Market Update | 4/25/2023
It was not always this way. Volatility had typically been confined to winters and the months leading up to winter. The zig and zag of what our customers pay, either directly or through the derivative power price, has covered a range last seen more than two decades ago. Because the core of our markets is in the northern portion of the Northeast, our local volatility has been more pronounced by natural gas’s lack of mobility into New England. I am referring to the physical limitations that cap the amount of natural gas that can be shipped by pipeline into the region during the cold-weather months. What that has meant to our customers is that the natural gas commodity price decline from $9.68 per mcf (in August 2022) to the print this past week of under $2.00/mcf does not provide accompanying relief on the basis portion of the fully loaded cost. Greater pipeline access to this region is not currently under consideration – so we work within the realities of the day. Just as the reality of last summer’s price run up was an ugly part of the conversation with our markets for the better part of 2022, the price decline of 80 percent since then should be propulsion for conversation starters.
But first, let us investigate recent history and get a refreshed appreciation of how quickly things change. It was in June 2020 when the price of natural gas made a 25 year low of $1.48 per mcf. Hitting this number occurred in the same period as the pandemic peak; but fear of the disease was by no means the dominant factor.
The path to $1.48 natural gas: Bulging Supply
The shale revolution caused an explosion of investment and production in the natural gas and oil extraction industries; output soared as fracking and horizontal drilling became the E&P norm. However, while investment dollars poured into the industry, only meager returns cycled back to investors. Timing is everything. Just as financiers tired of low rates of return (with gas getting so inexpensive), the market started to turn up. In fact, it was so inexpensive that coal and nuclear plants got knocked offline and were replaced by lower cost power producers with natural gas as their fuel.
The path to $9.68: Perfect Storm of Factors
The first rung of the rebound was the emergence of the economy from the throes of covid. Then came a series of weather events. Summer 2022 was abnormally hot, triggering an unusually strong demand for gas. Heavy storms and hurricanes followed, reminding markets of how easily substantial production shut-ins could choke off supply. And, in the same period, geopolitical tensions started to hit the headlines with soaring world-wide energy prices becoming the financial market’s expression of concern over access to supplies.
Big growth in demand. What came next was the lead role of the US, assuring the world that natural gas shortages in Europe and Asia would be met by increasing US exports of LNG. The US had agreed to shoulder the burden of keeping Europe supplied with whatever natural gas they were no longer going to source from Russia. With Russian supplies going to zero in May 2022, Europe looked to the US to make up the 55 percent of their requirements that had previously come from Putin & Co. This amounts to about 18 bcf/day, or one-third of the total European demand.
These were the forces that created a more than six-fold increase in price by August 2022.
Natural gas prices have dropped by approximately 80 percent in the last 8 months.
Why? And where did winter go?
- One statistic making rounds with natural gas price forecasters is the decline of European heating degree days in winter 2022-2023 of 15 percent below the 5-year average which reduced natural gas demand by 500 bcf over the 4-months.
- With mild winter weather dominating European gas markets, that, and other factors turned crisis into triumph for Europeans facing perilous times. In March 2022, inventories stood at very low 1.1 tcf. Owing to drastic measures such as increasing LNG imports, curtailing industrial production, and switching to coal and biomass, the gas inventories went from 475 bcf deficit to a 150 bcf surplus by the end of October 2022.
- The US experienced an unusually mild winter, as well, which helped to mitigate the gas inventory deficit which stood at 300 bcf below long-term seasonal averages at the end of March 2022. But it was a random event that magnified the erosion of natural gas prices; a fire and explosion at an LNG terminal in Texas in June took 2 bcf/day of exports off the international market and kept those supplies here. This overnight surplus, when coupled with absence of normal winter weather, flipped the market from being short supply to being short demand.
These are but data points in the macro energy picture; however, do not mistake them for anything more than temporary pauses in what is still a structural deficit in both US and global natural gas markets.
Masking this deficit are the one-off events of the past year that underscore the turbulent and volatile natural gas marketplace. Take stock of the added export potential for natural gas that will hit the market over the next 24- to 36-months when almost 5.7 bcf/day of new export terminal capacity comes online in Texas and Louisiana. With international markets offering prices 3- to 4-times above those domestically, the new export terminals will be busy! Also note that domestic natural gas production looks to slow its pace from the current performance in the major fields that have been responsible for the bulk of production over the last 15 years. And of course, when prices drop, marginal producers withdraw from production fields and button up their equipment until profitability returns.
The underlying fundamentals remain incredibly tight. However, with the drop in natural gas commodity pricing and the slowing of production, there is a possibility prices may boomerang again. Resolving the spread between future demand and where that demand will meet supply on the price curve will be the task of every energy buyer – and in our case – aided by their Freedom Energy advisor.