July 2014, Vol. 241, No. 7

From the Burner Tip

Natural Gas Price Forecasting Critical To Industry Operations

Sometimes it feels like a black box and a crystal ball are the biggest help in forecasting energy product prices. Forecasting prices on the primary fuels – crude oil, natural gas and coal – which comprise over 90% of the fuel used worldwide, is an important part of the business. Price outlook coupled with demand forecast are essential considerations for developing operational levels and planning capital expenditures to meet the constant demand for fuel.

Forecasting is an analysis and evaluation of all the factors going into supply and demand for the given fuel. The results of the analysis are expressed in a single number or small range such as dollars per barrel for crude oil, dollars per million Btus for natural gas or dollars per ton for coal.

Many of the factors involved in the supply and demand analysis can change for reasons beyond common logic such as weather, the economy, etc., so forecasting becomes a problem of dealing with uncertainty and volatility. Who can say with certainty what the weather will be in three or six months? Who knows with certainty what the economy will be in six months?

Analysis and evaluation play major roles in forecasting. Many in this business use large, econometric models to deal with the many variables and coefficients involved in the forecasting analysis. When properly handled, using the models should help provide an unbiased approach to the forecast process.

Since the days of whale oil and wood for fuel, prices for these commodities have been a question of uncertainty and volatility. In the relatively short time since the turn of the century, crude oil was $25/bbl in 2000 and averaged $127/bbl in 2008. U.S. crude oil prices based on West Texas Intermediate (WTI) are running just over $100/bbl at $102.80/bbl. During the high times of 2008, it reached as high as $150/bbl!

Natural gas is no different. Up to the 1980s, natural gas prices were government-regulated and were so out of tune with market demands that pricing played a big role in the gas shortages of the 1970s. The Natural Gas Policy Act of 1979 set the stage for gas prices to reflect market demand. In 2000, average U.S. wellhead price was $2.37/MMBtu and in the high-roller days of all commodities of 2008, it averaged $12.60, reaching higher prices some days. Prices for 2014 are estimated at an annual average of $4.14/MMBtu by the federal Energy Information Agency (EIA) in its May short-term analysis.

Even stable, dirty ol’ black coal, which traditionally has had stable prices, ran up almost 50% in 2008. While all fuel prices as well as most other commodities have fallen since 2008, they are still higher than those in the 1990s.

Natural gas prices are especially in the spotlight now for several reasons. Other fuels and commodities in general are under pricing pressure for some of the same reasons. These include rapid world economic growth, continuing conflict in parts of the world like Eastern Europe and the Middle East, and declining value of the dollar. These all contribute to uncertainty for commodities. Concern over climate change is especially affecting the volatility of energy products with gas likely getting most of the attention.

For natural gas, there are some specific reasons that are making it even more volatile – no pun intended! On the supply side, new sources of supply from unconventional deposits such as shale or tight sands have changed the supply picture 180 degrees. Early in the 2000s, plans were completed to build large importing facilities to bring liquefied natural gas (LNG) to supplement domestic production. With the new sources of supply, exporting LNG is planned and facilities are being completed. This will change the demand side of the equation substantially.

Further, the current political trend to use regulatory control to impact climate change more and to shut down the coal industry or curtail coal’s use will also create new demands on natural gas supply. The coal industry now supplies around 40% of the fuel used for the nation’s electric generation.

Likewise, regulatory efforts from government agencies or civic groups could impact the new natural gas supplies. Many are concerned that fracking used to free natural gas from the reservoir has bad effects on the environment. Further, there is concern that the increased use of natural gas with random losses of the gas from valves, fitting, drilling, etc. will add to climate warming. Natural gas’ main ingredient, methane, is a bigger heat absorber by many, many times than carbon dioxide, the main villain of climate-concerned environmentalists. Five states to date have put new regulations into effect to better contain fugitive natural gas losses into the atmosphere.

With these added uncertainties and industry volatility, it is easy to see why price forecasting is even more important today for the natural gas industry. U.S. natural gas exploration, production, transportation and delivery are a big business. Based on 2013 production, the wellhead value of natural gas for that year was approximately $95 billion. By the time gas is moved from the wellhead to the burnertip, considerable value-added factors increase this considerably.

Accurate price forecasting of the commodity plays a vital role in the industry. There are many reliable sources of natural gas price forecasting. This includes the federal government, energy consulting and management firms, financial and investment firms and trade publications. Many of the sources provide periodic revisions which reflect changes in supply and demand and impact on future pricing. This is all for the natural gas physical markets, where gas is essentially bought and sold for near-term delivery and consumption.

Natural gas has a big financial market where the gas is traded for income appreciation. The theory is to buy cheap and sell high! In the financial markets, which some estimate to be as high as 10 times the physical market in gas volumes traded daily, gas is bought and sold for delivery in the future as far out as a couple of years. Prices paid for future delivery are published by the Commodity Exchange. This makes a statement of natural gas values in the future by indicating what traders are willing to pay today. While the trading volumes are high and reflect many of the parameters affecting gas prices, only very small volumes are actually taken by the buyer for delivery.

Of the many sources available for natural gas price forecasts, the Department of Energy’s EIA gives a forecast of all major energy products on a monthly basis through its publication, Short Term Energy Outlook (STEO). Best of all, it is free and easy to obtain. Merely go to the EIA website, EIA.gov. and to the monthly STEO site.

Average price for natural gas at the wellhead for the previous year, the current year’s projection and the next year’s forecast are given in the energy prices data. The Henry Hub market price is provided as are the average estimated prices for natural gas going to the industrial, commercial, and residential sectors. On the same table under electricity, the cost of natural gas to electric generators is shown in comparison to other fuels.

Another good source of forecasts can be the financial and investment houses that have strong energy and natural resources departments. This would include – to name a few – Raymond James, Morgan Stanley, Macquarie, BNP Paribas, Jefferies and Standard & Poor’s. Banks with a strong energy and natural resources bent such as Wells Fargo and Barclays are also good sources of natural gas forecasting.

Of course, all the energy consulting and management firms like PIRA, IHS, Bentek, and Ziff Energy do natural gas forecasting as part of their consulting business. Their clients and subscribers receive these forecasts on a routine basis. Media sources of natural gas forecasts include the trade publication, Natural Gas Week, which quarterly polls 20-25 of the gas forecasters comprised of consultants, financial people, and operators, for a summary of their forecasts for the current period, the current year and the next year. In February, the average forecasted price for the group polled for 2014 was $4.41/MMBtu.

The quantity of natural gas forecasters is sufficient that different forecasts can be compared to get the best possible estimate of future prices. There will be some differences between forecasts as different parameters and expectations play a major role in the final numbers. The varieties in the models used by each forecaster can make a pronounced difference in the final results. Especially today with a wide variety of factors influencing the industry – changes in supply, potential opening of export markets, environmental pressures, etc. – using a range of forecasts to get the best final estimate is a wise choice.