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April 19th, 2012

Natural Gas Prices Are At 10-Year Lows: How Much Lower Can Prices Go?

by Andrew Price, President & COO

Natural gas prices continue to plumb new lows with each passing trading day. Prices for the May 2012 NYMEX futures contract closed at $1.95 per MMBtu yesterday.  We have not seen futures prices this low since January 2002 - is it possible that prices could go lower?

The somewhat surprising answer is yes. The proliferation of natural gas production from shale deposits, combined with the warmest winter since 1950, has resulted in an enormous amount of natural gas in storage for this time of year. Natural gas is produced at a relatively steady rate throughout the year. Production is higher than demand during the summer months and the excess is injected into over 400 salt caverns, depleted reservoirs or aquifer storage facilities. Production is lower than demand during the winter months and the shortfall is made up by withdrawing natural gas from these same storage facilities.

The US natural gas storage system had 2,512 billion cubic feet (Bcf) of “working gas” available for withdrawal as of April 13, 2012 according to the US Energy Information Administration. Inventories are 871 Bcf (53%) higher than last year on this date and 919 Bcf (58%) above the 5-year average of 1,593 Bcf. There is a serious chance that storage facilities could reach their absolute capacity, estimated at 4,400 Bcf, before the end of the traditional injection season in November. If this were to happen, prices would have to go much lower to force natural gas production offline. If production continued to exceed demand after storage reached capacity, there would physically be no place to put a marginal unit of natural gas as it comes out of the ground.

The weather forecasts are not providing much price support for natural gas. The current forecast is for a cooler summer than last year and for a below average hurricane season. Production of natural gas from land based shale has made the US much less reliant on the Gulf of Mexico. Today only about 6% of our natural gas is produced in the Gulf. A dearth of stormy weather, however, could keep production in the Gulf high and exacerbate the current supply overhang.

In the electricity market, spot prices can sometimes go negative to “incentivize” generators to stop producing electricity when production exceeds demand. Negative natural gas prices are very unlikely but if storage facilities reach capacity we could see very low prices for a short period of time. Many factors are contributing to continued production of natural gas despite very low market prices. These factors include: high costs to cap active wells; some production was previously hedged forward at higher prices; certain land leases require production; and, many new wells designed to produce higher value products such as oil also produce associated natural gas that is sold as a byproduct.

Low natural gas prices are attracting new end users. Trucking companies and fleet vehicles are switching from expensive diesel to cheap natural gas. Coal fired power plants – long the low cost king in many regions of the US - are being forced offline by cheaper natural gas units. New pipelines are bringing natural gas to new sections of the US and allowing end users to convert from expensive oil and propane. While these initiatives will all increase demand for natural gas in the long run, and producers continue to move drilling rigs from natural gas regions to higher value oil basins, these changes all take time to implement and may provide little price support this summer and fall.

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