Assessing the Impact of Higher Natural Gas Prices

There are two ways of looking at the substantial rise in the price of natural gas that has occurred in the U.S. economy in the last nine months. The first, to borrow a piece of economics jargon that anyone who's paid their bill recently should relate to, is as a "price shock." Although widely forecast, the unanticipated severity of natural gas prices that began at the mid-point of last year threw a curve ball at a wide range of activities that were expecting a different pitch. Throughout history such shocks to economic activity, whether they've come about due to wars, natural catastrophes, or crop failures, have often sent economies down to the mat.

But, in another sense, it's been the long-lived stability in energy prices preceding the recent rise that could be said to be the real shock. The U.S. economy produces 35 percent more goods and services today than it did in 1990, yet in the ten years prior to 2000, the wellhead price of natural gas showed no visible upward trend, remaining most of the time within a narrow range between $1.40 and $2.40 per million British Thermal Units (MMbtu). Although more volatile, crude oil prices, if anything, showed an overall decline in the 1990's.

When compared to the gradual inflation in prices of all other goods, that made energy a better bargain than anyone had a right to expect, given the political instability of some major suppliers and the ever-increasing world appetite for fossil fuel. Indeed, the "shock" of low energy prices prior to 2000 hit was a disruption in its own right, prompting energy company mergers, and canceling both new exploration and government-sponsored synthetic fuel initiatives alike.

But that history has made the explosion of prices since mid-2000 all the more painful. Indeed, natural gas prices have averaged $6.50 per MMbtu since October, shooting all the way up to $10 in mid-winter before settling back down to just above $5 at this writing. Increases in some regions of the country, notably California, have been even more severe, exacerbating that state's already precarious energy situation.

Some have characterized the effect of higher energy prices as a sort of tax increase on consumers and businesses, leaving them with fewer resources to spend on other goods and services. Others have seen energy price increases as the spark that will trigger the first sizable increase in inflation the economy has seen in years.

Neither of those fears were realized during the runup in gasoline prices that began in the fall of 1999 and remains with us, with a few less teeth, today. Indeed, that experience has taught us that energy price increases and general inflationary pressure are completely different animals, and that the portion of the prices of most goods that reflects transportation costs is quite small.

But the integration of natural gas into a whole host of production processes, made all the more pronounced by its relatively cheap availability in recent years, presents another sort of challenge. Not only does the magnitude of the natural gas price spike -- a 300 percent jump in the space of two years -- eclipse the rise in crude oil prices, but the growing use of gas in the production of electricity, whose use in nearly universal, makes its potential economic footprint significant.

The real fear of those who manage the economy is over the disruptions to business activity brought on by sky-high natural gas bills. Some energy-intensive industries have been especially hard hit, with little recourse but to delay or cancel production already scheduled. Although the worst of the price hikes look to be behind us, watching these cutbacks ripple through an economy already under strain puts wrinkles of worry on policymakers' brows.