Natural Gas Economics

Paul Theodosis
November 30, 2012

Submitted as coursework for PH240, Stanford University, Fall 2012

Introduction

Fig. 1: A natural gas processing plant. (Source: Wikimedia Commons)

Natural gas is an important commodity that provides roughly one forth of the electricity consumed in America. The principle of supply and demand is a major factor that governs its price. The drivers behind the supply of natural gas include pipeline capacity, the number of active drilling sites, storage, and imports. Similarly, the driving factors for demand include weather, GDP, and exports. By understanding these fundamental drivers, one can gain a basic understanding behind the cause of price fluctuations and build an economic strategy for personal, corporate, or government use.

Supply

Pipeline Capacity

Pipeline capacity is the rate of natural gas that can be transported from the well heads where the gas is collected to the consumers. For any current pipeline in operation, there is a limited amount of gas that can physically be transported over a period of time. Thus the size and number pipelines in operation is a major factor of the supply of gas on hand.

Number of Drilling Sites

Drilling operations represent the rate at which new sources of natural gas may potentially come from. Just like there is a limited amount of gas that can travel through a given pipeline, there is also a finite rate of gas that can be harvested from a particular well. As new sites are drilled and collection facilities are constructed, the supply increases. The price of natural gas is an important factor in the number of active drilling sites. If the price of gas is too low, the initial cost of investment prohibits drilling ventures that may not be profitable. As the price increases, the justification of risks and initial costs eventually motivates new drilling ventures. Government regulation and policies also affect the available sites. [1]

Fig. 2:Map of natural gas production in cubic meters per year. (Source: Wikimedia Commons)

Imports

One option a country has to fill its needs of natural gas is through imports. This can be accomplished through pipelines or from ships carrying liquified natural gas. This option can be very political because it implies the energy dependance or transfer of wealth to another country. Figure 2 gives an idea of what countries can produce natural gas as opposed to those that need to buy it. Price negotiations is a major player in how and from which sources a nation selects. For example, Poland has been dependent on Russia's natural gas for some time and is now leveraging other sources of imports to negotiate a better price. [2] For some countries natural gas is a major source of fuel for electricity generation because gas turbines can supply large amounts of electricity in a small space. [3]

Demand

Storage

In order to account for constant fluctuations is demand, storage facilities are used to collect and distribute gas from various enclosures. The most common type of storage used is depleted reservoirs. Major forms of storage use underground facilities for increased safety and volume.

Weather

Weather is an important component of demand particularly for the residential market. During the winter months, natural gas is a common fuel used for heating. The colder the winter, the more gas is used to keep houses warm. Additionally, in regions that use natural gas for electricity generation, the temperature during the summer can also significantly affect the demand for natural gas to air condition homes.

Economic Conditions

The current economic climate can affect the amount of natural gas needed by the commercial and industrial sectors. When the economy is slow, less natural gas is needed for production and manufacturing. These sectors can surge and fall effecting prices especially when orders and market trends are volatile.

Conclusion

In the past, the price of natural gas followed a similar trend with gasoline. However, recently gasoline prices have been high, while natural gas prices have been low from following a mild winter. [4] This is an example of how one can look at conditions that affect supply and demand to reason and plan for how the price of natural gas will change.

© Paul Theodosis. The author grants permission to copy, distribute and display this work in unaltered form, with attribution to the author, for noncommercial purposes only. All other rights, including commercial rights, are reserved to the author.