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 Remember when your mom used to remind you to "sniff for gas" before leaving the house? While safety was (hopefully!) her main concern then (natural gas is highly flammable, as evidenced every time one lights a gas-fed burner), today she might ask the same question in the interest of saving costs. Natural gas prices have taken off over the past five years, driven by an amalgam of high oil prices, stabilizing or declining gas reserves, especially near large consuming countries such as the U.S., concerns over greenhouse gas emissions, and a general run-up in fuel prices. Natural gas is a gaseous fossil fuel created by the underground decomposition of organic matter. The carbon and hydrogen from this organic matter, when buried deep underground, is converted into methane, which is the main component of natural gas. Natural gas is then produced by drilling into the earth's surface to create access to underground reservoirs of gas, and usually oil. The oil and gas typically reside in the spaces between and inside underground rock.   So natural gas is like oil, but in gas form? Not exactly. First, we believe there are more natural gas reserves than oil reserves, relative to annual production (65 years of natural gas versus 41 years for oil). Second, natural gas is used for a wide variety of uses, including electricity generation, residential/industrial heating, and transportation. Moreover, the carbon footprint of natural gas is significantly lower than that of either coal or petroleum-- CO2 emissions from natural gas energy generation are estimated to be 45% lower than those from coal generation and 30% lower than emissions from petroleum generation. Natural gas does share some similarities with oil. It's reserves are widely distributed around around the world, though largely concentrated in the Middle East and Russia. Saudia Arabia is to oil what Russia is to natural gas -- Russia controls 27% of the world's natural gas reserves. The U.S., the world's largest consumer of natural gas, contains the 6th largest stock of reserves, or 3.3% of worldwide reserves. However, unlike oil, the U.S. is among the world's top producers of natural gas, currently providing a significant portion of its domestic requirements from domestic production.  Perhaps the most important similarity between natural gas and oil, however, is the recent run-up in natural gas prices. In fact, the prices of natural gas and oil are typically highly correlated.
[edit] Economics of Natural Gas The natural gas value chain looks similar to value chains for many other fossil fuels, consisting of exploration & production, transportation, marketing/distribution, and ultimately, delivery to end users. Historically, the natural gas industry has looked a lot like the electricity industry-- a natural monopoly industry (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-- the U.S. only has 5 LNG terminals currently, 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 and 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). [edit] Drivers of natural gas prices[edit] Oil supply, demand, and pricingNatural gas prices historically are highly correlated with oil prices. 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.  [edit] Source of supplyHistorically, 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. As the chart shows, a drastic change in the supply of natural gas is beginning to occur and will continue for the next 30 years. The potential for supply disruptions has not been lost on financial markets considering the future price of natural gas. [edit] WeatherWeather can have a significant impact on natural gas prices in the short-term. Weather typically impacts prices through its impact on demand for heat and/or electricity from end-users, both residential and industrial, leading typically to increased demand in winter months. Cooler winters translate to smaller spikes in natural gas prices. Recently, however, Hurricane Katrina, and fears over repeatedly bad hurricane seasons, have led to higher prices by causing supply disruptions. The U.S. is particularly vulnerable to such supply disruptions, since 60% of production resides in Louisiana and Texas. [edit] Drilling and storageBoth 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 has increased in importance. [edit] Seasonal FluctuationsNatural 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. [edit] The Ethanol EffectEthanol 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[1]; 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 is driving natural gas demand (and prices) through the roof. [edit] Companies who stand to benefitA list of the top natural gas producing companies suggests some of the key players who will benefit from a rise in natural gas prices. The majors all represent solid investments to play the rise in natural gas trends, including Exxon Mobil, BP, and Chevron.  NiSource owns the largest natural gas pipeline in the U.S. through a subsidiary, Columbia Gas Transmission. NiSource serves nearly 4 million customers along the Eastern corridor, and provides services across the natural gas value chain, including storage, transmission, distribution, and marketing. Dominion Resources, also a large player in nuclear energy, owns the largest pipeline (in capacity terms). Sempra Energy offers an interesting play by combining a utility company (providing natural gas to 20+ million customers in Central and Southern California) with a natural gas storage, marketing, and transportation business (Sempra owns and operated a series of LNG assets and pipelines throughout North America. EnCana represents a unique play on natural gas, and peak oil more broadly, as the self-annointed industry leader in unconventional natural gas exploration and oil sands exploration and development. EnCana owns significant natural gas assets, most of which are marginal at historical natural gas price levels, and therefore represents a bet on continued high natural gas prices (and fossil fuel prices more generally). Cabot Oil & Gas (COG) owns a diverse portfolio of 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. [edit] Companies who stand to loseElectric utilities who don't own their own sources of production are especially exposed to increased natural gas prices in markets where they have to purchase natural gas on open markets. 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. Gas utilities will suffer from shrinking margins, as a delay between the time prices start to rise and the time regulators decide to raise rates would cause these companies to lose money. 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. LNG is the big disruptor in this market, and could, in theory, change the landscape of companies who benefit from natural gas. Those with large asset bases in Texas and Louisiana, notably Exxon Mobil and BP, could 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. |
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