Understanding the US Natural Gas Market: A Markov Switching VAR Approach

Over the past three decades, the US natural gas market has witnessed significant
changes. Utilizing a standard Bayesian model comparison method, this paper formally
determines four regimes existing in the market. It then employs a Markov switching
vector autoregressive model to investigate the regime-dependent responses of the
market to its fundamental shocks. The results reveal that the US natural gas market
tends to be much more sensitive to shocks occurring in regimes existing after the
Decontrol Act 1989 than the other regimes. The paper also finds that shocks to the
natural gas demand and price have negligible effects on natural gas production while the
price of natural gas is mainly driven by specific demand shocks. Augmenting the model
by incorporating the price of crude oil, the results show that the impacts of oil price
shocks on natural gas prices are relatively small and regime-dependent.