Natural gas prices are a function of market supply and demand. Because of limited alternatives for natural gas consumption or production in the short run, even small changes in supply or demand over a short period can result in large price movements to bring supply and demand back into balance. See Today in Energy, June 11, 2012 for recent examples.
Factors on the supply side that may affect prices include:
- Variations in the amount of natural gas being produced
- The volume of gas being imported and/or exported
- The amount of gas in storage facilities (referred to as storage levels)
Increases in supply result in lower prices, and decreases in supply tend to increase prices.
Factors on the demand side that may affect prices include:
- The level of economic growth
- Variations in winter and summer weather
- Oil prices
Source: NASA image courtesy Jeff Schmaltz, MODIS Land Rapid Response Team (Public Domain)
Higher demand tends to lead to higher prices, while lower demand tends to lead to lower prices.
Domestic Supply and Prices Can Be Cyclical
Most of the natural gas consumed in the United States comes from domestic production. U.S. production increased from 2006 through 2011, when it reached the highest recorded annual total since 1973. The increases in production were the result of more efficient, cost-effective drilling techniques, notably in the production of natural gas from shale formations.
Increased natural gas supply tends to dampen prices. In turn, lower prices can erode incentive for drilling, which eventually results in decreased production.
Severe Weather Can Disrupt Production
Hurricanes and other severe weather can affect the supply of natural gas. For example, in the summer of 2005, hurricanes along the U.S. Gulf Coast caused the equivalent of about 4% of U.S. total production to be shut in between August 2005 and June 2006.
Imports Contribute to our Supply of Natural Gas
In 2011, U.S. pipeline imports amounted to almost 13% of total natural gas consumption. More than 99% of the pipeline-imported natural gas came from Canada, with the remainder from Mexico. U.S. pipeline imports are expected to decline in the future because of robust U.S. production.
Economic Growth Can Affect Natural Gas Demand and Prices
The strength of the economy is a major factor influencing natural gas markets. During periods of 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.
Winter Weather Strongly Influences Residential and Commercial Demand
During cold months, residential and commercial end users consume natural gas for heating, which places upward pressure on prices as demand increases. If unexpected or severe weather occurs, the effect on prices intensifies because supply is often unable to react quickly to the short-term increased level of demand. These effects of weather on natural gas prices may be exacerbated if the natural gas transportation system is already operating at full capacity. Under these conditions, prices tend to increase, which reduces overall demand for natural gas and brings the market into balance. Natural gas supplies that were placed in storage during periods of lesser demand may be used to cushion the impact of high demand during cold weather.
Hot Summer Weather Can Increase Power Plant Demand for Gas
Temperatures also can have an effect on prices in the cooling, season as many electric power plants that are operated to meet air-conditioning needs in the summer are fueled by natural gas. Hotter-than-normal temperatures can increase natural gas demand and push up prices.
Natural Gas Supplies Held in Storage Play a Key Role in Meeting Peak Demand
The overall supply picture is also influenced by the level of gas held in underground storage fields. Natural gas in storage is a critical supply component during the heating season that helps satisfy sudden shifts in supply and demand, accommodates stable production rates, and supports pipeline operations and hub services. Levels of natural gas in storage typically increase during the refill season (April through October), when demand for natural gas is low, and decrease during the heating season (November through March), when space heating demand for natural gas is high. Natural gas in storage represents an incremental source of supply immediately available to the market. This can counteract the effects of sudden increases in demand for natural gas or supply disruptions such as pipeline outages that cause demand to exceed supply and thus lead to higher prices.
Competition With Other Fuels Can Influence Natural Gas Prices
Large-volume gas consumers (primarily industrial consumers and electricity generators) can switch between natural gas, coal, and oil, depending on the prices of each fuel. Because of the interrelationship between these fuel markets, when prices of the other fuels fall, any resultant shift in demand from natural gas to coal or oil reduces gas demand and pulls gas prices downward. When prices of the competing fuels rise relative to natural gas prices, there may be switching from the competing fuels to natural gas, increasing the demand for natural gas and pushing gas prices upward.
Although most of the switching occurs between natural gas and oil, natural gas and coal markets can also interact when the price of natural gas falls significantly. Electricity generation using natural gas can become attractive relative to coal-fired electricity generation in some areas of the country when the price of gas on an energy equivalent basis becomes less than the price of coal.