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Natural Gas Prices in the US

by Chris Kulczycki Fri Feb 24th, 2006 at 05:37:51 PM EST

Now I know that projections for natural gas costs in the US seem outside the scope of ET. But the cost of gas could have a profound influence on the US economy, and so the world economy. I am a subscriber to and fan of the Morningstar investment service. They seem a levelheaded bunch and not prone to speculative or rash analysis. So when their article about the future of natural gas costs appeared in my in box this afternoon, I thought I'd share it with the many folks here who closely follow energy issues.

First, we are raising our midcycle price assumption for the NYMEX Henry Hub benchmark to $5.67 per thousand cubic feet (mcf) from $4. Although natural-gas prices have drifted lower recently due to an abnormally warm winter, we based our midcycle price decision on several longer-term trends. Unit costs have been on the rise over the past two years, with the higher-cost, marginal producers experiencing the most marked increases in costs. We don't see this trend changing over the next few years, as firms are paying top dollar to acquire new properties and day rates for rigs are still well above normal. Further, as LNG becomes a larger contributor to supply over the next decade, we expect that it will support our midcycle price. Although LNG could displace high-cost domestic producers, we think that it should improve the reliability of supply--helping to stabilize gas prices near our midcycle price, rather than creating a glut of low-cost gas.

Henry Hub is the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX).

Demand for natural gas has not fallen considerably despite steeper prices in recent years. Although we think industrial consumers could continue to disappear if high and volatile prices persist, the large installed base of gas-fired power plants and home heating customers should help shape a floor for gas prices over the next decade.

This makes sense given the cost of replacing a gas furnace with, say, a heat pump.

Second, we have reduced our long-term inflation rate for natural gas to 3.6% from 6%. The new 3.6% figure matches our inflation rate for oil and reflects our opinion that prices for oil and gas should hover more closely to energy equivalence (roughly 6,000 cubic feet of natural gas per barrel of oil) over the next 10 years than they have in the past.

I wish there was more about this. Why? Or perhaps someone (Jerome) out there could elaborate.

Between our methodology changes and new price assumptions, we now expect benchmark natural-gas prices to average near $8 per mcf in 2006, $6.80 in 2007, and $6.20 in 2008. After 2008, we assume prices will grow at our projected long-term inflation rate of 3.6%. Despite our higher assumptions, we still consider recent prices exceeding $10 per mcf extremely high and ultimately unsustainable.

This really seems to contradict much of what I have read. On the other hand, after many years personal experience, I faith have in Morningstar's methods. Anyone want to comment?

There is a forward curve for NYMEX gas here:


you may have to startat NYMEX.com and click through accepting their terms of use to see the data.

What you will find is the mkt for 07 and 08 is more like $8.5-$9 bucks.  There is enough open interest to give some confidence as these prices being reflective of what the real buyers and sellers think.

I wouldn't put a lot of money on a long range forecast by Morningstar or anyone else.  There are just too many variables (and I used to have to make markets in related markets -- it ain't easy).  One hurricane and you are an idiot low.  A mild winter and $15 gas ($100 dollar oil!) becomes a spot price of $7.1 in February.  

Further forward, NYMEX prices are  lower ($6's and 7's).  This is primarily because of market imbalances.  Banks make small producers sell forward production to hedge in a return on drilling/exploration loans.  Buyers are much fewer and farther between.  Some Utils might hedge (less after Enron blew up making "trading" a word on a par with pedophile) and perhaps some fertilizer manufacturers.  But now that utils can float their energy sales prices, why bother?  Let the customer take the pain if prices shoot up.

by HiD on Sat Feb 25th, 2006 at 02:26:24 AM EST
At least there are some existing competitors for natural gas that technically are available to us today.  One of my investment sources referred me to Bush's Milwaukee speech::
Secondly, we need to reduce our reliance on natural gas for electricity generation. In other words, we've got to substitute other forms of power for natural gas if we expect to be able to maintain a manufacturing base that relies upon natural gas. And the best way to do that is to expand our use of coal, nuclear power and renewable sources of energy, like wind and solar.

Let me start with coal. Coal is by far our country's most abundant and affordable energy resource. It's estimated we've got more than 250 years of reserves. That's a lot, that's a lot. And I'm sure you recognize this, or realize this, but in Wisconsin, when you flip on the light switch, there's a 75-percent chance that electricity is generated by coal-powered plants. In other words, you use it here in Wisconsin.

Evidently in other deliveries of the speech he quoted that, paraphrasing because I can't find the transcript, just another source that quotes this; "Four principle sources power our homes and offices--1. 50% coal, 2. 20% nuclear, 3. 18% natural gas, and 4. the rest renewable, such as hydroelectric, solar and wind power".  So it's at least encouraging that we have existing and competitive sources for natural gas today,,,,whereas we are farther away from competitors for oil for transportation.

Another part of the transcript that was interesting and seemed to set the stage for advancements and capacity increases in coal and nuclear.

But we're getting closer to an interesting, important goal -- that by continuing to invest at the federal level, as well as encourage private investment, we will build the world's first power plant to run on coal that produces zero emissions by 2015. That will be a positive development for future generations of Americans. (Applause.)

I'd like to talk about nuclear power. Today there are more than 100 nuclear plants in America that operate in 31 states, including right here in Wisconsin. The plants are producing electricity safely, and they don't emit any air pollution or greenhouse gases. America hasn't ordered a nuclear plant since the 1970s, and that's the result of litigation -- or because of litigation -- and complex regulations.

It's interesting when you think about a country like France, however, they have built 58 plants since the 1970s; they get 78 percent of their electricity from nuclear power. It's an interesting contrast, isn't it? We haven't done anything since the '70s; this country has decided to recognize the importance of having renewable sources of energy that protect the environment, and 78 percent of their electricity comes from this form of energy. China has eight nuclear plants in the works, by the way, and plans to build at least 40 more over the next two decades.

by wchurchill on Sat Feb 25th, 2006 at 02:31:01 AM EST
Actually, the jump from 4 to 5.67$/mbtu is pretty daring for an outfit like Morningstar. That means they are significantly increasing their worst case scenarios for energy prices - which means that higher energy prices are finally seeping through to the long term financiers. This is a real change, because it means that they will now lend money on the basis of such higher scenarios.

You have to look at the rest as the usual prudent fudge: scenarios that remain close to current wisdom (which is that energy prices "always come back to the mean") while taking into account the facts on the ground, which are being persistently incompatible with said common wisdom.

So the lower inflation rate is, I think, a concession to "common wisdom" after the daring step of increasing the expected minimum price.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Feb 26th, 2006 at 07:35:23 AM EST
that higher energy prices are finally seeping through to the long term financiers. This is a real change, because it means that they will now lend money on the basis of such higher scenarios.
Also invest, but perhaps you meant that when you said "lending".  So many of the breakthrough ideas come from risk capital invested in start-ups and their new concepts.  But venture capitalists and private equity investors are trying to have the best chance of success in a very risky market--the seed capital and early stage investing market.  While there has been some investing in energy, IMO, it has been limited by the fact that oil prices have historically come back to lower levels, as you suggest.  So throw on top of all the other risks of private equity investing, the idea that the energy price levels you are assuming in your models could drop by 50%---whoa, does that destroy your projected ROI's.  

While Bush's comments on energy have been mocked, and for good reason.  His comments over time will also give some support to higher long term energy prices, and therefore VC models that are built on higher price assumptions, making returns on new technologies in energy more attractive.

by wchurchill on Sun Feb 26th, 2006 at 01:55:53 PM EST
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