In the previous topic, we discussed the fundamentals of crude oil. We will now turn our focus towards discussing the fundamentals of natural gas. Just like crude oil, natural gas is a source of energy that is found deep underneath the earth’s surface. Its formation is similar to how crude oil was formed - by the decomposition of plants and animals which died millions of years ago. The remains of these plants and animals were trapped at the bottom of the ocean floor within layers of silt and sand where they were subjected to tremendous heat, temperature, and pressure. Eventually, over a course of several millions of years, this entire process led to the formation of natural gas.
Just like crude oil, natural gas is a non-renewable source of energy. When burnt, one of the gas that natural gas produces is carbon dioxide, a major factor known to cause global warming. That said, natural gas is cleaner than both crude oil and coal, and it does not pollute the atmosphere as much as oil and coal do. Natural gas is both colourless and odourless. Because of this, producers of natural gas add an element called ‘’mercaptan” to it. The objective of doing so is to give natural gas a distinct, unpleasant odour, so that any leaks can be detected and acted upon quickly. Natural gas is used for various purposes, which would be discussed in the next section. In the US, natural gas is traded on the NYMEX platform; while in India, it is traded on the MCX.
Natural gas usage
Natural gas has a variety of uses. The pie chart shows the sector wise consumption of natural gas in the US, in 2017.
As can be seen, around 35% of the demand for natural gas in the US comes from industries, wherein it is used for heating and as a feedstock to produce chemicals and fertilizers.
Electric power accounts for just over a third of the natural gas demand. In the US, natural gas is widely used to generate electricity. In fact, as per the US Energy Information Administration (EIA), natural gas is used to meet over a fourth of the US electric power needs.
A sixth of the natural gas demand comes from the residential sector, wherein it is widely used for purposes such as cooking, heating water, generating heat in buildings during winters, and drying clothes. As per the US EIA, natural gas is used to meet nearly a fourth of the US residential energy needs.
Commercial sector accounts for 12% of overall natural gas demand in the US, wherein it has similar applications as those in the residential sector. In the commercial sector, natural gas is used for purposes such as heating buildings during winter, heating water, cooking, refrigeration, air conditioning etc. As per the US EIA, natural gas is used to meet nearly a fifth of the US commercial energy needs.
The rest of the demand for natural gas (around 3%) comes from the transportation sector, wherein in it is used to power vehicles. Compressed Natural Gas (CNG) and Liquified Natural Gas (LNG) are two of the most common forms of natural gas used as a fuel to power vehicles. Besides, natural gas is widely used as a fuel in natural gas pipelines in order to keep the gas pressurized and move it from one place to another.
Factors that impact the price of Natural gas
We will now talk about some of the key factors that influence the price for natural gas.
US Natural gas production
How much natural gas is produced in the US has a strong influence on its price trajectory. Other things constant, the higher the production, the lower the price, and vice versa. The US is the largest producer of natural gas in the world, accounting for nearly a fifth of the global production. In 2017, the US is said to have produced 734 Bcm (Billion cubic meters) of natural gas. Production of natural gas in the US has surged in the last one decade because of the shale gas revolution. Back then, shale gas accounted for just a sixth of total US NG production. Today, this share has increased to nearly three-fourths of the total US NG production. The surge in the overall output because of the shale gas revolution has caused the price of US natural gas to plummet more than 70% since 2008. Given the huge share of shale gas production in the total US NG production, one needs to regularly monitor how the trend in the pace of shale gas production unfolds, in order to gauge its impact on natural gas prices.
US Natural gas inventory levels
The natural gas inventory report is released each week by the US Energy Information Administration (EIA). Usually, it is released every Thursday during the early hours of the US session (which translates to 8 PM IST or 9 PM IST depending on the day light shift). The report shows the total amount of natural gas that is stored as inventories in various underground storage facilities across the US. Rising inventory levels indicate that production of gas is higher than the demand for it. As such, a rising inventory is considered bearish for price. Similarly, a falling inventory level indicates that production of gas is lower than the demand for it. A low inventory reading indicates that the quantity of gas stored in underground storage facilities might not be able to meet potential demand. As such, falling inventory levels are usually bullish for price.
Generally, gas inventories in the US tend to be seasonal - declining from November to March and rising from April to October. The period from April to October is often called the injection period. This is the time when demand for gas is low, causing surplus production to be injected into underground storage facilities in the form of inventories. Similarly, the period from November to March is often called the withdrawal period. This is the time when demand for gas is very high, causing inventories that were built-up between April and October to be withdrawn from underground storage facilities to meet winter demand for gas.
