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Uses of natural gas, EIA

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.^[1] 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 countries like the U.S., concerns over greenhouse gas emissions, and a general run-up in fuel prices. The financial crisis of 2008 and broader, global economic slowdown has caused demand growth for the gas to fall into the negatives, pushing down its price to a seven year low in February.^[2]

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.^[3]

The chart at left shows continuous front-month futures prices for natural gas traded on the NYMEX.

Who Benefits from Rising Natural Gas Prices

Top Natural Gas Producing Companies^[4]

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:

• NiSource owns the largest natural gas pipeline in the U.S. through a subsidiary, Columbia Gas Transmission.^[5] NiSource serves nearly 3 million customers along the Eastern corridor, and provides services across the natural gas value chain, including storage, transmission, distribution, and marketing.^[5]

• Dominion Resources, also a large player in nuclear energy, owns North America's largest natural gas storage system.^[6]

• Sempra Energy offers an interesting play by combining a utility company, which provides natural gas to 20+ million customers in Central and Southern California,^[7] with a natural gas storage, marketing, and transportation business. Sempra also owns and operates a series of liquid natural gas assets and pipelines throughout North America.

• EnCana has focused on unconventional natural gas exploration and oil sands exploration and development.^[8] Unconventional resource plays show small recoverable reserves on initial assessments, but have the potential for huge returns if new extraction technologies can be successfully developed, and if prices are high enough to make the required investment worthwhile.^[9]

• Cabot Oil & Gas (COG) owns a portfolio of both conventional and unconventional onshore natural gas properties in North America.

• Patterson-UTI Energy (PTEN) provides natural gas companies with contract drilling services. As the price of natural gas increases, demand for PTEN's services also increases because the sale of natural gas becomes more profitable.

• Gazprom (GZPFY) is the largest extractor of natural gas in the world. Gazprom owns more than 75% of Russian and most of eastern Europe's natural gas reserves.^[10]

Who Loses from Rising Natural Gas Prices

• Electric utilities who don't own their own sources of production are especially exposed to increased natural gas prices. As a result, where possible, electric utilities are vertically integrating, owning transmission assets at the very least, and often exploration and production assets as well.^[11] When prices are rising, utilities suffer from shrinking margins, as there is a delay between the time prices start to rise and the time regulators decide to raise rates.^[12] Gas utilities include Alliant Energy (LNT), AGL Resources, Atmos Energy, Energen, Equitable Resources, National Fuel Gas Company, ONEOK, Sempra Energy, Southern Union Company, and National Grid Transco.

• Liquefied Natural Gas (LNG) is the big disruptor in this market, and could change the landscape of companies who benefit from natural gas. LNG is natural gas that has been liquefied, making it easy to store and transport. Those with large asset bases in Texas and Louisiana, notably Exxon Mobil and BP, would face increased competition from overseas competitors in Russia and the Middle East in the event that LNG technology becomes cheaper and/or achieves some economies of scale in the U.S. This would also reduce the value of pipeline assets owned by the likes of pure-play pipeline companies such as Kinder Morgan. Companies with LNG terminals, or in the process of planning or constructing LNG terminals include: The Korea Gas Corporation, The Tokyo Electric Power Company, Inc., Enagas S.A., Chubu Electric Power Co., Inc., Sonatrach, Royal Dutch Shell, Osaka Gas Company, Qatar Petroleum, Petroliam Nasional Berhad, and Tokyo Gas Co., Ltd, Sempra Energy, Total S.A., El Paso, Equitable Resources, and Southern Union.^[13]

Prices

Natural Gas futures 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.)

Natural Gas Prices (NG) vs Crude Oil Prices (CL)

Economics of Natural Gas

Natural Gas Value Chain

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.^[14] 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.^[15]

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%.^[16] 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.^[17] 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.^[18] 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.^[19]

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.^[20] 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 and oil fields or underground aquifers.^[21] 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).

Energy Equivalence and the Oil/Gas Ratio

A barrel of oil contains roughly 6 BTUs of energy^[24], 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.^[25]

Drivers of natural gas prices

Oil supply, demand, and pricing

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,^[26] triple that of natural gas, changing the supply/demand fundamentals between the two sources of energy.^[27] 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.

Historical and Projected Natural Gas Imports, courtesy of the EIA

Natural Gas Supply and Demand

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.^[28] 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.^[29] 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.^[2] 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.^[30]

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.^[3]

Electrical Generation by Source for 2008^[31]

Expanding Liquefied Natural Gas (LNG) Demand Means Higher Natural Gas Prices

Over the next year, there are enough liquefied natural gas plants set to come online to expand global natural gas demand by 30%.^[32] As global gas demand increases for environmental and economic reasons, LNG will be needed to move gas more cheaply across long distances. With new terminals set to go live over the next year, natural gas will be able to reach places that previously had limited access - meaning demand is set to spike, with prices likely to follow.

