Andreoli on Oil and Fuel: Fuel price volatility is back

Natural gas prices have risen 40 percent to over $6 per thousand cubic feet (Mcf) since the beginning of the year. As a regular reader of this column, rising prices should come as no surprise. In July of last year, when the price was just $3.52 per Mcf, I predicted that prices would rise to between $4.00 and $4.25 per Mcf by the end of the year.

By the end of December, the price had risen to $4.30 per Mcf. Midway through January, when prices were $4.40, I recorded a webcast with LM in which I predicted that prices would rise above $5 in the first half of the year. By the time the webcast aired on January 30, prices had already risen above the $5 mark, and have continued to climb.

How high will natural gas prices go, and how will this affect CNG and LNG prices? More importantly, how will the price differential between diesel and CNG/LNG evolve? Answering the latter question requires insight into both natural gas and oil prices. Despite the fact that domestic oil production continues to grow, oil prices are up 8.7 percent since the beginning of the year. The impact of rising oil prices on diesel prices has been somewhat subdued, however. Since the first of the year, diesel prices have climbed from $3.90 to $4.02 per gallon.

Unlike diesel, neither CNG or LNG prices are reported on a timely basis, so exactly how CNG and LNG prices have been affected by the rise in natural gas prices is unknown. One thing that’s certain is that rising commodity prices will translate to higher pump prices. The rise in natural gas prices has been largely, but only somewhat deservedly, pinned on the series of arctic blasts that have hit the country. The bigger story is that natural gas storage volumes have been eroding for more than a year because consumption has been rising faster than production.

Prior to December 2012, the volume in storage was at a five year high, but by March 2013, storage levels had fallen to the five-year average. Between October and late December, storage volumes had fallen to the five-year low. This descent occurred prior to the repeated arctic blasts, so rising prices can’t be fully pinned on “unseasonably high” natural gas demand.

Since December, storage volumes have set new five-year lows every week, and they’re now on par with volumes last experienced in 2008, a year during which spot prices increased from just under $8 per Mcf to over $13.

In order for storage volumes to recover, new production wells need to be drilled, but drilling rates remain low. In September 2008, there were 1,606 rigs drilling for natural gas; but as of one year ago, there were just 428. As of late February, there were only 342. The hesitation to return to drilling natural gas wells is due in part to the weather, in part to the recent history of low prices, and in part to the opportunity cost of deploying drilling rigs on natural gas fields. These same rigs can be used to drill more lucrative shale oil wells. As of September 2008, the number of rigs drilling for oil was just 417, but this number has risen to 1,425.

As of November, the national average CNG price was just $2.49 per diesel gallon equivalent (dge), and the national average diesel price was $3.93 per gallon. With the price differential at $1.44 per dge, conversion from diesel to CNG looked very attractive for many fleet owners.

Although current CNG prices are not available, a bit of quick cowboy math can get us to an estimate of how the price differential has evolved since then. Between November and February, natural gas prices increased 71 percent, and the commodity constitutes approximately 25 percent of the final CNG price. Holding all other factors constant, an increase of 71 percent would push the CNG price up to $2.93 per dge. 

Meanwhile, diesel prices increased just nine cents per gallon. Consequently, we may expect that the diesel/CNG price differential to contract to just $1.09 per dge. At this price, many conversions become uneconomical, but three points must be made in this regard.

First, the calculations above imply that any natural gas price movements are immediately transferred to CNG prices, and this may not be true in many cases. With that caveat in mind, any sustained increase in natural gas prices must eventually be pushed to the end consumer. Second, the point at which the price differential does or does not justify conversion depends largely on the fleet in question. Third, all the prices quoted above represent national averages, and paying the national average price is like having 2.3 children—it may be the norm, but it’s certainly not normal.

Looking forward, I expect that natural gas prices will remain high, though they will fall somewhat as winter gives way to spring. Whether or not rising natural gas prices make potential natural gas conversions uneconomical, however, will depend on the characteristics of the fleet and the region in which it operates.