Factors Affecting Natural Gas Prices

Natural gas prices are a function of market supply and demand. Because of limited alternatives for natural gas consumption or production in the near term, even small changes in supply or demand over a short period can result in large price movements that bring supply and demand back into balance. See the June 12, 2012 and April 11, 2014 Today in Energy articles for recent examples.
There are three supply side factors that may affect prices:

• Variations in the amount of natural gas being produced
• The volume of gas being imported and/or exported
• The amount of gas in storage facilities (referred to as storage levels)

Increases in supply tend to result in lower prices, and decreases in supply tend to increase prices.
There are three demand side factors that may affect prices:

• The level of economic growth
• Variations in winter and summer weather
• Oil prices (the effects of oil prices on natural gas prices varies by global region)

Tropical Storm Katrina over the Bahamas and east of Florida, August 24, 2005

Source: NASA image courtesy Jeff Schmaltz, MODIS Land Rapid Response Team (public domain)

Higher demand tends to lead to higher prices, while lower demand tends to lead to lower prices.

Domestic natural gas prices driven primarily by supply

Most of the natural gas consumed in the United States comes from domestic production. U.S. dry production increased from 2006 to 2013, when it reached its highest recorded annual total. The increases in production were the result of more efficient, cost-effective drilling and completion techniques, notably in the production of natural gas from shale formations. See the March 11, 2014 Today in Energy article. Increased natural gas supply tends to lower prices. For example, average wholesale (spot) prices for natural gas fell significantly throughout the United States in 2012 compared to 2011. A mild 2011-12 winter, high natural gas inventories, and rising natural gas production in the Marcellus and Eagle Ford basins contributed to lower average spot natural gas prices at Henry Hub.

Severe weather can disrupt production

Hurricanes and other severe weather can affect the supply of natural gas. For example, in the summer of 2005, hurricanes along the U.S. Gulf Coast shut down about 4% of total U.S. production between August 2005 and June 2006.

Economic growth can affect natural gas demand and prices

The strength of the economy greatly incluences natural gas markets. During periods of economic growth, the increased demand for goods and services from the commercial and industrial sectors generates an increase in natural gas demand. This is particularly true in the industrial sector, which uses natural gas as both a plant fuel and as a feedstock for many products such as fertilizer and pharmaceuticals (see Annual Energy Outlook 2014 Issues in Focus article "Effects of lower natural gas prices on projected industrial production"). The increased demand can lead to increased production and higher prices. Declining or weak economic growth tends to have the opposite effect.

Winter weather strongly influences residential and commercial demand

During cold months, residential, and commercial end users consume natural gas for heating, which places upward pressure on prices as demand increases. If unexpected or severe weather occurs, the effect on prices intensifies because supply is often unable to react quickly to short-term increases in demand. The effects of weather on natural gas prices may be exacerbated if the natural gas transportation system is already operating at full capacity. Under these conditions, prices tend to increase, which reduces overall demand for natural gas. Natural gas supplies that were placed in storage during periods of lesser demand may be used to cushion the impact of high demand during inclement weather.

Hot summer weather can increase power plant demand for gas

Temperatures can also have an effect on prices during the cooling season. About 30% of U.S. electricity is generated by natural gas. Warmer than normal temperatures can increase the demand for air conditioning which increases the power sector's demand for natural gas and can lead to increased prices.

Natural gas supplies held in storage play a key role in meeting peak demand

The overall supply picture is also influenced by the level of natural gas held in underground storage fields. During the heating season, natural gas in storage is a critical supply component. Natural gas in storage helps satisfy sudden shifts in supply and demand, helps accommodate stable production rates, and helps support pipeline operations and hub services. Levels of natural gas in storage typically increase during the refill season (April through October) when demand for natural gas is low, and decrease during the heating season (November through March) when space heating demand for natural gas is high. Natural gas in storage represents a source of supply immediately available to the market. This can counteract the effects of sudden increases in demand for natural gas, or counteract supply disruptions that cause demand to exceed supply and lead to higher prices.

Competition with other fuels can influence natural gas prices

Large-volume gas consumers (primarily industrial consumers and the electricity generation fleet) can switch between natural gas, coal, and oil, depending on the prices of each fuel. Because of the interrelationship among these fuel markets, when prices of the other fuels fall, any shift in demand from natural gas to coal or oil reduces natural gas demand and pulls natural gas prices down. When prices of the competing fuels rise relative to natural gas prices, there may be a cutover from the competing fuels to natural gas, increasing its use and pushing natural gas prices up.
While 39% of electricity was generated from coal in 2013, the use of natural gas for electricity generation has been on the rise, generating 27% of electricity in 2013. Electricity generation using natural gas can become attractive in some areas of the country when the price of natural gas on an energy equivalent basis becomes lower than the price of coal.