Why is Natural Gas Valuable?
Natural gas is a fossil fuel formed from dead plant matter trapped between rock deposits deep beneath the earth’s surface. Its main component is methane, which is a chemical compound with one carbon atom and four hydrogen atoms. Natural gas also contains some hydrocarbon gas liquids and nonhydrocarbon gases.
Natural gas formation began millions of years ago. The remains of dead animals and plants decayed and formed thick layers of organic matter that mixed with sand and silt. Over time, additional deposits of sand and rock covered this material and buried it deep beneath the earth’s surface.
Pressure and heat transformed this organic material into the fossil fuels we use today. Some of the matter transformed into coal, some evolved into petroleum and some changed into natural gas.
The largest countries across the world extract and process hundreds of billions of cubic meters of natural gas annually. The commodity plays a critical role in producing electricity and serves as a source of fuel for homes, industries and governments.
How Did The Natural Gas Market Develop?
Although natural gas was known to ancient civilizations, the first commercialization of the fuel source didn’t occur until the Industrial Revolution.
In 1785, the British began using natural gas extracted from coal to light houses and streets.
By 1816, the city of Baltimore, Maryland began using natural gas to light streets, and in 1821, William Hart dug the first natural gas well in Fredonia, New York.
The Fredonia Gas Light Company became the first American natural gas distribution company.
The use of natural gas during the American Industrial Revolution was mostly confined to providing fuel for lighting. However, the development of effective pipelines in the 20th century opened up vast new markets for natural gas. This infrastructure facilitated the use of the commodity in home heating and cooking and appliances such as water heaters, oven ranges, manufacturing plants and boilers.
Today more than 900 public gas systems operate in the United States, which is the largest global producer of natural gas. Natural gas supplies more than half of the energy used by US residential and commercial customers and more than 40% of the energy consumed by industry.
How Is Natural Gas Produced?
Natural gas occurs mostly in three locations: (A smaller and often overlooked source of natural gas is biogas found in landfills and in large tanks called digesters that collect animal waste)
- Trapped between layers of rock.
- In the small pores of shale, sandstone or other types of sedimentary rock (shale gas or light gas.)
- In coal deposits (coalbed methane.)
Producing the commodity begins with geologists who study rock formations. Rocks yielding natural gas are found both on land and in oceans.
Geologists use seismic surveys – sound waves bounced off of underground rock – to determine which formations are likely to yield natural gas.
For land surveys, vibrating pads under special trucks produce echoes that scientists can analyze to determine the viability of a rock formation. In some cases, geologists use explosives to produce the source of vibration.
For ocean surveys, geologists use blasts of sound to create sonic waves. These waves allow scientists to determine the rock composition on the floor of the ocean.
Once geologists locate a promising deposit, the extraction process begins. First, they drill exploratory wells to test the composition of the rocks.
If the exploratory wells confirm that the rocks contain natural gas, then the next step is to drill production (development) wells. These wells extract natural gas and bring it to the surface for pro
In some countries, such as the United States, the pores of shale and other sedimentary rocks contain enough natural gas to make extraction economically viable. To release natural gas, producers fracture these rocks with a pressurized mixture of sand, water and chemicals. The internal pressure of the rock formation causes the natural gas to return to the surface via the well.
Wells used for oil drilling may also produce natural gas, and drilling for these two fuels often occurs at the same time. In recent years, more than half of new wells resulted in both crude oil and natural gas production.
Natural gas extracted from wells is known as wet natural gas since it contains liquid hydrocarbons and nonhydrocarbon gases. To obtain dry or consumer-grade natural gas, processing plants near the site of the wells separate methane and other useful gases.
Pipelines transport the final product to underground storage fields or to distribution companies and eventually to consumers.
Liquefied natural gas (LNG) is natural gas that has been cooled to a liquid state (about -260 degrees Fahrenheit). In its liquid state, natural gas is 600 times smaller than in its gaseous state. This allows natural gas to be transported to places that pipelines can’t reach.
Coal mining often produces natural gas as a byproduct. Natural gas produced from coal can be combined with production from other sources without any additional processing.
