Natural Gas: Winter is coming!
Natural gas prices increased through the first half of September, reaching the highest level in five months on September after touching their lowest levels since 2016 while spot prices slumped to the lowest in as much as two decades at the peak of the summer. In September 2019, total natural gas consumption as well as natural gas consumption for power generation established new monthly records, which provided some support for futures prices. U.S. cooling degree days were 27% higher than normal in September, contributing to the increased natural gas consumption for power generation. Last November, the price of natural gas exploded to a high at $4.929 per MMBtu as stocks peaked at only 3.247 tcf.
This year, the odds of a rally to anywhere near that price level are slim. Prices fell below psychologically important $2 MMBtu levels not seen in more than three years, reflecting a steady, albeit slow, and descent despite storage inventories ending withdrawal season at their lowest levels since 2014. The LNG market has been swamped by the startup of projects in Australia and the U.S., whereas mild weather throughout North Asia cuts consumption. In November 2018, the prices of natural gas went up to $4.80 per MMBtu, as storage went to a 15-year low, and was augmented further by production freeze offs, a fall which was colder than usual, in addition to increased exports.
Gas was also pressured lower by a broader decline in energy and agricultural commodities as U.S.-China trade war escalated, with Beijing responding to President Trump’s tariff threat by letting the Yuan tumble to the weakest level in more than a decade. The price has continued to fall through July even when a US heat wave led to an increase in demand for power plants. In some regions, such as in West Texas, natural gas has even sold at a negative value, which means that manufacturers have to pay pipeline companies to process and ship the item.
Market participants are worried that even a spike in heating demand might not be enough to stop the commodity's collapse as prices continue to decline despite high levels of natural gas exports and increased consumption in the electric generation sector. The current injection reflects a continuation of hot temperatures across US, increasing the demand for natural gas to power air conditioners during the summer season.
The weather forecasts for the coming week states that winters will begin and there are chances of winter to hit the markets but the inventories are still below the five-year average which will keep cap to the gains. Price volatility in the natural gas arena tends to increase as injections end, and withdrawals from storage commence each year. Now, the winter season i.e. the season of withdrawal will start in four weeks and markets are expecting that Natural gas might go into the peak season of demand for 2019/2020 with higher stockpiles of natural gas than last year.
But the odds remain as the injections to reach average 100.1 Bcf each week, is quite unlikely and we can expect 3.75 to 3.8 Tcf in storage across the US in mid-November. Another factor that could come into play is that we are entering peak hurricane season. Hurricanes and tropical storms have the potential to shut-in production, which will cause prices to increase. However, with LNG cargoes can be halted from entering the Gulf, causing a drop in demand and falling prices.
The uncertainties of storms in the Gulf, while historically bullish, now have uncertain outcomes in terms of pricing. It is unlikely that the market will get an extreme price run this summer, especially with Gulf Coast Express Pipeline Project expected to hit the market in late September. This pipeline runs from the Permian to the Gulf Coast and can carry ~2.0 Bcf/d. This will be the first major pipeline out of the Permian to hit the market and will be the start of relieving the pipeline bottleneck out of the basin.
Supply: Blame the Permian’s!
Markets turned cautious as despite the rise in consumption, natural gas injections into storage remained higher than normal throughout September, helping to bring prices down in the second half of the month. U.S. i.e. specifically Texas is a prolific natural gas producer, and in recent years it has also become a major exporter of LNG. U.S. has turned out to be largest producer of Natural gas as its U.S.
natural gas production increased by 12% respectively in 2018 and these established a new production record. The YoY increase of 7.0 Bcf/d in Sep is down from YoY increase of 10.8 Bcf/d in Jan 2019. The main reason for overproduction was record production from Marcellus. But oil drillers are also to blame. The frantic pace of drilling in Permian has been slowing as of late but has produced a wave of natural gas so large that industry is flaring enormous volumes of gas because of the lack of pipelines. Texas regulators seem unwilling to regulate the rate of flaring over fear of hurting the industry, so the flaring continues. Still, record levels of gas production from Permian are dragging down prices. New midstream capacity later this year from the Gulf Coast Express pipeline will bring more gas to market, adding to supply woes.
More pipelines are in the offing for 2020 and 2021. Working natural gas inventories in Lower 48 states totaled 3,519 Bcf and this is the first week that Lower 48 states’ working gas inventories have exceeded the previous five-year average since September 22, 2017. By the winter of 2018–19, natural gas frontmonth futures prices reached their highest level in several years. Natural gas inventories fell to 725 Bcf less than previous five-year average on Nov 30, 2018. In recent weeks, increasing the Lower 48 states’ natural gas storage levels have contributed to lower natural gas futures prices.
On a YoY basis natural production grew by 8.4% despite a fall of 25.9% in natural gas rig count. The rise in US shale oil production could explain this trend. Appalachia and the Permian together comprise 55% of total U.S. gas supply. They are the reasons why proven U.S. gas reserves have ballooned 85% since 2008 to 420 trillion cubic feet.
Even more amazingly, the two giant shale plays have accounted for over 70% of all new global gas supply, vital for a world increasingly turning to natural gas. Natural gas flows out of the Northeast region into the rest of the United States averaged more than 16Bcf/d during September— between 1 Bcf/d and 2 Bcf/d more than in previous months. The movement of natural gas has increased as natural gas spot prices have declined in the Northeast and as production in Appalachia has continued to grow.
