US natural gas stocks are at their lowest level since 2005, leaving the market easily spooked by spells of cold weather as the injection season draws to a close at the end of October.
‘The purpose of the market is to make sure you don’t run out of gas and don’t freeze anyone. The odds of violating that cardinal rule are higher than they’ve been for years,’ said Eric Fell, Senior Gas Analyst with Genscape last week.
“Wildly bullish’ weather over the injection season left inventories much lower than normal at the start of the summer, with only around 3.2 tcf in the ground at the end of the season compared to the five-year average of 3.7 tcf. Strong demand growth in the power sector driven by coal retirements and a record hot summer, as well as increases in exports to Mexico and feedgas LNG terminals, consumed the bulk of the surge in production, which was held back in some areas by pipeline constraints. Genscape calculates a record season-on-season increase of 8.7 bcf/d in supply and 8.4 bcf/d in demand.
Some basis dislocation has resulted, notably in the Permian region which is bumping up against constraints, and at Sumas due to a West Coast pipeline rupture. But prices this winter will remain primarily driven by temperature. ‘Weather is the 800lb gorilla that trumps everything, especially when storage is so low,’ Fell said.
And yet despite the dwindling reserves, prices at key benchmark Henry Hub in Louisiana are stubbornly clinging to the lower end of a $3 handle. The Energy Information Administration (EIA) is predicting average Henry Hub prices of $3.20/mmBtu from December to February, up 8% from last year. But the devil is in the detail, as the market will be very sensitive to supply bottlenecks and even a moderately cold winter.
‘Volatility isn’t dead, it’s just been sleeping and is about to awaken again here in the US,’ one trader said.
Basis, the difference between the price at US locations compared to Henry Hub, is higher than last year in many places, suggesting "a market expectation that both regions may face pipeline transportation constraints this winter," FERC's Office of Enforcement (OE) said in its 2018-2019 Winter Energy Market Assessment. Regional price bumps should not be a surprise, as last year highs of more than $100/mmBtu were seen in the Northeast with a record of $175/mmBtu for a single next‐day transaction. New pipeline additions have eased access to the Marcellus and Utica shale regions and major gas producers Antero Resources, EQT Corporation, and Cabot Oil and Gas are accelerating well completions this autumn, which might muffle the bullish impact of lower temperatures.
‘US production is on pace to continue breaking records through the winter and Criterion is bullish on production, despite pullbacks by some operators in the Northeast who are unable to reap the benefits of higher prices due to their hedging positions. New pipeline developments are already allowing incremental volumes to flow out of the Northeast, allowing producers to reach new markets,’ said James Bevan, at Criterion Research (see charts below).
When the cold bites, a key determining factor will be the price sensitivity of growing structural demand, and whether it will ramp down in response to spikes.
‘Essentially, the market seems to be thinking of coal and LNG as rather elastic, and therefore forms of virtual gas storage. But at what prices will coal come back into the market, or liquefaction ramp down?’ writes Amber McCullagh in RBN’s daily gas blog.
Cove Point offtakers GAIL and the Sumitomo/Tokyo Gas joint venture might decide to curtail LNG exports and sell gas back in the domestic market if Transco rockets like last year, said Nina Fahy, Head of North American Natural Gas at Energy Aspects. But Cheniere’s Corpus Christi and Sabine Pass cargoes are priced off Henry Hub monthly futures, which will not move nearly as dramatically as the day-ahead markets. And Mexico, which didn’t shut off any gas last year other than for an operational flow order, has no gas storage so is a price-taker, she points out.
‘Given pent up demand, a string of continuing delays to Mexican domestic infrastructure and only a few days’ worth of demand cover in LNG storage tanks, rather than in traditional aquifers, we still anticipate another 0.4-0.5 bcf/d year-on-year growth in Mexican pipeline trade this winter. That is likely to cross the border no matter the price.’
So should buyers sit tight and fasten their seatbelts to ride out short-lived turbulence or take evasive action by buying calls?
‘Considering the potential for both higher and lower prices, volatility seems cheap and long option strategies seem to offer attractive risk/reward potential,’ says Kyle Cooper of Ion Energy. ‘It’s still determined by Mother Nature… Still incredibly sensitive to temperature.’
The National Oceanic and Atmospheric Administration (NOAA) expects warmer-than-normal conditions across much of the northern and western US and an El Nino event in the next few months, making the region more susceptible to severe weather outbreaks.
While inventories are low, unless the forecasts for a mild winter are wrong, the US will have adequate supplies for the winter and the worst-case scenario is likely to be short-lived regional spikes with occasional recourse to falling back on coal generation or to a lesser extent, delaying LNG exports.
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