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Energy Update | 2 February, 2021

Is Natural Gas Backwardation an Opportunity to be Protected Against New Administration’s Sweeping Actions on Climate Change? https://youtu.be/vb0TOshGjgw In my

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Is Natural Gas Backwardation an Opportunity to be Protected Against New Administration’s Sweeping Actions on Climate Change?

In my Jan 25th Energy Update,  I said backwardation in Natural Gas’s forward market was an excellent opportunity for hedgers to secure rates far below the EIA’s forecasted rates for the next two years, and below where they have been over the last 20 years when prices were as low as they were in 2020.

natural gas market graph

In today’s report, I will address how proposed energy policies by the new administration will likely impact production and why it would be wise to take advantage of backwardation in Natural Gas’s forward markets.

Last week, President Biden signed an executive order directing the secretary of the Interior Department “to pause on entering into new oil and natural gas leases on public lands and offshore waters to the extent possible” while beginning a “rigorous review” of all existing fossil fuel leases and permitting practices. President Biden also directed federal agencies to “eliminate fossil fuel subsidies as consistent with applicable law.”

We are not sure which subsidies will immediately be stripped away under this order, but it is clear the Biden administration is committed to eliminating fossil fuel subsidies and he will ask Congress to end subsidies through legislation. This may take time but given the Biden administration now controls both houses of congress the elimination of Oil and Gas subsidies in favor of renewable subsidies appears baked into the cake in the not-too-distant future.

The question is, how will eliminating fossil fuel subsidies effect Natural Gas and Electricity prices? The production of Natural Gas depends upon drilling new wells on a regular basis. The average Natural Gas well’s production drops precipitously after the first year and new wells must constantly be drilled to maintain total production. The cost of drilling new wells is extremely expensive and without subsidies, the exploration and production of Natural Gas will inevitably decline, and lower Natural Gas supplies will result in higher Natural Gas and Electricity prices.

That is the bad news, but the good news is as I explained in my Jan 25th Energy Update, backwardation in Natural Gas’s forward market is offering hedgers an excellent opportunity to secure rates below the EIA’s forecasted rates for the next two years, and now below where prices will likely be based on the new administration energy policies.

Conclusions

No one can predict exactly where Natural Gas and Electricity prices will be over the next three years, but based on the following three facts prices will likely be higher than where they are today:

  1. The EIA’s forecast of higher Natural Gas prices in 2021 and 2022.
  1. Over the last 20 years whenever prices were as low as they were the last year, they were always higher at least three years.
  1. The Biden administration’s pause on new Oil and Natural gas leases on public lands and offshore waters along with asking Congress to end subsidies through legislation will inevitably lead to higher Natural Gas and Electricity rates.

Therefore, based on the above facts, I believe backwardation in the forward market is an excellent opportunity for hedgers to secure rates below where they will likely average over the next three years. Weather factors as always will influence the direction of energy prices near-term but based on the EIA’s supply/demand estimates and Natural Gas’s historical pricing over the last 20 years, the downside reward potential of lower prices short-term is minimal versus the upside risk of higher prices long-term.

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

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