The Real Price of Natural Gas

by Scott Irwin (University of Illinois/FarmDocDaily) A recent farmdoc daily article (August 19, 2015) documented that real (inflation-adjusted) prices of crude of oil and gasoline have recently fallen all the way back to levels prevailing more than a decade ago. Real crude oil prices near $20 per barrel and real gasoline prices near $1 per gallon (1982-84 $) have major consequences for not only the U.S. economy, but the entire global economy. The purpose of today's article is to provide further longer-term perspective on energy prices by considering the inflation-adjusted price of natural gas.

The first thing to notice in Figure 1 is the spiky nature of natural gas prices, whether in nominal or real terms. There spikes tend to occur in the winter months and correspond to particularly cold winters that boost natural gas usage. There are exceptions, such as the spikes in October 2005 and June 2008. The other notable feature is just how low real natural gas prices have plunged in recent years. The lowest real price over the sample period, $0.85 per million BTU, occurred in April 2012. The real price of natural gas did rebound after 2012, but the current price, near $1.15, is just barely above the lows of the late 1990s. It is no secret why the real price of natural gas is so low--fracking. This is short-hand for a production technique known as hydraulic fracturing, which is the use of liquids forced into deep rock formations to "crack open" previously unreachable deposits of natural gas. The application of hydraulic fracturing and horizontal drilling techniques in shale rock formations has had a dramatic impact on the supply of natural gas, and not surprisingly, the large increase in supply has kept a lid on natural gas prices.

Another perspective is provided in Figure 2, where real natural gas prices and real Brent crude oil prices are compared.

This also helps provide additional perspective on just how low real natural gas prices have sunk. To catch up with the real decline in natural gas prices, real crude oil prices would have to decline from the current level of about $20 per barrel to well under $10 per barrel. This would represent more than a 50 percent decline from current crude oil price levels. It is also interesting to observe that the sharp declines in the real price of natural gas and crude oil were both largely driven by fracking, with the only difference one of timing. The natural gas fracking revolution simply started earlier than the crude oil fracking revolution.

Real (inflation-adjusted) prices of natural gas have plunged in recent years and are now back to the levels of the late 1990s. To gain some perspective on just how low real natural gas prices have sunk, consider that real crude oil prices would have to decline from the current level of about $20 per barrel to well under $10 per barrel just to catch up. The low real price of natural gas has been and will continue to have major impacts on production costs of energy-intensive production processes. As just one example, we estimate that the drop in natural gas prices in 2015 alone will save the ethanol industry about $1.6 billion. READ MORE