Supply and Prices: Natural Gas

A Natural Gas Overview

In contrast to the world market for oil, natural gas in the U.S. is a North American market; 87 percent of marketed natural gas is produced in the U.S., and the balance is almost entirely produced in Canada. Natural gas production and marketing are deregulated; federal oversight of interstate pipelines is the major remaining component of regulation. Natural gas production peaked in the U.S. in 1973 at 21.73 trillion cubic feet (Tcf), dropped to 16.17 Tcf in 1986, and recovered to 18.79 Tcf in 1999. Consumption totaled 21.3 Tcf in 1999 and is expected to increase to 29 Tcf by 2010.

Illinois ranks first in the nation in per capita annual residential natural gas demand, second in total residential consumption, and third in total commercial consumption of natural gas among the states. Thus, natural gas supply and price trends are of major concern to Illinois residents, especially as the winter 2000-2001 price outlook for natural gas indicates winter gas costs will be 30 to 50 percent higher than last year because of higher gas prices and the expectation of a colder winter than any of the previous three years.

The Short-Term Outlook for Natural Gas

The current (November 2000) market prices for natural gas are over $5.00 per thousand cubic feet (Mcf) compared with about $2.50/Mcf at the same time last year. Current prices are driven by limitations in supply in the face of continuing gas demand growth, including the use of natural gas to generate electricity. In 1998-1999, low world oil prices and limited prices for natural gas meant that many oil and natural gas producers (often the same companies) were not drilling extensively for new supplies. Natural gas supplies decreased. In April 1999, only 371 drilling rigs were seeking new gas supplies, which was 34 percent below an average of 564 rigs operating the previous year. Although the number of drilling rigs seeking new natural gas supplies has averaged 832 for November 2000, new supplies from these wells will generally not be available until late winter-early spring of 2001.

An underlying cause for the limited gas supplies of the 2000-2001 winter would again be the Asian economic crisis of 1997-1998 that drove down world oil prices, cut income to oil and gas producers, and thus resulted in less drilling for both oil and gas in the U.S. Although less coupled to world events than are oil prices, natural gas prices and domestic supply are nevertheless linked to the global economy, particularly with increased use of natural gas as a fossil fuel with low environmental impact. The exact price path that natural gas will take this winter, however, depends on weather, electricity demand, and world oil prices. The mid-term outlook for natural gas price impacts on consumers looks less severe.

Mid-term Outlook for Natural Gas

According to many analysts, beginning in spring 2001, gas prices should moderate from $5.00/Mcf levels, but a new gas price floor is likely to be established at $2.50 to $3.00. If gas prices descend much below $2.50, the new drilling and other infrastructure necessary to satisfy expected U.S. demand will be discouraged. Gas prices will always fluctuate with electricity demand, weather, and, to some extent, oil prices (which affect producers of both oil and natural gas). Gas-fired electricity generation, particularly for peak load power plants that operate half time or less, is predicted to continue to grow as one effect of electricity market deregulation (Figure 4). This factor alone provides significant support to natural gas prices. However, Illinois will see good, even increasing, availability of natural gas supplies and should not be the victim of regional gas supply shortages.

figure 4: Natural Gas Consumption.

Figure 1.
Past and projected U.S. natural gas consumption. Source: Energy Information Administration





The Midwest, including Illinois, is capable of receiving the highest level of gas supplies of any region in the U.S. during peak consumption. Average daily flows into the Midwest increased 28 percent during 1990-1997. In addition to supplies from the long-term producing areas such as the Gulf Coast and the Midcontinent, the Chicago area is becoming a major hub for increasing Canadian natural gas imports. For example, the new Alliance Pipeline from Alberta, Canada, has started delivering up to 1.3 billion cubic feet of gas per day to a point near Joliet, Illinois. With an excellent gas supply infrastructure and accessible supplies from Canada and within the U.S., Illinois is not likely to see a state-based gas supply shortage. A widespread, extreme cold-weather event would test gas deliverability regionally, but impacts would not be limited to Illinois. These available gas supplies are in part why Illinois has seen construction of numerous gas-fired electricity generation facilities in the last 18 months with applications pending for many more

The Link Between Electricity and Natural Gas: The "Peaker Plant"

New utility power plant construction essentially ceased under electricity market deregulation in most areas of the country. Non-utility, or "merchant," generators have been filling the demand gap for electricity, particularly summer air-conditioning demand, by building gas-fired turbine electricity generating facilities. Summer represents the peak time for electricity use—hence, the term "peaker plant" applied to these power plants. More than 50 peaker plant permits were granted or pending in Illinois as of August 2000, and, since 1998, 16 plants totaling 5,305 MW of new gas-fired capacity have become operational or are being built. Illinois already was a net exporter of electricity as of the end of 1998. Thirty additional new peaker plants totaling 8,123 MW are permitted by the Illinois Environmental Protection Agency (10 plants) or are in the permit process (20 plants). Not all of these plants will be built since local permits and rapidly changing market conditions (including rapidly escalating natural gas prices) also affect plant construction decisions. As of August 2000, 11 additional electricity generation projects at existing industrial and utility sites have also been permitted or applied for.

Although natural gas supplies are ample in Illinois, gas-fired electricity generation in the state and nationwide will affect natural gas consumption and prices. Natural gas usage has historically been cyclic because of its extensive use in winter months for space heating purposes, resulting in decreased demand in summer. This decreased demand lowered wellhead prices in summer when gas storage reservoirs are filled to meet winter demand. As gas-fired electricity generation for peak summer loads increases, this historical cyclicity will be smoothed out, and higher natural gas prices will be supported during the summer months. Thus, gas used in the winter will consist of seasonally higher priced gas coming from wellheads directly to market plus higher priced summer storage gas.

An additional impact of gas-fired electricity generation, especially that beyond a peaker plant, will be deferral of generation capacity fired by other fuels, such as Illinois coal. This deferral will have a negative impact on the Illinois economy. It is also important to recognize that the gas turbines of peaker plants require substantial water resources for cooling and for boiler loops (in the case of combined cycle plants). Water demand could be on the order of several million gallons per day, depending on the generation capacity of the plant.