For the second consecutive year the prospects for natural gas markets are very good heading into the winter months, according to the Winter 2007/2008 Energy Market Assessment issued Thursday by FERC’s Office of Enforcement.

“Overall, current conditions for natural gas demonstrate significant flexibility to deal with most challenges that might arise this winter,” said Stephen Harvey, director of the Federal Energy Regulatory Commission’s Division of Energy Market Oversight.

According to the assessment, current natural gas market conditions are the result of a variety of national and international factors, including higher oil prices, growing domestic gas production, increasing use of gas in electric generation, strong storage inventories and winter weather forecasts.

The historic price competition between gas and oil may be coming to an end, Harvey said. Beginning early this summer natural gas spot prices, which had traditionally fallen somewhere between heating oil and fuel oil prices, fell below prices for oil and are expected to stay below oil prices through 2008.

“The change may reflect a new relationship between gas and oil prices. In fact, gas and oil price competition may be dead, at least for now,” he said.

Liquefied natural gas (LNG) is a growing part of the market, but LNG supply and price are dependent on international events, Harvey said.

“The United States enjoyed record LNG deliveries during the first part of 2007. Through mid-October 2007 U.S. LNG sendout averaged 2.5 Bcf a day, up 15% from the same period in 2006,” he said. Weather conditions in Europe, new supplies from the Middle East and the July shutdown of a major Japanese nuclear plant following an earthquake all affected U.S. LNG prices and sendout levels.

“LNG will be available when U.S. prices are relatively high — basically, times of more stress in energy markets here than abroad. Consequently, expanding LNG capacity serves as a sort of insurance policy, not used much when times are good but very helpful when times are bad. That leads to the apparent dichotomy that not using the new capacity will signal a better domestic supply demand balance than using it will.”

The best way to assess the net effects of supply and demand factors on U.S. natural gas markets is to look at storage inventories, Harvey said.

“At this point the United States appears to be heading toward another near-record level of storage. In April, at the beginning of the injection season, inventories were below last year’s level. Early in the summer inventories grew in comparison to last year, surpassing last year’s level in July.

“Basically, we expect to see full storage this year. And effectively, full storage goes a long way towards protecting the country from disruptions and price spikes associated with tight supply demand balances in the winter.”

Continued investment in infrastructure is the best way to avoid price volatility that produces extremes like the recent 1-cent deal reported in the Rockies on a day when Henry Hub prices averaged $6.23/MMBtu (see Daily GPI, Sept. 17).

“The difference in prices nationally and in the Rockies is further evidence of the extreme price volatility that can result from constraints on the interstate pipeline system,” Harvey said. “Producers have been producing effectively as much as can be used in or delivered from the Rockies since early 2007. When there simply isn’t anywhere else to take the gas, prices will respond, even to extremes.

“The dichotomy is that gas prices across the rest of the country remain high and are driven down only where the supply is bottled up. The fix for this type of price volatility is infrastructure. Forward markets are reflecting the expectation that, with its expected early 2008 completion, phase II of the Rockies Express pipeline will reduce the difference between Rockies prices and those to the east and west…the average difference between the Henry Hub and Colorado Interstate Gas Pipeline Pricing Point (CIG) is expected to narrow somewhat with the capacity addition, though not disappear.”

The opening of several new major infrastructure projects — including the Independence Trail and Rockies Express Phase II pipelines and the Northeast Gateway, Freeport and Sabine Pass LNG terminals — are likely to change U.S. gas market dynamics late this winter, Harvey said.

“In the Gulf of Mexico, new LNG terminals at Sabine Pass and Freeport will add 4.1 Bcf/d of new sendout capacity to an area well interconnected with existing pipelines. Still, depending on the vagaries of the international LNG market, those terminals may attract few cargoes this winter, or they may temporarily overwhelm the existing pipeline network,” he said. “In the unhappy event that U.S. gas prices become relatively high in international terms, heavy deliveries into the area could overload the system for some periods, depressing prices locally at the index points identified on the map. In the short term, local supply-oriented prices could get quite low, though I hope not the one penny that we saw in the Rockies under similar circumstances. Such prices could reduce drilling. In the long term, low and volatile supply area prices would be a strong incentive to develop further pipeline infrastructure along the Gulf Coast.”

But winter weather conditions could have the greatest effect on markets in coming months. The National Oceanographic and Atmospheric Administration (NOAA) has forecast above-average temperatures across most of the country this winter, with the possibility of a La Nina event, which in previous years has been found to disrupt natural weather patterns.

“Ultimately, the performance of natural gas markets next winter will be driven by weather,” Harvey said. While weather forecasting into the next season “is notoriously difficult,” a relatively calm winter like the one forecast by NOAA could leave gas prices “stable, or even [exert] some downward pressure.”

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