Hurricanes and Natural Gas Prices: The Link

May 2010

• The production of natural gas may be disrupted by hurricanes that damage or shut down offshore rigs in the Gulf of Mexico. Just the expected activity can exert a noticeable effect on prices long before any hurricanes form, let alone reach striking distance of offshore rigs.
• To date, the most active Atlantic hurricane season occurred in 2005, the year Hurricanes Katrina and Rita caused damage to offshore production facilities that took months to repair. 2009 was the least active season since 1997. The prices in each year reacted quite differently.
• Hurricane activity was a significant factor in forcing NYMEX natural gas prices over $10/MMBtu in the second half of 2005. In 2009, a below-average hurricane season applied additional downward pressure on prices and contributed to pushing the near-month contract to a 7-year low in early September 2009.

In the natural gas industry, the approach of the dog days of summer can have as much importance as the approach of the dead of winter. The summer build-up of natural gas inventories for the next winter is affected by gas-fired power generators' response to air conditioning demand. As well, the production of natural gas may be disrupted by hurricanes that damage or shut down offshore rigs in the Gulf of Mexico. Market participants take hurricane forecasts very seriously. The expected activity during hurricane season (June 1 to November 30) can exert a noticeable effect on prices long before any hurricanes form, let alone reach striking distance of offshore rigs.

To date, the most active Atlantic hurricane season occurred in 2005, the year Hurricanes Katrina and Rita caused damage to offshore production facilities that took months to repair. 2009 was the least active season since 1997. What drives the differences from one season to the next?

The primary factors that contribute to hurricane development are ocean temperatures and wind patterns. In 2005, pre-season forecasts from the National Oceanic and Atmospheric Association (NOAA) for the 2005 season indicated above-average hurricane activity in the Atlantic with conditions conducive to hurricanes in the form of warmer sea surface temperatures, low wind-shear, and favourable westward-blowing winds. After an unusually active early part of the season, NOAA revised its forecasts upward in August 2005 predicting even more storms for the rest of the season as meteorological factors continued to indicate a high level of activity. In the end, the Atlantic hurricane season of 2005 exceeded the most dire predictions, causing extensive damage. Hurricane activity was a significant factor in forcing NYMEX natural gas prices over $10/MMBtu in the second half of 2005.

In contrast, 2009's Atlantic hurricane season was marked by below-average activity which even undershot pre-season forecasts. NOAA's first forecast for 2009 indicated a 75% chance of an average or below-average season given the expected conditions. The forecast was based on an assessment of competing factors, namely, above-average sea surface temperatures in the Atlantic and high wind-shear. As the season progressed, NOAA revised its forecast to a 90% chance of the season being near- or below-average. NOAA reported the increased wind-shear over the Atlantic basin had been disrupting the growth of tropical depressions into hurricanes, a condition that was expected to persist. As well, the wind-shear factor offset the above-average sea surface temperatures, which support the development of hurricanes. When combined with lower demand for commodities in 2009 and continued strength in production from onshore rigs, the below-average hurricane season applied additional downward pressure on prices and contributed to pushing the near-month contract to a 7-year low in early September 2009.

This year, forecasters have indicated that the level of hurricane activity for 2010 is expected to be closer to 2005 than 2009. The wind-shear in the Atlantic is expected to decrease, and sea surface temperatures remain above-average. NOAA's outlook shows an 85% chance of above-normal activity. This analysis is supported by forecasts from Colorado State University and the UK Meteorological Office, who also suggest a high likelihood for unusually strong hurricane activity.

Partially in response to these forecasts, natural gas prices for contracts for delivery in the summer months have risen steadily from lows earlier in the spring, even though the first named storm of the season has just emerged. As shown in the chart below, the reaction to weather forecasts has affected more the nearer-term prices than longer-term ones. Notwithstanding the seriousness of weather-related disruptions to production and the potential for heat waves to increase gas demand for air conditioning needs, price curves suggest that the effect of this summer's weather will have little effect on supply-demand dynamics in more distant gas years.

Summer weather can affect prices quite noticeably, but the degree to which it affects prices can be difficult to forecast and its effect is far from uniform.

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