Natural gas is found it the same type of geological formation as crude oil and frequently does not come on its own but as a by-product of oil extraction. In the past if there was no way of transporting the gas – either by pipelines or in specially designed ships – it was cheaper to flare off or burn the gas at the wellheads than attempt to store it. This is still done in some African countries but because of environmental damage the practice is becoming less and less common.
There are three distinctly different gas markets that are only loosely linked because transport of gas is dominated by pipelines and only a small portion of gas travels across the oceans. In North America both the US and Canada are large consumers and most of the gas there travels to Henry Hub in Louisiana, which is the connection point for 13 different pipelines.
Europe is supplied by Russia, the UK, Norway and the countries of the Middle East. In the past the world’s largest producers, Russia, Qatar and Iran looked into forming the equivalent of a gas OPEC – a gas producers cartel – with the view of controlling output and prices, but this proved unfeasible because of the long term nature of supply contracts and because of the different political motivations of the countries in question.
Another way of transporting gas is by liquifying it, achieved by cooling it to -162 C. When liquid, gas takes up 600 times less space and can be transported in specially designed tankers that have reinforced walls designed to withstand the much higher pressure. Japan, being an island, is the biggest consumer of this type of gas and buys liquified natural gas or LNG from the US, Russia and the Middle East.
For those interested in trading natural gas markets, the key guide price will be NYMEX natural gas futures. The futures are quoted in 10,000 million British thermal units (mmBtu) for delivery via the Sabine Pipe Line at Henry Hub in Louisiana. Natural gas futures are also traded in Europe on the Intercontinental Exchange but turnover in 2010 was 2.1 million lots compared with 64.3 million lots on NYMEX. This means that prices are dominated by the supply and demand dynamic in the US and the local demand there for heating and power generation.
Most of the natural gas is used for domestic and commercial heating, for power generation and in manufacturing. The highest demand for gas is therefore in the winter months and to a slightly lesser extent in the summer when it is used for cooling. Spring and autumn are typically the periods of lowest gas prices. It is worth keeping an eye on the weather in the US as well, because extreme colds or a prolonged winter can boost demand and prices.
Natural gas prices have been going through a period of a slump which was partially brought on by the fact that US producers developed shale gas technology that allows them to drill for gas horizontally rather than only vertically. This has massively increased the level of production in the US and has created a glut in the market. European countries, particularly Poland, are looking to use the same technology to increase their output of gas. Shale gas technology seems here to stay and unless there is a large new area of demand, natural gas prices could stay flat over years to come.