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These Are Days To Remember

Natural gas prices are really, really low in the wholesale market.

The graph above shows daily natural gas prices traded at the Henry Hub, in dollars per million British thermal units ($/mmBtu), from January 1997 to today.  Prices on the graph are in nominal dollars, not adjusted for inflation.  Natural gas prices have exhibited a great deal of volatility.  The average price over this period is $4.60 per mmBtu and the long-term trend is upward sloping as shown by the red line.  This fits well with the widespread perception that energy prices always go up.

This graph shows prices on a monthly basis, which smooths out some of the volatility, but not much.  Prices on this graph are in real dollars.  Specifically, they have been converted to today’s (2015) dollars.  After adjusting for inflation, the monthly average price is $5.53 per mmBtu and the long term trend is downward sloping.  In other words, in real dollars, natural gas prices have declined over this period of time.

Why have prices declined?  In a few words—the shale gas revolution.

Until 2008, the contribution of shale gas production to total US natural gas production was small (see green area above).  Since then, total natural gas production has risen dramatically.  Even more dramatic is shale gas’ contribution to total US natural gas production which today is greater than 56%.  The Energy Information Administration’s 2012 “Outlook” projected this level of contribution on the part of shale gas would not happen until 2035.  Twenty years sooner than predicted, here we are.

Using December 2008 as a demarcation point and splitting the data into two segments, we see two very different worlds.  From January 1997 to December 2008, natural gas prices rose by more than 19% per year.  Since then, they have fallen 5.7% per year.

Other commodities are experiencing declining prices recently.  Iron ore and copper prices, for example, have dropped dramatically, primarily because of declining demand in China.  Natural gas prices have declined in the face of rising demand.  This is truly astounding.

This frequency diagram shows how today’s prices compare to historical prices (all in real dollars). Natural gas prices are really, really low.

But, there is more to this story.  First some background.

During World War II, two pipelines (the Big Inch and the Little Inch) were built by the US government to transport crude oil from the Gulf Coast to refineries in New Jersey. The pipelines allowed the oil to be transported by land, rather than by sea tankers (which were exposed to German U-boats) as had been the practice.  After the war, these pipelines were sold to commercial enterprises and transformed to transport abundant and low cost Gulf Coast natural gas to Northeast industrial markets.  Subsequently, other pipelines were built to move low cost natural gas from the Southwest to the pricier Northeast and Midwest markets.

The difference between the prices of a commodity at two different delivery points is known as basis.  If Gulf Coast natural gas at the Henry Hub sells for $5.53 per mmBtu and sells for $6.53 in New Jersey, the basis differential is $1.00.  And this is the way it was for many decades—natural gas in Northeastern markets trading at a basis (compared to the Henry Hub price) of a dollar or more.  But things have changed.

Because of the immense increase in volume of natural gas being produced from the Marcellus Shale, natural gas for delivery in Pennsylvania and New York State, for example, sells for $1.50 or more below the Henry Hub price. This is a negative basis.  Today, with natural gas trading around $2.60 per mmBtu at the Henry Hub, natural gas can be purchased for a little over a dollar per mmBtu in Pennsylvania and New York.

For energy buyers, these are days to remember.  For natural gas producers, not so much.

Evelyn Teel contributed to this article.

 

The Avalon Advantage – Visit our website at www.AvalonEnergy.US, call us at 888-484-8096, or email us at jmcdonnell@avalonenergy.us.  Please feel free to share this article.  If you do, please email or post the web link.  Unauthorized copying, retransmission, or republication is prohibited.  Copyright 2015 by Avalon Energy® Services LLC

See these related articles:

Real Electricity Prices (Energy Prices Always Go Up, (Part 5)

Energy Price Always Go Up (Part 4)

Energy Prices Always Go Up (continued)

Energy Prices Always Go Up

Natural Gas Prices Continue to March Down

How Low Can They Go?

Natural Gas Prices – Get Real

 

 

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OFO (No Room at the Inn)

Huh? What does OFO mean? First, a step back.

The US natural gas pipeline and distribution system can be thought of as a large container with producers injecting natural gas (supply) and customers withdrawing natural gas (demand).  Last year, during 2011, the US consumed 24.4 trillion cubic feet (TCF ) of natural gas, or, on average, about 67 billion cubic feet (BCF) per day.

Interconnected with the US pipeline system is about 4 TCF of working gas storage capacity that is used to help balance supply and demand. Generally, natural gas is injected into storage during the summer and fall and withdrawn during periods of peak winter demand. Formation pressure from natural gas wells along with pressure added to the systems by mechanical compressors (driven by reciprocating engines and gas turbines) move natural gas through the pipeline and distribution systems. There are times when customers take more natural gas out of the pipeline and distribution network than is being injected by production wells or from storage. This can occur during prolonged cold spells and when surface equipment associated with production wells freezes over, for example. In these cases, the result will be a decline in system pressure. As system pressure drops, the ability to deliver natural gas to all customers diminishes. Systems operators have several tools available to manage pipeline pressure, including using “line pack” or also interrupting service to some customers. However, during extreme conditions, these tools may not be enough to maintain system pressure and operators may resort to an Operational Flow Order (OFO).

