Natural Gas Market's Response to Fukushima

April 2011

• Examination of the price behaviour of natural gas futures contracts around the time of the March 11 earthquake in Japan and the subsequent events at Fukushima provides insights into how markets respond to these kinds of considerations.
• The natural gas forward curve is upward sloping, reflecting market expectations that prices will be higher in the future than they are today. Also as the year has progressed, the average price of the block of contracts for delivery in 2011 and 2012 (the front end of the curve) has moved lower, while the back end of the price curve has moved up noticeably. Typically, it is the front end of the price curve that is more volatile.
• Market participants seem to be increasingly of the view that gas supply/demand conditions a few years from now (2016 for example) will be tighter and prices higher than was their view only two months ago.

The crisis at Fukushima's nuclear reactors has affected public confidence in nuclear power and has already led to rather drastic shifts in policy in certain countries. Many governments have announced re-evaluations or safety reviews of nuclear plants, while Germany has announced plans to shut down all of its nuclear reactors by 2020. If nuclear capacity is to be used less in the future, then it seems likely that other forms of energy will see increased demand, to make up the difference.

Examination of the price behaviour of natural gas futures contracts around the time of the Fukushima events provides some interesting insights into how markets respond to these kinds of considerations.

We can construct a "forward curve" for natural gas that shows the currently prevailing price for a series of contracts for delivery at various dates in the future. The graph below shows the natural gas forward curve based on average NYMEX prices in each of January, February, March and April.

(N.B. all figures in graph are in $US/MMBtu, "Cal" = "Calendar")

The gas forward curve is upward sloping, reflecting the expectations of market participants that prices will be higher in the future than they are today.

What is noteworthy is how the natural gas price curve changed position and orientation over recent months. As the year has progressed, the average price of the block of contracts for delivery in 2011 and 2012 (the front end of the curve) has moved lower, largely in response to growing confidence that production will continue at a relatively high level and supplies are adequate to meet near term needs. However, note that from February to March, and continuing into April, the back end of the price curve has moved up noticeably, even while the front end has stayed lower than it was in January.

So what we have at one end is the price for contracts for delivery in 2011 falling from an average of $4.65 US / MMBtu in January (black curve) to April's average to date of $4.43 US / MMBtu (green curve). This is a decrease of roughly 5%. At the other end, the average price of contracts for delivery in 2016 has risen from January's average of $5.84 US / MMBtu to April's average to date of $6.45 US / MMBtu for a gain of roughly 10%

Typically, it is the front end of the price curve that is more volatile. That is because near term events like pipeline breaks or hurricanes or severe winter weather can have a severe short term effect on prices. Typically, the longer term view changes more slowly.

Clearly, since the end of February and the earthquake in Japan in March, market participants are increasingly of the view that gas supply/demand conditions a few years from now (2016 for example) will be tighter and prices higher than was their view only two months ago.

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