. Both help power the world, be it through fueling transportation, electricity generation or residential/industrial heating. Both help pollute the world, but natural gas is much cleaner - per unit of energy its combustion produces 30% less carbon dioxide than oil, and about 45% less carbon dioxide than coal. Natural gas is also more abundant: at constant levels of production, the worlds proven supply of natural gas will last 65 years, higher than oil's 41 years. Like oil, however, most of that supply rests outside US borders (96.7% for natural gas). Until the middle of 2008, natural gas prices were skyrocketing, driven by high oil prices, stabilizing or declining gas reserves near high-consuming countries, (ex. countries like the U.S.), concerns over greenhouse gas emissions, and a general run-up in fuel prices. The financial crisis of 2008 broader, global economic slowdown and excessive supply has caused demand growth for Nat Gas to fall into the negatives.
In December of 2009, the Independent Energy Agency (IEA) stated that world natural gas demand will increase from 3 trillion cubic meters (TCM) in 2007 to 4.3 TCM in 2030. Reserves of 180 TCM are expected to be sufficient for current world consumption, however the agency states that almost half of world production capacity will need to be replaced by 2030. At the end of 2009 U.S. natural gas price was up to $5.50 per million Btu (MMBtu), an increase of over 100% from the lows in September 2009 of $2.50.
The oil and gas majors all represent solid investments to play the rise in natural gas prices, including Exxon Mobil, BP, Chevron, CONOCOPHILLIPS (COP), Total S.A. (TOT), and Royal Dutch Shell (RDS'A). Other large oil and gas companies include Lukoil (LKOH-RS), ENI S.p.A. (E), Repsol YPF S.A. (REP), and SINOPEC Shangai Petrochemical Company (SNP). Other companies that stand to gain from a rise in natural gas prices include:
Future Natural Gas contracts are traded on the New York Mercantile Exchange under ticker symbol NG and are delivered in every month of the year. (For more information on commodity tickers, check out the commodity ticker construction page.)
Although natural gas prices were relatively low in 2009, new drilling technology has the potential of making unconventional gas operations lucrative in terms of size and profitability. As a result, companies that operate in Marcellus Shale in the Appalachians, the Bossier Shale in Texas and Louisiana, and the Eagle Ford Shale in south Texas have the potential of being acquired by larger producers and oil majors.
The natural gas value chain looks similar to value chains for many other fossil fuels, consisting of exploration & production, processing, transportation, additional processing, marketing/distribution, and ultimately, delivery to end users. Historically, the natural gas industry has looked a lot like the electricity industry-- a natural monopoly (due to the high capital costs of natural gas pipelines and difficulty in storing natural gas), heavily regulated at both the wholesale and retail levels. However, unlike the electricity industry, deregulation has been a boon to the natural gas industry, encouraging innovation and reliability of supply.
The key drivers of the end-user price of natural gas are two-fold. (1) The raw fuel costs account for about 60% of final costs, while (2) the transmission and distribution costs account for the remaining 40%. The raw fuel price is market determined, but is driven by a combination of market demand and both current and future supply of natural gas. Natural gas is unique in that it is challenging both to transport and to store, limiting the short-term flexibility of supply in response to demand shocks.
There are typically two methods of transporting natural gas, both requiring significant investment. The predominant method of transportation in North America is via natural gas pipelines. An increasingly popular method of transport, and one likely to continue to gain traction as the U.S. finds itself importing more natural gas from sources outside Canada, is Liquefied Natural Gas (LNG), which enables gas to be shipped overseas in tankers. LNG requires major investment in both deep-water, sheltered ports to harbor LNG tankers and in liquefaction and gasification plants on both ends of the transport route-- as of December 2008, the U.S. had only 8 LNG terminals, but plans to nearly double capacity over the next 3-5 years.
Gas storage also offers an opportunity to reduce the cost of natural gas. Natural gas prices are typically seasonal, peaking in the winter months and hitting lows in the summer months, when heating needs are least. Though storing gas is challenging, given that it is lighter than air and therefore prone to dissipation, solutions have been found. Typically, gas is stored in depleted natural gas/oil fields or underground aquifers. In times of abundance (i.e., summer) gas can be injected into storage facilities, only to be withdrawn again during times of scarcity. The state of storage capacity and technology has a significant impact on natural gas prices in both the short-term (as stocks of stored natural gas represent the most readily available supply in case of increased demand for natural gas) and the long-term (as increased storage capacity offers the opportunity to build up more substantial reserves of easily accessible natural gas).
|Fixed Cost (cents/kWh)||Variable Cost (cents/kWh)||Total Cost (cents/kWh)|
|Energy return on Energy Invested|
|Coal-fired power plant||2.5|
A barrel of oil contains roughly 6 BTUs of energy equivalence, so based on the idea of energy equivalence, natural gas should trade at one sixth the price of oil. When gas trades above its theoretical energy equivalence value, the oil/gas ratio falls below 6, and when gas prices fall, the oil/gas ratio rises above 6. In theory, when the oil/gas ratio is above 6, there is an arbitrage opportunity available from purchasing gas and selling it when prices revert to the energy equivalence value. As of May 29th, 2009, the oil/gas ratio is near 18x, the highest it's been in 9 years.
(For example: With WTI oil trading @ $75/barrel on NYMEX, Nat Gas "energy equivalence" pricing would be $12.50/MMBtu on NYMEX. Further, while in theory there is an "arbitrage opportunity" in practice it's a bit more difficult. Both commodities trade via future contracts, therefore "time" becomes a factor for any position held. Also, both commodities exhibit a great deal of intra-day price volatility.)
