The wellhead price of natural gas, as noted in this report, is competitivelydetermined by market forces. The process of natural gas pricederegulation began in 1978 when the Natural Gas Policy Act ( P.L. 95-621 ) became law. The NYMEX future price is determined by the interaction of traderswho have business interests in the real, physical natural gas market, and financial traders whospeculate on the market. (3) The effective capacity utilization rate (ECUR) is the ratio of actual production to effective productivecapacity. Surplus capacity is the difference between effective productive capacity and actualproduction. The correlation betweenhigh values of the ECUR and high prices suggests that when the ECUR is above 90%, conditionsare in place that are consistent with high, volatile natural gas prices. Productive capacity has declined since the late 1980s, but appears to haveremained stable since 1993. All of these alternatives suggest that prices for the consumer are likely to rise. The first run up in prices, from 1973 to the mid 1980s was theresult of price deregulation in a market where supply was not abundant, demand-after years ofregulated prices-was strong, and oil prices were high, as a result of the Arab oil embargo of theUnited States in 1973-74, and the Iranian political upheaval of the late 1970s. (7) Whether the recent increase in drilling activity resultsin large enough supply increases to allow the price of natural gas to fall depends on the explorationsuccess rate, the size of the fields found, and the degree to which existing producing wells showoutput declines. If the ECUR remains high, as is likely, and a cold winter weather pattern repeats, the limited amount of stored gas, as well as the unresponsiveness of both supply and demand to real time pricevariations at the consumer level, could well bring about another price spike in the winter of 2004-05. The nature of this relationship in the natural gas industry can, under some circumstances, lead to a cycle of unstable boom and bust feared by those investing in gas production. As the U.S. natural gas market develops, this restriction will become lessappropriate. If storage volumes are below normal as the winter heating season begins, and the ECURis above 90%, the potential for elevated prices must be considered to be high. High, sustained levels of natural gas prices can act asa drag on economic growth. As with oil price shocks in the past, high natural gas prices canconstitute a classic supply side shock which reduces output and productivity growth. If severeenough, a shock of this type can increase unemployment and cause inflation in the short term. (14)
Much can be done to alter the demand and supply characteristics of the natural gas market in the long term.
Intermittently high, volatile natural gas prices since 2000 have raised concern among all types of consumers. Residential customers have seen gas bills increase dramatically during the heatingseason. Industrial consumers have seen costs increase, which reduces their competitiveness. Because the price of natural gas at the consumer level is a mixture of market forces and regulation,explaining the behavior of price can be difficult.
Debate in the 108th Congress concerning the energy bill ( H.R. 6 ), considered provisions which are intended to improve long term natural gas supplies in the United States. Otherissues are likely to be brought before the 109th Congress for consideration. This paper analyzes theshort term forces which influence the natural gas market.
The Energy Information Administration has developed a metric called the effective capacity utilization rate as a framework for analyzing the economics of the natural gas market. This measurehas been shown to be correlated with the price of natural gas. When as the effective capacityutilization rate attains high levels (90% and above) it becomes increasingly likely that tight marketconditions will yield high prices.
As a result of the Natural Gas Policy Act of 1978 ( P.L. 95-621 ) and subsequent legislation in 1989 and 1992 ( P.L. 101-60 and P.L. 102-486 ) the wellhead price of natural gas is marketdetermined. Pipeline rates are federally monitored and distribution charges are regulated at the statelevel. Price variability centers on the wellhead price as well as the price determined in futuresmarkets.
Price spikes have occurred in two of the past three heating seasons. Whether severe weather causes price increases depends on the tightness of the market as measured by the effective capacityutilization rate. The same level of demand could lead to very different price results if the effectivecapacity utilization rate is high or low.
A variety of factors can affect the effective capacity utilization rate. Since short run supply adjusts to meet demand, the weather will be an important determinant. The relationship betweennatural gas prices and investment in exploration, development and production is an important factorin determining productive capacity. The availability of stored gas and imported gas become vitalto price stability as the effective productive capacity exceeds 90%.
In the very short term there appears to be little that can be done from a policy perspective to alter the fundamental economics of the natural gas market. In the longer term, policies that slowdemand growth and/or encourage the growth of supply, either from domestic or foreign sourcescould be effective.
This report will be updated as events warrant.