Extremely Hot Summer Causes Natural Gas Supplies to Remain Far Below Normal

(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.)

Three months ago, in my Apr 23^rd Energy Update, I explained the winter draw of supplies normally 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 we experienced cool weather well into April, thereby increasing heating demand for natural gas and supplies continued to decline into late April, which was unprecedented.

Every Thursday, the EIA, reports natural gas storage as of the previous Friday, and storage levels on Friday, April 20^th were 527 Bcf below the 5 Yr. Avg. At that time, I said projected increased production would help, but it would be difficult for supplies to approach the 5 Yr. Avg. by the end of October. Demand was increasing with exports to Mexico along with record shipments of liquefied natural gas (LNG) overseas were offsetting increases in production.

Also, I pointed out the single greatest factor causing demand for natural gas to increase was the generation of electric power. Electric power is the primary consumer of natural gas in the United States, and in previous reports I warned a warmer than normal summer would result in a significant shortfall of supplies prior to this year’s winter heating season, and the risk of higher prices this winter would increase.

Unfortunately, we have experienced very warm weather since the end of April and have not made headway in rebuilding supplies. Based on NOAA’s weather forecasts, I summarized below an estimate of natural gas supplies from July 20^th thru August 10th compared to the 5-Yr. Avg.:

By August 10^th natural gas supplies are expected to remain 516 Bcf below the 5-Yr. Avg.; therefore, supplies need to increase weekly 43 Bcf more than the 5-Yr. Avg. from Aug 10^th thru Nov 2^nd to return to the 5-Yr. Avg., which is a virtual impossibility.

But as I pointed out in last month’s report, the good news is due to a market phenomenon called “backwardation,” hedgers can secure rates below present levels in the forward market. Backwardation occurs when nearby contracts near-term sell at a higher price than contracts further out.

Below is a summary of the present backwardation in natural gas:

Present – $2.70 per MMbtu
Apr 2019 – $2.58 per MMbtu
Apr 2020 – $2.50 per MMbtu
Apr 2021 – $2.44 per MMbtu

The price of natural gas is lower in the forward markets, and astute hedgers understand the old proverb, “A Bird in the Hand is Worth Two in the Bush” is as true today as in the 16^th century and will benefit by reserving rates longer-term while they are below nearby rates, and not delay hoping for lower rates in the future.

This is especially true today when over the last 18 years rates were higher nearly 95% of the time over where they are presently in the forward market:

Conclusions:

This year’s extremely hot summer has caused an already tight natural gas supply situation to deteriorate further, and although no one can absolutely predict the future, with rates in the forward markets lower than where they were nearly 95% of the time over the last 18 years and supplies far below normal as we near the end of the injection season, we recommend hedgers secure rates now.

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