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Change in supply-demand dynamics seen supporting natural gas price recovery

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Change in supply-demand dynamics seen supporting natural gas price recovery

Natural gas storage could prevent an immediate price responseto the developing La Niña weather pattern that has historically supported sharpprice gains, but there is potential for prices to begin to increase, with producersplaying an important role in the recovery process, CME Group executive directorand economist Erik Norland said.

The similarities between the 2015-16 natural gas market fundamentalpicture and that of the 1997-98 period, when similar weather patterns were in place,suggest the natural gas price could see a sharp spike as the El Niño weather patternthat depressed the natural gas price to its lowest level in 17 years turns to aLa Niña event, Norland said in a presentation during the LDC Gas Forum Southeastin Atlanta on April 11.

As the La Niña took hold in 2000-01, prices that were depressedby El Niño eventually saw enormous gains from $2/MMBtu to $10/MMBtu, about a 400%increase, and evidence on the demand and supply sides of the market suggest pricesmay be set for a similar recovery.

The natural gas price should recover to $2.90/MMBtu between nowand the end of 2017, Norland said. There is a 50% chance of prices rising abovethat and a 50% chance of prices holding below that, with the price potential tothe upside much greater than the potential to the downside, Norland said. "Itis difficult for prices to go below $2/MMBtu; it is possible but it does becomedifficult for prices to go much further down."

The price recovery, however, could be held back by natural gasstocks that have built to a level 68% above last year, with 1 trillion cubic feetof additional natural gas in supply,Norland said. "That might keep the natural gas price depressed for a while,even as the weather changes and we see a cooler-than-normal winter this winter,but there is potential, as that storage comes down, for prices to begin to increase."

The price recovery that took hold in the early 2000s built toa soaring natural gas price in 2007 as demand rose but supply did not. The questionwith this current price recovery rests most importantly on the amount of supplyand whether natural gas supply increases again, stagnates, plateaus or decreases,Norland said. "A decline in supply could create a tremendous uphill climb inprices going forward."

"The future of natural gas and natural gas prices dependson whether or not we can continue to decrease shale gas production or, at the minimum,stabilize natural gas production from other sources," Norland said.

Shale gas production remains strong in a few areas of the country,particularly in the Marcellusand Utica basins in Pennsylvania, Ohio and West Virginia. Areas like Texas and Oklahomasaw production stall a long time ago and other areas have seen natural gas productionoutright decline or stagnate, Norland said.

He said it is concerning that, in this period of depressed pricing,the amount of investment into new exploration has declined very sharply. "Therig counts have come down to levels we haven't seen in a very, very long time." This can be deceiving as rigshave become more efficient over time and can produce at better rates; still, thefact that investment is declining is a source of concern for prices going forward,Norland said.

The picture is similar for crude oil with a storage level athighs that present the possibility, or even probability, that price will returnto lows of around $25.00/bbl or $26.00/bbl, Norland said. That has consequencesfor investment in the amount of oil rigs operating, which in turn has a consequencefor natural gas, due to residual gas production.

Hand in hand with the positive supply-side story, Norland saidthere is a tremendous demand-side story with the globalization of natural gas. "Whatthis has the potential to do is take the once local natural gas market and turnit into a global market," Norland said.

Natural gas had always been difficult to trade across continentsand as a result the commodity became a local market in North America, Asia and Europe."That is beginning to change with LNGexports particularly from [CheniereEnergy Inc.'s] Sabine Pass as well as many other facilities that couldcome on line," Norland said. "This has the potential to take the localHenry Hub and make it a much more global benchmark for natural gas prices."

But in order for that to happen you have to be able to arbitragethe tremendous differences between prices around the world profitably and that isnot too easily done, Norland said. While there is the potential for a lot of LNGexport, world economies also play an important role and similar to the U.S. arelargely awash in debt, which places headwinds on natural gas exports.

China, with an overvalued currency, provides a good market forU.S. LNG exports as the strong Chinese currency gives them a lot of buying power,but China as a potential market for natural gas might be somewhat impaired by adrop in their currency or if they have a severe economic slowdown, both of whichare possibilities, Norland said, as China looks to be following the example of theU.S. economic crisis.

LNG exporting provides opportunities for demand growth and apossible floor for the market, but impressive demand-side support will come fromthe U.S. power-generating sector.

Electrical power represents a complex demand picture as well, Norland said. "The mostinteresting thing about the new generating capacity that has come on line is thatnone of it is coal, but a great deal has been solar and wind," he said.

The natural gas capacity factor has increased greatly over the last few years, largely becauseof coal. Natural gas is operating at about 55% of capacity on average, which isquite different from solar at 28% and wind at 33%.

Solar capacity additions have been helped by tax subsidies, whichmade it competitive with natural gas. Should those subsidies expire, the amountof solar energy brought on line will likely plunge, which will boost the naturalgas market in the short term, Norland said. But in the long term, solar energy willcome down on its own and make it competitive with natural gas, he said.

Market prices andincluded industry data are current as of the time of publication and are subjectto change. For more detailed market data, including power, natural gas and coal index prices,as well as forwards and futures, visitour Commodities Pages.