Natural gas has been a hot topic on the news for reasons rather unorthodox—low prices and expectation of an overwhelming abundance of natural gas resulting from technological achievements in shale gas recovery (improved hydraulic fracturing and horizontal drilling). Fueled by the US government’s expectations of a supply of natural gas to last nearly 100 years, the US industry is looking for new opportunities in delivering gas in a liquefied state (liquefied natural gas or LNG) worldwide which can put the nation to the forefront of the energy leadership.

Natural gas prices have been demonstrating a high volatility throughout the history of markets, and projecting their movements has never been easy. Forecasts are built on historical data, current movements in traded financial instruments and fundamentals; however, such factors as future technologies, regulations or geopolitics, and their impact on future prices, can and do get omitted from the analysis. Up until several years ago, the number of input parameters into forecast models was not overwhelming, still many forecasts, even those provided by credible agencies, have not demonstrated a perfect track record.

The U.S. Energy Information Administration (EIA) produces a long-term natural gas price outlook as part of its Annual Energy Outlook (AEO), which is updated annually. The graphs 1-3 demonstrate the EIA annual forecasts for Henry Hub developed in years 2003-2011 compared with NYMEX futures and the actual market prices.

Figure 1: Henry Hub Natural Gas Prices Projections (2003-2005) vs. Actual Prices

Figure 2: Henry Hub Natural Gas Prices Projections (2006-2008) vs. Actual Prices

Figure 3: Henry Hub Natural Gas Prices Projections (2009-2011) vs. Actual Prices

As shown in Figure 1, in its year 2003 outlook, the EIA predicted that natural gas prices will stay at the levels noted at the end of 2002 and subsequently move even lower. After the winter of 2003 price spike on the East Coast, which happened due to a shortage of stock during cold weather, the EIA revised its expectations upward for 2004. As real-time natural gas prices continuously edged up in 2004, prices for the 2005 forecast were revised upward as well.

After a substantial natural gas price increase in 2005, driven by hurricanes Katrina and Rita in the Fall of 2005 and the stock shortage in December of the same year, the EIA projections moved incrementally higher as can be seen in Figure 2.

At the same time, expectations for more delayed periods remained subdued due to the conviction that prices will ultimately settle down at the reasonable level of $5-$6/MMBtu. Projections prepared in different years, even in 2005 and 2008 when price spikes exceeded $10/MMBtu, converged at the $5-$6/MMBtu mark after year 2012.

NYMEX Henry Hub natural gas futures, representing a so-called collective market opinion, are used as a tool for longer-term market analysis, as well as inputs into price forecast models. While many rely on results of trades of these futures to prepare a view of future market movements, plotted against the actual gas prices, as shown on Figure 1 – Figure 3, NYMEX futures have consistently failed to predict market movements. It is almost certain that collective market opinion represented by NYMEX Henry Hub natural gas futures works for near-term periods only.

The expansion of shale gas resources is not in question, nor is the technical ability to extract them. Changing technologies, the regulatory environment, potential legislation that would promote or limit LNG exports, the generation stack and renewable generation, available infrastructure, and other market developments can have a reversal effect on natural gas recovery and prices.

Now, given a demonstrated weak ability to predict natural gas movements in the past, does it make sense even to try to forecast prices now when other factors and numerous uncertainties increase the complexity of forecasting? These complexities are spurred out by globalization of natural gas, changing regulations, an uncertain political climate and potential technological improvements. How many scenarios do we have to develop now? How many adjustments have to be made to the fundamentals and technicals? Will expert’s opinion be more critical than ever before? How many new data sources will be added and data points will be included in future price simulation models?

To learn more about the topic, read out In-Depth article “Shale Gas: A Game Changer and More Complications for Price Forecast Developers – Part One” in DataWatch of May 2012.