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Tuesday, March 21

"Natural Gas Prices Could Plunge Below $2"

By Nick Cunningham
March 14, 2017 - 5:57 PM CDT
Oil Price

" ... the side-effect of the shale comeback is an uptick in gas production."

So far this year, natural gas has performed the worst among major commodities, posting painful losses in January and February. It has rebounded somewhat in the last few weeks, but hovering around $3 per MMBtu, gas prices are still sharply lower compared to the fourth quarter.

Changes in seasonal temperatures are a pivotal factor for natural gas markets, and warmer winters mean weaker demand. Natural gas consumption spikes during winter months as millions of people crank up the heat, while consumption patterns descend into valleys in the spring and fall, with a smaller peak in the summer. A bout of warm weather during winter can upend gas demand forecasts.

And that is exactly what happened this year. According to NOAA, the U.S. just posted its second warmest February on record, dating back to when data collection began in the 19th century. Average temperatures were 7.3 degrees higher than average.

Heading into winter, natural gas analysts expected colder temperatures to help draw down on record high inventory levels. But it wasn’t to be. After mild temperatures swept across the continent for long stretches of February, natural gas spot prices crashed below $2.50/MMBtu by the end of the month, down more than a third compared to December highs.

The kicker was a shocking injection in natural gas storage levels in the last week of February – the first February increase in storage levels ever recorded. The surprise uptick in inventory levels threw demand projections off track, and it suggests that natural gas markets are heading back into a period of oversupply. Gas bulls might have hoped that prices would stay above $3/MMBtu and head towards $4/MMBtu, which would help gas drillers across the country, but that looks unlikely for the near- to medium-term. The unexpectedly weak drawdown season puts inventories back above long-run averages (see blue line in chart).

[CHART]

Prices have firmed up more recently as a result of a cold snap, pushing prices back to $3/MMBtu. But with winter coming to an end in the next few weeks, demand will plummet. As March comes to a close, “injection season” begins, pushing inventories back up for the rest of the year.

But there are some signs that things could actually get much worse for gas markets. According to the EIA’s new Drilling Productivity Report, gas production could jump by more than 1 percent in April, with output gains coming from the Permian Basin (+154 million cubic feet/day), the Marcellus Shale (+167 mcf/d), the Haynesville Shale (+108 mcf/d) and even the Eagle Ford (+43 mcf/d). Many of these shale basins saw production decline over the past year, so a rebound is notable – and very bearish for gas prices. The combined increase of 562 mcf/d will push gas production from the top shale basins to an all-time high.

In fact, while there is a lot of media attention surrounding the resurgence in U.S. shale oil, with a sharp rise in rig counts and a rapid rebound in production, the side-effect of the shale comeback is an uptick in gas production. Natural gas is typically produced in conjunction with oil – when oil comes out of a well, gas comes along with it. Thus, the production of “associated gas” is set to rise substantially because of the new interest in oil drilling, not necessarily because of an enormous appetite for gas drilling. So even if prices remain low, gas production should continue to ramp up.

In one startling prediction, Tudor Pickering Holt & Co. believes that natural gas production in the Permian region will rise by 25 percent, a rather staggering growth rate, but considering the drilling frenzy underway there for oil, maybe that shouldn’t come as a surprise. But the spike in gas production could send prices below $2/MMBtu, Tudor Pickering analysts say. Permian gas could come on top of an expected rise in output from the Utica and Marcellus shales in Pennsylvania and Ohio, where more pipeline capacity should open up new flows of gas to mid-Atlantic and Northeast consumers.

“It’s a real risk that a year from now that prices could be below $2,” Brandon Blossman, a managing director at Tudor Pickering Holt, said in a Bloomberg interview. “You have this unfortunate confluence of Permian production ramping right into the teeth of a lot of new takeaway capacity in the Northeast.”

It was only a few months ago that predictions of $3 to $4 gas seemed like the consensus estimate, but it is not out of the realm of possibility that gas trades 50 percent lower than that in the coming year.

[END ANALYSIS]

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