Natural gas prices are a function of market supply and demand
Increases in natural gas supply generally result in lower natural gas prices, and decreases in supply tend to lead to higher prices. Increases in demand generally lead to higher prices, and 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.
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 other fuels
Because of natural gas supply infrastructure constraints and limitations in the ability of many natural gas consumers to switch fuels quickly, short-term increases in demand and/or reductions in supply may cause large changes in natural gas prices, especially during the wintertime.
Domestic natural gas production increased in recent years
The United States produces most of the natural gas that it consumes. Annual U.S. dry natural gas production generally increased from 2005 through 2019, and U.S. natural gas prices generally decreased during the same period and have been less volatile since 2010.
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.
Severe weather can disrupt supply
Hurricanes and other severe weather can affect the supply of natural gas. Natural gas prices have been affected when hurricanes disrupted natural gas production in the Gulf of Mexico as in 2005 with Hurricanes Katrina and Rita. In recent years, disruptions in Gulf of Mexico production tend to affect prices less than in the past because the share of total U.S. dry natural gas production from the Gulf of Mexico has declined from about 25% in 2001 to 3% in 2018. Very cold weather can also disrupt natural gas production. If these supply disruptions occur when demand for natural gas is high, prices may increase more than expected.
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)
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 can intensify 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 transmission (pipeline) system is already operating at or near full capacity. Natural gas supplies in storage can 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. Hot weather tends to increase demand for air conditioning in homes and buildings, 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. In addition, 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 affect 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 supply. Storage also supports pipeline operations and trading 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, injections of natural gas into storage have often continued into 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 power plants and iron, steel, and paper mills can switch between natural gas, coal, and petroleum, depending on the cost of each fuel. When the costs of the other fuels fall, demand for natural gas may decrease, which may reduce natural gas prices. When the prices of competing fuels rise relative to the price of natural gas, switching from those fuels to natural gas may increase natural gas demand and prices. However, the capability of the U.S. manufacturing sector to switch fuels has declined in recent decades. Favorable natural gas prices in recent years have contributed to increased natural gas use by the electric power sector.
Last updated: August 21, 2020