Global natural gas production has been steadily increasing each year over the last 25 years.
Top 10 Natural Gas Producing Regions
|Rank||Flag||Country||(Billions of cubic meters)|
Most natural gas is used to heat buildings and generate electricity, but other sectors of the economy also use the fuel source.
Which Countries Have the Most Natural Gas?
|Rank||Flag||Country||Billions of meters³|
5 Main Uses of Natural Gas
|Electric Power||The electric power sector accounts for 36% of annual US natural gas demand. More than 27% of US electricity generation takes place using natural gas.|
|Industrial||The industrial sector accounts for 34% of annual US natural gas demand. This sector uses natural gas for heat and power systems and as a raw material to produce chemicals, fertilizer, and hydrogen.|
|Residential||The residential sector accounts for 16% of annual US natural gas demand. About half of all US homes use natural gas to heat buildings and water, cook and dry clothes.|
|Commercial||The commercial sector accounts for 11% of annual US natural gas demand. The commercial sector uses natural gas to heat buildings and water, operate refrigeration and cooling equipment, cook, dry clothes and provide outdoor lighting.|
|Transportation Sector||The transportation sector accounts for 3% of annual US natural gas demand. This sector mostly uses natural gas as a fuel to operate compressors that move natural gas through pipelines.|
In the United States, five states – Texas, California, Louisiana, Florida and New York – account for almost 40% of natural gas usage.
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What Drives the Price of Natural Gas?
There are a limited number of natural gas sources, and it takes time to develop, survey and drill new ones.
Similarly, many consumers of natural gas have limited consumption alternatives over the short term. Residents and small businesses that use natural gas can’t instantly switch to new fuel sources.
As a result, small changes in the supply of or demand for natural gas can cause big swings in its price. Specifically, the following factors can lead to the largest price moves:
- Natural Gas Production
- Economic Growth
- Supplies in Storage
Natural Gas Production
In the United States, most natural gas consumption derives from domestic production. Since natural gas transportation requires pipelines, most other countries rely on domestic production or imports from neighboring countries. (LNG can be transported without pipelines.)
In recent years, US prices for natural gas have been strongly correlated with production. During periods when production increased, consumer prices for natural gas fell, whereas declines in production produced higher prices.
Severe weather can have a big impact on natural gas prices.
Hurricanes or storms can curtail drilling activity and create supply shortfalls. Severely cold weather can also limit production and cause prices to rise.
Weather also affects the demand side of the equation. Severe winter weather can cause big increases in natural gas demand for heating by residential and commercial customers. Generally, sudden changes in weather can have the biggest effect, particularly if supplies of natural gas are in short supply and pipelines are transporting at full capacity.
Strong economic growth generally correlates with higher natural gas prices.
Increases in demand for goods and services from the commercial and industrial sectors occur when the economy is strongest. A rise in economic activity in the commercial and industrial sectors usually means greater demand for natural gas. This is particularly true of the industrial sector, which uses natural gas for fuel and as a component in items ranging from fertilizers to pharmaceuticals.
Supplies in Storage
Supplies of natural gas held in underground storage facilities can impact prices, especially during periods of high demand.
Storage can provide supplies of natural gas when domestic production and imports are not enough. During periods of low demand, storage facilities can absorb production and prevent prices from falling too far.
Natural gas storage in the United States typically rises from April to October, when demand is lower, and decreases from November to March, when demand is higher. However, in recent years, storage supplies have been increasing in the beginning of November.
Natural gas competes with other sources of power including coal, solar, wind and hydroelectric power. Coal, for example, often competes strongly with natural gas on price.
Some high-volume fuel consumers such as electric power plants and iron, steel, and paper mills can substitute between natural gas, coal, and petroleum, depending on the cost of each fuel.
3 Reasons You Might Invest in Natural Gas
Historically, natural gas has been a regional business. The low density of the fuel makes putting it in cargo ships and transporting it overseas an impractical endeavor. (LNG solves the problem of density, but LNG adoption has been limited due to the high cost of cryogenic equipment and other LNG infrastructure.)
However, recent developments such as compressed natural gas (CNG) could soon change the economics of the business and make trade in natural gas more practical.
