As a long time observer of energy markets, I have maintained a continuing skepticism as many people assured the world that we were entering into a lengthy period of low, well-behaved natural gas prices. I have heard that before and watched as the fuel’s natural volatility took over and prices see-sawed with great drama. Though natural gas has many good qualities, the only time that it is not subject to periods of dramatic price changes is when its price is regulated and that situation has its own significant disadvantages.
Traders love gas; they make their living on changing prices and often benefit no matter which direction the movement is happening.
Yesterday there was another day of excitement on the trading floor as natural gas prices increased by 15% in a single day, rising 42.7 cents per million BTU to settle in New York at $3.256 per MMBTU. As is true for most market fluctuations, the reporters and traders can list a number of factors that caused the movement. People with longer than daily time horizons should recognize that the previous price of $2.90 is/was clearly unsustainable in a world where heating oil, one of the prime competitors to gas in some markets, sells for a price that is 4 times as high. At yesterday’s market close of $1.78 per gallon for heating oil, one can use the conversion of 139,000 BTU per gallon to figure out that it costs $12.80 per MMBTU.
Gas is currently selling for about 25% of its 2008 market highs, also around $12 per MMBTU. That means that the dramatic increases in available fuel reserves that were revealed at that price are NOT going to arrive in the market because the drilling effort that makes them accessible for human use has slowed dramatically. It is predictable human and businessman behavior to slow or stop a difficult and expensive activity if the promised reward for success falls by 75%.
Aside – MMBTU is an archaic, but still frequently used market unit symbol. The MM stands for “thousand thousand” from Roman numerals which equals a million. To add to the confusion of casual market observers, many participants will talk about gas in “per M” which also means a million BTU. Conveniently, one thousand cubic feet of gas holds almost exactly 1,000,000 BTU, so you may also hear people talk about the price per thousand cubic feet – it is generally within pennies of being the same as per M. I know that this kind of discussion frustrates the heck out of engineering types and everyone outside of the USA that like metric units, but we are talking about markets here and need to be familiar with the market lingo.End Aside.
Some of the specific factors cited for yesterday’s move include a lower than expected increase in gas storage additions. Fall, which is closely followed by winter when gas begins to be used for both space heating and for producing electricity, is normally a period when gas storage increases due to lower overall demand. Fall is also the onset of one of the normal maintenance period for some large base load generating plants like coal and nuclear facilities. At this point in the cycle, US nuclear plants are operating at a total of 94% of rated capacity; there are only 5 plants that are in a maintenance period. The trend over the next few months will be for that number to drop as more plants enter into their scheduled refueling periods in the lull between summer and winter demand.
When traders saw the Energy Information Agency storage addition number and saw that it was lower than expected for this time of year, they piled in, causing that dramatic price increase that many have been expecting would happen. The price has plenty of room for additional increases, each of which makes natural gas less and less competitive in the electricity production market where it competes against coal, which has fallen by about 50% since last year to its more normal range of something close to $1.50 per million BTU and commercial nuclear fuel, which has sold for a rather steady price over the past 15 years of about 50 cents per million BTU.
Natural gas producers will cheer the sales price increases as they fall directly to their bottom line, but I expect that they will continue to talk to politicians and electrical power customers about the massive quantities of gas that can be extracted from shale gas areas. They like to tell the story to some listeners that gas is a reliable, low cost, environmentally sound fuel while they tell their investors about the profit increases that will come when the prices increase due to increased demand and less competition.
It sure seems strange to me that power companies think that there is too much risk in planning a large nuclear power facility yet they will make what appears to be an even riskier bet by building lots of natural gas fired capacity where the major cost component is something that can vary in price by 15% in a single day. (In a gas fired electrical power plant, the cost of fuel is between 80-95% of the total cost of generation.)
Perhaps the regulated utilities are comforted in their decision making by the nearly automatic fuel price adjustments that are allowed by essentially all of the public utility commissions in the United States. I wonder how the producers in more competitive markets feel about the risk balance between the two choices or how the customers in those regulated markets feel about the variation in the fuel surcharges?