Natural-gas prices are market driven and consequently are a function of supply and demand. What do we know about those two quantities? As far as demand is concerned, natural gas is increasingly popular because it is efficient, clean and reliable. Demand is also driven by weather conditions. A warm late winter (2005-06) reduced demand thereby increasing supply and reducing the price late in the winter. Interestingly, a hot summer also increases demand for natural gas because electric-power-generation plants use gas to generate electricity. In August of this year, electricity demand reached weekly records more than once due to the hot weather. This resulted in the first natural-gas inventory decline ever recorded in the summer months.
While supplies declined slightly in early August, these inventories were well above long-term and last year's inventories. This bodes well for short-term price stability. Long-term fundamentals suggest that prices will stay high and gradually increase. Some of the reasons for this are as follows:
- Lower production from new gas wells and depletion of older wells.
- New electricity generation has, and continues to be, gas-fired.
- Supply is flat and demand is up.
- Economic outlook is improving, and this will increase energy consumption.
What does all this mean for prices this winter? The Energy Information Administration of the federal government believes that natural-gas prices will be lower through the rest of this year relative to the same period in 2005. Barring extreme weather for the rest of the year, the 2006 average price is expected to be $7.69/mcf, which would be a drop of $1.17 from the 2005 average.
As of this writing, the contracts for delivery during the entire upcoming heating season (Nov. 2006 - March 2007) averaged $9.97/mcf. This is down over $0.90 in the last month and is the first time it has dropped below $10.00 since July. At the same time last year, the heating-season average future price was $12.15/mcf.
With futures averaging more than $2.00/mcf lower than this time last year due to such things as a higher inventory, cooler late-summer weather and a relatively calm early hurricane season (so far), the early heating-season prices promise to be favorable as compared to last fall. Supply is up and current demand is down. The free market is doing its job, as it should.
Unfortunately, as prices go up people tend to look to the government to fix the problem. Government "control" is typically in the form of producer price controls/limits, and this type of control throws the free-market system out the window. Abandoning the free market can result in shortages, which will not benefit us personally or professionally. So if/when prices do rise, realize that the free market is still at work and don't seek to fix something that isn't broken.