A highly contested election, global pandemic, and historically low oil prices have grabbed headlines in recent months but there has been little focus on the surging natural gas market. In recent weeks, natural gas rose to prices not experienced in over a year and a half when the Henry Hub gas benchmark climbed to a 19-month high in late October. With a cold winter ahead, a historic Hurricane season in full swing, depressed oil production, and soaring LNG exports; the gas futures market remains strong and will maintain its upward momentum into the foreseeable future.
- The futures market for natural gas appears to have gained momentum over the past two months as oil futures have continued to struggle. The November contract closed nearly 43% higher than the October closing price. A cold upcoming winter season paired with depressed oil production and additional LNG exports may impact further natural gas price support.
- Natural gas posted a 25-year low in June when the Henry Hub price touched $1.432/MMBtu. By the end of October, natural gas climbed to a 19-month high of $3.396/MMBtu. The switch for front month contracts at the end of September and October have shown large jumps in price between the old contract close and new contract open, increasing by $0.67 and $0.29 respectively.
- Major drivers for this upward trajectory are colder weather, less associated gas production, hurricane outages, and LNG exports. Demand for heating in the winter months has caused price peaks to occur in November for the past two years. It appears a similar trend is occurring again for 2020 with colder than average temperatures expected from La Niña. Weather related production shortages due to hurricanes in the Gulf Coast have also helped to support natural gas prices. Tropical Storm Zeta alone caused over 55% of gas production in the Gulf to be shut-in for a short time period.
- Nearly 5 BCFPD of dry shale gas production has declined across all U.S. basins in 2020. Shut-ins to uneconomic wells and reductions in capital for drilling new wells have caused less associated gas production in areas like the Permian and Bakken. Without new drilling in these regions, the previous growth in gas production will not be possible as associated gas is throttled back along with reduced oil production.
- U.S. liquified natural gas (LNG) exports have climbed in recent months with demand from PetroChina expected to double in the next 15 years and U.S. export capacity anticipated to increase by 50% through 2025. China’s imports of LNG will likely grow by 10% this year as companies take advantage of the low prices and increased industrial demand.
- While natural gas will likely not reach historic highs seen in the mid-to-late 2000’s, it is probable that market forces will sustain prices near the $3 per MMBTU range for at least the next quarter and possibly further into 2021.
The media, as well as the RARE PETRO Media Team, has been following the global pandemic, social and political unrest, and global oil markets in recent months. Interestingly, there has been little focus on a surging market in the fossil fuel industry, natural gas. In recent weeks, natural gas rose to prices not experienced in over a year and a half when the Henry Hub gas benchmark climbed to a 19-month high in late October. The natural gas markets of course are highly driven by weather, so as the temperatures plunge in the United States it should continue to drive demand higher. With dropping temperatures heading into the winter season, the futures gas market has seen outstanding growth, all while oil prices are seeing continued depressed prices at historic lows. Natural gas contracts expire three business days prior to the first calendar day of the delivery month, so the front month contract is delivered on the calendar month following the trade date . On October 28th, the November contract closed 42.6% higher than the previous month’s close, and this momentum seems to be continuing for the December contract. With a cold winter ahead, a historic Hurricane season in full swing, depressed oil production, and soaring LNG exports; the gas futures market remains strong and will maintain its upward momentum into the foreseeable future.
Recent Futures Crossovers
The futures contract for natural gas has seen spectacular growth in recent months. “After gas posted a 25-year low of $1.432/MMBtu on June 26, it didn’t take long for speculative traders to notice and start jumping in. Gas then traded to a nine-month high of $2.473/MMBtu on August 28th, a gain of 70.2% top to bottom, in two months and two days. Once these traders ‘pulled the plug’ in the face of the massive storage overhang, prices pulled back to a wave low of $1.795/MMBtu on September 21 which triggered the latest running of the bulls” . On October 30th, the gas benchmark, Henry Hub, climbed to a 19-month wave high at $3.396/MMBtu as a blast of winter-like temperatures swept the Rockies and the Midwest fueling a surge in heating demand . Two days later at the New York Mercantile Exchange, the November 2020 contract expired at $2.996/MMBtu . Although just shy of the three dollar barrier, this is a 42.6% increase in price from the previous months close continuing the upward push in the natural gas futures market.
