While California basked in record heat, winter arrived in the rest of the country this week. Oil and gas markets reacted by pushing prices higher after gradually declining from the spike caused by hurricanes Katrina and Rita. Levels of natural gas in storage are nearly as high as this time last year, despite a reported 450 billion cubic feet of production shut in by the hurricanes. Nevertheless, natural gas prices were trading yesterday at around $12/MMBtu. The disconnect between robust storage levels and current high prices continues to puzzle analysts. Market manipulation cannot be ruled out. Equally puzzling are longer-range gas prices. The average price of futures contracts for delivery over the next 12 months stands at around $11/MMBtu. Evidently, market participants would rather lock in today's high prices than risk even higher prices over the coming year, despite evidence that natural gas supplies in North America continue to be adequate. The big unknown continues to be consumption. Reports this week indicate that gasoline consumption did not fall significantly during the recent period of high prices. While sales of gas-guzzling SUVs may have dropped, apparently $3 gasoline did not change driving habits very much. Natural gas consumption is even less likely to have responded to prices. Gas demand is substantially lower because of hurricane damage, not from a reaction to prices. Barring unforeseen developments, I expect gas prices to return to the $8/MMBtu range early next year after the worst of the cold weather is over and production in the Gulf returns to normal. But it seems unlikely that prices can fall much farther than that as long as the industry has to struggle to maintain current production levels.