Still, regional economic, political and regulatory factors matter to natural gas prices more so than to many other commodities. With that in mind, traders should consider buying natural gas for the following reasons:
- Clean Fossil Fuel Demand
- Inflation and Weak US Dollar Hedge
- Portfolio Diversification
Clean Fossil Fuel Demand
Natural gas is considered a much more environmentally-friendly fuel than petroleum or coal. It burns cleaner and produces fewer carbon emissions.
In addition, natural gas is lighter than air. In the case of a leak, it will dissipate, which gives it a safety advantage over gasoline.
Inflation and Weak US Dollar Hedge
Investing in natural gas is a way to bet on a weak US dollar and higher inflation.
Natural gas is priced in US dollars, so the performance of the world’s largest economy can impact its price. The US Federal Reserve Bank has kept interest rates low and the US dollar weak for many years.
A weak dollar could stoke inflation concerns. Since there is a limited supply of natural gas, the price of the commodity could benefit from fears of inflation.
Investing in natural gas along with other commodities is a way to diversify an investment portfolio.
Investors seeking true asset class diversification should consider putting a portion of their investable assets into a basket of commodities including natural gas, other energy commodities, metals and agriculture.
Should I Invest in Natural Gas?
Natural gas prices can be volatile, and traders should expect large price swings.
However, investing in natural gas can be part of a sensible plan to mitigate risk and diversify the composition of assets in a portfolio.
Investing in a basket of commodities that includes natural gas, other energy commodities such as gasoline and crude oil, agricultural commodities and metals can protect against inflation. It can also protect a trader from the volatility of movements in individual commodities.
There are three specific trends that could boost natural gas prices in the years ahead:
- Global Demand
- Environmental Concerns
Developments in CNG have the potential to make natural gas more of an international commodity. As transportation of natural gas becomes more affordable and practical, demand for the commodity could surge.
Some fossil fuels such as coal are receiving intense scrutiny because of the pollution they create. These concerns make greener energy sources such as natural gas more attractive.
Fossil fuels such as coal and crude oil produce harmful and toxic carbon emissions. China is regulating the production of these dirty fuels and replacing coal-fired plants with natural gas and wind.
However, traders should also consider the risks of investing in natural gas:
- A global recession could weaken energy demand.
- Higher natural gas prices or lower costs for even greener sources of energy could lead consumers to substitute consumption.
- Global economic or political turmoil could strengthen the US dollar and weaken demand for commodities.
Expert Opinions on Natural Gas
Many energy companies see natural gas as a key driver of their future growth. A CEO of one of the world’s largest energy companies sees the energy as the fossil fuel of the future:
“Natural Gas is flexible enough to offer the right combination with renewables…we are positioning Total more and more in gas, and in 35 years Total will distribute more oil than gas.”
Patrick Pouyanne, CEO of Total SA
The largest oil and gas company in the United States and fifth largest in the world agrees with this assessment:
“Natural gas is a major game changer with fewer emissions, flexibility and abundance.”
However, analysts have mixed opinions about natural gas.
One leading analyst believes that increased US production of natural gas from shale and declining demand will produce lower prices in the future:
“Natural-gas prices are very low and have been for a while. It’s also a by-product of the shale revolution in the U.S. Natural gas is what powers most of our electricity needs, right? And that combined with renewables is another important trend that will affect energy prices globally. So we also have a negative long-term view.”
Dan Chung, Fred Alger Management
How Can I Invest in Natural Gas?
Investors have several ways to invest in natural gas:
|Method of Investing||Complexity Rating (1 = easy, 5=hard)||Storage Costs?||Security Costs?||Expiration Dates?||Management Costs?||Leverage?||Regulated Exchange?|
|Natural Gas Futures||5||N||N||Y||N||Y||Y|
|Natural Gas Options||5||N||N||Y||N||Y||Y|
|Natural Gas ETFs||2||N||N||N||Y||N||Y|
|Natural Gas Shares||2||N||N||N||N||Y||Y|
|Natural Gas CFDs||3||N||N||N||N||Y||Y|
Natural Gas Futures
The Chicago Mercantile Exchange (CME) offers a contract on natural gas futures. The contract is based on delivery at the Henry Hub in Louisiana, a location where multiple interstate and intrastate pipelines converge. The contract settles into 10,000 million British thermal units (mmBtu) of natural gas.
