The falling price of natural gas

Natural gas prices plunged in late August to a seven-year low after an Energy Department report showed that the amount of gas in storage had hit a record high for this time of year. The sharp price decline, to below $3 per thousand cubic feet from a peak of over $13 last summer, has been caused by a drop in demand from factories and homes because of the recession, coupled with a big expansion of domestic production over the last few years.

While the current price environment is causing consternation among pipeliners, some industry officials see a silver lining, arguing that the low prices will help them make a case in the Senate when it takes up energy and climate change legislation later this year. Natural gas industry officials have argued for federal incentives that will convince utilities to switch to gas from coal; and they want more government entities and businesses to convert their diesel bus and truck fleets to compressed natural gas. The House version of the legislation, passed in June, disappointed industry leaders who contended that coal interests got a better deal than they did, even though gas is a cleaner fuel.

The weekly Energy Department natural gas stockpile report showed that underground storage in the Lower 48 states rose by 52 billion cubic feet, to about 3.2 trillion cubic feet, for the week ending August 21st. That figure is 21% above the previous-year levels, and 19% above the average for the last five years at this time of year. Experienced industry observers know that it is normal for stockpiles to grow during the summer, but the current level is usually reached in late September or October. Gas demand is so weak and supply so abundant that some experts think the country could run out of storage capacity before the winter heating season begins, requiring gas companies to reduce flow from their wells or even shut down production.

Natural gas producers have already cut back on drilling, and are loathe to cut production on wells already completed. But they may have no other choice if the storage system and pipeline network get backed up. “We have never been here before in terms of what to expect when storage gets this high,” said Aubrey K. McClendon, chief executive of Chesapeake Energy. “It’s like a balloon; there comes a point where you can’t blow any more air into it.” McClendon, quoted by the New York Times, said he hoped that low gas prices could stimulate more replacement of coal with gas by utilities, something that is beginning to happen in some places, and said he was also hopeful that a cold winter would spur demand. “It doesn’t set the stage for $10 gas, but it does set the stage for $6 to $8 gas, which is in our view a fair price for consumers and producers,” McClendon added.

Kenneth B. Medlock III, an energy economist at Rice University, said there had not been such a drastic storage buildup since 2002, the last time gas prices swooned during a recession. But he said the situation could be temporary and prices could quickly rebound, noting, “If the economy starts to recover, and recover quickly, we will eat through those inventories very quickly.” 

It may be somewhat obvious to point out that the price decline is rooted in supply and demand. Energy experts note that factories and power plants have slowed production because of the weak economy. The Energy Department reported that consumption of natural gas was down about 5% in May from May 2008.

On the supply side, a boom in domestic production has followed improvements in recent years in drilling technology, opening immense shale gas fields across Appalachia, the Great Plains and northern Texas and Louisiana. Of course, these new fields have been opening up new opportunities for pipeliners in recent years, as producers have developed new transportation systems to get the shale gas to market. But as natural gas prices hit rock bottom, will the pace of construction slow as well? For pipeliners, that is the $60,000 (or more) question. Stay tuned.