US gas price spike scrutiny unwarranted

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US natural gas prices have arrived: They are now the likely subject of a congressional investigation.

Spiking crude oil and gasoline prices are usually the target of such hyperinflated indignation. Now natural gas prices get their due, misguided though such efforts are.

Gas price spikes

It is an understatement to say that markets were surprised by a 50% spike in natural gas futures prices on the New York Mercantile Exchange earlier this month. With storage abundant, how could gas prices have jumped to a 9 month high near $7/MMbtu?

That question was asked with ire and skepticism by some influential politicians. But instead of Democratic Reps. Henry Waxman (Calif.) and John Dingell (Mich.) dredging up yet another pointless and superfluous investigation of possible gasoline price-fixing and gouging of consumers—which has become an annual rite of spring—we have Sens. Orrin Hatch (R-Utah) and Harry Reid (D-Nev.) hinting darkly of possible gas price manipulation and asking for investigations of the matter early next year. Hatch raised the ghost of Enron Corp. and gas price manipulation in California. Reid contended in a letter to Sens. Pete Domenici (R-NM) and Jeff Bingaman (D-NM) that the market "does not appear to be reacting to the fundamentals of supply and demand" in asking the two leaders of the Senate Energy Committee to conduct hearings on possible gas price manipulation.

But Bill O'Grady, analyst with A.G. Edwards & Sons Inc., suggests that the ire and skepticism aren't warranted.

"I think some folks have noticed the large short position held by hedge and commodity funds and somehow managed to see this as manipulation," he said in a recent research note. "Its only effect was to keep the price lower than it otherwise would have been."

O'Grady also noted that the chemical industry is threatening legal action, "to which I think an intelligent observer would note that they could have hedged their needs in November at significantly lower prices."

The hue and cry over how prices jumped relative to the ample status of gas inventories is similarly misguided, he added: "If reports of falling production, here [in the US] and in Canada, are true then the level of inventory will 1) fall quickly or 2) depress prices later this month."

Supply-demand factors

Indeed, the signs continue to mount that production is falling despite a frenzied drilling pace.

According to the latest data from the US Energy Information Administration, US gas production fell 2% from June to July. It could be that the market was spooked by the latest production numbers coming in tandem with successive blasts of cold weather early in the season.

While there are dissenting voices on the subject of various methodologies used to track US gas production, the likelihood is that US gas production is falling by at least 2.5% year to year, according to J. Marshall Adkins, analyst with St. Petersburg, Fla.-based Raymond James & Associates Inc.

"Furthermore, it does not appear that this trend is likely to reverse itself anytime soon" regardless of increased drilling activity, he said in a December research note.

At the same time, demand may be on the upswing, thanks to a recovering US economy. Ron Denhardt, vice-president, natural gas services, with Winchester, Mass.-based Strategic Energy & Economic Research Inc., noted that the US gas supply-demand balance has tightened since the beginning of October.

". . .We believe close to 1 bcfd of gas demand has returned because of increased production in gas-intensive industries. . .," he said."

A number of analysts have pointed out that the gas futures and spot markets were overbought in early December and are likely due for a correction if the wintry temperatures ease off a bit.

Of course, that correction still may leave a gas price floor of $5-6/MMbtu for the rest of the heating season. And judging from the recent skittishness of the markets, anything above $5/MMbtu will be a real rollercoaster ride.

(Author's e-mail: [email protected])

OGJ HOTLINE MARKET PULSE

Latest Prices as of Dec. 15, 2003