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The Ups And Downs Of Natural Gas Costs

Natural gas prices are affected by a number of factors.

TW Special Report

T extile manufacturers master a technically complicated process, maintain strict production deadlines and simultaneously keep up with countless related business issues - including labor, environmental regulations and energy, of which natural gas is one source.

What determines the price of natural gas, which has become a growing component of the textile industry's operating expenses? While there is no simple answer, there are a variety of factors that contribute to natural gas pricing, and they are no less complex than the current headline issues affecting oil prices.

Supply And Demand

Starting with the basics, it should be noted that natural gas is in high demand across the nation for a number of reasons. It is an economical source of British thermal units (BTUs), the standard measure of heat energy; it has a safe and efficient delivery system; and it has important environmental advantages. Most observers expect this demand to increase year after year, along with population and economic growth.

Keeping Pace With Demand

Last summer, Federal Reserve Board Chairman Alan Greenspan  said, "Today's tight natural gas markets have been a long time in coming, and futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon."

The supply side presents a challenge because US natural gas supplies have been increasingly unable to keep up with the growing demand.

A report released recently by the National Petroleum Council notes that traditional North American gas-producing areas will provide about 75 percent of long-term natural gas needs. To help make up the difference, imports of liquefied natural gas  are on the rise. Producers also are looking at expanded pipeline access to Alaska and the Rocky Mountains, as well as other supply options.

New Supply Sources

To address this supply need, Southern California Gas Co., Los Angeles, is taking steps to improve customer access to these new supplies and reduce the prices they would otherwise have to pay absent the development of these new gas supplies.

The company believes access to new supply sources will increase reliability and gas-on-gas competition,  reducing price volatility and creating lower prices for all of its customers.

Residential and small business customers stand to save at least several hundred million dollars, and possibly as much as $1 billion, per year through reductions in the commodity cost they otherwise would face.

The company also plans to develop a diversified portfolio of interstate pipeline-capacity commitments on behalf of its customers. It also plans to provide firm access rights to the transmission system to ensure new and current suppliers of natural gas will be allowed to compete on an equal basis for deliveries into the utility system.

To realize this vision, Southern California Gas will have to build new gas-transmission and related gas facilities to handle supplies from new sources.

National Gas Market

Although production and consumption of natural gas vary widely across the United States, two factors help create a national gas market, creating trends in pricing that can be felt from coast to coast. One factor is the extensive network of pipelines and storage fields, which links gas users to an abundance of diverse supply areas. The other is a nationwide commodity market for natural gas.

Since 1990, commodity traders have bought and sold natural gas on the New York Mercantile Exchange (NYMEX). They trade the fuel in two principal ways: on a daily or spot price; or on a fixed futures price. Prices on the NYMEX reflect the cost of gas delivered to Henry Hub - a natural gas pipeline hub located in Louisiana that acts as a delivery point for NYMEX natural gas futures contracts. This hub frequently serves as a point of reference for wholesale natural gas prices across the country.

Based on location, these prices are then further broken down to various delivery points throughout the country. Each location has its own price that differs from the established Henry Hub price. This differential is called the basis, which reflects the value of transportation and pipeline capacity for transporting the gas to the specific delivery point, plus local demand.

Weather, Storage Levels
And Oil Prices Are Drivers

NYMEX traders monitor supply and demand by looking at a number of factors including weather, national gas storage levels and oil prices. If the temperature in a region is below average levels in the winter, natural gas costs can increase in anticipation of greater demand for space heating and water heating.

In addition, in the Pacific Northwest, low snow pack and hydro conditions may increase the demand for natural gas for electric generation during the spring, when hydropower is normally used. In the summer, if the weather forecast calls for above-average temperatures, air conditioning also could increase the demand for natural gas in electric generation.

Finally, inclement weather, such as hurricanes in the Gulf Coast, can limit production of natural gas at the wellhead. Depending upon the severity, these situations can tighten supplies for a number of days, affecting prices.

Significant factors in the natural gas market that gas traders must consider are the amount of natural gas in storage and the forecast demand.

Natural gas costs also tend to follow oil prices. Energy traders often treat different fuels in a similar way, while giving some premium to natural gas for its environmental benefits. Also, many industrial customers can use both oil and natural gas, and they switch back and forth to take advantage of price swings.

Other trends gas traders monitor include gross national product (GNP) and drilling rig count, as well as other economic indicators that come into play. GNP is a common indicator of demand; variable determinants such as drilling rig count help estimate future supplies.

Finally, costs that go up often come down. High gas costs do translate into an increase in exploration as more investors, attracted by the high cost of gas, look for new production sites. As new exploration yields more supplies, prices often do come down.

Editor’s Note: Southern California Gas Co. is the nation’s largest natural gas distribution utility, providing energy to 19.2 million consumers. The company is a regulated subsidiary of Sempra Energy, San Diego.

October 2004