EIA tracks over 160 new U.S. gas pipeline projects, with a staggering 113 Bcf/d of capacity. In Appalachia for instance, where nearly 40% of U.S. natural gas is produced, there is a gigantic $32 billion in new pipelines in the works. This will add 23 Bcf/d of new takeaway capacity to a region that already produces 33 Bcf/d. The U.S. Department of Energy reports that the majority of new power plants in U.S. will be natural gas, a hefty 235,000 MW of additional gas capacity in the coming decades. In Europe, prices are poised to fall further below their lowest in a decade as suppliers show few signs of scaling back abundant deliveries. Inventories are near capacity weeks earlier than usual and are being flooded with more stocks coming both from tankers and pipelines.
While producers have reduced some flows with repairs and maintenance at gas fields processing plants, the price have crashed and are struggling to recover. Supplies continue to exceed EIA forecasts that average annual U.S. dry natural gas production will average 91.6 Bcf/d in 2019, up 10% from 2018 average. The northeastern region continues to be largest natural gas-producing region in the country, accounting for 34% of the U.S. total. Record levels of natural gas production growth continue to put downward pressure on prices.
It even forecasts that natural gas storage levels will be about 3,700 Bcf by the end of October, which is slightly higher than the five-year average. EIA forecasts Henry Hub prices to average $2.43/MMBtu in the fourth quarter of 2019, a decrease of more than $1/MMBtu from the fourth quarter of 2018, subsequently increasing to an average of $2.52/MMBtu in 2020.
EIA expects that natural gas production will grow much less in 2020 because the delayed effect of low prices in the second half of 2019 will reduce natural gas-directed drilling in 2020. EIA forecasts natural gas production in 2020 will average 93.5 Bcf/d. EIA forecasts that natural gas storage levels will total 3,792 Bcf by the end of October, which is 2% above the five-year average and 17% above October 2018 levels.
Demand: Cleaner fuels situation at rescue.
Demand for Natural gas is rising as power generators shut coal plants and burn more gas for electricity and as rapidly expanding LNG terminals turn more of the fuel into super-cooled liquid for export. In 2018, natural gas played a major role in a remarkable year for energy driven by strong economic growth, the transition away from coal-fired electric power and weather-related demand. Gas accounted for nearly half of the world’s growth in energy demand, with most of the higher consumption coming from China and the United States. Global energy consumption rose at its fastest pace this decade, with natural gas accounting for 45% of the increase.
The demand for cleaner fuels has increased the Natural gas share of domestic electricity generation to 35%, from 25% in 2011. Moreover, new pipelines to Mexico, together with large-scale liquefied gas export facilities have meant that exports out of U.S. are set for a quantum leap. Finally, higher consumption from industrial projects will likely ensure strong natural gas demand.
However, record high production in the U.S. and expectations for healthy growth through 2020 means that supply will keep pressure on prices U.S. LNG exports, particularly to Asia, are powering increased demand. They are expected to rise from a record 3.0 bcfd in 2018 to 6.9 bcfd in 2020, making LNG the nation’s fastest-growing source of demand. Still, LNG exports account for only about 5% of total U.S. gas use and not a significant enough portion of the consumption pie to independently push prices higher.
However, IEA forecasts that extraordinary growth rate is not sustainable as over the next five years gas demand to increase by 1.6% per year on average, marking a return to levels seen before 2017, when growth suddenly gained steam due to weaker economic growth, a return to average weather conditions and diminishing opportunities to switch from coal to gas in electric power plants.
The coal demand remains is strong in Asia, but it’s withering in North America and Europe as power generators turn increasingly to cheaper and cleaner natural gas, wind and solar power. By the mid-2020s, renewable energy really starts to begin eating into the gas industry’s market share. To date, natural gas in electric power sector has grown briskly, seizing market share from the mortally wounded coal industry. But in the 2020s, gas will have a tougher time, as it begins to fall prey to clean energy.
Money Managers: Scenario
Between August and September, the number of short positions that money managers reported holding declined by 44%. Money managers collectively held the largest short position on August 13 since March 8, 2016. Money managers increased their short positions through the summer concurrently with declining natural gas prices, which reached their lowest level in more than three years on August 5, 2019. Prices then began increasing and rose to their highest level in five months by the middle of September. The higher prices encouraged many money managers to purchase offsetting contracts to get out of their short positions, which may have contributed to some of the increase in futures prices during this time.
In late September and early October, the total number of open long and short positions rose from 1.122 to 1.268 million contracts from September 25 to October 10. The increase of 146,000 contracts was likely the result of overenthusiastic speculative shorts pushing the price lower
Markets are turning extremely bullish on severe winters to hit U.S. markets like previous year where the prices touched the levels of $5 but we expect prices might experience short-lived surge based on positive weather forecasts and potential storm-induced supply disruptions. The price of the energy commodity will be a function of heating demand over the winter months. A warmer than expected winter season could send the price of natural gas below the $2.00 level over the coming months. However, the uncertainty of the weather conditions and heating demand over the coming months could push the price higher if it breaches levels of $2.42 which will take prices to $2.75 - $3.00 level on the peak season January futures contract. At below such low levels, it may be sound like an excellent time to consider buying the natural gas, as the U.S. production and U.S. gas exports have climbed to a record and power plants are burning more of the fuel than ever, the demand boost has been no match for soaring output from shale basins.
Overall, we expect U.S. natural gas market will remain oversupplied in 4Q2019 and 1Q2020, with inventories leaving the year at an 18% surplus to the five-year average, with pricing to remain under pressure on the assumption that gas volumes continue to ramp into the full start-up of Texas. Looking at this market, if we break down below the $2.00 level, then we could go down to the $1.75 handle but we can see some weather-driven movement.
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