# Presentation: 233024

## U.S. Natural Gas MarketsDevelopments and Outlook

- Barbara Mariner-Volpe
- February 2001
- Bangladesh Ministry of Energy and Mineral Resources
- barbara.marinervolpe@eia.doe.gov

- <date/time>

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## Scope of Presentation

- Recent market developments
- Volatility
- Market convergence / mergers
- Short-term outlook
- Long-term outlook

## Components of Reserves Changes for Dry Natural Gas,1989-1999

## Gas Reserve Additions Replaced Production For 5 of the Last 6 Years

## Technically Recoverable U.S. Natural 

- Technically Recoverable U.S. Natural
- Gas Resources as of January 1, 1998
- (Trillion Cubic Feet)

## Gas Discoveries Per Exploratory Gas Well Have Been Trending Up Since The Mid-1980’s

## Resource Depletion 

- Progressive reduction of the overall volume of a resource over time as the resource is produced.
- As existing wells, reservoirs and fields are depleted, new portions of the resource base must be tapped to replace those that can no longer be produced at economical levels.

## Pace of Depletion is Increasing 

- Average annual declined of gas wells:       drilled in 1972 (17%) v. 1996 (49%)
-  Advances in Technology - production grows but depletion is faster
- Changes in Prices affect drilling and hence depletion

## Gas wells drilled in 1972 declined 17% per year, wells drilled 1996 declined 49% 

- 1.	Advances in Technology
- 2.	Changes in Resource Base
- 3.	Greater Efficiency

- Depletion - Occurring at more rapid rates

**Notes:**
1.	Advances in Technology.  Aggressive use of 3D seismic, horizontal wells, advanced hydraulic fracturing, multiple completions and infill drilling all enable reservoirs to be produced (“depleted”) faster.
2.	Changes in Resource Base.  Productive lives of smaller fields, such as are being discovered in mature basins and plays, are shorter.  (Faster depletion from advances in technology has made many of these smaller, marginal fields economic.)
3.	Greater Efficiency.  With natural gas deregulation, the emergence of hubs and changes in pipeline approvals, less natural gas is required in the “warehouse” of proved reserves.

## Natural Gas Production Exhibits Significant Decline Rates

**Source: Advanced Resource International**

**Notes:**
  This slide illustrates the nature of gas production by use of data for the Gulf Coast area.

  Gas production is vintaged by year of well completion.

  As wells produce, resources are drawn down and flow rates decline.  

  Failure to maintain drilling rates may have consequences in subsequent periods.

## Slide 11

**Notes:**
From preliminary data, nominal economics

7000 oil fields discovered in the Permian basin through 1996

Estimated Ultimate Recovery of first 700 fields = 30 Billion bbls

Estimated Ultimate Recovery of last 700 fields = 650 Million bbls

Estimated Undiscovered Oil = 3 Billion bbls to be found in relatively small fields

## Slide 12

## Slide 13

## Slide 14

## Does Depletion Preclude Production Increases? 

- Answer:   NO.
- First fields developed are relatively large and accessible. Future development requires more effort.
- Counterbalance - increasing initial production and advances in drilling technology.
- But, higher initial rates are accompanied by more rapid declines in later stages.
- Hence, more exploration and development activity needed to maintain production levels.

## Depletion (continued)

- If drilling increases sufficiently, production can actually increase despite the finding of smaller and potentially less productive fields.

## Proved Reserves - Defined

- Estimated quantities, which, on a particular date, geological and engineering data demonstrate with reasonable certainty to be recoverable in the future from known reservoirs under existing economic and operating conditions.

## Reserve Growth - Ultimate Recovery Appreciation (U.R.A.)

- Increase in estimates of ultimate recovery over time due to the extension of proved reservoir areas, in-field discovery of more reservoirs and other factors - that account for the majority of gas supplies and current additions to reserves.

## Historical Record on Ultimate Recovery Appreciation

- Shows that the estimates of ultimate recovery increase over time for most reservoirs, the vast majority of fields, all regions, all countries, and the world.

##  Ultimate Recovery Appreciation in the U.S.

- Still occurring at low rates in fields found more than a century ago.
- From 1977-1995, approximately 86% of the additions to U.S. proved gas reserves were due to ultimate recovery appreciation rather than the discovery of new fields.