An OFO is an order to transportation customers and their suppliers that they together must keep the amount of natural gas they inject into the system within a tight limit compared to the amount of natural gas a customer burns. If injections for a customer fall below the threshold compared to actual burns, penalties are applied which, in the worst case, can be substantial.

So far, the 2011/2012 winter has not been very cold. Why, then, would a discussion of OFOs be of interest today?

On Friday, March 16, Delmarva Power (which operates a natural gas distribution system) issued an Operational Flow Order “until further notice.” This OFO was issued “due to warmer than normal weather conditions…and the inability to inject gas into storage.” So, here we are still in the winter heating season, when distribution companies are normally withdrawing natural gas from storage, and Delmarva has run out of storage capacity into which to inject natural gas. Rather than being concerned that system pressure will drop to an unacceptably low level, the concern is that system pressure will RISE to an unacceptably HIGH level.

Rather than being concerned that customers will withdraw more natural gas from their system than is delivered into their system, in their OFO, Delmarva indicates that “customers may deliver no more than one hundred and five percent (105%) of the volumes of gas tendered for burn by the customer on a daily basis, net of losses and unaccounted-for gas.”

Because deliveries are scheduled in advance (“nominated”) and because actual usage can vary significantly due to changes in weather and other factors, this is a tight threshold on a short cycle (daily) basis.

And what if a customer over delivers? Delmarva’s OFO states, “For all such … over-delivery volumes, a charge of THIRTY FIVE DOLLARS ($35.00) per MCF will be applied…” (emphasis added).

Currently, Delmarva’s commodity cost rate is $5.28 per MCF. This means the penalty is 563% of the cost of delivered natural gas. If you file your taxes late, you may be subject to a 10% penalty. If you deliver natural gas over the threshold into the Delmarva system, the penalty is more than SIX-FOLD the commodity cost of natural gas.

OFOs, when they are issued, occur during the winter. OFOs issued to ensure adequate delivery of natural gas during times of exceptionally cold weather do occur but are infrequent. OFOs, such as this one, issued during winter time to ensure that excess deliveries are not made are highly unusual. An employee of another East Coast natural gas utility indicated that over the company’s life, there has never been an OFO related to reducing system pressure during the winter time. The size of the penalties in the case being discussed here is a measure of how significant the current oversupply situation is.

What is driving this situation? Simply put, the combination of unusually warm weather this winter and diminished industrial demand for natural gas has created a large natural gas surplus. Normally, imbalances can be managed with storage. But, this year, there is no room at the Inn. Storage levels are far too high. There is nowhere for the natural gas to go.

Below are updates to two graphs presented in a previous blog post (https://avalonenergy.us/2012/02/how-low-can-they-go/).


Natural gas storage levels remain excessively high. And, as noted previously, the gas cannot stay in storage until next winter because the reservoirs need to be cycled down. As we predicted, this “overhang” continues to keep downward pressure on natural gas prices. On Friday, the April 2012 natural gas futures contract closed at $2.33 per dekatherm (Dth) and the twelve month strip at $2.92/Dth.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484- 8096, or email us at jmcdonnell@avalonenergy.us.

Copyright 2012 by Avalon Energy® Services LLC

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Natural Gas Price Drivers

We have noted previously on this blog that natural gas prices have declined dramatically over the last three years. On January 19, 2012 the February futures contract settled at $2.32 per million Btus. This is lower than natural gas prices have been in a decade and we are in the winter heating season, a time when prices generally rise. Adjusted for inflation, prices have not been this low since late 1998.

Looking ahead, the graph below shows the evolution of the twenty-four month natural gas futures curve over the last year and a half. It may seem counterintuitive, but as the futures curve has dropped it has remained upward sloping. In other words, as natural gas prices have declined, the market has continued to expect prices to rise in the future.

Several readers have asked what the major influences on natural gas prices are. Natural gas is very much a commodity and, as such, its price at any point in time is subject to the economic interaction of supply of and demand for natural gas. For our purpose here we have identified a number of influences and grouped them into those that create upward pressure on natural gas prices and those that will continue to moderate natural gas prices.

Influences that could drive natural gas prices upwards:

– Economic recovery
– Coal fired power plant shutdowns
– Greater industrial use of natural gas
– The development of a US LNG export trade
– More restrictive regulation of hydraulic fracturing (fraccing or fracking)
– Natural gas well shut-ins
– Decreased drilling for natural gas and the shift to more profitable oil basins

Influences that will continue to moderate natural gas prices:

– Further development of shale gas reserves, particularly the Utica Shale in the Appalachian Basin
– Drilling to hold onto mineral leases

This list is certainly not comprehensive but should serve as a good starting point. We will discuss these influences in this and future blog posts.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096, or email us at jmcdonnell@avalonenergy.us.

Copyright 2012 by Avalon Energy® Services LLC