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May 24th, 2012

Near Term Natural Gas Prices Are Up Sharply. Why?

by Andrew Price, President & COO

Near term natural gas prices have jumped up over 40% in the past few weeks.  The June 2012 NYMEX natural gas contract bottomed out at $1.90 per MMBtu in mid-April and is now trading close to $2.80 per MMBtu. What has changed?

After a period of sustained growth, natural gas production from shale has tailed off in March and April as market prices set new lows (see chart published by the EIA).

Monthly dry shale gas production bcf /day

NG Graph

At the same time, US demand for natural gas has been up. During the week ending May 16th, natural gas usage was up 6.2% over the prior year. The demand increase was entirely due to increased usage of natural gas in the power sector. Power sector usage during the week was up 27% compared to last year. Although a single week can be misleading, these numbers are indicative of a recent trend towards higher natural gas usage in the power sector. Natural gas has become cheap enough to economically displace coal fired generation in parts of the US and has also taken up the slack for lower than average output in the US nuclear fleet.

 As a result of lower production and higher demand, weekly injections of natural gas into storage have been well below historical averages over the past month. Storage levels are still at record levels for this time of year, but the surplus has dropped from a high of 60% over the historical average to 41% above as of last Thursday’s report from the EIA.

There is evidence, however, that higher prices are already bringing some of this recently curtailed production back online. According to the EIA, for the week ending May 16th, domestic dry gas production was 0.2% higher than the previous week and 3.7% above the same week last year. The price increase has also been heavily focused on the near term contracts. Looking out beyond 2012, the calendar 2013, 2014 and 2015 strips are up much more modestly at 11%, 7%, and 4% respectively. The price impact has been heavily concentrated in the near term, perhaps indicating that the market expects production to ramp up again.

Low domestic natural gas prices will almost certainly spur increased demand and higher prices. It will take time for demand to really take off, however. Exporting domestically produced natural gas for consumption in higher priced markets around the world will not begin in earnest until 2015. The conversion of a meaningful number of trucks from high priced diesel to low priced liquefied natural gas or compressed natural gas will also take years as the filling station infrastructure is in its infancy and engine conversions will take place slowly over time. As natural gas prices rise the power sector can easily switch back to coal.   

The near term spike in natural gas prices looks to be a bit overdone. Unless we get a sustained hot summer to drive power demand, there is still a risk that the supply overhang is not worked off fast enough and natural gas storage levels come close to physical capacity this fall. If this were to happen, the only way to force additional natural gas production offline would be lower prices.  

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