## Factors that lead to U.R.A.

- Lack of adequate geotechnical information at the time of discovery
- Effect of post-discovery development and production processes
- Technological progress

## Evolution of Canadian Export Policy

- Purpose - ensure sound development/conservation and market practices
**Export Prices**:
-      Prior to 1975 - negotiated
-      1975-1984 - set by Canadian government
-       1984 + - negotiated, subject to criteria
-                    - after-the-fact monitoring

## Canadian Policy re Export Volumes

- Goal - ensure that exports are surplus to reasonably forseeable Canadian requirements
- Early, Mid 1980’s - reserves/production ratio procedure
- Initially 25 years protection, then 15 years in late 1980’s
- 1987 - Market based procedure adopted.

## Components of Canada’s Market-Based Export Procedure

- Protection of Core Markets (residential, commercial and small industrial)
- Public Hearings: complaints, export impact assessment, public interest determination
- Monitoring: long-term, short-term market outlook and assessment

## Gas Price Surge in 2000

## Why Have Natural Gas Prices Surged in 2000?

- Supply Tightness
- Storage Stocks - lower than average
- Consumption increases
- Oil Price Increases
- Market Perceptions

## Natural Gas Storage

- Critical supply component during heating season
- Natural gas demand is highly seasonal
-  Natural gas works on a “real time” delivery system at the consumers’ site
-  There is no storage of natural gas at customer site

## As of Jan. 12, 2001, Storage Stocks are Down About 30 Percent from the 5 Year Average

## Outlook for Winter 2000/2001

- Prices significantly higher than last winter
- Current storage levels are low and may be very tight if gas demand surges beyond expected levels
- Record drilling levels will start to ease supply tightness but timing is an issue
- With normal weather, consumption will be higher than last winter
- Barring extreme weather, pipeline capacity will be adequate to satisfy firm load requirements

## Rigs Drilling Gas Wells Are At All-Time Highs

- Drilling Rigs 1/2/98 - 1/19/01

**Notes:**
  Rigs drilling for gas wells hit a weekly low point of 362 in mid April 1999.

  Gas rigs in operation have more than doubled since then, hitting a record of     887 as of January 19, 2001.

  The increasing number of resulting gas well completions have been expanding production in major producing States, such as Texas.  

  For the year 2000, dry gas production is estimated to have increased by 1.2%.  However, recent estimates show a greater response–fourth quarter production is up 4.4% over the same period in 1999.

## Short Term Forecast

## Current Natural Gas Spot Prices: Well Above the Recent Price Range

**Notes:**
.   Prices on this figure are for spot transactions only.	

.   The surge in spot prices at the Henry Hub since April are well above a typical range for 1998-1999  (in this context, defined as the average,  +/- 2 standard deviations) 

.   The upper bound on the typical range for 1998-99 is less than one-third of recent spot prices.

. The Henry Hub spot price recently spiked at $10.53 per MMBtu on Friday 12/29.   Spot prices at the Henry Hub traded at a midpoint of $6.91per MMBtu on Wednesday, January 24. This is the first time the price has been below $7.00 since December 1, 2000 and is more than $3.60 per MMBtu lower than at the peak price on December 29th. 

## Residential Prices Do Not Reflect the 

**Residential Prices Do Not Reflect the **
**Volatility Seen in Upstream Prices**

**Notes:**
A key concern about the level of current upstream prices is the impact on consumers, especially residential and small-volume commercial customers

  Using monthly average prices for residential customers and daily Henry Hub spot prices for the past 4 winters and EIA’s latest projection (January  STEO): significant price fluctuations are apparent at the Henry Hub, but residential prices respond relatively less.  The major reasons for the lesser response in residential prices are:

  Residential prices are monthly averages, which will not move as erratically as daily prices   (even Henry Hub prices averaged over a month are much less volatile) 

  Gas supplies to residential customers generally are arranged prior to delivery, and agreed price terms, while flexible, may not be fully responsive to contemporaneous upstream price shifts 