The contract trades globally on the CME Globex electronic trading platform and has a variety of expiration months.
Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions.At expiration, the contracts are physically settled by delivery of natural gas.
Investing in futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.
Natural Gas Options on Futures
The CME offers an options contract on natural gas futures.
Options are also a derivative instrument that employs leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.
Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of natural gas futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in natural gas futures to profit from their trades.
Natural Gas ETFs
These financial instruments trade as shares on exchanges in the same way that stocks do.
There are several ETFs that invest in natural gas including some that make leveraged bets on the commodity. However, traders should be wary of leveraged ETFs since they reset each day. This makes them only effective as day-trading instruments. The most popular non-levered natural gas ETFs include United States Natural Gas Fund and First Trust ISE-Revere Natural Gas Index Fund.
|United States Natural Gas Fund||First Trust ISE-Revere Natural Gas Index Fund||S&P Oil & Gas Exploration & Production Select Industry||Dow Jones U.S. Oil & Gas Index||VelocityShares 3x Long Natural Gas|
Natural Gas StocksThere are many publicly traded companies that have various levels of exposure to natural gas prices. While investing in companies can be a leveraged way to gain exposure to natural gas prices, many of these companies have exposure to other products such as crude oil.
In addition, these shares can react to other factors such as regional demand for their products, competition, production costs and interest rates. Finally, factors such as company management and the overall stock market can also affect these investments:
|Current Price||Overview||Listings||Founded||Number of Employees||Interesting Fact|
|BHP Billiton ||Anglo-Australian multinational mining, metals and natural gas company.||London (LSE)|
New York (NYSE)
|1885||60,000+||The World's Second Largest Mining Company|
|Antero Resource Corporation ||Natural gas and oil company based in Denver, CO.||New York|
|2002||500||Owns 485,000 acres in the southwestern core of the Marcellus Shale.|
|Enterprise Products Partners ||Natural gas and oil pipeline company headquartered in Houston, TX.||New York|
|1968||6,000+||Owns 50,000 miles of pipeline|
|Phillips 66 ||Multinational energy company based in Houston.||New York|
|1917||14,000+||Warren Buffett's Berkshire Hathaway is a significant shareholder|
|Cheniere Energy ||Developer and operator of natural gas terminals.||New York|
|1983||900||Cheniere's NYSE ticker is LNG, representing their biggest product - liquefied natural gas|
| Cabot ||Independent oil and gas company engaged in shale exploration in the United States. The company also purchases natural gas for resale.||New York|
|1989||691||In 1994, the company acquired Washington Energy Resources in a $180 million stock transaction.|
|Chesapeake Energy ||US company that acquires, explores and develops properties that produce oil, natural gas and natural gas liquids.||New York|
|1989||1,000+||The company was founded in 1989 by Aubrey McClendon and Tom L. Ward with only a $50,000 initial investment.|
|Sandridge Energy ||US oil and gas company that explores and develops properties that produce oil, natural gas and natural gas liquids.||New York|
|2006||501+||In November 2015, the company acquired 136,000 net acres in the Niobara shale formation for $190 million in cash.|
|Stone Energy ||Independent oil and gas company that explores for oil and natural gas in the Gulf of Mexico.||New York|
|1993||501+||Stone holds interests in over 100 lease blocks throughout the Gulf of Mexico.|
One way to invest in natural gas is through the use of a contract for difference (CFD) derivative instrument. CFDs allow traders to speculate on the price of natural gas and natural gas shares. The value of a CFD is the difference between the price of natural gas (or shares) at the time of purchase and its current price.
Many regulated brokers worldwide offer CFDs on natural gas and natural gas shares. Customers deposit funds with the broker, which serve as margin. The advantage of CFDs is that trader can have exposure to natural gas prices without having to purchase shares, ETFs, futures or options.
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