Why do consumers need information about natural gas prices?
 

Over the past several winters, some consumers have experienced unexpected fluctuations in their heating bills. The fluctuations have generally resulted from adjustments to new marketplace conditions These new conditions, in turn, are part of the "growing pains" of the natural gas industry, which, over the past ten years, has increased market competition and, overall, kept consumer prices far below those of the early 1980s.
 

Price fluctuations can alarm consumers. Unexpected rises can cause financial hardships, and price drops can lead uninformed consumers to expect that prices will continue to drop or that they will stabilize at the new, lower level. Informed consumers can better budget for all contingencies.
 
 

Who buys natural gas, and how do they do it?
 

Large industrial gas users and electricity generators buy gas directly from producers and marketers. So do local distributors, who then re-sell the gas to residential and commercial customers in their regions.
 

While most customers who use relatively small amounts of gas in their homes or businesses must today obtain gas from a local distributor, this situation is changing. In the future, most gas consumers will have the choice to buy gas from several different marketers. This will allow all consumers to choose the services and prices that best suit their needs.
 
 

In the past, residential natural gas prices stayed relatively level despite changing weather conditions. Why the change?
 

Until the mid-1980s, the federal and state governments regulated all aspects of natural gas production, transportation, and distribution. This unwise manipulation of the marketplace led to many problems in the gas industry, including prices that, while level, were excessively high.
 

To solve these problems, government has gradually released the natural gas marketplace from excess regulation and permitted the industry and its customers to enjoy the benefits of competition: lower prices and a reliable gas supply and delivery system.
 

How does the natural gas market work?
 

Like wheat or corn or beef, natural gas is a commodity product. Buyers of the gas commodity have several types of supply contracts to choose from:
 

A long-term, fixed-price contract assures that gas will be available at a set price. The price for this type of contract may be higher than for other types of contracts because the sellers assume a great deal of risk. For instance, during a cold winter, the seller would not get the benefit of higher prices. Or the seller might not be able to recoup its investment if unexpectedly expensive technology is needed to find the gas with which to fulfill the terms of the contract.

A long-term variable-price contract assures supply, but the price will vary with market conditions. The price may be determined by some variable such as averages for a basket of different fuels during a particular period of time.

Short-term contracts permit buyers to purchase gas on the "spot market," where gas is sold when it has been produced or is about to be produced but has no other buyers. Producers and marketers sell extra gas on the spot market, as do large industrial companies that have contracted for more gas than they actually need. Buyers frequently use the spot market for gas for which there is an unexpected demand caused, for instance, by unexpectedly cold weather. They can also use spot-market gas to fill storage areas that can subsequently be tapped if demand or prices rise.

Buyers may also use risk-management tools like futures, which act as an insurance contract to guarantee prices for a certain amount of gas during a particular month. Like any form of insurance, these risk-management tools cost money. Also like other forms of insurance, they may appear to some people to be a great investment if prices rise and a poor investment if prices fall rather than rise.
 

What specific market conditions caused price fluctuations over the past several years?
 

Winters early in this decade were generally warmer than average in most of the gas-consuming regions of the U.S. This fact added to the historic low spot-market prices that prevailed since the mid-1980s encouraged many buyers to depend heavily or exclusively on spot-market (short-term) contract.
 

While weather during the winter of 1995-96 was not overall markedly colder than average, there were a few cold periods during which gas prices skyrocketed from $2-3 per mcf (thousand cubic feet) to more than $40/mcf. These prices lasted for only short periods, and little gas was bought and sold at these prices. Many cities, concerned about the prices, made public announcements asking people to keep heating and other gas uses low. Consequently, distributors had little or no high- priced gas to average in to overall monthly rates, and since consumption was generally average or above, there was a lot of lower-priced gas with which to average the few instances of high-priced gas. As a consequence, few customers saw major fluctuations in their bills in 1995-96.
 

This situation was different during the winter of 1996-97. In early September, contracts were available at about $2/mcf for gas to be delivered in January at one of the major market centers. The month of November was 18 percent colder than average, however, and buyers began to worry that the coming winter would be unusually cold. This encouraged them to buy contracts for more gas to be delivered in the coming months. A sudden, sharp rise in short-term "spot market" natural gas prices resulted, so that the contract price more than doubled by the beginning of December.
 

As it turned out, this winter of 1996-97 warmer than average in most regions. Contract prices plummeted; gas that cost $4.50 in December sold for about $1.70 in February. But many buyers had already committed to the higher-price contracts. Consequently, consumers whose distributors bought at the high point paid higher prices; so did those whose distributors negotiated supply contracts linked heavily to "spot market" (short-term) prices. On the other hand, consumers whose distributors bought in advance, at the low, or whose distributors used long-term contracts, storage, and other price-leveling strategies, did not.
 

A number of distributors and state regulators held hearings to examine the winter's experience and developed alternative supply strategies that, for instance, aim to balance a supply portfolio with both long- and short-term buying strategies. Many have also committed to an "early warning" system for consumers so that if prices appear to be rising, consumers can be alerted to prepare for higher bills and/or cut back on gas use.
 

As we enter the winter of 1997-98, gas is selling at market hubs for prices higher than last year--around $3/mcf.
 