  Gas commodity charges are a fraction of the delivery price for small customers–averaging about 33 percent during the heating season, although that fraction is expected to exceed 50% this winter.  Costs of services–e.g., transportation, storage, and local delivery–are the major cost components for gas sold to residential customers

## Volatility

## Transportation Constraints Can

**Transportation Constraints Can**
**Result in Dramatic Price Differentials**

## Price Volatility Increases As Beginning Heating Season Storage Levels Declined

**Price Volatility**

**Stocks Relative to Heating Season Demand**

## What Are The Main Drivers OfShort-term Price Volatility?

**Economic/business conditions **
**Stock levels**
**Pipeline capacity**
**Operational difficulties**
**Lack of  timely,**
**reliable information**

**Affects Supply       Affects Demand**

- What Are The Main Drivers OfShort-term Price Volatility?

## Natural Gas is Second Only to Electricity in Energy Futures Price Volatility

## Energy Prices Are More Volatile Than Other Commodities

**Natural Gas**

**Crude Oil**

**COB Electricity**

**Wheat**

**T Bonds**

## High Prices and Volatility Do Not Necessarily Happen at the Same Time

**Notes:**
Volatility has a slight (statistically insignificant) trend over the past 6 years.
Volatility follows a seasonal pattern tending to be greater during the heating season months and lesser during the non-heating season months.
 However, over the past two years, volatility has been increasing during the summer months.  This may reflect the increase of gas fired electric generation facilities.
Prices have also displayed a fairly flat trend over the past six years.
However, in the past two years, prices have developed a sharp upward trend that may reflect that the growth of productive capacity has not kept pace with the growth of demand.
Prices have also displayed seasonal variation over time with prices peaking during the winter months.
High prices do not imply high volatility (and conversely)
Highest volatility  occurred during 12/95 when prices were just under $4.00.
Highest price of approximately $10.00 occurred during 01/2001, and volatility was less than 120 percent.

## The Futures Market is Used Largely for Short-term Price Stability

## U.S. Gas Market Increasingly Interacts With Other Markets

- Example: Fuel oil / gas market interaction in 2000
- California gas / electricity market
- Development of Btu market

## Winter 1999/2000: Fuel Oil and Gas Market Developments

- New England heating oil prices increased $0.78 per gallon (to $1.97) between 1/17 and 2/7
- Factors that led to the surge
- increases in crude oil prices
- cold weather
- low fuel oil stocks
- refinery outages
- transportation problems
- natural gas interruptible load switching to distillate

## Heating Oil Prices Spiked

**Notes:**
At the end of last January, a brief cold snap cause distillate demand to increase and interfered with deliveries of distillate to the Northeast.

The region also had low inventories, so there were little nearby supply available to respond to the demand increase.

Prices were bid up rapidly on January 21.  They peaked February 4 at $1.77 before falling back when both milder weather and the arrival of new supplies -- mainly imports resolved the problem. 

## Natural Gas Prices Also Spiked

**Notes:**
When the weather turns cold, natural gas prices are also affected.  

Notice that in this graph the price of natural gas has tripled.  The price of distillate doubled.  Some natural gas customers end up switching to distillate fuel oil under these circumstances.  

## Natural Gas Customers Switching to Distillate Impact Heating Oil Prices

- Natural Gas Market

- Heating Oil

- Switching

- $ --  Economic -- $

- Vol -- Interruptible -- Vol

- Other Liquids

- (Not to Scale)

**Notes:**
During a cold spell, these switching customers jump into the heating oil market as “base load” distillate demand is increasing, adding to the heating oil demand surge that occurs during a cold snap.  

As will be discussed later in the presentation in more detail, some natural gas customers have contracts that require them to get off of natural gas when demand increases so that residential and other “firm” customers can be served.  These are customers on “interruptible contracts.”

Other switching natural gas customers have contracts that allow them to switch when it becomes economic.

Not all customer that get off of natural gas move to distillate.  Some natural gas customers use other liquid products when they leave the natural gas market such as jet fuel, residual fuel oil and propane.  (Propane is stored and transported as a liquid, which is easily achieved by increasing the pressure slightly.)  Liquids are easy to transport and store and thus provide a convenient backup fuel for customers that switch out of natural gas.

