Natural gas, a hydrocarbon found deep in underground rock formations or associated with other hydrocarbon reservoirs is used primarily in electricity generation, but also has applications including cooking, residential and commercial heating and industrial process feed stocks.
Clean burning, efficient, and now thanks to technological advances readily available and affordable, natural gas is becoming more prevalent as a source of energy in America. According to the EIA, 2016 will be the first year that natural gas will surpass coal in mix of fuel used in electricity generation. For decades coal has been the dominant energy source.
Demand for Natural Gas
Natural gas’ primary use is in electricity generation and direct use to heat homes. Therefore, demand for heating and air conditioning are the major drivers of natural gas demand. This means natural gas demand has a huge seasonal factor. In the summer, electricity demand is to power air conditioners; in the winter, natural gas demand is to generate electricity to heat homes and direct heat such as natural gas powered fireplaces, etc.
Natural gas demand’s primary peak is in the winter and its secondary peak season is in the summer. The natural gas production and distribution system is not designed to satisfy demand in peak seasons. Natural gas is put into storage in low demand periods and used in the high demand season. This means prices can see significant fluctuations over the year.
Supply of Natural Gas
Natural gas processing removes impurities and separates higher valued products that are sold in separate markets. Processing prepares a dry gas stream that meets industry standards for transportation in high-pressure pipelines. Natural gas is transported in high-pressure pipelines from producing areas to local distribution companies, storage areas, industrial end users, and electricity generation facilities. Local distribution companies own and operate the network of pipes that carry natural gas to final consumers, although large electric generators and industrial customers frequently take service directly from a pipeline rather than from a local distribution company.
The shale oil boom has revolutionized the natural gas industry in the US, making it more affordable and readily available. Thanks to the increased availability, the US government recently approved the export of natural gas, and Liquefied Natural Gas can now be exported around the world.
Natural Gas Prices
Heating demand for natural gas puts upward pressure on natural gas prices during winter and summer and this is when regulated distribution companies that place gas in storage during lower-price, off-peak periods, actually make money. These companies place gas in storage for peak demand independent of prices because they are required to.
Despite the storage of natural gas in the off-peak season, natural gas prices can fluctuate dramatically with changes in weather and the amount of natural gas in storage during the peak season. If storage levels are low in the fall, cold weather snaps can spark concern that it will be difficult to meet peak demands throughout the winter, and traders may be willing to pay more to secure natural gas volumes for winter month deliveries. This causes prices to rise. In contrast, high stockpiles and/or warmer winter weather can cause a large fall in natural gas prices. In summer, natural gas prices are responsive to hotter weather, and the sentiment around air conditioning demand, but the demand (and price response) is generally not as big as in the winter.
How The Natural Gas Market Works
The natural gas industry in the United States is highly competitive, with thousands of producers. These producers market and sell their natural gas to local distribution companies or to large industrial buyers. Others are directly connected to an interstate pipeline while other producers sell their gas to marketers. Customers usually purchase natural gas from a local distribution company, but large industrial customers may purchase their natural gas from a marketer or directly from the producer, removing the middleman of the distribution company.
It is important to note that pipeline companies, those responsible for the transportation and storage of natural gas, are not directly involved with the sale or purchase of natural gas. Instead, they act like a toll bridge, collecting fees in exchange for transporting and storing natural gas.
Natural Gas: Futures Vs. Spot
Natural gas can be purchased in the spot market, with both daily and monthly transaction options or through the futures market. In the US, the natural gas marketplace has a highly active spot market where brokers and others buy and sell natural gas. The Henry Hub is located in southern Louisiana, and is the delivery point for the NYMEX natural gas futures contract.
In addition to daily spot transactions, monthly spot transactions are often entered during “bid week,” the last five business days of a month. During bid week, buyers and sellers arrange for the purchase and sale of physical natural gas to be delivered throughout the coming month. Many customers purchase natural gas under longer-term contracts that provide for delivery of natural gas. These longer-term contracts usually are not for a fixed price; instead they are indexed to price.
To invest in natural gas there are plenty of options. Natural gas futures are traded on the NYMEX and there are derivative contracts traded in OTC markets. There are natural gas related ETF’s such as the United States Natural Gas Fund LP, and there are plenty of companies whose stock can be purchased, these companies are involved in different parts of the natural gas supply chain.