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High Gas Prices: The Edge Comes Off

High Gas Prices:
Fortnightly Magazine - November 2004

equipment replaces older equipment, reduces the expected demand for natural gas per unit of output.

A decline in the expected demand for natural gas in the manufacturing sector also is consistent with the relative growth in manufacturing activity overseas. The growth in manufacturing business overseas extends from chemicals to steel to concrete. The growth overseas reduces the cost of building material, clothing, and consumer staples. It therefore keeps inflation low and improves overall economic welfare. For these reasons natural-gas demand is likely to continue to weaken.

Natural Gas Expenditures and the Economy

Looking beyond this heating season, the market situation is not as bleak as many have predicted. Previously available supplies of natural gas should increase but not by much, and expected demand should get reduced. But it will still be a seller's market this heating season.

The retail price paid by residential and commercial customers this heating season will stay the same or increase, especially if utility customers are locked into recently signed long-term contracts for significant volumes of natural gas. If the weather turns especially cold for an extended period of time, things could get nasty. Instead of being at least 7 percent of monthly income for households comprising the bottom 40 percent of income, bills will be 10 percent or more when volume and price effects are taken into account. 4 For the bottom 26 percent of black households, bills could increase from 16 percent of income to more than 19 percent.

High Gas Prices Drive Away Consumers

The wholesale price level for natural gas rose to a new plateau during the last several years (). Accordingly, natural gas consumption is beginning to slide (), as it did starting in 1973.

Following an especially mild summer storage season, early September 2004 prices were significantly reduced from month-earlier values. Unfortunately, new supplies from production sites remained tight, stopping the price erosion.

The residential customer-the marginal buyer of natural gas in the winter-sets the wholesale price at that time. If storage supplies and supplies at production sites are robust in January 2005, the wholesale price of natural gas could tumble to the marginal cost of natural gas at such times, which is still less than $3/MMBtu. On the other hand, the electric generation customer is the marginal buyer of natural gas in the summer and could set the wholesale price then at less than $3/MMBtu. 5 Interestingly enough, price volatility has declined during much of the last year, but the price level has jumped more than the price volatility has fallen. Hence, at prices that prevailed this past summer the chance of a wholesale price spike above $10/MMBtu is much greater than it was several years ago.

Unfortunately, expected heating season demand has been shored up in the last several years as a consequence of additions to the existing building stock, especially homes. This effect is a direct result of 40-year-low interest rates that are slowly starting to rise. Consequently, consumer debt levels are also at historically high levels. A steep uplift in seasonal natural gas demand from a temperature drop,