The question the survey will explore is what volumes and price impacts these switching customers may be having on the heating oil market?  Informal estimates have indicated that they can represent a sizeable marginal volume in the heating oil market.  

## Distillate Stocks Were Low – Especially on the East Coast

**Source: EIA**

**Notes:**
Distillate stocks are normally built during the summer for use during the winter as shown by the normal band.

Currently, stocks are very low for this time of year. 

Stocks are the nearest source of supply when demand surges, and they are the buffer when production or import supplies slow.  

As an indicator of the balance between new supply (production and net imports) and demand, stocks are a good barometer of price.  When stocks are low and falling, buyers worry about supply availability and bid prices up.  

As was evidenced this summer in the gasoline market, and last January and February in the Northeast heating oil market, below average stock levels translate to increased potential for price volatility.

## Distillate Stocks Are Important Part of East Coast Winter Supply

**Source: EIA**

**Notes:**
Why do stocks matter in the Northeast?  They are the nearest source of supply when anything unexpected occurs, and they supply a significant portion of demand during the peak heating season.  This chart is for the entire East Coast, but the main points apply to the Northeast.

Stocks are normally an important part of East Coast winter distillate supply.  Over the last 10 years, they provided about 15% of supply during the peak winter months of January and February.  One of the biggest stock draws we have seen was in January 1994, when a prolonged severe cold spell required 666 MB/D of stocks, covering almost 36% of demand for that month.
Stocks supply the East Coast with about 260 MB/D on average in January and 280 MB/D in February.  Those supplies represent draws of about 8 million barrels in one month.  

East Coast refineries meet about 25% of demand during January and February, and other regions -- mostly the Gulf Coast -- supply 40-50% of the region’s needs.

Imports generally supply about as much as stocks during the peak months, with most of the product coming from Canada, the Virgin Islands and Venezuela.  During the peak months, product from more distant sources also helps to supply the region.

Thus, about 60% of the East Coast’s supply comes from distant sources, so if cold weather increases demand, re-supply from these distant sources can take several weeks.

## Typical Price Surge Dynamics: 1989

**Notes:**
What factors contribute to a price spike?

The largest spikes have occurred when stocks are running below normal, then a cold snap hits the Northeast.

Both demand and supply are affected.  Cold weather can have high winds that hinder barges from landing in the harbor and it sometimes freezes rivers and slows truck deliveries of distillate.

Cold weather also causes demand to surge.  As demand surges and supply slows, inventories drop rapidly.  As they approach low levels, wholesale buyers bid up scarce supplies that are arriving.  

The high prices attract new supplies, but these supplies take time to arrive -- usually weeks.  Marginal supplies usually come from abroad and the Gulf Coast, and travel from the Virgin Islands, Venezuela, Europe and even the Gulf Coast takes time.

But eventually new supplies arrive, weather subsides and the market returns to more normal price levels.

## Typical Price Surge Dynamics: 2000

**Notes:**
The price spike this past winter followed the usual pattern.

Stocks had been drifting down as refinery margins stayed relatively weak, but a brief cold spell hindered supply and increased demand.  Prices rose rapidly as previously shown.

The demand surge during cold snaps is comprised of the usual increases in usage by all sectors that use distillate for heating needs.  In addition, utilities may purchase more distillate to fire up diesel generators to meet rising peak electricity needs.  And last, but not least, natural gas customers play a role in this increase as well.  
Usually during a cold snap, natural gas prices and natural gas demand rise along with distillate prices and demand.  
Many large natural gas customers that are on interruptible natural gas contracts or that find rising natural gas prices less economic than distillate switch to distillate fuel.  
This adds to the surge already underway, and exacerbates the distillate price increase.  

These demand surges during a cold weather snap take place in a matter of weeks, and monthly data are too aggregate to pick up the severity of the marginal demand changes that impact price.   The issue that our survey is designed to explore is the impact on the volume and price increases that the customers switching to heating oil from natural gas may be having.  

