US Natural Gas Prices and the Election

Every fall my natural gas utility asks if I'd like to lock in my gas price for the next 12 months.  In some respects the timing for this looks ideal.  Commodity natural gas prices haven't been lower than this year's average since 1999.  Gas is also historically cheap relative to other fuels.  Heating oil recently averaged above $4 per gallon, while the fixed price my natural gas provider is offering equates to $1.36 per gallon, including distribution charges.  However, overhanging this relatively simple choice are big uncertainties related to the economy and the potential impact of regulations on shale gas production.  To complicate matters further, both of these uncertainties are entangled with the outcome of the US presidential election, and my gas provider wants my answer by next Monday.

When I last looked at this question in detail, in 2010, I concluded that the utility's offer was attractive, after scrutinizing then-current gas futures prices and the historical relationship between the futures market and "city gate" prices for Virginia, where I live.  Using the same methodology, this year's offer of $0.62/therm ($6.20/MMBTU) looks reasonable.  Much has changed in the interim, though, in ways that undermine the rationale for locking in consumer gas prices.  The biggest benefit of a fixed price is avoiding nasty surprises during winter heating season.  More than four-fifths of my household's gas consumption occurs from November through March, a period when gas prices used to be alarmingly volatile.  

That's less of a concern, now, with US gas inventories high and supply ample. The same shale gas revolution that has increased domestic supply and backed out imports has also reduced volatility and promoted big shifts in demand. Since 2009 residential gas demand has been essentially flat, while demand from commercial and industrial users has grown by 6.5% and consumption in power generation is up by more than 10%, despite a lackluster economy.  (Gas for use in transportation grew even faster but still constitutes less than 0.2% of total gas demand.)  As a result of these shifts, peak monthly average natural gas prices since the winter of 2009-10 have occurred in summer, coinciding with air conditioning demand. With less winter price volatility, the decision to lock in prices now is mainly a bet on gas prices for the next 12 months.  The outcome of that bet hinges on future supply and demand.

On the supply side, will the surge of US shale gas production continue?  New regulations are among the biggest potential constraints on output.  The EPA has set new rules on emissions during well completion and production, with the most expensive aspect phasing in by 2015.  EPA will also issue new rules on wastewater disposal from fracking by 2014. There is growing pressure on the administration to impose federal regulation of most aspects of shale development, superseding management by the states.  Thus far, the White House has avoided a sweeping crackdown that would disrupt gas markets, and the EPA administrator is on record opposing comprehensive federal regulation of all wells.  However, it's not obvious whether such reticence stems from a basic belief in the national importance of this resource or the simple expedient of not killing the golden goose before the election.  Governor Romney has proposed streamlining regulations affecting gas production. Next Tuesday's outcome should resolve this uncertainty.

The other big uncertainty surrounding gas prices concerns demand.  High shale gas output isn't the only reason gas is cheap today.  Anemic GDP growth such as the 2% rate for the third quarter reported last Friday has helped keep gas prices low.  A stronger economy with higher full-time employment would put upward pressure on prices by soaking up much of the surplus production that has depressed them.  However, the consequences of failing to mitigate January's "fiscal cliff"--federal budget "sequestration" and the expiration of many tax cuts--would likely drive natural gas back toward the lows we saw this spring.  With the economy still the number one issue for most voters, its likely future impact on gas demand is linked with our perceptions of the candidates' economic programs and promises. 

My best bet is to convince my supplier to let me wait until after the election to reply.  There's nothing like additional information to improve the value of a decision. Failing that, I'm inclined to pass on this opportunity.  The possibility of cheaper natural gas next year acts as a modest hedge against the risk of another recession, while the benefits of a stronger economy would more than outweigh any natural gas price increases I might experience on the upside.

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The Year of Regulation?

Some new years seem newer than others, bringing major changes rather than just the turning of a calendar page. 2011 is shaping up that way, with a return to divided government in the US and the beginning of national greenhouse gas regulation by the EPA based on that agency's interpretation of the Clean Air Act, rather than as a result of explicit new Congressional legislation. As the ongoing legal battle over this between the EPA and the state of Texas demonstrates, there's a lot at stake, and the final outcome has not yet been determined.

When the US Supreme Court ruled in 2007 that CO2 and other greenhouse gases constituted pollution that was subject to regulation under the Clean Air Act, it set in motion the process that is now culminating with the EPA's proposed rules for regulating these gases. Initially this will take the form of what the agency calls New Source Performance Standards, applying only to new facilities and modifications within existing facilitates, and only for sources emitting more than 50,000 tons per year of greenhouse gases (GHGs). That exempts residential and most business activities using less than the energy equivalent of about two gasoline tank-trucks per day. The first phase of these regulations is specifically targeted at power plants and oil refineries, and over time it could significantly alter the way that electricity is produced and oil refined in this country.

I've argued for years that this is entirely the wrong way to go about reducing emissions, because greenhouse gases are global, rather than local in effect, and a command and control approach applied to point sources of CO2 and other GHGs will miss many of the least expensive emission reduction opportunities while forcing businesses to focus their efforts on some of the most expensive. Cap and trade or some other means of establishing a price on emissions would have been much more efficient, although the version of cap and trade passed by the House of Representatives in 2009 was a miserable excuse for such a system, distorted as it was by preferential treatment for favored groups and sectors.

But this isn't just a question of economic efficiency; it's also a question of effectiveness. Regulating power plant emissions addresses 34% of total gross US GHG emissions, including roughly 92% of the emissions from the coal value chain, while regulating refineries tackles less than 10% of the emissions from the petroleum value chain--and some of the hardest ones to cut, at that. Refineries are already about 90% efficient. Squeezing even more efficiency from them--which would be the net effect of capping their GHG emissions, since most of those are associated with the combustion of fossil fuels--is likely to cost a lot more than the value of any energy savings such changes would yield. That could have a significant impact on states like Texas, which is home to more than a quarter of the country's refining capacity. The result would also increase national energy costs in either of two ways, with higher operating costs at US refineries being passed on to consumers in the price of fuels, or by reducing US refining throughput and capacity and increasing our reliance on product imports. The latter works directly against the widely-held notion that anything that reduces emissions must automatically be good for our energy security.

None of this is set in stone, although I certainly wouldn't bet against some version of it coming into effect. The incoming Republican chairman of the House Energy and Commerce Committee has already indicated his determination to restrain the regulation of GHGs by the EPA, and even without a majority in the Senate the House, which controls the government's purse strings, could make it much harder for EPA to pursue this course. At the same time, several previous sponsors of Senate energy and climate legislation have expressed interest in a new, bi-partisan approach to energy, and it's not inconceivable that watering down the proposed EPA regs could become part of a deal to establish a national low-emission energy standard that would include not just renewables, but also nuclear energy and possibly even natural gas. I will be watching these developments with great interest in the weeks and months ahead.

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