A dramatic increase in natural gas prices over the past few months, amplified by a natural gas futures market mirroring these high prices, indicates many U.S. properties will encounter significantly increased energy costs for the remainder of this year and into 2004.
The impact of the current situation (particularly given recent events in Iraq) will vary from one market to another. Regions where natural gas is the primary fuel for electricity generation--Texas, California and the Northeast--are likely to witness the greatest effects of higher gas prices. In Texas, which is entering its second year of retail electric choice, prices offered by retail electric suppliers are running 25 percent above last year's levels.
Properties with gas and electricity contracts linked to index pricing are also likely to witness increased costs. And even in regulated energy markets, utilities are often allowed to adjust their prices to reflect higher fuel costs.
Given both the volatility of the energy situation and the fact energy costs represent a major component of overall operating expenses, property owners and management teams in all parts of the country should review their gas and electricity budgets and, investigate alternative energy strategies.
Price Increases: Past, Present and Future
The average price of natural gas has more than doubled in the past year (see Figure 1), from a level of less than $2.50 per million BTUs (MMBTU) in January 2001, to more than $5.50 per MMBTU in January 2002.
The futures market is sustaining these levels. New York Mercantile Exchange/Henry Hub natural gas futures prices for 2003 are running in the range of $4.85 to $5.60 per MMBTU and averaging about $5. Comparable figures for 2002 were in a range from $1.90 to $5.30, with an average of about $3.50 per MMBTU. The increases will translate into higher heating prices, and the higher prices will most likely carry over into the 2003-04 winter.
Market Uncertainty Fuels Increases
Several forces conspired to produce this magnitude of price increases. First, supply and demand imbalances in the natural gas industry have affected prices dramatically. In 2001, natural gas costs actually declined. This had the effect of constricting exploration for new sources, since lower prices reduced the economic incentive for investments in new gas supplies. As gas prices have risen once again, exploration for new supply has not kept pace.
In addition, one response to widespread energy shortages in 2001 was the development of new generating capacity. Since virtually all new electrical plants are gas-fired, this has created still more demand for natural gas. Finally, gas wells currently in service are not producing as much as they did in the past and are being drained more quickly.
Uncertainty in global oil markets also contributed to higher natural gas prices. The recent strike by Venezuelan oil workers and the war in Iraq have yielded higher oil prices. When the cost of oil rises, some energy consumers have the option to switch to natural gas. As the demand for natural gas increases, so does its price, until it approaches current oil prices. …