Does Hurricane Harvey Increase Risk of Higher Natural Gas Prices?

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

In today’s report, I discuss why I believe Hurricane Harvey increases the risk of higher prices both short-term and long-term.

 In my July 27^th Energy Alert, I explained why Natural Gas prices consolidated over the previous 2 months and why it was a harbinger of increased volatility, and why the upside risk of higher Natural Gas prices far exceeded the downside reward potential of lower prices.

 I pointed out after reaching the Spring 2016 low at $1.61 per MMbtu, Natural Gas quickly rallied to near $3.00 per MMbtu, but to date has not traded below $2.50. And since Bull Markets typically trade in a sequence of higher highs and higher lows, Natural Gas will likely not decline below $2.50 prior to trading much higher than its present pricing near $3.00 per MMbtu.

Below is the chart of Natural Gas contained in the July 27^th Energy Alert:

After writing the July 27^th Energy Alert, mild weather was forecasted for August, and Natural Gas declined briefly below the Consolidation Pattern formed the previous 2 months:

But as you can see in the above chart, after briefly declining early in August as shown by the red box, prices rallied and are consolidating again within an even tighter trading range. Tight trading ranges often precede large price movements; therefore, the risk of a large move continues to increase, and based on the factors delineated in my July 27^th Energy Alert, the upside risk of higher Natural Gas prices still far exceeds the downside reward potential of lower prices.

In this context, I will now explain why Hurricane Harvey increases the risk of higher Natural Gas prices both short-term and long-term.

Prices are determined primarily by supply/demand factors, and Hurricane Harvey will impact both supply and demand. Demand for Natural Gas will decline in the short-term as homes and businesses directly affected by the storm cannot use Natural Gas until repairs are completed for the delivery of supplies. But I believe the decline in the supply of Natural Gas will exceed the decline in demand.

Hurricane Harvey might result in the greatest flood disaster in the history of our nation, which not only has led to massive destruction of homes and businesses, but will shut-in Natural gas wells for weeks, if not months. Texas produces approximately 25% of our nation’s Natural Gas, and the shut-in of production for an extended period will decrease Natural Gas production regionally and support higher prices nationally.

In previous reports, I warned we are experiencing structural supply/demand imbalances, and supplies were expected to end this year’s injection season below the 5-year Moving Average; thereby limiting the downside risk of lower prices.

The lost production caused by Hurricane Harvey’s flooding will likely drive Natural Gas storage even further below the five-year average before winter, which will not only support higher Natural Gas prices in the short-term, but if we end the injection season substantially below the 5-year moving average, the risk of higher prices long-term will also increase.

In my July 27^th Energy Alert, I pointed out the similarities between now and what took place prior to the winter of 2013/14. The chart below reflects those remarkable similarities:

As you can see present trade action of Natural Gas is amazingly like what took place prior to the explosive rally in the winter of 2013/14, and it is important to note, prior to the winter of 2013/14, Natural Gas ended its injection season with 3,834 Bcf in storage. If the shut-ins caused by Hurricane Harvey lead to our ending this year’s injection season far below the 5-year moving average, we will also end the injection season below the injection levels prior to the winter of 2013/14. Therefore, although past trade action does not guarantee future results, the risk of higher prices this winter is significant and should not be ignored.

Conclusions

Damage directly to homes and businesses caused by Hurricane Harvey will decrease the demand for Natural Gas short-term, but I believe the decline in the supply of Natural Gas will far exceed the decline in demand. Texas produces approximately 25% of our nation’s Natural Gas, and the shut-in of production for an extended period will decrease Natural Gas production regionally resulting in a net loss of supplies. The net loss of supplies caused by Hurricane Harvey increases the risk of higher prices short-term and long-term as we enter the winter heating season with supplies far below the 5-year moving average.

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