In recent months, in response to very tight supplies, prices
of natural gas have increased sharply. Working gas in storage is
currently at very low levels relative to its seasonal norm because
of a colder than average winter and a seeming inability of increased
gas well drilling to significantly augment net marketed production.
Canada, our major source of imported natural gas, has had little
room to expand shipments to the United States, and our limited capacity
to import liquefied natural gas (LNG) effectively restricts our
access to the world's abundant supplies of gas.
Our inability to increase imports to close a modest gap between
North American demand and production (a gap we can almost always
close in oil) is largely responsible for the marked rise in natural
gas prices over the past year. Such price pressures are not evident
elsewhere. Competitive crude oil prices, after wide gyrations related
to the war in Iraq, are now only slightly elevated from a year ago,
and where spot markets for natural gas exist, such as in Great Britain,
prices exhibit little change from a year ago. In the United States,
rising demand for natural gas, especially as a clean-burning source
of electric power, is pressing against a supply essentially restricted
to North American production.
Given the current infrastructure, the U.S. market for natural gas
is mainly regional, is characterized by relatively longer term contracts,
and is still regulated, but less so than in the past. As a result,
residential and commercial prices of natural gas respond sluggishly
to movements in the spot price. Thus, to the extent that natural
gas consumption must adjust to limited supplies, most of the reduction
must come from the industrial sector and, to a lesser extent, utilities.
Yesterday the price of gas for delivery in July closed at $6.31
per million Btu. That contract sold for as low as $2.55 in July
2000 and for $3.65 a year ago. Futures markets project further price
increases through the summer cooling season to the peak of the heating
season next January. Indeed, market expectations reflected in option
prices imply a 25 percent probability that the peak price will exceed
$7.50 per million Btu.
Today's tight natural gas markets have been a long time in coming,
and futures prices suggest that we are not apt to return to earlier
periods of relative abundance and low prices anytime soon. It was
little more than a half-century ago that drillers seeking valuable
crude oil bemoaned the discovery of natural gas. Given the lack
of adequate transportation, wells had to be capped or the gas flared.
As the economy expanded after World War II, the development of a
vast interstate transmission system facilitated widespread consumption
of natural gas in our homes and business establishments. On a heat-equivalent
basis, natural gas consumption by 1970 had risen to three-fourths
of that of oil. But natural gas consumption lagged in the following
decade because of competitive incursions from coal and nuclear power.
Since 1985, natural gas has gradually increased its share of total
energy use and is projected by the Energy Information Administration
to gain share over the next quarter century, owing to its status
as a clean-burning fuel.
* * * * *
Recent years' dramatic changes in technology are making existing
energy reserves stretch further while keeping long-term energy costs
lower than they otherwise would have been. Seismic techniques and
satellite imaging, which are facilitating the discovery of promising
new natural gas reservoirs, have nearly doubled the success rate
of new-field wildcat wells in the United States during the past
decade. New techniques allow far deeper drilling of promising fields,
especially offshore. The newer recovery innovations reportedly have
raised the average proportion of gas reserves eventually brought
to the surface. Technologies are facilitating Rocky Mountain production
of tight sands gas and coalbed methane. Marketed production in Wyoming,
for example, has risen from 3.4 percent of total U.S. output in
1996 to 7.1 percent last year.
One might expect that the dramatic shift away from hit-or-miss
methods toward more advanced technologies would have lowered the
cost of developing new fields and, hence, the long-term marginal
costs of new gas. Indeed, those costs have declined, but by less
than might have been the case because much of the innovation in
oil and gas development outside of OPEC has been directed at overcoming
an increasingly inhospitable and costly exploratory physical environment.
Moreover, improving technologies have also increased the depletion
rate of newly discovered gas reservoirs, placing a strain on supply
that has required increasingly larger gross additions from drilling
to maintain any given level of dry gas production. Depletion rates
are estimated to have reached 27 percent last year, compared with
21 percent as recently as five years ago. The rise has been even
more pronounced for conventionally produced gas because tight sands
gas, which comprises an increasing share of new gas finds, exhibits
a slower depletion rate than conventional wells.
