The spike in natural gas prices in November may prove to be short-lived.
Natural gas spot prices jumped as high as $4.70/MMBtu in November, the highest price since the Polar Vortex of 2014. The run up in prices caught the market off guard, and even pushed an options trading firm to suddenly shutter its doorsvirtually overnight.
The price increase was the result of a several factors that conspired to dramatically tighten the supply/demand balance. The U.S. has seen structural increases in gas demand over the last few years, with coal-fired power plants shutting down in favor of gas generation. The U.S. has also inaugurated a handful of LNG export terminals, diverting a growing portion of gas production overseas.
There are also a series of seasonal factors at play. Last spring was unusually cold, then the summer was unusually hot, magnifying demand on both counts. This winter got off to a cold start, the spark in November’s price spike. The U.S. entered the winter drawdown season with natural gas storage levels at their lowest level in 15 years.
However, those factors are now starting to ease up. “The gas market’s bullish fervor has died down, as warm weather expected for the end of the month slowed the rally, for now at least,” Barclays wrote in a December 24 note to clients.
“Two months ago we warned about heightened volatility in this market due to the thin storage cushion, and that warning still holds. Gas prices remain prone to another upside spike should the weather maps turn blue again, at least until the end of January when heating loads typically peak,” Barclays wrote.
But the edge has been taken off of the market. “For the time being, any rally is likely to be easy come, easy go as production growth and low storage battle it out to determine the direction of the market.” The investment bank expects natural gas prices to average $2.92/MMBtu for 2019, which is notably lower than the current price at around $3.50/MMBtu.
Part of the reason that prices have cooled is the effect of high prices themselves. The spike over the last moth or so “eroded gas burns, as coal units gained share in power generation,” Barclays said. The bank estimates that higher natural gas prices destroyed about 1.3-1.8 billion cubic feet per day (bcf/d) of demand, with coal plants ramping up to capture some of that lost market share. Nuclear power also ratcheted up generation after a period of maintenance.
For 2019, Barclays and others had long expected the tightness to ease. Upstream production is expected to continue to break records, with Marcellus output cleared of obstacles after new pipelines came online in 2018, and more slated for 2019. Diminished inventories are supposed to be replenished.
However, the 2019 forecast has come a bit more complicated as of late. The meltdown in oil prices could curtail oil drilling activity in the Permian, which could cut into expected growth of associated gas supply. The flip side is that discounts for Permian gas could ease due to less upward supply pressure.
Permian gas has been running into pipeline constraints, and Permian prices even briefly dipped into negative territory a few weeks ago because of the glut.
The Marcellus is also not immune to operational issues. Barclays says that many shale drillers in the Marcellus and Utica have burned through a big backlog of drilled but uncompleted wells. With fewer than 600 DUCs, the backlog is not at its narrowest since the EIA began collecting the data back in 2013. Fewer completions could slow production growth going forward.
Budget exhaustion is also something to keep an eye on. “Rig activity in early 2019 will tell if this trend will necessitate a revision to Appalachia growth expectations,” Barclays concluded.
Barclays says that amid the souring outlook for oil – and for global equities more generally – natural gas assets have not been quite as affected, but could still take a hit. Speculators have slashed their positions in gas futures, reducing net length by 23 percent since mid-November. “The March/April spread – the
bellwether bull spread – has also plunged by about two-thirds from its peak,” Barclays noted.
In other words, the spike seen in November was a temporary phenomenon, even if the potential for higher prices has not fully gone away.
|Nick Cunningham for OilPrice.com|