The Fuel of the Future: Understanding Natural Gas

An Explanation of Supply and Demand

Natural gas flame
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Natural gas as the fuel of the future makes sense no matter how you analyze it. Natural gas is one of the cleanest burning fuels and the United States has enough of a supply to become energy independent. It has also become one of the cheapest fuels - even cheaper than coal. So why is it not the most widely used fuel in the country when the facts clearly show that it should be our number one energy source?

Price of Natural Gas

At the time of publication, crude oil is trading at $41 a barrel and natural gas is trading at about $2.83. Natural gas prices have been declining for several years and are currently 50 percent off their 2008 peak. Typically, when a commodity drops this much in price, demand will increase and prices begin rising again. This has not yet been the case for natural gas as supplies are more abundant than ever.

Supply of Natural Gas

Even though the price of natural gas is at multi-year lows, the supply of natural gas continues to increase. There are some short term and long term reasons for the oversupply situation. The number of rigs pumping natural gas out of the ground has actually been declining, but natural gas producers have become extremely efficient at extracting natural gas. They have actually gotten so good at it that we now have a supply glut that probably won’t go away anytime soon.

The winter of 2012 was also mild which compounded the supply problem. The winter months usually burn off most of the extra supplies of natural gas every year, but if it doesn’t happen the market is left with an excess. The cost of production for most natural gas producers is around $3, so they are operating at a loss below this level.

As might be expected, some of the major producers like Chesapeake Energy have announced they are cutting production significantly, and this might mean a bottom in the market is near.

Increased Usage of Natural Gas

Everything about natural gas makes sense, but there really hasn’t been a government mandate to increase the usage and infrastructure of natural gas. There have been some issues with environmentalists claiming that natural gas extraction is bad for the environment. It really isn’t, but chemicals that are used in the fracking process sometimes it results in minor earthquakes. There are natural alternatives to the chemicals that could be used, and stronger regulation in the industry would minimize this issue.

Proponents of natural gas, like the oil icon T. Boone Pickens, have been pushing hard for politicians to get behind it. Eventually, they will, but when is the question. If the government set a mandate in natural gas it would certainly help accelerate growth, but the private sector is moving along regardless. Clean Energy Fuels (CLNE) is creating an infrastructure of natural gas stations throughout the country. Think of a typical gas station, but instead, you fuel your tank with natural gas.

In 2014, CLNE had 30 fuel stations open, 60 more ready to go with a goal of 150 total.

Westport Innovations (WPRT) produces engines that run on natural gas and demand is growing strongly. While cars might be best suited to run on natural gas, large trucks for hauling the nations' freight is where the industry is concentrating.

It costs about $30,000 to convert a fleet truck to using natural gas. At natural gas prices around $2.50, each truck would recoup the conversion cost in a year and save about $20,000 a year thereafter. The engine costs are expected to drop in half in the coming years, which will give more incentive for the conversions.

Investment in Natural Gas

With the supply glut of natural gas, a long-term investment outlook is in order. Buying natural gas futures is one option, but it's necessary to keep excess funds in reserve in case the price sinks further. There is a commodity etf - UNG, but the costs to roll the futures contracts are very high. The companies mentioned above, Clean Energy and Westport Innovations, should benefit in the coming years. There are also many publicly traded companies that produce natural gas that would benefit from rising natural gas prices.

Update: The Future of Natural Gas

After a winter-related rally in February 2014, the price of natural gas fell to levels not seen since 1998. Fracking technology and huge discoveries of the energy commodity in the Marcellus and Utica shale regions of the U.S. resulted in lower production costs. Temperate weather conditions caused demand to sink at a time when supplies rose. This is a highly bearish environment for any commodity market. During the fall of 2015, stockpiles of natural gas for immediate delivery in the U.S. rose to over 4 trillion cubic feet, an all-time high.

A warm winter season in 2015/2016 across the U.S. caused the price of the energy commodity drop to $1.6110 per MMBtu’s in March 2016.  In April, the price remained below $2.00. The long-term price range for natural gas futures has been $1-$15 per MMBtu; thus, natural gas was cheap given its history. At prices below $2, production is not economic. Therefore, it is likely that producers will cut back output until prices rebound. At the same time, new technology that liquefies natural gas for export via ships to markets where prices are higher could boost demand and price in the future. However, in early 2016, the price of natural gas offers a cloudy future for producers. Meanwhile, low prices mean lower energy bills for consumers and those who use natural gas in manufacturing businesses across the U.S.