Energy Update |Oct 27, 2020

Are Natural Gas Structural Supply/Demand Imbalances Increasing the Risk of Higher Prices?

In my Aug 31^st Energy Update, I said the Energy Information Administration’s (EIA’s) forecast of decreased Natural Gas production from declining active Oil and Gas rigs and increased demand from recently completed Mexican pipelines and Liquified Natural Gas exports would result in structural imbalances and increase the risk of higher Natural Gas prices long-term.  

In my Sept 29^th Energy Update, I said If the EIA’s forecast was correct, then seasonal pullbacks during “Shoulder Periods” were buying opportunities. The chart below reflects how Natural Gas traded after reaching its Fall low on Sept 21^st:

In my Sept 29^th Energy Update, I also said we were likely in the early stages of a cyclical bull market; therefore, it would be wise to take advantage of seasonal declines to secure fixed rates. Shoulder periods occur in the Spring and Fall when demand for Natural Gas and Electricity are low between the Summer cooling and Winter heating seasons.

It is common for cyclical lows to occur during Shoulder periods and as expected Natural Gas rallied off its Spring low, but the rally was cut short by the Covid-19 shutdowns resulting in decreased demand and a retest of its Spring low on June 26^th. But as you saw in the above chart, Natural Gas has sharply rallied off its Fall low.

The question is, is there empirical evidence the Structural Imbalances forecasted by the EIA are now in place and increase the risk of higher prices going forward?

Each week, the EIA releases a storage report reflecting the amount of Natural Gas in storage. As we approached the Winter heating season, it appeared we enjoyed a surplus of Natural Gas and enough to meet our winter heating demand. But as you can see in the tables below, Natural Gas’s surplus measured in Bcf, is beginning to decline versus the 5-Year Avg:

On Oct 2^nd, Natural Gas supplies were 12.0% above the 5-Year average, but two weeks later the surplus was 9.1%. And the surplus is expected to decline further the next three weeks:

Natural Gas’s surplus appears to be evaporating declining from 12.0% to 5.5%. over five weeks from 10/02 thru 11/06.

Although no one can predict exactly where prices will be in the future, the following is a list of five risk factors that may lead to higher prices.

1. Year-over-year, we have 70% less active Oil rigs and 45% less Gas rigs; therefore, the EIA is forecasting Natural Gas production will be sharply lower this Winter and into 2021.
2. In 2016 when active Oil & Gas rigs were this low the average price of Natural Gas and Electricity were higher the next 3 years.
3. Demand for Natural Gas is highest during the Winter; therefore, if we experience a colder than normal Winter, prices would likely be much higher.
4. The possibility a ban on fracking by a new administration would lead to decreased production and increased prices.
5. The uncertainty of PJM Capacity Auctions being delayed that could result in higher supplier prices.

The above list of risk factors is the basis of my recommendation for anyone who has not already secured a fixed Natural Gas or Electricity rate, do so as soon as possible.

You may hesitate locking in rates now because they are higher than where they were a few weeks ago. But hopefully after looking at the 5-Year Natural Gas chart below you will appreciate the wisdom of securing rates now and not delay hoping for lower rates later on:

As I pointed out in the list of five risk factors, in 2016 when active Oil & Gas rigs were as low as today, the average price of Natural Gas was higher the next 3 years. In 2016, those who secured long-term fixed rates in the early stages of the cyclical bull market paid less than those who delayed hoping for lower prices that never arrived!

Conclusions:

Over many years of trading, I learned past performance does not guarantee future results, but based on the EIA’s long-term production and demand estimates we will likely experience Natural Gas supply deficits in 2021, increasing the risk of higher prices long-term. Therefore, I recommend securing fixed rates prior to the winter heating season. My concern is the longer you delay, the more you may pay later.

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