How Natural Gas Transport Can Drive Energy Prices3 min read
To understand market pricing trends, we often look to key supply and demand factors. Some supply drivers include increases in production due to hydraulic fracturing and horizontal drilling innovations and well expansion, among other sources. Some demand drivers include weather, industrial production, growth and development, and liquefied natural gas exports.
In this blog, we want to highlight a third factor that can easily be overlooked: the transport that connects that supply (production) to the demand (end users).
What is transport?
A third key market driver, transport, is the movement of physical natural gas along inter- and intra- state pipeline networks from producing regions to end users. You can think of these as the highway system for the natural gas industry.
For many customers, physical natural gas is transported across longer distances to get to the local utility, and these costs will be typically factored into your gas price. Then the local utility will take it that last mile to your facility. The utility typically charges for local distribution separately.
What makes transport a market driver?
1. A pipe has a maximum capacity: A pipeline has a finite capacity it can carry in a given timeframe regardless of how much supply or demand exists at either end. Logically speaking, if you have more supply than demand, prices go down. However, if a pipeline is already operating at maximum capacity, it doesn’t matter how much supply you have, you cannot deliver any more gas in a given timeframe because the pipe can’t hold any more.
2. Different market areas might have multiple pipelines flowing in: Besides the amount of space on a single pipeline, the number of available pipelines is also a factor. In some regions, multiple pipelines deliver into the same area, creating some optionality to how shippers can plan to meet demand.
Having these options can sometimes make it easier for a shipper to manage their transport costs and deliveries. To give an illustration: if you’re stuck in traffic on the highway because of roadwork, you might be able to change your route to get to your destination faster. To compare, some market areas have only one road into town, so to speak, which means that delivery area is dependent solely on that one pipe.
3. Pipelines don’t always flow: An Operational Flow Order (“OFO”) is a mechanism used by pipelines and utilities to protect operational integrity of the system by limiting the delivery of any additional supply into a region. A pipeline or utility might call an OFO during a cold winter to tell shippers and customers that they can only use a maximum amount of physical natural gas to prevent a strain on the system. They also can call an OFO during a hot summer to tell them they must use a minimum amount. Remember, a pipeline is a physical pipe that is holding gas at a specific pressure, so in these events, they are alerting the market and setting specific delivery guidelines because reliability and safety are the first priority. If a shipper or customer goes outside of those guidelines (burned more or less than requested), it is possible that they might be subject to cost penalties, as prescribed in the applicable tariff. For the gas that can flow within the tolerance when demand is high but supply is limited can also cause significant spikes in pricing.
4. Tariffs and regulations sometimes change: Similar to the way there are tolls when you drive on the highway, shippers typically must pay for the space on the pipeline between point A and point B (“reservation fee” in many cases) plus the cost of the gas itself (“commodity rate” in many cases). Over the last year, we’ve seen a number of interstate pipelines pursue rate cases with the Federal Energy Regulatory Commission (“FERC”) to make updates to their tariffs, rate structures and/or rates. When a pipeline changes their tariff, this typically will impact utilities, retail suppliers and other stakeholders and can have a direct impact on energy prices. Even if supply and demand stay the same, the cost to move the physical gas will sometimes change.
Understanding the transportation system in your region can give some key insights into physical natural gas costs in your area and how it might be factoring into your pricing.
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