Abundant Natural Gas Leads to Record-Low Prices; Natural Market Forces Will Correct the Oversupply

Wall Street Journal -- "U.S. natural gas prices fell to their lowest point in more than two years, underscoring how the nation's booming energy business is becoming a victim of its own success. Mild weather and oversupply have pushed the fuel's price below $3 (see chart above).

Prices for the commodity have been under pressure over the last couple of years, as new drilling techniques unlocked vast new stores of natural gas from shale formations and other so-called unconventional reservoirs. But in the last two months, the steady price decline has turned into a free-fall, as unusually mild temperatures across much of the U.S. have damped demand for gas to heat homes and offices.

Natural gas for February delivery settled Friday at $2.989 per million British thermal units, the lowest closing price for the commodity since September 2009 (see chart). It closed below $3 in the winter for the first time in nearly a decade.

"The sub-$3 levels for gas prices in the winter really point to the incredible amount of nonconventional gas that has come onto the market the last two years," said Gene McGillian, analyst at Tradition Energy in Stamford, Conn. "Our production levels, our mild winter and the gas we have in storage have combined to crush natural gas prices this month."

Natural gas traded as high as $13 per million British thermal units in July 2008. But in recent years, domestic production boomed, with horizontal drilling techniques and hydraulic fracturing, or "fracking," helping producers unleash a flood of gas from shale formations in Pennsylvania, Arkansas and elsewhere.

Natural gas production in the lower 48 states hit a record 71.3 billion cubic feet a day in October (see CD post). The bonanza has ushered in lower prices for many consumers and businesses. New Jersey's Public Service Electric and Gas Co., citing lower costs partly due to shale drilling, reduced residential gas rates on Dec. 1 by 4.6%, bringing to 35% the utility's total decrease since January 2009.

Shale drilling has also created jobs and the prospect of greater energy independence, while raising environmental concerns. But the fresh abundance of natural gas has also weighed on its price, undercutting the profitability of the business for energy companies.

Still, due in part to the structure of the business, the torrid pace of natural gas production shows few signs of slowing. Producers often have a limited time to begin drilling once they lease property, which leads many to drill wells regardless of commodity prices or risk losing their hold on reserves. Other companies are forced to drill by the terms of joint ventures they signed when the outlook on gas prices was rosier."

MP: Overall, the fact that the shale gas industry is "becoming a victim of its own success" is only a temporary "problem," and demonstrates that the price system and competitive market forces are working as expected: an abundant supply of natural gas leads to falling prices, which lowers the profits of producers, which then leads to automatic, self-correcting adjustments and responses as the natural gas market moves towards a new equilibrium.

Those adjustments might include: a) increased demand for natural gas as residential and commercial consumers shift from oil and electricity heat towards natural gas (see CD post), b) increased demand for natural gas by energy-intensive manufacturing companies that produce steel, plastics, chemicals, etc. c) increased demand for vehicles powered by natural gas, d) increased demand for natural gas for electricity generation, and e) reductions in the production of natural gas as it becomes less profitable and some producers shift towards shale oil.

All of those automatic adjustments (increased demand and decreased supply) will raise the price of natural gas over time, eliminate any economic losses currently being incurred by producers because of the low prices (and drive economic profits to zero in the long run), and the market will move towards a natural market-clearing equilibrium that eliminates the current "oversupply."

HT: Warren Smith