Natural Gas Is On Fire

By Allan Brady 01/11/01 8:30 AM ET

The U.S. is weathering a barrage of energy-related jolts, each of which is contributing to the increasingly uncertain outlook. While oil prices remain high, there is little doubt now that short-term supplies are adequate to meet demand. As a result, prices have fallen for gasoline and heating oil. Natural gas, however, which accounted for 23% of domestic energy use in 1999, is a completely different story.

Uncertainty surrounding the capacity of natural gas inventories to meet demand is pushing prices through the roof. In the first two weeks of January 2001, the price of gas at the benchmark Henry Hub rose to $10.40 from just over $2.00 a year ago. Household heating bills are doubling and electricity prices are are under tremendous upward pressure in some parts of the country as electricity is increasingly generated from natural gas.

The runup in natural gas prices is driven by fundamentals. National natural gas inventories are now almost 30% below year-ago levels, and there is no hope of quickly rebuilding supplies. Poor resource development was masked for several years by warm winter weather. In 1998, there were 12% fewer heating degree days than the long-run average, 1999 was lower by 8%. Even the first half of 2000 was unusually warm. Natural gas supplies ballooned reaching a high in 1998; at the same time, rig counts plummeted. Now though, stronger demand during this past summer due to higher electricity usage and a return to cold winter weather is exposing inadequate production capability.

There is no reason to believe that the natural gas prices that prevailed over the last decade will return. Moreover, there is a growing consensus that natural gas prices will be two or three times higher than they have been historically for the next few years. The reasons for this view are due to the inflexibility of supply. It takes about one year to fully develop natural gas resources, and a couple of years will be required to rebuild inventories to pre-crisis levels.

The certainty of continued underlying demand growth for natural gas despite higher prices is tied directly to electricity. Almost all planned electricity plant additions in the U.S. will be powered by natural gas. Environmental regulation has made the construction of other plant types extremely costly. Without such regulation, coal would take preeminence in electricity generation. Furthermore, natural gas heats about 50% of all homes in the U.S., and if winter weather returns to its historical average number of heating degree-days, a considerable increase in natural gas use will result.

The outlook is undeniably gloomy. Consumers will feel the pinch for the next two years, and there is little that can be done to improve the situation in the nearterm. Rig counts have already rebounded in a rush to take advantage of the higher prices. There were only 466 active rigs searching for natural gas in January 1999, 606 by January 2000, and there are now 862 rigs searching currently. It is now a waiting game until these new rigs are able to replenish supplies. In the mean time, any government intervention to cap prices will only serve to exacerbate the situation by encouraging higher use and less production

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-- Martin Thompson (mthom1927@aol.com), January 12, 2001