Wednesday, October 31, 2012

US Natural Gas Prices and the Election

Every fall my natural gas utility asks if I'd like to lock in my gas price for the next 12 months.  In some respects the timing for this looks ideal.  Commodity natural gas prices haven't been lower than this year's average since 1999.  Gas is also historically cheap relative to other fuels.  Heating oil recently averaged above $4 per gallon, while the fixed price my natural gas provider is offering equates to $1.36 per gallon, including distribution charges.  However, overhanging this relatively simple choice are big uncertainties related to the economy and the potential impact of regulations on shale gas production.  To complicate matters further, both of these uncertainties are entangled with the outcome of the US presidential election, and my gas provider wants my answer by next Monday.

When I last looked at this question in detail, in 2010, I concluded that the utility's offer was attractive, after scrutinizing then-current gas futures prices and the historical relationship between the futures market and "city gate" prices for Virginia, where I live.  Using the same methodology, this year's offer of $0.62/therm ($6.20/MMBTU) looks reasonable.  Much has changed in the interim, though, in ways that undermine the rationale for locking in consumer gas prices.  The biggest benefit of a fixed price is avoiding nasty surprises during winter heating season.  More than four-fifths of my household's gas consumption occurs from November through March, a period when gas prices used to be alarmingly volatile.  

That's less of a concern, now, with US gas inventories high and supply ample. The same shale gas revolution that has increased domestic supply and backed out imports has also reduced volatility and promoted big shifts in demand. Since 2009 residential gas demand has been essentially flat, while demand from commercial and industrial users has grown by 6.5% and consumption in power generation is up by more than 10%, despite a lackluster economy.  (Gas for use in transportation grew even faster but still constitutes less than 0.2% of total gas demand.)  As a result of these shifts, peak monthly average natural gas prices since the winter of 2009-10 have occurred in summer, coinciding with air conditioning demand. With less winter price volatility, the decision to lock in prices now is mainly a bet on gas prices for the next 12 months.  The outcome of that bet hinges on future supply and demand.

On the supply side, will the surge of US shale gas production continue?  New regulations are among the biggest potential constraints on output.  The EPA has set new rules on emissions during well completion and production, with the most expensive aspect phasing in by 2015.  EPA will also issue new rules on wastewater disposal from fracking by 2014. There is growing pressure on the administration to impose federal regulation of most aspects of shale development, superseding management by the states.  Thus far, the White House has avoided a sweeping crackdown that would disrupt gas markets, and the EPA administrator is on record opposing comprehensive federal regulation of all wells.  However, it's not obvious whether such reticence stems from a basic belief in the national importance of this resource or the simple expedient of not killing the golden goose before the election.  Governor Romney has proposed streamlining regulations affecting gas production. Next Tuesday's outcome should resolve this uncertainty.

The other big uncertainty surrounding gas prices concerns demand.  High shale gas output isn't the only reason gas is cheap today.  Anemic GDP growth such as the 2% rate for the third quarter reported last Friday has helped keep gas prices low.  A stronger economy with higher full-time employment would put upward pressure on prices by soaking up much of the surplus production that has depressed them.  However, the consequences of failing to mitigate January's "fiscal cliff"--federal budget "sequestration" and the expiration of many tax cuts--would likely drive natural gas back toward the lows we saw this spring.  With the economy still the number one issue for most voters, its likely future impact on gas demand is linked with our perceptions of the candidates' economic programs and promises. 

My best bet is to convince my supplier to let me wait until after the election to reply.  There's nothing like additional information to improve the value of a decision. Failing that, I'm inclined to pass on this opportunity.  The possibility of cheaper natural gas next year acts as a modest hedge against the risk of another recession, while the benefits of a stronger economy would more than outweigh any natural gas price increases I might experience on the upside.

1 comment:

Geoffrey Styles said...

Jackie Champion,
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