This correlation is driven by two key factors. First, oil and natural gas are substitutes for many end-users, especially industrial and transport consumers (residential consumers do not have the choice to "switch" to petroleum powered stoves). Second, natural gas and oil often are found in the same geologic formations, and therefore, as oil prices rise, encouraging more exploration and production of oil, typically, exploration and production of natural gas increases as well. However, the US fulfills more than 65% of its oil needs from imports, triple that of natural gas, changing the supply/demand fundamentals between the two sources of energy. That means that oil prices are more dependent on rising demand internationally, especially in countries like India and China, while natural gas prices are more dependent on rising domestic demand (until late 2008) and slowing growth in North American supply.
During the week of July 14th 2008, it was revealed that natural gas inventories had gained 104 Bcf; on July 17th, shares of natural gas producers fell as investors made a run on the gas market. Later, in September 2008, a report by the IEA predicted natural gas imports will reach about half of world demand by 2015; though the OECD North America will still produce 90% of its own natural gas, imports will double. Because of the 2008 Financial Crisis, however, natural gas demand has been falling since the summer of 2008. In September, demand for natural gas declined by 2.62%, according to the EIA. As excess supply in North America can't be cheaply shipped to other countries, falling domestic demand has translated into rapidly falling prices and reductions in gas drilling. Data from July 2009 shows that the number of drills operating in the U.S. is down by 55%, or 851 rigs, year on year. This reduction in production, however, should help bring prices back up rapidly once demand starts to increase, as there will be a lag between the time demand starts to rise and the time enough rigs are in place for supply to catch up.
In December of 2009, the Independent Energy Agency (IEA) stated that world natural gas demand will increase from 3 trillion cubic meters (TCM) in 2007 to 4.3 TCM in 2030. Reserves of 180 TCM are expected to be sufficient for 60 years at current world consumption, however the agency states that almost half of world production capacity will need to be replaced by 2030.
Working gas in storage was 3,368 Bcf as of Friday, December 17, 2010, according to EIA estimates. This represents a net decline of 184 Bcf from the previous week. Stocks were 56 Bcf less than last year at this time and 264 Bcf above the 5-year average of 3,104 Bcf. 
During 2009 & 2010, there are enough liquefied natural gas plants set to come online to expand global natural gas supply by 30%. If global gas demand increases for environmental and economic reasons, LNG can supplement domestic sources. (LNG breakeven for 2009 from Qatar to America is $2.50MBTU) What effect this additional supply will have on current future prices is unknown at this time.
Over the past ten years, approximately 85% of natural gas imports into the U.S. have come from Canada. Canada's reserves, however, are beginning to dry up. This presents a problem, because Canada has been an advantageous trading partner for the U.S., given its stability and the established network of transcontinental pipelines providing a low-cost distribution network for natural gas from Canada. The potential for supply disruptions is considered by financial markets in projecting the future price of natural gas. The United States holds only 3% of the worlds proven reserves of natural gas, compared to 28% for Russia and 40% for the Middle East. As we import more of our natural gas from overseas, the cost of converting and distributing liquefied natural gas will represent more of the gas's end-user price.
From September 2008 to March 2009, the number of natural gas drilling rigs operating in the U.S. fell from 1,606 to 884, because of the contraction in gas prices that occurred following July 2009. When natural gas prices dropped, producers had less incentive to spend on drilling, and so brought many rigs offline; however, the reduction in rig numbers has the potential to be a negative feedback mechanism, as the subsequent reduction in natural gas supply would cause prices to increase. Futures traders are already jumping on this concept, with January 2010 delivery contracts trading 49% higher than April 2009 contracts.
Natural gas demand observably fluctuates on a seasonal basis, falling in summer months and rising in winter months. The need for heat during the winter and lack thereof during the summer are the primary factors responsible for these fluctuations. Seasonal anomalies, like cooler summers or warmer winters, can dampen this effect and change the amount of gas demanded on a large scale, thereby affecting natural gas prices, revenues, and profits. Utilities that purchase gas when prices are lower during the summer months, in order to keep inventories ready for the winter, also have a muting effect on natural gas seasonality. Recently, however, fears over repeatedly bad hurricane seasons have led to higher prices because of their track record of causing supply disruptions. The U.S. is particularly vulnerable, since approximately one third of domestic production of natural gas resides in Louisiana and Texas, where hurricanes are likely to land.
Both drilling programs for new gas discoveries and storage of existing reserves of natural gas heavily influence natural gas prices. Typically, the stock of natural gas in storage is crucial heading into the winter months, when natural gas is typically withdrawn from storage. Drilling programs, which increase in number when gas prices are high, lead to increased discoveries and/or production of natural gas in 6-18 months, depending on complexity of discovery and extraction. Therefore, drilling programs are more likely to impact medium to long-term prices for natural gas. As resources on land mature and deplete, drilling in deep water and coal-bed methane extraction has increased in importance.
Ethanol mandates around the world (including the U.S. Energy Independence and Security Act of 2007) have driven up demand for the corn-based fuel (cellulosic ethanol is still a developing technology). Ethanol is distilled in refineries that use gas boilers - and it takes 30,000 BTU of the stuff to produce a single gallon of "green" fuel. In other words, a 50-million-gallon-per-year plant uses 5 billion cubic feet of natural gas; with corn-based ethanol production in the U.S. alone set to increase to 15 billion gallons per year by 2022, it is ironically a response to environmental energy issues that had been driving natural gas demand (and prices) through the roof. Obama has indicated a willingness to remove some subsidies for food-based ethanol, but supports next generation biofuels.
In late 2008 a major change occurred in the global energy industry when the previously informal association of countries in the GECF- Gas Exporting Countries Forum transitioned to a more formal status by adopting a formal charter and opening offices in Doha, Qatar. Energy industry and political analysts are probing the question of whether the GECF can or will function as a "cartel" for natural gas and thus significantly influence global energy markets.