Energy Update | March 18th, 2019

Energy Update
March 18^th, 2019

Natural Gas Supplies Near Historic Lows As We Approach The End Of The Winter Heating Season.

In my Feb 25^th Energy Update, I explained why it was not surprising Natural Gas held above long-term support near $2.50 per MMBtu, but recent price action might be signaling Natural Gas could trade below long-term support and if it did it would insure much higher prices for an extended period of time. As you can see in the chart below, Natural Gas continues to hold above long-term support near $2.50 per MMBtu:

In today’s report, I explain the possible ramifications of Natural Gas supplies ending the winter heating season near historic lows. The winter heating season ends near the end of March and is followed by the injection season running from April thru October. Supplies need to be rebuilt during this period to prepare for the next winter heating season. This year supplies are projected to end the winter heating season near a historic low approximately 34% below the 5 Yr. Avg.

Clearly since supplies are starting the injection season far below average, they will need to be rebuilt at a much higher rate than normal. As I explained in my last report, Natural Gas is not much higher at this time because it is assumed production increases will be sufficient to quickly rebuild supplies when mild weather arrives in April and demand decreases.

But the problem with this assumption is although heating demand will decrease during the spring, export demand for Liquified Natural Gas overseas, and Mexico due to increased pipelines are expected to continue increasing, and the low price of Natural Gas versus Coal is an incentive to use Natural Gas as a power source for the generation of Electricity.

In Sept 2018, I warned although prices remained relatively stable since the beginning of the year, it was not wise to become complacent and count on increased production handling demand this winter with supplies starting the winter heating season at historically low levels.

As you know prices this winter didn’t remain stable with prices increasing to near $5.00 per MMBtu in November. In subsequent reports, I warned the dramatic price increases this winter are likely a harbinger of a new reality in which structural imbalances in supply/demand will periodically result in explosive price increases and I recommended securing long-term hedgers as protection.

Therefore, as we close this year’s winter heating season with historically very low levels of supplies, I am again warning not to become complacent and count on increased production being sufficient to rebuild supplies quickly when mild weather arrives in April. No one knows with any certainty how quickly supplies will be replenished, but one thing is certain, if prices decline from present levels it will likely insure much higher prices for an extended period of time. I based this conclusion on the empirical evidence contained in the 20-year chart of Natural Gas below:

Natural Gas is the largest source of power for the generation of electricity; therefore, they follow similar cyclical patterns primarily due to supply/demand factors. When prices are high, producers are motivated to increase production, and demand declines until prices collapse. Conversely, when prices are low, suppliers are motivated to decrease production and demand increases until prices spike higher. Since 2000, there were 3 periods when Natural Gas was below $2.50 per MMBtu for a few months, and as you can see in the above chart Natural Gas prices below $2.50 per MMBtu always preceded much higher prices for an extended period of time. This is not surprising since suppliers cannot generate profits when prices are this low, which is why prices were above $2.50 per MMBtu 95% of the time.

This historical perspective should help you understand why, based on present cyclical and historical price patterns, the upside risk is substantial at this time. When your cost of Natural Gas or Electricity is not hedged you are short these markets. Do you really want to be short when a market has been higher 95% of the time over the last 20 years? If your answer is, “No”, then you know why we recommend hedging your cost of Natural Gas and Electricity at today’s very low historical price levels.

Conclusions:

Natural Gas and Electricity prices are near cyclical and historical lows and although it is possible prices could decline marginally from present levels, I recommend anyone with agreements expiring within the next 18-months not delay hoping for lower prices, and reserve energy at today’s very low prices to be available when their present agreements expire. The upside risk is too great to justify waiting for slightly lower prices.

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