Natural gas prices started the winter season with a bang, but could end it with a whimper.
Henry Hub natural gas prices spiked last November to multi-year highs, nearing $5/MMBtu. The extraordinary drawdown in inventories left the U.S. with the smallest cushion of gas supplies in over 15 years. A cold snap threatened to push gas supplies to dangerously low levels, and eyeing that thin margin, prices jumped and volatility spiked.
The surge in prices was brief, however. Winter got off to a mild start, and demand was relatively muted as well. The record-setting cold at the end of January saw demand spike once again, but the market barely budged. Everyone knew that the Polar Vortex, though intense, was only going to be around for a limited period of time.
A massive upswing in temperatures occurred at the start of this month, with much of the country thawing out. Now, although we have a few weeks left of the high-demand winter season, the end is within sight. After all, Punxsutawney Phil didn’t see his shadow.
With spring just around the corner, the risk to the gas market is just about over. “There is simply not enough winter heating demand left to drive end-March storage below 1 Tcf,” Barclays wrote in a note. “Rebounding production and weak cash prices during recent cold spells also eroded our confidence in another rally.”
The investment bank lowered its pricing forecast for the first quarter of 2019, predicting average Henry Hub prices at $2.98, down sharply from its previous estimate of $3.51/MMBtu. For the full year, the bank expects prices to average $2.81/MMBtu.
As it stands, front-month natural gas prices were trading as low as $2.67/MMBtu on Wednesday.
Rising upstream production should lead to “smoother seas,” Barclays argued. “We still see prices falling modestly this summer, as production growth dominates balances.” Related: Hedge Funds Drop Shorts On Crude Oil
“Since October, we have been warning about higher volatility, but with heating demand on a downward slope and acute storage scarcity largely out of the picture, we believe volatility should decline towards historical averages into this summer,” Barclays added.
One notable development is the emergence of a stronger inverse relationship between WTI prices and the price of natural gas. The higher WTI goes, the worse off it is for natural gas prices. That may seem counter-intuitive since the two fuels have, at times, had a positive correlation. A general rise in commodity prices, whether due to a booming economy, or asset price inflation, or supply shortages, can affect both oil and gas in the same way.
However, the difference now is the surge in associated gas production. The more U.S. shale companies step up shale drilling in pursuit of oil, the more natural gas comes out of the ground as a byproduct. As such, when WTI rises and the industry throws more oil rigs into the field, it tends to lead to higher levels of gas output, pushing prices down. Barclays says that with associated gas account for roughly 40 percent of total gas production in the Lower 48, the negative correction “is likely to persist or even strengthen in the coming year.”
Because of this link to the oil market, the fate of oil prices will have significant influence over the behavior of natural gas. For instance, if U.S. oil production growth slows to just 0.6 million barrels per day – well below the 1.2 mb/d the EIA is forecasting – that would push natural gas prices up roughly $0.50/MMBtu relative to Barclays’ baseline scenario, due to lower associated gas supply.
On the other hand, if the shale industry surprises and adds a rather massive 1.4 mb/d of new oil supply, that would lead to a surge of associated gas production as well, pushing Henry Hub prices down by $0.20/MMBtu relative to the reference case.
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Overall though, prices should be muted this year. Winter demand season is coming to an end and shale gas production continues to rise. That will allow inventories to be replenished, dramatically reducing the volatility and risk associated with tight supply conditions.
By Nick Cunningham of Oilprice.com
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