Introduction to Natural Gas
Natural gas is the third most important source of energy after oil and coal. The use of natural gas is growing quickly and is expected to overtake coal in the second spot by 2030.
Natural gas was first developed commercially in 1825 in the United States, but took off as a major source of energy around the world in the 1970s. Today, natural gas is used by power plants to generate electricity, as well as for domestic cooking and heating. The world’s largest producers of natural gas are currently the United States, Russia, Iran, Qatar, Canada, China and Norway. These countries have excess natural gas that can be exported to other countries around the world, which is either transported through pipelines or as liquefied natural gas (LNG).
Regional Natural Gas
The three most developed demand centers for natural gas are western Europe, North America and north Asia. These regions have dense pipeline networks and high demand for natural gas.
Natural gas is the fastest growing energy source in north America. There are dozens of natural gas trading hubs around the United States. But by far the most dominant is the Henry Hub in Louisiana. Henry Hub is strategically situated in a major onshore production region and is also close to offshore production.
Henry Hub also has excellent connectivity to storage facilities and to pipeline systems. This allows natural gas to be moved from supply basins and exported to major consumption markets. This highly integrated network is served by both interstate and intrastate natural gas pipelines. It is no surprise that the price of natural gas at Henry Hub has become the dominant global reference price for natural gas. Henry Hub is the delivery location for Natural Gas futures contracts at CME Group, the largest gas futures contract in the world.
UK AND THE NETHERLANDS
In western Europe, gas is the dominant fuel for electricity production. Prices are set at several trading hubs around the region. The two most important hubs in the region are the National Balancing Point or NBP in the UK and the Title Transfer Facility or TTF in the Netherlands. CME Group lists futures contracts based on both the NBP and TTF.
Supply and Demand
Natural gas production in the United States has been rising steadily since 2011. Over 90% of the increase in domestic natural gas production has happened in the seven most prolific shale formation regions, with the largest increases coming from Marcellus. While the states within those shale regions produce the highest volumes of natural gas, there is a broad area of production across the majority of the United States.
Gas storage levels also plays a key role when looking at supply side. Natural gas in storage provides a valuable cushion to meet peak demand. During periods of lower demand, surplus can be injected into storage facilities. The natural gas storage infrastructure can be utilized to accommodate sudden rises or falls in demand, up to a certain point.
Overall, natural gas supply is characterized as being quite responsive to a relatively wide range of prices. However, restrictions of the existing infrastructure impact additional flows, rendering the supply curve very inelastic even when prices are high. On the demand side, overall economic growth, weather and competing fuel prices affect gas demand. Here is a general breakdown of the demand of natural gas across the some of the main sectors.
Demand of Natural Gas
When it comes to electrical power generation, natural gas power burn has been increasing due to low gas prices relative to coal. The second largest sector is within industrial usage. Natural gas is used as raw material to produce fertilizer, chemicals, and hydrogen.
Residential and commercial sector utilize gas as a fuel for heating or cooling purposes. Natural gas suppliers are usually insulated from short-term fluctuations through existing tariffs. The transportation sector accounts for a small amount of natural gas used as vehicle fuel from liquefied natural gas or LNG.
Over the last few years, the United States has seen the development of new LNG exporting terminals, mostly in the gulf coast region. The demand for natural gas for LNG export to international markets is expected to rise significantly.
Natural Gas Seasonality
When it comes to natural gas prices, traders see regular patterns of price fluctuation throughout the year. These patterns reflect the seasonal changes in weather.
Seasonality plays an important role when analyzing natural gas supply and demand. It helps gas producers, storage facilities and energy utilities manage their physical volume exposure as well as financial price risk in the market. By anticipating seasonality, they can adjust their operations and look to reduce their financial risks. Supply, demand and storage are the three major factors used in analyzing natural gas seasonality. Gas production is relatively stable, but may experience unexpected disruptions such as unscheduled pipeline maintenance, explosions or extreme weather.
In the United States, the gross production of natural gas has increased steadily over the past five years.
Within each of those years, seasonality plays a small role in production level changes. Seasonality patterns appear regularly on storage and consumption volumes, where there is a relative high price elasticity. This means storage levels and gas consumption respond quickly to market price changes.
You can see seasonality in this chart of U.S. monthly underground storage of natural gas. Storage levels tend to be highest between the end of October and mid-November, during the lead up to winter, and lowest at the end of winter after a season of high consumption.
Consumption Driving Patterns
When you look at consumption, heating and cooling demand are the main drivers for the cyclical pattern. In winter, the increase of space heating for both residential and commercial use leads to the surge of demand of natural gas. During the summer, use of natural gas is much lower due to summer cooling through air-conditioning. Other factors may influence the demand of natural gas, including climate change and the price of competing generation fuels sources such as coal and fuel oil. We can see the seasonal curve of storage matches the consumption curve. One of the most liquid futures contracts, Henry Hub Natural Gas futures, shows a distinct seasonal pattern. The cyclical change of production, storage and consumption are reflected on the price of this derivatives contract.
Having a general understanding of seasonality in natural gas markets and the potential impact on gas prices is important to anyone planning a natural gas trading strategy.