## California Electricity Market - Market Stresses in 2000

- Load growth without complementary generation expansion (supply constraints), hydro down
- Strong demand
- Generation cost increases (including natural gas, emission credits).  Cap on spot electricity prices.
- Results
- Other states are concerned it could happen to them
- May slowdown retail restructuring programs

## Development of a Btu Market

- Some market participants are insensitive to the choice of commodity:  gas, electricity, petroleum
- domestic as well as international markets
- Customer wants power and has the option to self-generate, using gas, or purchase the electricity.  Economics drive customer selection.

## Mergers / Acquisitions

## Types of Corporate Combinations

- Merger
- Acquisition
- Divestiture
- Joint Venture
- Alliance

## Drivers

- Deregulation / Re-Regulation
- Technology
- Shrinking Margins
- Customer Demands
- Fears

## Goals

- Penetrate New Markets
- Offer “New” Services
- Take Advantages of Synergies
- Reduce Taxes
- Establish Brand Name
- Gain Access
- Timing
- Avoid Costs / Cutting Costs

## Cutting Costs

- Economies of Scale
- Divestiture
- Reduce Overhead
- Outsourcing
- Joint Ventures
- Strategic Alliances

## Strategies

- Expand into Non-Regulated Businesses
- Focus Marketing Efforts
- Advertise
- Develop One-Stop Energy Service
- Establish Brand Identification

## Strategies - Cont.

- Combinations
- Defensive
- Expansive
- Territory
- Local  / Regional
- National
- International

## Top 20 Natural Gas Marketers: Growth in Volume Outpaces Growth in Share

## U.S. Market Outlook

## Outlook for NEXT Winter 2001/2002

- Average wellhead prices expected to be lower than current levels.
- Production in 2001 will increase 5.4% from 2000 level. (Additional 2.5% growth in 2002)
- Increased imports from Canada
- Winter consumption close to 2000/2001 level
- (Annual growth:  2.9% in 2001 and 2.7% in 2002)

##   U.S. Consumers Will Pay 45 percent more and 

**Total Heating Bills will be about **
**75 percent higher than Last Winter**

**Notes:**
  Mild weather minimized residential gas consumption over most of the past 3 winters.  Our projections for more or less normal winter weather this year mean about 11 percent greater demand this winter compared to last year.

  The combination of higher consumer prices and demand increases expected under normal weather suggests an average increase in gas home heating costs  of about 70 percent this winter.  Our projections imply natural gas customers would be expected to pay almost $400 more this winter for heat than last year.  

## Natural Gas Spot Prices: Base Case and 95% Confidence Interval 

**Notes:**

  Peak monthly spot wellhead prices this winter of over  $8.40, occurred in December 2000.  Last month we projected a price average of $6.13 per mcf for December. Recently, concern about cold weather and low stocks pushed daily spot gas prices over $10.50  per mcf on December 29, 2000.  However in early January of this year, forecasts of warm weather pushed the price down by more $1.00 per mcf in one day, indicating the extraordinary volatility in the current U.S. market.

  Spot prices at the Henry Hub traded at a midpoint of $6.91 per MMBtu on Wednesday. This is the first time the price has been below $7.00 since December 1, 2000 and is more than $3.60 per MMBtu lower than at the peak price on December 29th. 

## Annual Changes in Natural Gas Demand by Sector

**Sources: History:  EIA;  Projections: Short-Term Energy Outlook, January 2001.**

**Notes:**

  Overall gas demand growth for 2001 is projected to be 2.9 percent.

  The strong growth rates in the industrial sector reflect the shifting of electric generation units from utility to non-utility categories.  Demand for natural gas by NUGS in 2001 is projected at about 9.0 percent.

  For the 4th quarter of 2000, gas-weighted heating degree days is estimated to have been up by 28 percent over the relatively mild weather of late 1999.

## Working Gas in Storage(Difference from Previous 5-Year Average)

**Working Gas in Storage****(Difference from Previous 5-Year Average)**

**Sources: History:  EIA;  Projections: Short-Term Energy Outlook, February 2001.**

**Notes:**
According to the American Gas Association (AGA), during the week ending January 26, a total of 128 billion cubic feet was withdrawn from storage, bringing the total of working gas to 38 percent full, or 1,241 bcf.   

