Natural gas prices have more than doubled from its six-year low

28 Dec 2009
Amidst the talks of economic recovery and improvement in global demand, the prices of most of the industrial commodities have more than doubled during March-November 2009. The gains also intensified due to a weaker dollar and the liquidity in the financial markets. Natural gas prices, however, seem to be driven more by its demand- supply equation rather than extraneous factor such as liquidity flows that seem to play key role in the prices of other commodities.

Unlike the major commodities, natural gas price experienced a continuous decline since the beginning of 2009, and reached a six-year low in August, only to show a rebound from early September. This behaviour has sustained in last one month from the time when natural gas’s energy counterpart, crude oil remained range bound, while the former has moved closer to its 2009 highs (chart-1).

To understand this price performance one needs to understand the characteristics and uses of natural gas. Natural gas, one of the common energy resources, is an odourless, highly flammable hydrocarbon gas, which has a wide range of industrial and household usage. It is widely used as a fuel for base load and combined cycle power plants. Liquefied Natural Gas (LNG) is a popular piped fuel, which is used for cooking and heating in most households in the developed world. Its industrial use as a fuel varies from that in boilers, baking ovens, air conditioning and in manufacture of fertilizers and petrochemicals. In recent years, compressed natural gas (CNG) is gaining in popularity as a relatively cleaner and cheaper alternative to auto fuels like diesel.

Globally, the natural gas usage accounts for about one-fifth of total energy consumption. US, Russia and Canada followed by Europe are the biggest producers as well as consumers of the commodity. The reason behind a sustained fall in prices in early 2009 was a continuous rise in storage inventories in the US, world’s biggest consumer of natural gas. Natural gas accounts for nearly a quarter of the US energy consumption. For this reason, the New York Mercantile Exchange future price derived from the spot deliveries taking place at the Henry Hub in Louisiana is considered the North American benchmark for the natural gas prices. US natural gas storage surged to a new all time high of 3,837 Billion Cubic Feet (Bcf), which was well after the prices started showing a turn around.

The turnaround was caused by the plunge in prices to a six-year low of $2.80 per Million British Thermal Units (mmbtu) in August ’09 even as the traditional demand season was approaching. However, rising inventory was more than offset by rising demand for heating due to colder than expected winter in northern hemisphere this year. So, in last few weeks, the price rise has been supported by the beginning of a strong heating season in the US and parts of Europe where temperatures dropped significantly in the first half of December. In most part of the US, temperatures were about 20% lower than normal. The early and strong cold weather thus reduced concerns regarding the abundance of natural gas in storage.

As can be seen from the second chart, the 2009 storage reached record high in the end of November and is way above its 5-year range and 5-year average.

Nonetheless, due to the expectations of continued extreme cold in consuming regions the latest reported stock withdrawal (of 207 Bcf) also exceeded the 5-year (2004-2008) average withdrawal by 63% and the last year’s withdrawal by 78%. In the coming weeks while the extent of chill in the consuming regions could help prices, the speculative interest could also lend a support. Traditionally, a rebalancing of commodity indices takes place in the start of a calendar year, wherein the commodities with dismal price performance during the year gain a higher weight in an index depending on its performance. Accordingly, funds adjust their exposures in the futures market which can give a push to prices.

However, once the winter season is over, the prices may experience a corrective pressure given the flattening of the forward curve. The direction of natural gas prices then would be a function of the end of the season stocks and the status of industrial demand.

VIA: E.T