The natural gas market is looking rather tight, even as U.S. production continues to set new records.
Inventories fell sharply last winter, leaving the country a little light on stocks heading into injection season. That did not concern the market much, with record-setting production expected to replenish depleted inventories.
However, the past six months has not led to surging stockpiles, and inventories replenished at a much slower rate than expected. We are about to enter the winter heating season with inventories at their lowest level in 15 years. For the week ending on October 19, the U.S. held 3,095 billion cubic feet (bcf) of natural gas in storage, or 606 bcf lower than at this point last year, and 624 bcf below the five-year average.
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The reason for this is multifaceted, with seasonal weather playing a role, but also structural increases in demand. “Hot summer weather, LNG liquefaction demand, exports to Mexico, and the industrial sector have all mitigated the impact from a 8.7 bcf/d YoY production growth surge this summer,” Bank of America Merrill Lynch said in a recent note. Low inventories and potential deliverability risks led the investment bank to hike its price forecast for the first quarter of 2019 to $4 per MMBtu, up from a prior estimate of just $3.40/MMBtu.
Coal shutdowns have led to a lot of fuel switching. Moreover, new gas-fired power plants have opened up and continue to do so. The U.S. also became a sizable LNG exporter in 2016, and exports will continue to climb in the years ahead with more terminals coming online. New pipeline interconnections with Mexico should also lead to more shipments from Texas to the U.S.’ southern neighbor. Related: Can U.S. Gas Demand Keep Up With Surging Production?
Peak winter demand in the early 2000s stood at around 75 to 85 billion cubic feet per day (bcf/d), according to BofAML. That figure spiked to 100 bcf/d last winter, helping to explain the rapid decline in inventories. There was a cold snap in early January, but the winter on the whole was “near normal,” BofAML argues, making the steep fall in stocks all the more remarkable. In other words, demand is structurally much higher than it used to be; the sudden tightness is not just because of a seasonal anomaly.
But, as always, natural gas markets can be highly volatile, and very sensitive to extreme weather. A cold snap this upcoming winter could lead to a price spike, especially with the inventory buffer so low. “The Polar Vortex winter of 2013-2014 realized a record low salt inventory level of 54 bcf,” BofAML said. Salt inventories are those that can be called upon quickly. “Another Vortex, which on average has occurred once every 7 years in the 1950-2018 period, would be catastrophic,” Bank of America Merrill Lynch warned.
Unlike 2014, the last time we saw a polar vortex and a natural gas price spike, this time around there is a lot less coal to fall back on in the event that inventories plunge to low levels amid soaring demand. As a result, natural gas prices might be forced even higher. “A cold winter paired with higher coal prices and reduced gas-to-coal switching could propel NYMEX natural gas to a brief spike over $5.00/MMbtu,” BofAML said.
This does not negate the long-term bearish forecast for natural gas prices. The U.S. shale bonanza continues, both in the Marcellus and Utica shales in the northeast and the Permian basin in West Texas. “Past this winter, we expect production to overwhelm demand growth and lead to above-normal inventories by 2H19 and a risk of storage congestion in 2020. Our average price forecast for 2020 remains $2.55/MMbtu, reflecting bearish longer-term fundamentals,” BofAML concluded.
Still, in the short run, structurally higher demand and the prospect of another polar vortex, or merely below average temperatures this winter, could overwhelm what has been record natural gas production.
By Nick Cunningham of Oilprice.com
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