The Fuse

Natural Gas Prices Crash, Chances of a Rebound Are Slim

by Nick Cunningham | December 17, 2015

Amid all the buzz of the crash in oil prices, natural gas prices have quietly fallen to dramatically low levels, eclipsing even the rock bottom prices seen years ago when the shale gas revolution took off. Henry Hub spot prices closed on December 15 at $1.82 per million Btu (MMBtu), the lowest level since 1999, and also the second lowest price on record when adjusted for inflation.

Supply-side price crash

Similar to what’s happened in the crude market, the crash in natural gas prices is largely a supply-side phenomenon. The innovations in hydraulic fracturing and horizontal drilling sparked a shale gas bonanza years before a similar story played out for oil.

Unlike oil, natural gas production continued to climb for years without interruption, even in the face of low prices.

However, unlike oil, natural gas production continued to climb for years without interruption, even in the face of low prices. Natural gas output also increased despite the sharp drop off in the number of active rigs used for drilling. The number of gas rigs has fallen to just 185 in mid-December, down from more than 900 four years ago.

Marketed production of natural gas surpassed 80 billion cubic feet per day (bcf/d) in the third quarter of 2015, a record high, a level that puts the U.S. as the largest natural gas producer in the world.

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Natural gas prices have historically been extremely volatile, but the sharp increase in supply beginning about a decade ago smoothed out some those rough edges. Aside from an unusually cold winter in 2014, natural gas has consistently traded below $6/MMBtu since 2010.

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Cheaper gas displaces coal

Cheap gas has led to an increase in consumption, sparking some major upheavals in electricity market, allowing natural gas to undercut its competitors and capture a growing share of the market. For instance, some nuclear power plants have announced closures because of the inability to compete with cheap gas.

Cheap gas has led to an increase in consumption, sparking some major upheavals in electricity market, allowing natural gas to undercut its competitors and capture a growing share of the market.

Coal, meanwhile, has experienced major setbacks. Coal-to-gas switching has been accelerated by an array of EPA regulations intended to crack down on emissions from coal-fired power plants, as well as pending regulations to slash carbon pollution. Adding to coal’s woes is a flurry of lawsuits that environmental organizations have bombarded the industry with in recent years. Just recently, in June, a subsidiary of Alliant Energy decided to end a legal battle when it agreed to shutter six coal plants in Iowa. The move brought the total number of retired coal plants since 2010 to 200, according to the Sierra Club.

In short, cheap gas and the tightening environmental screws have pushed coal’s share of the electric power sector down from nearly 50 percent in 2007 to 39 percent in 2014. This year, the EIA expects natural gas and coal to account for almost the same share of electricity, each making up around one-third of the nation’s total generation. It won’t be long until natural gas outstrips coal as the nation’s top source of electricity.

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Rising supply, tepid demand

The surge in natural gas production has been met with a significant rise in consumption. However, natural gas consumption patterns are highly seasonal, with a spike in demand during cold winter months, and much lower demand during the rest of the year.

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Record production and record storage levels have run full steam into a warmer-than-normal beginning to winter, creating a perfect storm for natural gas markets.

The seasonal nature of consumption means natural gas storage levels also rise and fall seasonally, with inventories building in the summer and subsequently drawing down through during the winter. The massive drawdown in storage levels in early 2014 helps explain the price spike during the harsh winter on the East Coast that year.

But right now, the U.S. finds itself in the opposite situation. El Nino has hit the U.S., bringing unusually warm weather at a time when the nation usually begins turning up the heat. New York saw temperatures in the mid-70s in early November, the warmest on record in over 60 years. The warm weather has not let up—above-average temperatures are expected across the entire East Coast during the holiday season.

Against this backdrop, there will be an unusually late start to winter demand, which is coming after an incredibly strong “injection” season. Storage levels spiked beyond the five-year average because of record gas production throughout 2015, with inventories hitting a record high in November, briefly surpassing 4 trillion cubic feet.

Record production and record storage levels have run full steam into a warmer-than-normal beginning to winter, creating a perfect storm for natural gas markets. As a result, prices have crashed from just under $3/MMBtu over in the summer of 2015 down to just around $1.80/MMBtu today.

Glimmers of hope for the industry

Supply and demand could come back into balance. Supply may take a hit from lower prices. The EIA notes in its Drilling Productivity Report that several of the major shale regions are already seeing production decline as drilling has dried up. The sharp drop in prices to $1.80/MMBtu could force a deeper contraction in supply in 2016, possibly erasing some of the supply overhang.

Prices could also rebound from higher demand. As mentioned above, demand fluctuates with the seasons, and the winter “peaks” in consumption have grown over the past decade as more utilities switch from coal to gas. But demand has not yet risen fast enough to soak up all of the extra supply. Still, record low prices could accelerate the coal-to-gas switch as natural gas increasingly beats out coal.

The first shipment of LNG is expected to depart from the Gulf of Mexico, which will add 0.7 bcf/d in demand. That is not exactly a “game changer,” but will help shrink excess supplies.

Bearish outlook

U.S. prices could remain low for at least another few years.

Although the plunge in natural gas prices can be chalked up to unusual weather patterns that should dissipate by next year, the situation is not all that simple. In fact, U.S. prices could remain low for at least another few years, for several reasons.

First, if warm weather extends through much of this winter, storage levels will remain elevated well above the running average. This trend would  set the stage for the possibility of record-breaking storage levels next year as injection season begins anew.

Second, natural gas production could very well continue to rise, even with rock-bottom prices. The U.S. is expected to average a record-high 79.6 bcf/d in 2015, but the EIA says that figure will swell to a new record of 81.2 bcf/d next year. Again, this estimate is subject to a lot of uncertainty, especially with companies continuing to pull back on drilling. But for now, the EIA’s best forecast is for supply to continue to grow in the near-term.

Next, there is a backlog of drilled but uncompleted wells along with the wells that have been shut in. These wells are essentially acting as temporary storage. In other words, the gas will come on line when market conditions warrant it. “The storage situation is worse than it’s implied in our weekly storage number because we know that the Appalachian Basin has become a de facto reservoir,” Teri Viswanath of BNP Paribas told Bloomberg in November. “Now $3 is off the board until 2018,” Viswanath added.

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