 

Do high prices indicate that we are running out of gas?
 

No. There is plenty of natural gas to meet our country's needs. Today, producers are doing more drilling and exploration than ever before, especially in promising regions like the Gulf of Mexico. Pipelines and distributors are constantly expanding their systems and improving their operations to ensure that this gas gets to consumers at competitive prices. And Canadian producers are planning several major new projects to bring large amounts of surplus gas into the U.S. market.
 

Natural gas is a clean-burning fuel that can be counted on to meet consumer energy needs and contribute to the nation's economic prosperity now and in the future.
 
 

How can consumers judge whether the gas system is reliable?
 

Here are some factors that demonstrate the reliability of U.S. natural gas:
 

Reliability is based on contracts. In today's gas market, customers reliably receive the gas supply and service for which they have contracted.

Reliability of natural gas supply has been significantly enhanced by the increased reliance on competitive-market forces in the gas industry. Previously, when prices were completely regulated, demand outstripped supply. Today, competition in the natural gas market, as in other commodity markets, ensures reliable supply in several ways. For instance:

- Short-term increased demand encourages industrial users to switch to other fuels, freeing up supplies for residential and commercial users unable to switch. The industry saw this market force at work last winter, when record cold east of the Mississippi did not affect supply availability for firm customers.
 

- Producers can respond to increased demand through supply-increasing operational adjustments. For instance, a skid-mounted compressor moved into a field can significantly increase production in a matter of hours.
 

- Long-term increased demand encourages producers to increase exploration and production activities that can bring more gas to market. Over the past year, for instance, natural gas drilling activity has risen markedly in promising areas such as the Gulf of Mexico.
 

Competition in natural gas transmission has also increased reliability. As a result of changes in the marketplace, shippers frequently have several potential routes for reaching a given market. Thus, should high demand or operational issues make it difficult to get new supplies to market on one pipeline, shippers can frequently find alternatives.

Reliability of natural gas delivery has been enhanced through the development of a reliability network, sponsored by the Natural Gas Council, which puts into immediate contact with each other those industry operations people best able to resolve problems such as unexpectedly high demand (usually related to cold weather) or temporary transmission interruptions.
 
 

Should distributors be required to use gas storage to protect residential customers?
 

Not necessarily. Storage costs money; if it is not needed, it adds unnecessarily to prices.
 

Relatively little storage may be appropriate for regions like Southern California, where demand is relatively level year-round and where there is a great deal of unused transportation capacity that can be placed in service during periods of unusually high gas demand.
 

Storage is generally a significant part of the business strategies of distributors in regions like the Northeast or Midwest, where gas must travel a long distance from producing fields, and where demand can fluctuate greatly in response to short-term weather conditions. There are, however, alternatives to storage, including gas peaking facilities (such as propane/air or LNG), switching to an alternative fuel, temporary facility closings, or limited purchases of higher-price spot-market gas. A number of distributors also have made arrangements with large industrial gas-using facilities so that, if there is an unusually high spike in demand, gas can be diverted from industrial use and used instead by residences, hospitals, and schools.
 

Should distributors be required to use financial instruments and risk-management strategies to achieve level prices?
 

Again, not necessarily. As in other industries, gas-market risk-management strategies cost money, and some may prevent customers from benefiting fully from low prices during periods when supplies are high and demand is low.

Some analysts believe that during the past decade, temporary market conditions (high supply and low demand) may have encouraged some buyers to ignore the benefits of risk-management strategies and rely too heavily on the spot market. As supply and demand have achieved greater balance, this situation appears to be changing.
 
 

Should the U.S. return to regulated natural gas prices?
 

Regulation of natural gas prices in the 1970s and early 1980s caused gas shortages and prices far higher than those today. Increasing competition and reducing needless, counter-productive regulation have, on average, dramatically lowered consumer's natural gas bills and increased both the supply of natural gas and the reliability of the industry.
 

There is a price for these vast improvements. As in all competitive markets, there are occasional unexpected shifts in natural gas prices. While the tools and techniques to manage those shifts are becoming better understood every day, the market is still relatively "immature." Mistakes and incorrect evaluations of unknown future market and weather conditions can be made.
 

Overall, residential consumers have benefited greatly from competition. From 1987 through 1995, their price for natural gas, unadjusted for inflation, fell by nearly 16 percent; the inflation-adjusted percentage is much higher. The effects of this competition in the supply and marketing areas have been so positive that most states are now extending competition to local consumer markets.
 
 

Have independent studies been performed of recent natural gas prices?
 

In addition to these questions and answers, this site contains:
 

An analysis of consumer natural gas prices during the winter of 1996-97 from the Department of Energy's Energy Information Administration.

An article on early-1997 consumer gas prices in Missouri published in a major independent industry publication, Natural Gas Intelligence.

An article from another independent industry publication, Natural Gas Week, which discusses the actions underway at many local gas distributors that change the way they procure gas, offer new consumer payment options, and help customers prepare for possible price volatility.
 
 

Competitively priced natural gas has spurred the American economy and provided families with a higher standard of living. The domestic integrated and independent producer-members of the Natural Gas Supply Association are proud to be part of an industry that is dedicated to providing all of our customers with clean, reliable natural gas for generations to come.
 

--November 1997