November 17th, 2015 in Energy

The changing relationship between weather and natural gas prices

Contributed by Todd Crawford

Most forecasts are calling for a record El Nino this winter, and traditionally that has meant warmer temperatures, lower heating demand, and thus lower natural gas prices in the U.S. At this point, WSIsuggests that the current El Nino event will be the strongest since at least 1997, and potentially the strongest in recorded history.  While we may have another warm El Nino winter, the impact on natural gas prices may be less substantial than it used to be due to changes in market fundamentals.

Beginning about 8 or 9 years ago, energy producers began drilling for natural gas in the shale rock formations that are found across parts of the Appalachian and Ozark Mountains and up into the Dakotas. The vast reservoirs of gas tapped into during this process (the “shale gas revolution”) have changed the US energy landscape for the better, with increased supply and thus lower prices for residential and commercial entities.

 

The sharply increased supply of natural gas has also altered market price dynamics, as the price has been generally falling over the last decade. Prices of $7 or $8 per million metric British thermal units (mmBTU) seven or eight years ago have fallen to levels closer to $2.50 per mmBTU this year.

Of course this is good news for the consumers of natural gas, who are always happy to see lower prices. But for natural gas traders, the sharply increased supply means reduced price volatility and less opportunity to capitalize on weather-related moves in the market. When natural gas was more scarce (and more expensive), temperature fluctuations often caused large swings in the price, giving shrewd traders an opportunity to profit. The price could drop a few dollars during a warm winter, and could even go up on the order of 20-30 cents in a single day if weather forecast models showed a strong Arctic air mass moving into the U.S. – which would create frigid temperatures and much stronger gas demand.

Today, however, much of that volatility is gone with the significantly higher supplies of natural gas in place. With natural gas heading toward $2 per BTU, the price fluctuations simply aren’t very large—and that means less profit to be made by trading. The biggest concern now among energy traders is that a big El Nino could drop natural gas prices below $2, suppressing volatility even more.

Will this trend continue? Maybe not. There is some evidence that the shale gas revolution may be over, or at least subsiding. If so, prices would start to rise again and increased volatility would return to the market.

For the time being, however, we can expect a strong El Nino this winter to increase the odds of lower-than-normal heating demand, which would favor even lower natural gas prices. This is not good news for natural gas traders, but is good news for those who like milder winters and lower gas prices!

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