Energy Update | December 17th, 2018

Energy Update
December 17th, 2018

Warmer Than Normal Temperatures Forecasted into Early January Cause Natural Gas Prices to Decline, But Risk of Another Explosive Rally Remains!  

(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 Nov 14^th Energy Report, I said the explosive rally in the first half of November was triggered by cooler than normal temperatures in November resulting in an already dire supply situation to continue to deteriorate and Natural Gas supplies were now projected to remain approximately 700 Bcf below the 5 Yr. Avg. by the end of November.

In today’s report, I update what has transpired since my last report and discuss why recent price decreases do not lessened the risk of another explosive rally this winter.

As you can see in the chart below, after rallying in early November due to cool weather prices have tumbled based on a warmer than normal forecast from now into early January:

The primary reason for the explosive rally in early November was we began the winter heating season with very low supplies and although warmer than normal weather forecasted into early January will help supplies draw closer to the 5 Yr. Avg., Natural Gas supplies will still be approximately 600 Bcf below the 5 Yr. Avg by the end of December. Although this is an improvement from where we were at the end of November, we will still be nearly 20% below the 5 Yr. Avg., and if colder than normal weather returns in January, Natural Gas prices will again likely skyrocket!

Therefore, I strongly recommend hedgers take advantage of the attractive rates in the forward markets from April 2019 and beyond, and the recent declines in this year’s winter rates have made immediate starts more attractive when you factor in the lower rates in the forward market.

This is evident when you look at the chart below:

As you can see in the above chart, prices starting in April 2019 even after the most recent declines are still far below present pricing. Also, as I explained in the Oct 31^st Energy Update, the above prices are not sustainable since E&P companies are not profitable when prices average below $3.00 per MMbtu. Therefore, I believe backwardation in the forward markets from Apr 2019 thru Apr 2022 in which prices average approximately $2.70 per MMbtu will likely lead to much higher prices in 2019 and beyond!

I believe the recent volatility we experienced over the last 2 months is a harbinger of a new paradigm in which structural imbalances in supply/demand will periodically result in explosive price increases similar to what we experienced from 2000 thru 2008 and I recommend securing long-term hedgers to protect yourself.

Finally, as I pointed out in in Nov 14^th Energy Update, based on the empirical evidence contained in the chart below:

90% of the time over the last 20 years, Natural Gas prices have been above $2.70 per MMbtu, and since I believe prices below $3.00 per MMbtu in the forward markets will inevitably lead to structural supply/demand imbalances, and higher prices, I trust you can appreciate the wisdom of securing long-term hedges to protect yourself from the likelihood of higher prices in 2019 and beyond.

Conclusions:

Mild weather forecasted into early January caused prices to tumble from near $5.00 per MMbtu to $3.60 per MMbtu as I write this report with a possible objective to fill a gap created in the chart from $3.31 to $3.43 per MMbtu in early November. Although the mild weather forecasted will decrease our supply deficit, we will still be nearly 20% below the 5 Yr. Avg., and if colder than normal weather returns in January, Natural Gas prices will again likely skyrocket!

Therefore, given the fact that prices in the forward markets from April 2019 thru Apr 2022 average approximately $2.70 per MMbtu and over the last 20 years, prices have been above $2.70 per MMbtu 90% of the time, I continue to believe it is wise for anyone with contracts expiring within the next 18-months to secure long-term hedges to protect themselves from the increasing risk of higher prices.

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
Energy Professionals
Senior Commodity Analyst