Natural Gas Prices Reach Highs; But Where Will They Go Now?
By Carol Freedenthal, JOFREEnergy Consulting, Houston, TX

Pipeline & Gas Journal
May 2003

A Close-up Look At The Natural Gas Business

Believe it or not _ lightning can strike twice in the same place! U.S. natural gas prices that spiked to historical highs in late 2000-early 2001 did it again. Spot gas prices at Henry Hub hit an individual day high on Feb. 25 of $19/MMBtu and a monthly average for March of $8.06/MMBtu (based on Natural Gas Week's price reporting). A year earlier average spot price was $2.85/MMBtu. Whether it was perception or reality driving the market is unclear.

Sure, in February, there were many reasons for prices to spike and hit the roof. A late winter brought cold temperatures to much of the nation, especially high population areas where natural gas is a major fuel. Crude oil prices were teasing the $40/B mark because of Middle East war fears. Gas in storage was a high of 3.17 Tcf when winter began, but came down like a burst balloon.

U.S. gas production in 2002 was slightly down and it looked like Canadian imports were also dropping. Drilling rigs hunting for new gas supplies were at all-time lows. It was a "perfect storm" for high prices. Natural gas returned to low prices in mid-2001 after reaching all-time highs earlier in the year - January average was $9.13/MMBtu, the highest monthly price since natural gas was decontrolled. Remember, natural gas prices went through the roof in late 2000, early 2001 because of historically high demand in late 2000.

Those high prices were assisted by power shortages on the West Coast, especially California, strong positions in natural gas financial markets and, not to be forgotten, some hanky-panky by EnronOnline and other gas and power marketers. Information learned about a year later showed many marketing companies had played games in an attempt to manipulate and raise gas and power prices. All of this supposedly was cleaned up by late 2001. Enron went belly-up and Enron-Online shut down to regroup.

Other marketing and trading companies added to the stories about rogue traders, distorted prices going to trade publications and other tidbits questioning whether there really had been a gas shortage. With spot prices down to $2.24 in September 2001 and only $2.33/MMBtu in December, it looked like gas prices might break the $2 barrier shortly.

Where are prices now in late April? This is a shoulder month. Its five-year average monthly spot price at Henry Hub is $3.17/MMBtu. Average price for the first 21 days of April is $5.25 and as the month ends, it is in the $5.60 range and rising. Prices dropped slightly below $5/MM in late March but some colder weather later in April and continued greater withdrawals from storage than injections, as there should be once April starts, has pushed the price upward again.

Part of the perfect storm has subsided as crude oil prices took a nice drop once the first shot was fired in the Iraqi war. Crude oil prices, based on West Texas Intermediate spot prices, deflated from close to $40/B to $27.50 when the hostilities began. They have moved up and down but remain close to $28-30.

In natural gas equivalents, a $28 barrel of crude oil would give distillate oil (usually called No. 2 fuel oil and used for diesel and home heating) in the range of $5.80/MMBtu and residual fuel oil, the bottom of the barrel, around $3.75/MMBtu. Should oil prices tumble to the low $20 range as Iraqi production comes back, political problems in Nigeria subside, and Venezuela reaches full production after the strike, then the span between the two oil products would be from $2.90 to $3.60. Add another dollar per million Btu for the use of residual fuel oil and the range narrows to around $4 for the major competitor to natural gas - fuel oil.

Will natural gas stay in the $5 range? Some are projecting gas prices in the $6 - 8/MMBtu range and other forecasters are looking at the probability of even higher spikes before the 2003-2004 winter season ends. There are more in favor of rising prices than against. Pushing the higher prices mentality is the belief that 2002 production was down 4-6%, an error according to the Energy Information Agency's latest data, which shows a drop of only 2.6% for data through November.

Further pushing higher prices is the need to refill storage from the record lows of around 623 Bcf in mid-April. Competition to refilling is expected from the high demand for natural gas for electric generation to meet the summer air-conditioning load. What the bulls are not saying is how demand has come down in gas consumption both in 2001 and 2002.

Gas demand, according to the EIA's April short-term outlook, indicates that demand in 2002 was down 2.6% compared to 2001 even though the end of 2002 was so much colder. Volatility of gas prices is casting a dark shadow on the advantages of using natural gas. As prices increase, demand will decrease, especially in the industrial and electric generating sectors. Gas prices staying in the $5 range are possible but the pressure to come down some will increase for many reasons.

Wood-McKenzie, the Scottish consulting firm that expanded its U.S. operations recently, told the industry that gas prices have to come down and stabilize to keep the market position it enjoys. Especially with the weakness seen in crude prices later in the year, supporting over $5 prices seems inappropriate. Wood-McKenzie is looking for prices in the $4 to $5 range for the remainder of the year.

Continuing volatile prices will not help the industry. In 2000, everyone looked to gas as the fuel of the century, especially for the power industry and its growth. Now that the growth for power has been impacted by good ol' economics and the outlook is for much smaller demand, the potential of rising gas prices beyond its competition is a lot dimmer. And, the competition is coming. In addition to oil products, there is renewed interest in coal with mine-mouth generating facilities and a rebirth of nuclear is evident, both in making existing facilities more efficient and longer-lasting, and new designs for smaller, safer reactors.

The days of $2 to $3 gas appear gone but at the same time, gas at prices above the competition will not last long either. It is a new era where parity between fuel prices is the name.

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