Figure 1 shows the large upward gap that has occurred in the last two months demonstrating how as the contracts expire the futures price was elevated. Normally the first and second month contract price would converge as the expiration date nears. For the last two months, gas prices closed down on the contract settlement date and then the new contract caused a large jump on its open. Luckily the cyclic nature of the futures market is still trending upwards proven by the fact that the December 2020 contract settled at $3.291/MMBtu the same day the November contract expired . The price of the 12-month strip averaging December 2020 through November 2021 futures contracts remains elevated at $3.108/MMBtu .
Reason For Momentum
It is that time of year again when natural gas demand picks up drastically into the winter season. It is anticipated to be a colder than usual winter, and if that is going to be the case, it should only drive natural gas prices even higher. That being said, there appear to be four reasons behind the upward trajectory of natural gas prices heading into the winter months. Those are the cold weather, associated gas production, hurricane outages, and LNG exports. While it is difficult to tell which is most responsible for upward pressure on gas prices, the combination of efforts have led to a 19-month high for the struggling natural gas market.
Cold weather means warm clothes, warm houses, and subsequently peak demand and withdrawal season for natural gas. Last winter, Henry Hub gas prices averaged just $2.10/MMBtu from November to March, fueling record winter-season demand from power generators, despite historically mild weather during the typically peak-demand months of December and January . With the arrival of La Niña, colder than average temperatures are expected across the U.S. which will further drive up demand. Figure 2 shows that over the past two years, the natural gas futures market hit peaks in November. In 2018, the high was at $4.929 per MMBtu, and at the end of the 2018 injection season inventories rose to a high of 3.234 tcf. This was a low inventory level going into the winter months. In November 2019, the high was $2.905 per MMBtu with stockpiles hitting a high of 3.732 tcf . As of October 2020, the price has already moved marginally above the November 2019 high, trading at $3.396 per MMBtu on October 30 .
As noted above, a similar trend is developing in the early winter months. Supported by the recent Midwest cold front that dropped temperatures across the nation, futures prices are climbing rapidly. During those same historic peak-winter months, weather-driven demand and price volatility could see single-day cash prices climb significantly higher – particularly at hubs in the U.S. Northeast where winter prices often climb into the $5 to $6/MMBtu range . During a record-setting cold spell in January 2018, even benchmark Henry Hub prices climbed to over $7, up from a winter-season average at under $3/MMBtu . While these prices do not maintain at severely elevated levels, colder weather in winter months drives up demand to heat buildings and thus drives up prices in the natural gas market.
Associated Gas Production
Another factor supporting the steady rise in prices in the natural gas market is the associated gas production that has come offline as a result of shut-in oil wells following COVID-driven demand destruction. Nearly 5 BCFPD of dry shale gas production has declined across all of the basins in the U.S. Although the Marcellus region has not decreased its overall production of gas, other regions’ trajectories have fallen off significantly.
Figure 3 shows the wedge for shale gas in the Permian was growing rapidly up until the pandemic. Previously, operators in the Permian cared more about the revenue from oil produced and the gas that came with the well was more of a nuisance. Because of this logic, economics for these shale wells were less tied to natural gas prices, which in turn hurt the natural gas market. Then as oil prices caused production to fall creating uneconomic wells and less drilling, associated gas production dropped rapidly. Although still the second largest gas producing region, the upward trajectory has been decimated as a result of depressed oil prices. Without new drilling in the region, the previous growth in gas production will be impossible as less associated gas is produced from older oil wells following steep declines. As a result, depressed oil prices have brought associated gas production offline which has consequently reduced domestic gas supply. With less supply on the table and ever growing demand for the winter season, prices are expected to continue to climb for the near term.
