Even though the US experienced one of the coldest winter heating seasons in (2013/14) many years, the spot Natural Gas or Nat Gas for short, futures price did not increase to anywhere near the levels it did during previous very cold winters nor did volatility go through the roof. The main reason for this significant change in price activity is the surge in US production of Nat Gas from several very large shale gas producing regions of the country. That said, Nat Gas price activity remains a function of supply and demand. Although futures prices have not returned to the double digit levels seen in the pre-revolution years, prices did hit the highest level this past winter since the winter of 2009.
The major change in the Nat Gas market over the last several years is primarily on the supply side of the equation. Demand has been growing slowly with the occasional demand surge due to weather as we saw in the winter of 2013/14. The Nat Gas futures contract traded on NYMEX is principally a US produced and consumed commodity. Some Nat Gas flows from Canada and some gas flows to Mexico but as of now the LNG market is still not a factor in either flow direction.
The demand side of the equation is impacted by the economy. As the US economy moves into a sustainable growth pattern, the use of Nat Gas will likely continue to increase in the industrial and commercial sector. With the abundance of Nat Gas due to the shale revolution and relatively low prices versus many other places in the world, there has been a manufacturing advantage for those sectors using Nat Gas in their manufacturing operation. Although this is a growth area for Nat Gas, it will not result in a surge in demand in the short to medium term, rather, it is a slow and steady growth area.
Utilities may burn more or less Nat Gas depending on prices between oil, coal and Nat Gas. Many utilities have the capability of switching between Nat Gas and coal based on the most economical fuel at the time. Since the second half of 2012 the majority of the time coal has been more economical than Nat Gas for power generation. To the extent that a utility has the capability to burn coal it was likely their preference for the last several years. This pattern is likely to continue in the medium term especially with Nat Gas inventories still well below normal after the cold winter of 2013/14 (and prices higher than the last few years). Over the long term the EPA has placed additional regulations on coal driven power plants which will result in less coal and additional Nat Gas consumed for power generation.
Thus the main incremental use for Nat Gas in the US is for meeting heating and cooling needs and will remain in this pattern for the foreseeable future. A larger percentage of Nat Gas is consumed during the winter heating season with a portion of the consumption during the summer cooling season to supplement utility demand of air conditioning.
Nat Gas futures prices are generally driven by the short term weather forecasts produced by NOAA (free) and many private forecasters (fee based service).
Following is the latest actual and forecasted demand for Nat Gas produced by the EIA shown on a quarterly basis. The table shows the seasonal demand for Nat Gas during the winter and simmer seasons and is highlighted in red.
|Nat Gas Consumption US (EIA Data), BCF/Day|
|Lease and Plant Fuel||3.95||3.98||4||4.02||4.05||4.06||4.06||4.08|
|Pipeline & Distribution Use||2.68||1.75||1.75||2.01||2.49||1.78||1.76||2.03|
Source Data: U.S. Energy Information Administration Data
Moving over to the supply side of the equation, the shale revolution has had a significant impact on the overall performance of Nat Gas prices as well as the volatility of this contract. The following chart from the most recent EIA Short Term Energy Outlook report (issued monthly) shows the steady growth in supply over the last several years.
Nat Gas production has steadily grown over the last several years adding a needed cushion to cover unscheduled issues as well as seasonal demand surges along with diversifying the supply profile in the US. The US is now less dependent on Nat Gas from the Gulf of Mexico (still a very important supply source) as all of the new production gains have been on-shore and out of harm’s way of hurricanes that often times find their way in the Gulf of Mexico and disrupt supply lines from that region. The projected supply growth should act to dampen any severe seasonal weather occurrences going forward.
That said, there is still a large variation in the inventory profile for Nat Gas. The following chart shows the normal seasonal movement in Nat Gas and how low inventories occurred after the severe winter of 2013/14.
Source Data: U.S. Energy Information Administration Historical Data
The recovery of inventories heading into the winter of 2014/15 should have a strong impact on price activity during the summer cooling season as well as during the upcoming winter heating season. Weekly inventory levels have demonstrated a quick and strong impact on price activity.
As an example, with inventories below normal in 2014 so far the market has been maintaining a modest and widening price risk premium compared to 2013. The premium has been averaged about $0.485/mmbtu above 2013 since the beginning of April into early June.
This premium is a risk premium of starting the winter heating season with a gap in inventories. The widening premium suggests that the market is starting to take a stand that the projected gap in inventories ahead of the upcoming winter is likely to be the dominant price driver in the near to medium term. The premium may gain momentum at this point in time as the industry seems less relaxed that the recent pattern of above normal injections over the last several weeks will continue throughout the season.
Nat Gas trading is very dependent on supply and demand fundamentals with the supply side of the equation resulting in the most significant change in the structure of the Nat Gas market since it was deregulated in 1990 (also when the NYMEX Nat Gas contract came in to existence).
Peter Knight Advisor