US weather conditions
Weather conditions in the US tend to have a strong impact on the short-term price trajectory of natural gas, both from the demand side as well as from the supply side. On the demand side, demand for natural gas picks up during the winter season in the US, which falls between late November and early March. During this period, extreme cold weather conditions increase demand for gas, which is used as a fuel to heat homes, offices, and other places. As per the US EIA, nearly half of the homes in the US use natural gas as a primary source of fuel to heat homes. On the supply side too, extreme cold weather conditions can hamper production, which in turn is supportive to price. To trade natural gas during the US winter season, one must keep a close watch on the inventory levels. If inventory levels are low during the winter season, it means that existing inventories might not be able to meet the potential winter demand, which is very bullish for gas price. Besides winter, natural gas prices are impacted by the occurrence of unexpected natural events such as hurricanes, especially in gas producing regions of the US.
US economic conditions
In the previous section, we said that over a third of US natural gas demand comes from industries, wherein it is used for heating and as a feedstock to produce chemicals and fertilizers. Manufacturing activity and industrial production is heavily influenced by the state of the US economy. Stronger the economic conditions, higher will be the manufacturing and industrial activity, and vice versa. As such, stronger the US economy, higher will be the demand for natural gas to meet industrial needs. Similarly, weaker the US economy, lower will be the demand for natural gas from industries. Hence, natural gas prices usually tend to rise during periods of strong economic activity and fall during periods of weak economic activity.
How to trade Natural gas
Natural gas prices are quite volatile in nature and are heavily influenced by changes in short-term demand and supply factors. Some of the key things to keep in mind when trading natural gas are:
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Track the inventory report released by the EIA every Thursday. Given that natural gas is more responsive to short-term fluctuations in demand and supply, prices usually respond quickly to changes in weekly inventory levels. Generally, if inventories come in higher than expectations, expect prices to react negatively, and vice versa.
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Monitor weather conditions in the US. Any sudden and unexpected change in weather can lead to significant volatility in natural gas prices. Also keep a close track on winter projections in the US. If the projections suggest that winter could be very severe, natural gas prices are likely to react very positively.
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During periods of extreme weather conditions, monitor how the inventory levels in the US are. If the inventory levels are low, existing supplies might not be able to meet short-term demand for natural gas, which is very bullish for prices.
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Keep a track of the economic health of the US, as a stronger economy could increase demand for natural gas from the industrial and the commercial sector, and vice versa.
Next Chapter
Comments & Discussions in
FYERS Community
venkatappa gangadhar commented on June 14th, 2019 at 7:24 PM
good, give trading strategies.
tejas commented on June 14th, 2019 at 7:48 PM
Hi Gangadhar, Trading Strategies on Natural Gas? Hmmm.. that's not the intent here. However, we will write about trading strategies separately in the future.
sreedhar kv commented on June 14th, 2019 at 7:36 PM
keen to know on Natural gas
tejas commented on June 14th, 2019 at 7:49 PM
I understand. There is barely any information on Natural Gas product in India. I was amazed to know that most traders didn't even know that the MCX prices are based on the NYMEX contracts. Anyways, hope this has been useful.
Sundar Raj commented on June 14th, 2019 at 11:25 PM
Thanks for the information I was not aware that the MCX prices are based on the NYMEX. So as a trader, we need to check NYMEX prices also for commodities or MCX charts are enough.
tejas commented on June 17th, 2019 at 2:51 PM
Hi Sunder, tracking NYMEX prices will definitely help get an international perspective. In fact, all commodities should be tracked as per the USD prices. If not, you'd get a very incomplete view.
Naveen Kumar commented on June 14th, 2019 at 10:06 PM
Just for curiosity, I am asking. US is the largest producer for natural gas and crude oil.
But why US imports more crude oil compared to other developed countries.
tejas commented on June 17th, 2019 at 2:52 PM
Surplus demand.
Naveen Kumar commented on July 3rd, 2019 at 10:13 PM
Sir, Still if you compare US with China, Both the countries are at the same levels. China doesn't produce that much oil and it imports less compared to US.
Shriram commented on January 27th, 2020 at 9:53 PM
That is because US consumes significantly more oil than China does. Secondly, the boom in US oil production over the past decade or so has mostly been due to US extracting huge quantities of shale oil, predominantly of lighter grades. However, most of the US refineries, which were built decades ago, are more suited to procuring medium to heavier grades. This is another reason why US imports are on the higher side.
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