Like any other commodity, natural gas is influenced by the forces of supply and demand. An understanding of both supply- and demand-side factors can help investors better evaluate fluctuations in natural gas prices to better gauge future market trends.
Natural gas prices have fluctuated wildly over the past three months. While this is partly influenced by the overall state of the energy sector, seasonal influences have contributed to the dramatic rise – and fall – in natural gas prices. An expected warm spell in February has placed further downward pressure on the commodity.
Learn here about how an interest rate hike can affect commodities.
Indeed, seasonal influences are one of the three main demand-side factors that influence how natural gas is priced on the open market. Relatively warmer periods tend to reduce demand for the commodity, thereby exerting downward pressure on the market.
In addition to seasonality, level of economic activity also influences the price of natural gas. Typically, expanding economies experience higher relative growth in industrial and commercial industries, which creates higher demand for natural gas. As such, periods of strong economic growth are often correlated with rising natural gas prices.
Natural gas and its derivatives also serve core functions within specific sectors. Case in point: the pharmaceutical industry uses butane and ethane to develop a myriad of consumer products; industrial companies rely on natural gas for clean-burning fuel sources; farmers use methanol for fertilizer; and metals manufacturers rely on the commodity for infrared heating units.
The third demand-side factor influencing natural gas prices is the availability and pricing of competitive products. Since companies look to leverage the cheapest fuel source available, demand for natural gas and other energy products varies throughout the year. At the same time, natural gas tends to move in a similar direction to the rest of the energy market, namely crude oil and coal.
As the following chart illustrates, natural gas and crude oil prices have historically moved in tandem with one another.
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Source: CBOE Group.
When it comes to commodity futures, it is important to know about contango. Check out this article to understand more on this.
On the opposite supply-side of the spectrum, the amount of natural gas produced plays a direct role in how the market is priced. If natural gas production is higher than perceived or actual demand, the price of the commodity declines. If the commodity is in shorter supply relative to demand, then prices rise.
When it comes to energy, “supply” also entails the amount of the commodity held in storage. The cost of maintaining natural gas storage facilities has a direct role on the price consumers pay. Since natural gas is stored underground, it must make its way through the supply chain in order to reach utility providers, businesses and homes. Any change in fees along the supply chain can have a direct impact on prices. This factor is so important that energy traders monitor natural gas storage reports on a weekly basis to gauge supply levels.
The third supply-side factor influencing natural gas prices is import/export trends. By becoming a net exporter of natural gas, a nation can alleviate downward supply pressures on the price stemming from the other two factors discussed above. If a country is a net importer, it could mean that it has very little domestic production or that it is meeting the growing demand from foreign sources. However, a country being a net importer of natural gas as well as a high producer of the commodity could lead to oversupply, which would have a downward effect on prices.
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The Bottom Line
Natural gas is a critical component of the U.S. economy. Exploring the factors that affect natural gas prices is crucial to understanding the market’s future trajectory and its interplay with other energy commodities.
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