The Fuse

With Inventories Low, Natural Gas Prices will Depend on Production Growth this Winter

by Nick Cunningham | September 12, 2018

The U.S. is poised to enter the winter heating season with storage levels at the lowest point in a decade. Gas demand in the electric power sector continues to rise, LNG exports are scaling up and gas demand in petrochemicals is destined for long-term growth.

However, despite the abnormally low level of gas sitting in storage, prices have barely moved. Shale gas drillers continue to add supply, which will likely allow the U.S. to avoid a supply crunch this coming winter.

Low storage levels

For the week ending on August 31, U.S. natural gas storage levels stood at 2,568 billion cubic feet (Bcf), or 643 Bcf less than for the same week in 2017 and also 590 Bcf below the five-year average.

There are a few reasons why storage levels lag behind previous years. First, demand continues to ratchet up with each passing year. Consumption is cyclical, peaking in the winter, but the peaks are rising as aging coal-fired power plants retire, with new natural gas plants and renewables stepping in to fill the gap. On top of that, hot temperatures this summer accentuated demand, putting gas-fired “power burn” at a record high in July.

The result is that the U.S. natural gas inventories are well below average, and by October, just ahead of the peak winter season, inventories could be at the lowest level in more than a decade.

In addition, new LNG export capacity is set to come online at Cheniere Energy’s Sabine Pass and Corpus Christi terminals, and Kinder Morgan’s new LNG export terminal at Elba Island in Georgia. The increase in exports from these terminals should begin in the first quarter of 2019, or perhaps earlier, adding 1.5 Bcf/d when at full capacity, according to Barclays.

The result is that the U.S. natural gas inventories are well below average, and by October, just ahead of the peak winter season, inventories could be at the lowest level in more than a decade. “The market seems largely unconcerned about running short of gas this winter. After ending last winter with the least amount of gas in storage since the 2013/2014 polar vortex, storage injections have been below normal all summer, and show no sign of accelerating,” Barclays wrote in a note on August 28. “We anticipate a fundamentally tight start to the 2018/19 winter and are lowering our end-October 2018 storage forecast to 3.4 Tcf, as the market appears content to bank on further production gains to meet demand this winter.”

The relatively low level of storage led Barclays to revise up its pricing forecast for the fourth quarter, but only modestly. The bank puts Henry Hub prices at $2.83 per million Btu (MMBtu) in the last three months of the year, up from a previous estimate of $2.58/MMBtu. The price increase in the forecast is notable, but still low by historical standards. Prices have been “remarkably non-volatile” given the abnormally small cushion of gas stocks, the bank said.

Production growth

In fact, the market tightness could be short-lived. The muted volatility in the natural gas market, and the lack of concern about the low level of gas inventories, is largely the result of expectations of ongoing increases in gas production. “Surging production growth should backstop the market this winter,” Barclays said. The coming wave of supply “drives natural gas prices lower in 2019.”

U.S. natural gas drillers could add as much as 4.5 Bcf/d next year, two-thirds of which will come from the Marcellus and Utica shales. The Permian will add another 1.5 Bcf/d in associated gas, the outgrowth of an oil drilling frenzy where gas is produced as a byproduct.

The surge in production will be made possible by the flurry of new pipelines set to come online, particularly in Pennsylvania, unlocking new supply. Two new pipelines in the Permian will also allow more gas to escape the region, potentially easing the astounding rate of gas flaring in West Texas. The flip side of this dynamic is that any slowdown in oil drilling, perhaps related to pipeline bottlenecks, could also curtail expected gas production.

The surge in production will be made possible by the flurry of new pipelines set to come online, particularly in Pennsylvania, unlocking new supply

Another reason why the current low levels of gas storage may not be a major problem is that the power sector may see softer demand increases next year compared to the recent past. A relatively small amount of coal-fired capacity is set to retire in 2019—only about 1.4 gigawatts (GW), compared to around 10 GW annually between 2012 and 2017. As a result, the jump in gas demand will be smaller than in years past. “Overall load growth in the power sector is forecast to be minimal to non-existent on a national level,” Barclays wrote.

Ultimately, Barclays estimates that gas inventory levels will return to the five-year average by the end of October 2019, just ahead of the winter season.

There are some risks to this cheery pricing forecast. Unexpected weather can always scramble the supply and demand figures—causing both demand surges and supply outages. The polar vortex in 2014, in addition to a period of extreme cold in early 2018, led to occasional price spikes. Inventories fell sharply in these periods, although the worst pricing effects were regional and temporary.

Gas pipelines that are pivotal to future production growth also face some degree of uncertainty. The Atlantic Coast pipeline and the Mountain Valley pipeline—two projects that will connect the Marcellus shale to the U.S. Southeast—ran into some regulatory trouble this summer. FERC suspended construction over environmental concerns, and while the owners of the pipelines expect to overcome these hurdles in relatively short order, the decisions could push back the in-service dates. Barclays notes that uncertainty over construction timelines is one of the main risks to its relatively sanguine gas pricing forecast.

Barclays notes that uncertainty over construction timelines is one of the main risks to its relatively sanguine gas pricing forecast.

Nevertheless, given the low levels of natural gas sitting in inventory, the expectation of relatively muted prices over the next year is noteworthy. To be sure, a supply crunch is not entirely out of the realm of possibility. But surging shale gas production and a lull in demand growth could prevent the market from tightening too much.

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