EIA estimates that gas stocks at the end of January were about 510 billion cubic feet (or 1/3) below the previous 5-year average.   Although this points to an improvement for end-January stocks over previous expectations, with almost two months of winter still to go, continuing fears about the domestic supply situation are helping to maintain relatively high spot and futures prices.  Still, given recent spot price movements, a drop of about $3 per mcf is possible in February compared to the January average $8.98.

## Low Natural Gas Stocks Expected

- at the End of the Current Heating Season

**Notes:**

 January withdrawals for the first 12 days of the month are 5% below average daily rate for the month (over the first 19 days, the daily average is more than 15% below average).  This is considerably below the more than 4 above average withdrawal rate in the EIA short-term outlook.

 Assuming average withdrawals over the remainder of the heating season from 1/12, 506 Bcf is projected for end season.

  The 1,051 Bcf withdrawn in November and December is 66% above the 5-year avg of 634 for those months.

  If summer gas demand next year is as strong as we currently expect it to be, the low end-winter storage levels will present a strong challenge to the North American gas supply system to maintain flexibility and provide additional gas in preparation for the subsequent winter season.

## The Commodity Portion of Delivered Residential Prices Is a Fraction Of The Total

## U.S. Gas Drilling Activity Levels

**Assumes rigs stay constant**
**at about 880 in forecast**

**Notes:**
A striking recovery in gas drilling activity has sharply increased estimated and expected gas well completions in the United States since 1999.

While expected prices fall well short of the peak prices seen this winter, they remain within a range ($4-$6) over the next two years that should be sufficient to sustain very drilling rates.

New well completions probably increased between 40% and 50% in 2000 from the relatively depressed levels seen in 1999.  An average increase of between 20% and 25% seems likely in 2001.

Although production increases in 2000 were not sufficient to head off sharp increases in spot prices at the end of last year, we expect that the drilling effort will pay off more noticeably in 2001.  We expect an increase in domestic output of 5.4% this year, with continued growth likely next year.  We think that increased U.S. demand and large net injection demand this year will more than absorb such an increase.

## Natural Gas Market Outlook For 2020

- Market growth (32 Tcf in 2015, 34 Tcf in 2020)
- After the 2000/2001 surge, prices will drop, then increase slowly to about $3.10 (‘99 dollars/mcf) in 2020
- Imports increase to about 5 Tcf in 2020
- Rising prices and  lower drilling costs increase reserve additions and production
- Technology improvements limit cost increases

## World Oil Prices in Three Cases,1970 - 2020

- (1999 dollars per barrel)

**History**

**Projections**

**High Oil Price**

**Low Oil Price**

**Reference**

***Reference case***

***(nominal dollars)***

***36.04**** *

***17.10**** *

## World Oil Consumption in the Reference 

- Case by Region
- (million barrels per day)

## World Oil Production in the 

- World Oil Production in the
- Reference Case by Region
- (million barrels per day)

## Lower 48 Natural Gas Prices,1970 - 2020

-  (1999 dollars per thousand cubic feet)

**History**

**Projections**

**High Growth Price**

**Low Growth Price**

**Reference**

***5.03**** *

***1.55**** *

***Reference case***

***(nominal dollars)***

## U.S. Natural Gas Consumption, Production, and 

- Imports, 1970 - 2020 (trillion cubic feet)

**Consumption**

***Net Imports***

**Production**

**History**

**Projections**

## U.S. Natural Gas Consumption by Sector, 

- 1990-2020
- (trillion cubic feet)

**History**

**Projections**

**Industrial**

**Residential**

**Electricity Generation**

**Commercial**

**CNG Vehicles**

## U.S. Natural Gas Production by Source, 1990-2020

**(trillion cubic feet)**

**L48 Associated/**
**Dissolved**

**L48 NA Onshore**
**Unconventional**

**Alaska**

**L48 NA Offshore**

**History**

**Projections**

**L48 NA Onshore**
**Conventional**

## In Summary:  The Gas Industry is Dynamic

- and Faces Opportunities and Challenges...

- Prices will moderate in 2001
- Continued volatility of prices
- Significant market growth in the long-term
- Domestic production and imports will increase significantly in the future
- Natural gas is an abundant resource

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