Source of supply

Over the past ten years, approximately 85% of natural gas imports into the U.S. have come from Canada.^[33] 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.^[34] 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 for Russia and 40% for the Middle East.^[35] As we import more of our natural gas from oversees, the cost of converting and distributing liquefied natural gas will represent more 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.^[36] 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.^[37]

Weather & Seasonal Fluctuations

Natural gas demand observably fluctuates on a seasonal basis, falling in summer months and rising in winter months.^[38] The need for heat during the winter and lack thereof during the summer are the primary factors responsible for these fluctuations.^[38] 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.^[39] Recently, however, fears over repeatedly bad hurricane seasons have led to higher prices because of their track record of causing supply disruptions.^[40] 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.^[41]

Drilling and storage

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.^[39] 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.^[42] 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.

The Ethanol Effect

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^[43]; 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.^[44]

Gas Exporting Countries Forum (GECF)

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.

References

1. ↑ NaturalGas.org - Natural Gas and the Environment
2. ↑ ^{2.0 2.1} SeekingAlpha: "Natural Gas Demand Continues to Decline"
3. ↑ ^{3.0 3.1} Saadallah Al Fathi, "IEA forecasts stir debate," December 8, 2009
4. ↑ Oil&Gas Journal SPECIAL REPORT: Global processing capacity flat; US construction pace quickens
5. ↑ ^{5.0 5.1} Reuters - Full Description: NiSource Inc (New York Stock Exchange)
6. ↑ Dominion Resources - Company History
7. ↑ Sempra Energy - About Us
8. ↑ EnCana - Resource Plays
9. ↑ EnCana - Advantages of Resource Plays
10. ↑ The New York Times - Europe Worries Over Russian Gas Giant's Influence
11. ↑ 24/7 Wall St. - Electric Utilities Make News on Expectations, Merger Plans
12. ↑ Edison Electric Institute - Rising Electricity Prices: A Challenge for Consumers, Regulators, and Utilities
13. ↑ Research and Markets - Global Top 10 LNG Companies: Detailed Analysis and Forecasts of All Active and Planned LNG Terminals To 2012
14. ↑ NaturalGas.org - Processing Natural Gas
15. ↑ NaturalGas.org - The Market Under Regulation
16. ↑ NaturalGas.org - Natural Gas Distribution
17. ↑ Center For LNG - About LNG, Overview
18. ↑ Center For LNG - About LNG, FAQ
19. ↑ Federal Energy Regulatory Commission - Liquefied Natural Gas (LNG) in the US
20. ↑ Federal Reserve Bank of Dallas - Natural Gas Pricing: Do Oil Prices Still Matter?
21. ↑ Energy Information Administration - The Basics of Understanding Natural Gas Storage
22. ↑ Montana Environmental Information Center
23. ↑ Suzlon FY 07-08 Annual Report, Management Discussion and Analysis, p. 5
24. ↑ SeekingAlpha: Gas/Oil Ratio: Flashing an Extreme
25. ↑ SeekingAlpha: Gas/Oil Ratio: Flashing an Extreme
26. ↑ CIA - The World Factbook: United States
27. ↑
28. ↑ MarketWatch: "Natural gas shares fall to lowest level in months"
29. ↑ SeekingAlpha: "Natural Gas to Play Larger Role in Many Markets"
30. ↑ SeekingAlpha: Natural Gas Rig Count Is Slightly Up
31. ↑ SeekingAlpha: Electric Utilities: Coal vs. Renewables
32. ↑ FT: Expansion of LNG threatens gas glut
33. ↑ Energy Information Administration - U.S. Natural Gas Imports by Country
34. ↑ Energy Information Administration - International Energy Outlook 2008
35. ↑ Low Impact Living - the story behind natural gas
36. ↑ SeekingAlpha: Natural Gas Price Could Soar as Number of Idle Rigs Grows
37. ↑ SeekingAlpha: Natural Gas Price Could Soar as Number of Idle Rigs Grows
38. ↑ ^{38.0 38.1} NewsOK - Cold weather pushes natural gas prices up
39. ↑ ^{39.0 39.1} San Diego Business Journal - SDG&E also bracing for the long winter: despite the natural gas stockpiles, buy low, sell high still equals soaring prices
40. ↑ International Business Times - Natural Gas Weekly Update - December 18
41. ↑ Indiana University - Natural Gas Production by State, 2005
42. ↑ Energy Information Administration - Natural Gas Outlook Through 2025
43. ↑ SeekingAlpha: "Filling Up on Natural Gas", April 3rd, 2008"
44. ↑ NY Times - Obama Camp Closely Linked With Ethanol