What's Happening to the Price of Natural Gas?

Today’s guest blogger is Peter Franolic, who heads up the Energy practice at Greybeard Advisors LLC. Pete is the former Director of Energy Affairs for one of the largest energy users in North America, where he managed all aspects of energy, including procurement, risk management and hedging, conservation, and regulatory matters, before joining Greybeard. Pete can be reached at: Franolic@GreybeardAdvisors.com

Over the last few days natural gas futures price hit a 7 year low, dipping below $3 to $2.68 per MMBTU and headed lower. Not only has it reached a historic low, it is currently about 70 percent below a historic high of over $9 per MMBTU achieved only 12 months ago. Additionally, the current cash price at Henry Hub (La.) is approaching $2.00/MMBTU. 

Natural Gas is one of the most volatile commodities traded on the New York Mercantile Exchange (NYMEX). Any slight change in one of the price drivers can have serious impact on the prompt month futures price as well as forward prices. The severe economic upheaval we have been experiencing has been especially influential on the natural gas market, because unlike many of the other commodities, it is primarily a domestic market. It does not trade internationally the way crude oil does. 

Because of the industry downturn, relatively mild winter, and reduced cooling demand in the summer, demand for natural gas has been seriously curtailed. But supply and production levels cannot easily adjust to lowered demand. 

Production levels had accelerated over the past few years due to heightened exploration and favorable economics due to increasing pricing. But production is not readily "turned off" to counterbalance deceases in demand. There is a significant lag in the supply/demand balance. Therefore, even with much lower demand, the supply side is still forced to push its production into a shrinking market.  

Part of the market for natural gas is storage injection. Storage is used in the winter to meet demand that cannot be supplied by pipeline deliveries alone. Because of reduced consumption levels, much more natural gas is being injected into storage. In fact, storage levels are way ahead of five year averages and are expected to be full to capacity sooner than the end of storage injection season (end of October). This will actually “strand” some natural gas supply and will force "shut ins," when producing wells are shut off (this practice is avoided because some of the gas in the shut in wells becomes unrecoverable). 

"Shut ins" of wells, especially off the Gulf of Mexico, is also caused by threat of hurricane during the months of August thru October. This usually has a temporary effect of increasing near-term forward prices due to supply disruption. But, this hurricane season is not expected to be significantly disruptive and will have little influence on natural gas prices. Even if a hurricane did impact producing platforms, the already high storage levels and reduced demand would mitigate price impacts.

Speculators who trade natural gas on NYMEX are betting 2 to 1 that natural gas prices will continue to go down in the near term.  

As a result of the current situation, development of new natural gas production is severely curtailed and it is expected that 2010 will have a more bullish sentiment for natural gas price. Additionally, if the economy perks up and there is increased industrial demand, prices will most likely increase significantly with greater volatility. 

What can an end user do?

It should be obvious to any company that uses natural gas in more that trivial amounts, that it is vital to be very knowledgeable as to the drivers in the gas market and have specific strategies to react to market conditions. Now is a good time to consider seriously instituting hedge strategies that will take advantage of the low prices and mitigate the inevitable increases next year and further as the economy improves.