Improved technologies, however, have been unable to prevent the
underlying long-term price of natural gas in the United States from
rising. This is most readily observed in markets for natural gas
where contract delivery is sufficiently distant to allow new supply
to be developed and brought to market. That price has risen gradually
from $2 per million Btu in 1997 for delivery in 2000, and presumably
well beyond, to more than $4.50 for delivery in 2009, the crude
oil heating equivalent of rising from less than $12 per barrel to
$26 per barrel. Over the same period, the distant futures price
of light sweet crude oil has edged up only $4 per barrel and is
selling at a historically rare discount to comparably dated natural
Because gas is particularly challenging to transport in its cryogenic
form as a liquid, imports of LNG have been negligible. Environmental
and safety concerns and cost have limited the number of LNG terminals
and imports of LNG. In 2001, LNG imports accounted for only 1 percent
of U.S. gas supply. Canada, which has recently supplied a sixth
of our consumption, has little capacity to significantly expand
its exports, in part because of the role that Canadian gas plays
in supporting growing oil production from tar sands.
Given notable cost reductions for both liquefaction and transportation
of LNG, significant global trade is developing. And high gas prices
projected in the American distant futures market have made us a
potential very large importer. Worldwide imports of natural gas
in 2000 were only 26 percent of world consumption, compared to 50
percent for oil.
Even with markedly less geopolitical instability confronting world
gas than world oil in recent years, spot gas prices have been far
more volatile than those for oil, doubtless reflecting, in part,
less-developed global trade. The updrift and volatility of the spot
price for gas have put significant segments of the North American
gas-using industry in a weakened competitive position. Unless this
competitive weakness is addressed, new investment in these technologies
Increased marginal supplies from abroad, while likely to notably
damp the levels and volatility of American natural gas prices, would
expose us to possibly insecure sources of foreign supply, as it
has for oil. But natural gas reserves are somewhat more widely dispersed
than those of oil, for which three-fifths of proved world reserves
reside in the Middle East. Nearly two-fifths of world natural gas
reserves are in Russia and its former satellites, and one-third
are in the Middle East.
Creating a price-pressure safety valve through larger import capacity
of LNG need not unduly expose us to potentially unstable sources
of imports. There are still numerous unexploited sources of gas
production in the United States. We have been struggling to reach
an agreeable tradeoff between environmental and energy concerns
for decades. I do not doubt we will continue to fine-tune our areas
of consensus. But it is essential that our policies be consistent.
For example, we cannot, on the one hand, encourage the use of environmentally
desirable natural gas in this country while being conflicted on
larger imports of LNG. Such contradictions are resolved only by
debilitating spikes in price.
* * * * *
In summary, the long-term equilibrium price for natural gas in
the United States has risen persistently during the past six years
from approximately $2 per million Btu to more than $4.50. The perceived
tightening of long-term demand-supply balances is beginning to price
some industrial demand out of the market. It is not clear whether
these losses are temporary, pending a fall in price, or permanent.
Such pressures do not arise in the U.S. market for crude oil. American
refiners have unlimited access to world supplies, as was demonstrated
most recently when Venezuelan oil production shut down. Refiners
were able to replace lost oil with supplies from Europe, Asia, and
the Middle East. If North American natural gas markets are to function
with the flexibility exhibited by oil, unlimited access to the vast
world reserves of gas is required. Markets need to be able to effectively
adjust to unexpected shortfalls in domestic supply. Access to world
natural gas supplies will require a major expansion of LNG terminal
import capacity. Without the flexibility such facilities will impart,
imbalances in supply and demand must inevitably engender price volatility.
As the technology of LNG liquefaction and shipping has improved,
and as safety considerations have lessened, a major expansion of
U.S. import capability appears to be under way. These movements
bode well for widespread natural gas availability in North America
in the years ahead.