As a commodity, natural gas prices are affected by supply and demand factors. Supply-side factors include production volume, storage volume, and import-export volume. Demand-side factors include economic growth, fluctuations in weather, and the prices of alternative fuels such as oil and coal.
Natural Gas Supply
Unlike electricity, natural gas can be stored. Underground storage facilities include salt caverns in the Texas-Louisiana Gulf Coast area, depleted oil and gas fields, and aquifers. The ability to store natural gas greatly influences the supply curve. Natural gas is injected into storage facilities during low demand periods (April through October) and is withdrawn during peak usage periods (November through March) when demand outpaces supply. This has a buffering effect on prices and reduces the likelihood of short-term supply disruptions. The U.S. Energy Information Administration reports injections and withdrawals from storage facilities on a weekly basis. These weekly storage volume reports, along with other data, have a significant impact on the natural gas and electricity markets.
Almost all natural gas consumed in the United States comes from domestic production sources. Production has been bolstered in recent years by the increase in natural gas extraction from shale formations. Natural gas produced in the Marcellus and Eagle Ford basins has kept prices at historically low levels and created export opportunities. Importing and exporting natural gas outside of North America requires that the gas be liquefied, transported on tankers, and then converted back into gas once it reaches its destination port.
Natural Gas Demand
Natural gas has its primary demand period during the winter months when it is used as a direct energy source for heating and as fuel for power plants. There is a secondary, although lower, demand period in the summer when usage increases to meet power plant fuel requirements. Electricity generation fueled by natural gas represents the marginal generation. In other words, during peak electricity demand periods, the incremental fuel used to supply the power grid is natural gas. Therefore, electricity prices are largely driven by the price of natural gas and the efficiency of these marginal generating units.
Demand from commercial and industrial customers is also affected by economic growth. The demand for goods and services typically increases during strong economic times, which, in turn, leads to increased natural gas consumption and higher prices. In the industrial sector, natural gas is used both as a fuel and as a manufacturing component for products ranging from fertilizer to pharmaceuticals.
Weather fluctuations also influence natural gas prices, as it is the primary fuel used for heating. Increased consumption during cold months puts upward pressure on prices. Weather-related changes in demand can affect prices as supply, whether from production or storage, often lags in meeting the change in demand. Limitations in the natural gas transmission system may also limit the ability of increased supply to mitigate sudden shifts in demand. This can lead to price volatility.
Fuel switching is another demand component that can affect prices. Electricity generators and industrial customers often have a limited ability to switch fuel sources between natural gas, coal, and oil. Each of these commodity markets has a unique set of fundamentals that drives prices. When coal and oil prices are high relative to natural gas, these large customers may switch fuel sources to natural gas. This increases demand and places upward pressure on natural gas prices. The net effect of fuel switching is that long-term price advantages between these fuels are usually not sustainable.