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Natural Gas: The Commodity.com Guide


Why Is Natural Gas So Valuable & What Drives the Price of Natural Gas?

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.

Natural Gas Formation diagram
Natural Gas Formation via Siyavula Education on Flickr

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.

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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. 

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:

  1. Natural Gas Production
  2. Weather
  3. Economic Growth
  4. Supplies in Storage
  5. Substitutes

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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.

Weather

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.

Severe Weather
Severe Weather via Wikimedia

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.

Economic Growth

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.

Substitutes

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.

Adam Beck Complex via Ontario Power Generation in Ontario
Adam Beck Complex via Ontario Power Generation on Wikimedia

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.

How Is Natural Gas Produced?

Natural gas occurs mostly in three locations:

  1. Trapped between layers of rock.
  2. In the small pores of shale, sandstone or other types of sedimentary rock (shale gas or light gas).
  3. In coal deposits (coalbed methane).

(A smaller and often overlooked source of natural gas is biogas found in landfills and in large tanks called digesters that collect animal waste)

Non Conventional Deposits of gas
Non Conventional Deposits via Wikimedia

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.

Shale Gas

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.

Shale Gas diagram
Shale Gas via Thomas Splettstoesser on Wikimedia

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.

Coalbed Methane

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.

Biggest Natural Gas Producing Countries

Top 10 Natural Gas Producing Regions

RankFlagCountry(Billions of cubic meters)
#1


Flag of USAUnited States766
#2Flag of RussiaRussia598
#3Flag of IranIran185
#4Flag of QatarQatar164
#5Flag of CanadaCanada150
#6Flag of ChinaChina138
#7Flag of EUEuropean Union120
#8Flag of NorwayNorway117
#9Flag of SaudiSaudi Arabia102
#10Flag of TurkmenistanTurkmenistan84

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?

RankFlagCountryBillions of meters³
#1Flag of RussiaRussia47,800
#2Flag of IranIran33,500
#3Flag of QatarQatar24,300
#4Flag of USAUnited States8,714
#5Flag of SaudiSaudi Arabia8,602

5 Main Uses of Natural Gas

UsesDescription
Electric Power
electricity cables
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
heater
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
stove
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
refrigeration
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
compressor
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.

Further Reading

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