Cool Spring Tightens Natural Gas Supplies, But Natural Gas Has Not Rallied, Why Not?

(My reports focus on Natural Gas as it is the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity are highly correlated.)

In my Mar 12^th Energy Update, I said the average temperature in March would be cooler than normal, and supplies would end the winter heating season at the upper end of the previously estimated 15% to 20% range below the 5 Yr. Avg. In today’s report, I discuss the ramifications of cooler than normal weather continuing into the middle of April, which further tightened supplies, and why a Natural Gas rally has been delayed.

Normally the winter draw of supplies ends by the end of March and the injection season (building supplies for the next winter heating season) runs from April 1^st thru Oct 30^th. But this year very mild weather in March continued into the first half of April, thereby increasing heating demand for Natural Gas and the supply situation worsened. Every Thursday, the EIA, reports the amount of Natural Gas in storage as of the previous Friday.

Based on NOAA’s present weather forecast for the first half of April, below is a summary of estimated Natural Gas supplies from March 30^th thru April 13^th compared to 5 yr. Avg.:

As you can see in the summary above, Natural Gas supplies are expected to decrease until April 13^th, which is unprecedented, and supplies will be approximately 25% below the 5 Yr. Avg. The deficit of 450 Bcf below the 5 Yr. Avg. is the lowest storage level for this time of the year since the spring of 2014, which clearly increases the risk of higher prices during this year’s injection season.

But as you can see in the chart below, after holding above long-term support on Feb 15th near $2.50 per MMbtu, Natural Gas has traded within a tight trading range:

Why have prices not increased substantially with supplies at such low historic levels? I believe the answer lies in one factor, the belief record increases in production will allow supplies to quickly increase and be close to the 5 Yr. Avg. by the end of October.

But while it is true production is expected to increase to a new record in 2018, I believe, demand factors will potentially offset most of the increased production. Exports of United States Natural Gas continues to increase with pipelines to Mexico providing additional growth along with record shipments of Liquefied Natural Gas overseas. But the single greatest factor is increased demand of Natural Gas for the generation of Electric Power. Electric power is the primary consumer of Natural Gas in the United States. Natural Gas annually provides more than 30% of the energy needed to generate electricity, and most importantly during the injection season Natural Gas’s share for the generation of Electricity increases to nearly 50%.

The primary reason for increased Natural Gas usage for the generation of Electricity is the decline of Coal. Coal usage is declining because it is no longer price effective versus Natural Gas and Coal and Natural Gas prices are continuing to move in opposite directions with the relative price of Natural Gas near a record low versus Coal prices. Therefore, Coal-to-Natural Gas switching is expected to increase further, and any short-term decline in Natural Gas would likely accelerate switching of Coal-to Natural Gas, thereby increasing the demand of Natural Gas, and inhibit the ability of Natural Gas supplies to return to where it needs to be by the end of October leading to higher prices long-term.

As I have explained in previous reports, Natural Gas prices are low from a long-term perspective, and a buying opportunity for hedgers, especially when supplies are substantially below the 5 Yr. Avg., which can be fully appreciated by reviewing the chart below:

Although near-term, prices could decrease slightly due to the belief record production will allow supplies to return to where they need to be prior to next winters heating season, but if they do, I believe it would support higher prices long-term as demand factors would offset most of the increased production and result in higher prices. Therefore, since Natural Gas prices are very low from a long-term perspective, I believe hedgers would be wise to secure Natural Gas and Electricity near present price levels.

 Conclusions:

Cool spring weather will cause Natural Gas supplies to be approximately 25% below the 5 Yr. Avg. by mid-April, which will be the lowest storage level for this time of the year since the spring of 2014, and clearly increases the risk of higher prices during this year’s injection season.

Short-term Natural Gas could decline slightly, but if it does, it would result in accelerated switching of Coal-to Natural Gas, thereby increasing the demand of Natural Gas for Electric Power and inhibit the ability of Natural Gas supplies to return to where they need to be by the end of October resulting in higher prices long-term.

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

Ray Franklin
North American Energy Advisory
Senior Commodity Analyst