Although less significant than associated gas production out of shale well regions, hurricane outages have also limited domestic natural gas supply. The past three major storms have had fairly substantial production influences on both oil and natural gas. In August, Hurricane Laura forced Gulf of Mexico Operators to evacuate nearly 300 platforms and shut-in more than 84% of oil production and more than half of their natural gas production . Less than a month later, another record breaking storm, Hurricane Delta, forced operators to shut-in an estimated 80% of the Gulf’s oil production and 49% of natural gas production, including over 180 production platforms being evacuated . Just this week, Tropical Storm Zeta forced 1.50 Bcf/d of natural gas, which is more than 55% of the total gas production in the Gulf, to be shut-in . While significant for the region, these outages are short lived. With platforms evacuated and production being down for less than a couple of days, the effects on overall supply are fairly minimal. Regardless, as one of the most active hurricane seasons on record continues for another month in the Gulf, further supply destruction from mother nature is likely. If this trend continues, it will further support the upward trajectory of natural gas prices, at least for a short while.
Aside from weather induced demand increases, the natural gas market is being largely influenced, and at times driven, by liquified natural gas (LNG) demand. U.S. natural gas futures jumped over 4% at the beginning of October on forecasts of more demand over the next two weeks than previously expected due to a rise in LNG exports . Demand increases are further supported through actions taken by the U.S. Department of Energy in late October that extended the terms of three long-term LNG export authorizations through 2050 . The United States is among the top three global exporters of LNG, and its operating export capacity is expected to increase by more than 50% by the end of 2025 as a result of the deal. PetroChina, China’s largest natural gas supplier, has predicted that demand will double over the next 15 years despite the effects of the pandemic and the rising importance of renewables . As a result, China’s imports of liquefied natural gas will likely grow 10% to new highs this year as companies scoop up cheap supplies to cover increasing industrial use and robust residential demand . This can be seen in Figure 4, when at the peak of the pandemic, China was importing LNG above 2018 levels. As restrictions have eased with the virus phasing out in China, more LNG will be needed from domestic producers. By continuing to export domestic energy abroad, especially to LNG thirsty economies like China, the natural gas market is poised for a rebound.
Although down significantly from their historic peak in January, the LNG market is already making a substantial comeback. Last week alone, Sixteen LNG vessels, seven from Sabine Pass, three from Cameron, two each from Freeport and Corpus Christi, and one each from Cove Point and Elba Island, with a combined LNG-carrying capacity of 58 Bcf departed the United States indicating a rapid shift in domestic exports according to shipping data provided by Marine Traffic . With economies of the world demanding more energy on a daily basis, increased LNG demand will further support the upward price movement in the natural gas markets.
With Henry Hub gas prices already at over $3/MMBtu, mounting concerns over low U.S. production levels fueled by hurricane driven outages and associated gas production alongside potential supply-deliverability constraints this winter are fueling a bullish run in the futures market. On October 30th, calendar-month prices for the December, January and February contracts settled at $3.316, $3.431 and $3.384/MMBtu, respectively according to the CME group . Clearly the upward momentum for natural gas is probable to continue through the cold winter months. La Niña will bring a colder than average winter to the Northern Hemisphere boosting demand to heat buildings and homes, especially if more and more individuals are forced to remain home due to the global pandemic. Increased global demand for LNG will further support natural gas prices as the United States continues its efforts to return to its historic LNG export peak from January fueled by China’s increasing demand needs. Although not as significant a driver as increased demand from cold weather and LNG exports, supply constraints from associated gas production and hurricane outages are the cherry on top that will support natural gas prices through the winter months at a time when oil prices have continued to fall. While natural gas will likely not reach historic highs seen in the mid-to-late 2000’s, it is probable that market forces will sustain prices near the $3 per MMBTU range for at least the next quarter and possibly further into 2021.