Ohio is sitting on a portion of two of the largest natural gas reserves in the world with the Utica and Marcellus basins in the eastern part of our state. Through fracking technology, producers in our region have found a way to extract large volumes of natural gas and oil from the ground at a relatively low cost. This drilling activity has been a game changer, flipping the natural gas and electricity market on its head. As consumers we have felt the benefits of this in lower energy prices, but will this continue?
Natural gas production in the U.S. has increased by almost 50% since 2005. Nearly all of this production increase is attributed to the shale production in our region. This production, which was negligible until 2010, has exploded to more than 20 billion cubic feet of natural gas per day, significantly impacting the price of natural gas in Ohio.
Prior to the shale play, natural gas in Ohio cost a premium of $0.25 to $0.50 per one million British Thermal Units (MMBTU) when compared to the NYMEX trading location in Louisiana. Now, the premium has gone negative to a discount of $0.20 to $1.00 per MMBTU. And, instead of gas flowing in one direction from the Gulf of Mexico to Ohio, the long haul pipes are now bidirectional as we have the ability to push Ohio gas to higher priced markets.
Natural gas prices are so low in Ohio that this fuel is now competing with coal to generate electricity. Just this spring, the U.S. Energy Information Administration reported the production of electricity by natural gas converged with the amount from coal-fired generation. This has happened only one other time and is a function of both the utilities retiring older coal plants and record low natural gas prices.
So the big question for the consumer is: What could change these historically low prices? One influence could be the expiration of shale producer’s hedges. Upon the start of shale production in 2005, many producers fixed the rate of the gas they extracted in multiyear forward contracts. These hedges were at prices much higher than the current market. Many of these fixed price contracts expire in 2016 and 2017. Producers will not likely enter into new hedges since the forward rates are so low. Instead, they will either reduce production to raise prices or ride out the spot prices looking for any opportunity to lock if the market rises. If the producers continue their current rate of production even as their hedges expire then that will be a strong indication that these prices are here to stay.