by Belinda Petty, Enerdynamics Instructor

Natural gas prices in North America rise and fall. In the last decade, the Henry Hub monthly price has been as high as $14/MMBtu and as low as $2/MMBtu. How can the same commodity at the exact same location be sold for seven times more one year than the next? Can we expect such instability to continue into the future, and should we be wary about becoming more dependent on natural gas as a key fuel?

Why price levels change
In North America, natural gas is a commodity whose price is driven by fundamentals. The value of natural gas, or price level, is determined by the perception of the supply and demand picture. Long supply, meaning suppliers are producing more supply than required by market demand, pushes prices down since buyers are able to negotiate price among multiple suppliers who need to sell for cashflow. Short supply means that production is equal to or less than demand. This results in buyers bidding up the price so they can get supply before another buyer does.

Currently in North America, the market perceives the balance to be supply long, and prices are at a traditionally low level below $4/MMBtu. Price volatility, or short-term price spikes and dips, is the result of a perceived supply and demand imbalance caused by supposed changes in underlying fundamentals. Once the fundamental factors causing the spike and dip resolve, prices should fall back in line with the overall perceived value of the commodity.

A century of natural gas use has led to the development of a robust set of assets to produce gas and move it to consumers, thus fulfilling the overall level of gas demand. These assets include a variety of supply basins with producing wells, gathering systems, processing plants, transmission pipelines, storage facilities, distribution networks, and a variety of customers. As long as there is excess capacity along the network of assets, there is flexibility to meet minor changes in the supply/demand balances. However, any major change in the balance disrupts the market, and the pricing, until the change can be absorbed.

This process may include getting new assets in place to alleviate the imbalance or customers changing their usage patterns. But in some cases, like the recent development of techniques to economically produce shale gas, major changes are structural and result in a long-term transformation of market fundamentals.

Market changes can come from anywhere along the value chain. Sometimes they impact the entire market. Other times they impact a region or location only. Next week’s post will look at some examples of game-changers in recent years on both the supply and demand side.