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Natural gas system structure
Old 10-02-2005, 04:10 AM   #1
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Natural gas system structure

I've got to admit I'm not well versed in the structure of the natural gas markets and the supply infrastructure for natural gas.
The price has gone up significantly in wake of the general energy price rise and the two hurricanes, yet I don't have a clear understanding of the components of the price increase (it seems to me there are too many producers and suppliers for price manipulation to continue for a long time).
Does anyone have a better handle on this market and its structure, or can you point out an article or series or articles that explain it?
Just want to know how many cords of wood I should actually get this winter.
Thanks
Uncledrz
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Re: Natural gas system structure
Old 10-02-2005, 10:30 AM   #2
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Re: Natural gas system structure

Hi Uncledrz,
I don't think energy markets are being manipulated. It does seem to me that there is a high degree of speculation that is pushing prices higher though. Although there are long-term fundamental reasons for higher energy costs, I don't think they adequately explain the explosion in energy prices. The natural gas market is a perfect example.

Because it is difficult and costly to ship natural gas internationally, gas markets tend to be local, rather than global, in nature. Therefore, the price of gas in North America should be determined by supply / demand factors specific to that region. Historically the domestic price of gas has generally tracked gas storage levels with "below average" storage resulting in higher than average prices and vice versa.

However, North American natural gas capacity has plateaued while demand continues to rise. Over the long-term domestic sources of gas may be challenged to meet the growing demand. Companies are starting to build LNG import capacity which should be coming on line in a few years, but LNG will still be a relatively small portion of the total North American gas market. Furthermore, most LNG imports are only economic with gas prices above $4 / Mcf, meaning our days of $2 gas may be over.

We're all dead in the long-run though. In the here-and-now gas prices should be set by current supply demand fundamentals as reflected in current gas inventories. Coming out of the 2004-2005 winter heating season gas inventories were ABOVE NORMAL. Analysts scratched their heads at $6 / Mcf gas prices when gas stocks heading into the summer injection cycle were above historic averages. Conventional wisdom coalesced around the idea that high oil prices were supporting natural gas. The theory went that the marginal users of natural gas (those that set the price) were able to substitute gas usage for oil. A barrel of oil has about 6 times the amount of energy (BTUs) as a Mcf of gas, so at $40 oil a $6 gas price seemed reasonable not withstanding high gas inventories - and all was well with the universe.

An extremely hot summer this year resulted in above average natural gas usage (nearly all of the power plants built over the past 5-10 years are natural gas fired so gas is increasingly being used for cooling as well as heating). By the end of summer we ate through the surplus gas, but inventories were still normal by historic standards.

Now two hurricanes move through the gulf coast forcing a significant amount of our natural gas production to be shut in. Sub-sea pipeline damage could keep production down for a while. Unless production is brought back soon, inventories could drop below normal.

But we're still talking about natural gas inventory at levels close to their historic averages. A cool winter could very well bring us back to or above normal. Variations of this sort used to have gas bounce between $2 to $3 - not $6 to $14. Even the argument that oil is supporting gas as a substitution fuel no longer holds with oil ($60-$70 / barrel) trading below the BTU equivalent of natural gas ($72-$84 / barrel equivalent).

I'm not sure where all this ends but you have to wonder if our economy can cope with $14 gas and $70 oil for any sustained period. International economies that are less efficient than the US, and more dependent on industrial production, are less able to cope. It seems to me that there is a lot of froth in energy markets currently. If global GDP begins to buckle under the weight of these extreme energy prices we could see a very sharp correction in the price of oil and natural gas.

Until then, stock up on wood.
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Re: Natural gas system structure
Old 10-02-2005, 11:21 AM   #3
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Re: Natural gas system structure

Yeah, the trend right now is continued demand pushing prices higher, but eventually that will upset the economic apple cart. I think we will see the beginning of that this winter, unless it is extraordinarily mild. When the Fed stops raising rates, it may be time to start shaving commodity investment positions.
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Re: Natural gas system structure
Old 10-02-2005, 09:50 PM   #4
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Re: Natural gas system structure

I would only add that natural gas production has been declining, while demand has been increasing. Costs of finding, producing and transporting have been rising. Without the hurricanes, the market was already concerned that we were closely balanced. One could say this is evidenced by the fact that it took $6/mcf+ gas price to get us to the storage levels we have today. Not only did Katrina and Rita take production down, some 79% the GOM production remains offline (plus a large chunk of shallow water and onshore production). Rita in particular did significant damage to electrical, pipeline, and gas processing facilities which are key links in the whole supply chain. And the timetable for resumption of production is still not clear.

Offsetting this is the potential drop in demand from users such as fertilizer and petro chemical companies...as well as oil refiners in the GOM area (big nat gas users) which remain offline.

We appear to be at a key juncture, where prolonged production delays, or a colder than normal winter could cause natural gas shortages. Since this is a commodity, prices are set at the margin. Demand price for the last molecule determines pricing for all gas. OTOH, a warmer winter could bring them down quickly. Sometime between now and the end of the year a clearer picture will form. Watch the weekly inventory numbers and expect more volatility!

And no, not much potential of switching from gas to oil. And the price of wood and woodstoves is also going up!

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Re: Natural gas system structure
Old 10-04-2005, 06:47 AM   #5
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Re: Natural gas system structure

Thanks for the replies. Didn't quite understand how key the gulf was to natural gas supplies. Wood is 120 a cord, cured, unstacked, delivered. Up, but not anywhere near as much as natural gas and oil.
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