Why US natural gas prices are so low – Are changes needed?

US natural gas prices are at record lows–about where they were in 1976, and at the low points in the 1990s, in today’s dollars (Figure 1).

Figure 1. US wellhead natural gas prices based on EIA data, adjusted to January 2012 price levels using US CPI All Urban Price data.

There are several reasons why US natural gas prices are so low:

  • Our pricing system is based on short-term supply and demand, and storage facilities are limited. It is very easy for supply to overwhelm the system, and prices to drop very low in response, if there is a mismatch.
  • US demand for natural gas has been fairly flat for the last 10 years, regardless of price. Of the four major uses for natural gas ((1)residential heating, hot water, and cooking;  (2)commercial heating, hot water, and cooking; (3) industrial demand; and (4) electricity), only electrical use has been growing.
  • Supply does not drop very quickly, even if prices fall, because producers need to continue to extract natural gas in order to repay loans and to comply with use-it-or-lose-it lease terms.

Besides variability, there are a number of other problems with depending on short-term supply and demand for pricing:

  • Today’s prices appear to be far below the cost of production for some providers, leading to the likelihood of a shakeout.
  • Unless price levels are higher and more stable, it is not clear that natural gas supply will grow over the next 10 or 20 years, making long-term investment in new uses (for example, vehicular use, gas-to-liquids, and pipelines to underserved areas) questionable.
  • Natural gas prices in the US are much lower than prices elsewhere in the world (Figure 2, below). This means that there is likely to be strong demand for US exports of natural gas, most likely as Liquefied Natural Gas (LNG), competing with internal US uses.

Figure 2. Natural gas prices in the United States, Europe, and Japan, based on World Bank Commodity Price Data (pink sheet)

Ramping up natural gas production is now very much of interest, even if new sources of demand are not available, because

  • Oil prices are high and some believe that natural gas can act as a substitute, and
  • Natural gas seems to produce less CO2 than coal or oil.

It is not clear that the current natural gas pricing approach is up to handling this mismatch between supply and demand.  In many ways, natural gas is a drill-it-as-you-need-it product, and our current market free-for-all does not recognize this.

Perhaps we should be considering a different method of regulating natural gas, since in many ways natural gas is essential. It is needed for balancing wind and solar PV, and for allowing us to continue to continue to heat our homes and businesses with natural gas. In the early days of gas, gas was regulated to produce a reasonable rate of return for providers. Perhaps something closer to this approach needs to be used again today.

If price is regulated, the amount to be drilled would need to be regulated as well, probably on a month-to-month basis. Higher prices would probably be needed under the new system to provide funds for more storage and for maintenance of pipelines, and to assure that US needs could compete with demand for LNG from overseas markets. I am doubtful that such a method of regulation would be feasible or would be politically acceptable, however.

In this post, I will explain these issues further.
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