Possibility of major US hurricanes, hotter-than-normal US summer weather and robust core demand v/s supply will impact natural gas prices over the next six months

Natural gas has seen some violent moves in the past few weeks. It rose by 30% in five weeks, but has declined by 5% in the last couple of days. Traded on the Multi Commodity Exchange, natural gas price increased from Rs175 per MMBtu on 30th April, to Rs235 per MMBtu on 5th June this year. What are the reasons for this and will prices keep rising?

This kind of volatility is natural in natural gas. For instance, from 5 July 2008, its price crashed from Rs591.80/MMBtu all the way to Rs118.60/MMBtu on 5 September 2009, a fall of 80%. Gas price has been trading within a range for the next eight months before the recent volatile move. What are the reasons for such sudden price movements and what does the future look for this commodity?

There are three reasons: possibility of major US hurricanes, hotter-than-normal US summer weather and robust core demand v/s supply. We explore the three major variables that will impact the natural gas price in the next four-six months.

Natural gas prices rose last week after the US government forecast up to 14 hurricanes, second only to a record 15 storms in 2005 when hurricanes Katrina and Rita had shut offshore oil platforms for weeks and some refineries for months.

Analysts say high US inventories and industry preparation should temper energy price swings even if storm-related disruptions to oil and natural gas facilities on the level of those seen in 2005 and 2008 would cut the supply overhang.

"From a supply standpoint, we're probably better prepared for an active hurricane season than we have been in the last 20 years. The surplus in inventory has already decreased the hurricane premium in the market, estimating that without high inventories, crude, product and natural gas prices would all be slightly higher," said a Reuters report.

The hurricane season runs from 1st June through 30th November and often affects the Gulf of Mexico, home to about 30% of US oil production, 12% of natural gas production, and 40% of US refinery capacity. Storms may hit a larger overall portion of the US refining sector as more capacity is concentrated on the Gulf Coast after economic shutdowns on the East and West Coasts. "We have a few more eggs in one basket. The amount of crude, natural gas, and product inventories could prove irrelevant if a significant amount of energy demand is knocked out by severe storms," said the report.

Colorado State University researchers said on 2nd June that there is a 76% chance that a major hurricane, with winds of 111 mph (178 kph) or greater, will strike the US this year. The past-century average is 52 percent. "A hurricane could disrupt industrial activity and power generation in the south, throwing a stronger punch to demand than to supply," said the report.

The second reason natural gas prices rose last week was that forecasts showed hotter-than-normal weather across much of the US next week, boosting demand for the power-plant fuel. High temperatures will stretch from the Southwest to New England according to MDA Federal Inc's EarthSat Energy Weather. About 21% of electricity is generated using natural gas, according to the US Energy Department. Natural gas fell almost 5% over the past couple of days after revised forecasts showed cooler weather for the US Midwest and Northeast, reducing demand for gas-powered electricity for air-conditioning. Temperatures next week will "fall to at least normal, if not below" average, according to MDA Federal Inc's EarthSat Energy Weather.

The third reason is robust core demand as opposed to supply. Manufacturing in the US has expanded for the 10th straight month. According to a US Labor Department report, factories across the US added about 101,000 to their payroll during the first quarter of 2010. Don't be surprised to see the supply-demand picture start to brighten next year... And if that's the case, we'll easily see natural gas prices rebound.

On the supply side, the energy production landscape has shifted in recent years. A greater percentage to onshore sources and better industry preparations should soften the impact of hurricanes, experts said. Back in 2005, the US was not producing gas from shale at the current level. There's been a boom in onshore natural gas production since 2005. Thanks to the rise in unconventional shale deposits during the past few years, the US finally overtook Russia as the world's largest gas producer-and that's to be expected after US shale gas production jumped 71% between 2007 and 2008.

According to Bloomberg, the number of US oil and gas rigs operating in the Gulf of Mexico dropped by half last week to a 16-year low. The number of natural-gas rigs dropped by 20 to 947. The US government started to curtail offshore drilling and it is going to impact gas supply and prices. The halt in deepwater drilling in the wake of the BP oil spill took the Gulf rig count to 23 last week, the lowest level since August 1993, from 46 a week earlier. About 11% of US gas is pumped on federal leases in the Gulf. According to the US EIA short-term energy outlook, sustained low natural gas prices this summer are expected to contribute to a decline in natural gas drilling activity over the next several months. As a result, the current 2011 forecast of higher prices comes as production begins to decline later this year and the next. The projected Henry Hub spot price averages $4.49 per MMBtu in 2010 and $5.06 per MMBtu in 2011.

Natural gas has gained prominence in India too as in the rest of the world over the last decade. India has consumed around 41.4 billion cubic metres (bcm) of natural gas in 2008, of which domestic production is 30.6bcm and imports as LNG have been 10.79bcm. The share of imports is expected to increase in the coming years and cross 30% from the current level of around 25%. Fertiliser (41%) and power (37%) are the major users of natural gas in India. The fertiliser sector in India is highly subsidised by the government and it fixes the rate at which natural gas is provided to the fertiliser-manufacturing units. So, as all these factors collide, expect more volatility.