Natural gas prices are a function of market supply and demand

Because of limited alternatives for natural gas consumption or production in the near term, even small changes in supply or demand over a short period can result in large price movements that bring supply and demand back into balance.

Increases in supply generally result in lower prices, and decreases in supply tend to lead to increases in prices. Increases in demand generally lead to higher prices, while decreases in demand tend to lead to lower prices. In turn, higher prices tend to moderate or reduce demand and encourage production, and lower prices tend to have the opposite effects.

A chart showing monthly U.S. dry natural gas production and monthly average spot prices from January 2007 through December 2016
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More data: monthly U.S. dry natural gas production and monthly average natural gas spot prices. The Natural Gas Weekly Update is a source of information on the factors that affected natural gas prices during each report week.

Three major supply-side factors affect prices

  • Amount of natural gas production
  • Level of natural gas in storage
  • Volumes of natural gas imports and exports

Three major demand-side factors affect prices

  • Variations in winter and summer weather
  • Level of economic growth
  • Availability and prices of competing fuels

Domestic natural gas production increased in recent years

Most of the natural gas consumed in the United States comes from domestic production. U.S. dry natural gas production increased from 2006 to 2015, and U.S. natural gas spot prices and consumer prices generally decreased during the same period. Imports of natural gas declined from 2007 through 2015. However, in 2016, production declined for the first time since 2005, and prices increased toward the end of the year.

Tropical Storm Katrina over the Bahamas and east of Florida, August 24, 2005
Tropical Storm Katrina over the Bahamas and east of Florida, August 24, 2005

Source: NASA image courtesy Jeff Schmaltz, MODIS Land Rapid Response Team (public domain)

Severe weather can disrupt supply

Hurricanes and other severe weather can affect the supply of natural gas. For example, in the summer of 2005, hurricanes along the U.S. Gulf Coast shut down about 4% of total U.S. natural gas production between August 2005 and June 2006. In the winter, natural gas supply sometimes declines temporarily because of cold weather-related production constraints.

Economic growth can affect natural gas demand and prices

The strength of the economy influences natural gas markets. During periods of economic growth, increases in demand for goods and services from the commercial and industrial sectors may increase natural gas consumption. Economic-related increases in consumption can be particularly strong in the industrial sector, which uses natural gas as a fuel and a feedstock for making many products such as fertilizer and pharmaceuticals. (See Annual Energy Outlook 2014, Issues in Focus, Effects of lower natural gas prices on projected industrial production).

Winter weather strongly influences residential and commercial demand

During cold months, natural gas demand for heating by residential and commercial consumers generally increases overall natural gas demand and can put upward pressure on prices. If unexpected cold or severe weather occurs, the effect on prices intensifies because supply is often unable to react quickly to short-term increases in demand. The effect of weather on natural gas prices may be greater if the natural gas transportation (pipeline) system is already operating at full capacity. Natural gas supplies in storage may help to cushion the impact of high demand during cold weather.

Hot summer weather can increase electric power demand for natural gas

High summer temperatures can have direct and indirect effects on natural gas prices. Warm temperatures increase the demand for air conditioning, which generally increases the power sector's demand for natural gas. During high demand periods, natural gas prices on the spot market may increase sharply if natural gas supply sources are relatively low or constrained. Increases in natural gas consumption by the electric power sector during the summer may lead to smaller-than-normal injections of natural gas into storage and to lower available storage volumes in the winter, which could have an effect on prices.

Natural gas supplies held in storage play a key role in meeting peak demand

The level of natural gas in underground storage fields has a large influence on overall supply. Storage helps to meet seasonal and sudden increases in demand, which domestic production and imports might not otherwise meet. When demand is lower, storage absorbs excess domestic production and, sometimes, imports. Storage also supports pipeline operations and hub services. Levels of natural gas in storage typically increase from April through October, when overall demand for natural gas is lower. However, in recent years, natural gas in storage has often increased during the first half of November. Levels of natural gas in storage typically decrease from November through March, when demand for natural gas for heating is generally high.

Competition with other fuels can influence natural gas prices

Some large-volume fuel consumers such as electricity producers and iron, steel, and paper mills can switch between natural gas, coal, and petroleum, depending on the cost of each fuel. When the cost of the other fuels fall, demand for natural gas may decrease, which may reduce natural gas prices. When the cost of competing fuels rise relative to the cost of natural gas, switching from those fuels to natural gas may increase natural gas demand and prices. In 2016, more electricity was generated from natural gas than coal for the first time on record, and natural gas was the largest source of overall electricity generation.