This is the fourth in a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 4 looks at natural gas, in particular the US market.
1) Natural gas production
Most of the natural gas consumed in the United States comes from domestic production. U.S. dry gas production increased from 2006 to 2014, when production reached the highest recorded annual total. The increases in production during that period were mainly the result of more efficient, cost-effective drilling and completion techniques, notably in shale and other tight geologic formations.
2) Storage levels
The overall supply picture is also influenced by the level of natural gas held in underground storage fields. Storage helps to meet seasonal and sudden increases in demand, which otherwise may not be met by domestic production and imports. When demand is lower, storage absorbs excess domestic production and possibly lower-cost imports. Storage also supports pipeline operations and hub services. Levels of natural gas in storage typically increase April through October, when demand for natural gas is lower, and decrease November through March, when demand for natural gas for heating is generally high.
Cold weather increases demand for heating while extreme cold may affect the ability of gas producers as well as infrastructure to produce and deliver the gas to the final consumer. Hot weather on the other hand increases demand for cooling during the summer, which increases natural gas demand by electric power plants. Hurricanes in the US Gulf where there is still a significant amount of natural gas production may curtail supplies to the East coast of the US.
4) Economic activity
Economic conditions influence demand for natural gas, especially by manufacturers. Recent low prices have encouraged industries as diverse as transport to chemicals to rely on natural gas and its byproducts to increasingly use it. Changes in underlying demand from these and other industries may now have a bigger impact on overall demand.
5) The price of substitutes
Some large-volume fuel consumers such as iron, steel, and paper mills and electricity generators can switch between natural gas, coal, and petroleum, depending on the cost of each fuel. When the cost of the other fuels fall, demand for natural gas may decrease, which may lead to lower prices for natural gas. When the cost of competing fuels rise relative to the cost of natural gas, switching from those fuels to natural gas may increase natural gas demand and prices.
Related to number 5 electricity generators are switching from coal to natural gas due to stricter rules on coal burning in the US. The speed of the switch from coal to natural gas infrastructure will have implications for natural gas demand and prices.
7) The US dollar
US natural gas futures prices are in dollars. Not all commodities will be affected by movements in the dollar in the same way. Those commodities where the market is domestic to the US, with little scope for transportation outside of North America such as natural gas tend to see relatively little impact from currency movements. Indeed natural gas prices have a relatively low inverse correlation against the dollar of around -0.2.
8) Financial sentiment
The actions of speculators and financial traders such as hedge funds may result in natural gas prices diverging from what prices should be based on fundamentals alone.
The US gas market is essentially a large regional market cut off from outside influences. All the factors above affect global gas prices to some degree, but the final two factors relate particularly to natural gas prices outside the US.
9) Geopolitical events
The risk of disruption to supplies due to geopolitical factors is much greater in other parts of the world. For example, in Europe around one-third of its gas supplies are imported from Russia with many Eastern European countries almost completely dependent on imports from Russia. Russia has used its importance in the continents energy supplies as a bargaining chip on a number of occasions, threatening to cut off supplies.
The growth in Liquid Natural Gas (LNG) has meant that gas markets are increasingly global in nature. For example, a warm winter in Asia may reduce demand for natural gas. This could mean that LNG supplies from the Middle East which would have been destined to go to Asia switch to supplying Europe instead, increasing supplies and resulting in lower gas prices in Europe.