Natural Gas Price Spikes: Causes and Potential Cures. (A Market Primer)

Article excerpt

Natural gas is an essential energy source in this country that has many applications, including heating more than 59 million homes and 5 million businesses, powering industrial and agricultural production, and generating a substantial amount of the nation's peak electricity needs. During the winter of 2000-2001, the wholesale price of natural gas peaked at a level almost four times greater than the average price since 1993. Figure 1 (on page 21) reflects this price spike in relation to natural gas prices over the period from 1993 through 2001.

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One extraordinary aspect of this price spike was its prolonged duration, with prices remaining at high levels for a year. This period of high gas prices raised concerns among industry and government officials as to whether they would again see the relatively low prices of the past any time in the near future. Although the 2000-2001 price spike was the longest experienced since federal wholesale price controls were removed in 1993, it did not mark the record high price for natural gas. This record high occurred on February 2, 1996, when the price was 46% higher that the peak price of the 2000-2001 winter.

The dramatic and prolonged price spike of 2000-2001, coupled with increased gas usage, affected all facets of the American economy. Millions of residential customers who purchase natural gas from local utility companies saw the costs of heating their homes increase significantly from the previous winter's costs. Nationwide, the average residential customer's total gas heating costs for the winter months increased from $380 to $624. In addition, some companies significantly curtailed their production of products such as fertilizer because of the increased price.

Natural gas is a crucial source of energy in the United States. It is used in five sectors: residential, commercial, industrial, electric generation, and transportation. The United States used about 23.5 trillion cubic feet (tcf) of natural gas in 2000. Figure 2 (on page 22) shows the percentages of total gas usage by each of the five sectors.

The Energy Information Administration expects the country's consumption of natural gas to increase to 33.8 tcf per year by 2020. More than half of this increase is predicted to come from gas-fired electric generation. Eighty-four percent of the natural gas used in the United States is produced domestically, 15% comes from Canada, and about 1% comes from other countries. Almost 8,000 companies produce natural gas from wells located in 37 states and offshore. The producing companies range in size from small family-owned businesses to large international corporations.

Over the years, the natural gas market has undergone major changes, and it is still growing and evolving. However, perhaps the most significant change in the gas market--the transition from a regulated to a competitive natural gas market--has already occurred. Under the regulated market, producers sold their gas directly to interstate pipeline companies at prices set by federal regulation. Although this system ensured stable prices, it also caused severe gas-supply shortages. These shortages occurred because, with artificially low prices, producers had no incentive to increase production and consumers had no reason to curtail their demand. Ultimately, the gas shortages led to delivery curtailments during cold winters for many customers in the northern United States.

Responding to these supply problems, Congress passed the Natural Gas Policy Act of 1978, which began the phased deregulation of natural-gas producer prices. This act established a pricing arrangement that encouraged increased production of natural gas, but producer-price deregulation was not completed until after passage of the Natural Gas Wellhead Decontrol Act of 1989. This act mandated that federal controls over natural gas wholesale prices end by 1993, allowing the price to be set freely in the marketplace. …