Energy Update | April 22nd, 2019

Energy Update
April 22nd, 2019

Natural Gas: The Longer It Stays Low the Higher It Will Go.

In my Apr 18th Energy Update, I said the demand for Gas and Electricity always declines in the spring and fall prior to increasing again during the summer cooling and winter heating seasons. Prices near cyclical and historical lows during “Shoulder Periods” are in most instances excellent buying opportunities and although it is possible prices could decline marginally from present levels, I recommended anyone with agreements expiring within the next 18-months not delay hoping for lower prices.

In today’s report, I explain why prices must go higher longer-term, and the longer prices remain near today’s very low levels the higher they will go in the future. To understand this premise, you must first understand the production of Natural Gas requires a large amount of ongoing capital investment (CAPEX). New wells must constantly be drilled to replace the huge volumes lost due to well depletions. When Natural Gas prices are high Exploration & Production companies have sufficient cash for the capital investment needed to drill new wells, but when prices are low, capital investment for new wells decline.

The 20-Year chart of Natural Gas below shows what has taken place when prices have fallen to near present price levels:

Since 2000, there were 3 periods when Natural Gas was below $2.50 per MMBtu for a few months, and as you can see in the above chart Natural Gas prices below $2.50 per MMBtu always preceded much higher prices for an extended period of time. This is not surprising since pricing this low force Exploration & Production (E&P) companies to lower their CAPEX leading to decreased production until prices increase.

Another factor pointing towards higher Natural Gas prices long-term is demand for Natural Gas is expected to continue increasing due to exports of Liquified Natural Gas overseas, increased pipelines to Mexico and switching from Coal to Natural Gas for electric power generation.

Low Natural Gas prices lead to the ominous combination of E&P companies decreasing CAPEX leading to less production, while low prices increase demand for exports and power for electric power generation. This combination has resulted in many E&P companies turning to debt for the capital needed to maintain production, and low prices are a threat to many E&P companies’ long-term survival. As reported in Haynes & Boone LLP, Oil Patch Bankruptcy Monitor, over the last 3 years more than 100 Oil and Gas and companies have declared bankruptcy from January 2015 through December 2018. In 2018, Oil and Gas bankruptcies involved nearly $13.2 billion in debt, which was up from $8.5 billion the prior year.

This is clear evidence that low Natural Gas prices are causing increased stress on production, which I believe in conjunction with increased demand for Natural Gas will inevitably lead to much higher prices long-term.

Conclusions:

Natural Gas and Electricity prices are near cyclical and historical lows during this year’s “Shoulder Period” and although it is possible prices could decline marginally from present levels, the longer they stay low, the higher they will go long-term. Therefore, I recommend anyone with agreements expiring within the next 18-months not delay hoping for lower prices, and reserve energy at today’s very low prices to be available when their present agreements expire. The upside risk is too great to justify waiting for slightly lower prices.

Not every client’s risk tolerance and hedging strategy is the same, but the above report will help you put into perspective the risk/reward opportunities. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Energy Professionals
Senior Commodity Analyst