How rising natural gas prices will affect the power sector in 2017
Analysts expect cooler weather and higher demand to limit fuel switching and raise residential power prices
Natural gas prices have been trading at historic lows in recent years, below $3 per million British thermal units (Btus) at the Henry Hub. For comparison, prices in the $4 and $5 range have not been uncommon in the last five years, with spikes even higher.
That's not bad, considering natural gas makes up a rising share of the nation's generation (expected to be more than a third, next year), and it is the primary heating fuel as well.
But with rising consumption comes upward pressure on prices, and most analysts expect them to rise next year across the U.S. Because of the way utilities purchase the fuel and electricity, the impacts on consumers will remain muted unless prices rise for an extended period of time. And the higher prices mean power generators will likely use less gas this year than last.
The U.S. Energy Information Administration expects spot prices at the Henry Hub, a liquid gas trading point often used for price formation, to average more than 20% higher next year. Prices this year are averaging $2.51/MMBtu — the lowest in a decade — but the federal agency expects to see a 2017 average around $3.07/MMBtu.
Several analysts and consultancies have their own specific forecasts, and though the general trend is up, their reasons are varied. But one commonly named variable is that gas consumption from the power sector has risen 25% in recent years.
Deutsche Bank has Q1 Henry Hub gas at $3.25/MMBtu, Energy Ventures Analysis puts it at $3.30, and Goldman Sachs predicts $3.15.
"Overall we believe rising gas prices will translate to higher electric prices in the near term and beyond," said Denny Yeung, principal consultant for Black & Veatch Management Consulting. "Natural gas will be the marginal fuel, so as gas prices rise over time we do see that impacting power markets."
Why are prices rising?
Wherever you stand on hydraulic fracturing and the shale gas revolution, advances in production flooded the market with cheap gas and have fundamentally remade the supply-demand balance, as well as created a decade-long surge in consumption.
Gas production rose from about 71 billion cubic feet per day (Bcf/d) in January of 2014, to almost 80 Bcf/d in some months this year. And EIA expects production to continue to rise, reaching almost 83 Bcf/d by the end of next year. But a key is that gas producers throttle back production when prices drop, and several other factors move in tandem.
EIA actually expects marketed natural gas production to average 77.5 Bcf/d this year, a decrease of 1.6% from last year. That would be the first annual decline in production since 2005, but the agency also said it expects production increases by 3.7 Bcf/d in 2017.
So while production capacity likely exceeds 83 Bcf/d, producers last month produced only about 76 Bcf/d, a response to some of the lowest gas prices ever seen, and gas storage that is higher than the five-year average.
With winter now settling in, the gas industry will go into the "withdrawal season" where consumers begin using gas in storage for home heating alongside power generators. Gas in storage is 3,963 Bcf, almost 200 Bcf above the five-year average. But even though the industry could potentially reach all-time record storage levels, the Natural Gas Supply Association (NGSA) believes it will have a minimal and neutral impact because only about 16% of winter supply comes from storage.
The same for those lower production figures. NGSA believes a production decrease of about 0.5 Bcf/d relative to last year isn't enough to move the needle in a relatively liquid market. So what's pressing up prices?
In part, it's weather. This winter is expected to be about 12% colder than last, though still slightly warmer than the 30-year trend. But the biggest driver is just increased demand. NGSA said in its winter outlook that it expects overall customer demand to average 92.3 Bcf/day, with colder weather fueling residential needs. NGSA expects the industrial sector to set new demand records, while exports to Mexico and into the international market for liquefied natural gas will both increase.
Somewhat contrary to expectations, natural gas generators will actually burn less fuel this winter. Why? Fuel switching. Prices were so low at some points last winter that it made more sense to burn natural gas than coal. That's an unusual dynamic for the winter, and it isn't expected to repeat this year.
The electric power sector consumed 22.3 Bcf/d in 2014, rising to more than 28 Bcf/d predicted for this year year. But absent fuel switching, EIA expects the power sector's gas consumption will decline to 27.4 Bcf/d in 2017.
NGSA paints a similar picture: the group expects the power sector to consume about 3.3 Bcf/d less this winter, but the overall supply-demand balance is tightening. The group expects demand will rise 1.6 Bcf/d, compared with last winter. Supply, however, is expected to rise only 1.5 Bcf/d.
A relative unknown is the impact of the burgeoning LNG export market. The United States terminals are only now ramping up to full capacity. This will be the first winter where both Trains 1 and 2 at the Sabine Pass terminal are operational, and right now the global market is oversupplied. Longer-term, however, NGSA said it expects liquefaction capacity to reach 15.5 Bcf/d, with the United States ultimately becoming the world's largest exporter.
"There has been no impact on pricing yet," Yeung said, "but we do believe over time there is going to be one. ... There is going to be a lot of potential LNG demand to be exported and we believe there will be a large supply response. A lot of producers want to serve that load, so they will be ramping up production."
Where are prices heading?
Natural gas prices are going to start rising this winter, but just how high remains the question.
The American Gas Association said consumers could see heating bills rise more than 10%, and increases could have been worse absent robust supply and storage. But the association also points out that bills will still be almost 30% lower than all-time highs, and gas remains the cheapest way to heat a home.
“Even with increases in consumption this winter, low cost natural gas may mean that many Americans on average, can expect to see one of the lowest bills in the past decade," AGA senior energy analyst Brendan O’Brien said in the group's winter outlook.
According to EIA, Henry Hub spot prices will average $3.04/MMBtu in the final months of this year, and slightly higher next year. The agency says futures contracts for January 2017 delivery averaged $3.34/MMBtu in early October. And NYMEX contract values have suggested a price range from $2.28/MMBtu to $4.88/MMBtu for January gas.
BV's longer-term analysis puts Henry Hub gas at $3.57/MMBtu in 2020, $4.67/MMBtu in 2025, and $5.46/MMBtu in 2030. And the firm expects those increases will have a sustained impact on power markets. Gulf Coast wholesale energy prices are expected to rise from $39.06/MWh in 2020, to $44.19/MWh in 2025, and just over $50/MWh in 2030.
"The big takeaway is that we do believe these two markets are going to be closely aligned," said Yeung. While renewables and demand management are a growing resource, natural gas will remain essential for years to come.
"As you see more renewables, more demand response and distributed energy resources come online in the near term and out years, that correlation could weaken a bit, based on how many hours gas is on the margin, Yeung said. "As you start incorporating more non-gas resources, that correlation could weaken."
EIA predicts gas costs for power generation will rise from $3.02/MMBtu to $3.61/MMBtu, and retail residential power prices will be strongest hit.
The country's average power price is expected to rise from $0.1254/kWh this year to $0.1295/kWh in 2017. Those price increases will also hit the industrial and commercial sectors, though not as significantly. Commercial customers will see prices rise from 10.37 cents/kWh to 10.64 cents/kWh. The industrial sector will see rates rise from about 6.75 cents/kWh to 6.9 cents/kWh.
Regional differences will come into play, of course. BV sees New England as the most gas constrained, with the potential for shortages in the Southeast as well.
But for gas, said Yeung, "the most importance times are winter peaking." As renewables begin to play a more significant role, he said the impact of gas on power prices will fluctuate.
"If that resource mix changes, and you have a lot more firm renewables, maybe hydro, wind or solar, then that changes how much gas you need ... but overall I believe during your peak winter period you're still going to need gas fired generation to serve loads."
And BV is bullish on gas long-term. In the next 20-25 years, Yeung said natural gas could be making up 45% to 50% of the country's generation.
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