Natural gas prices are sharply up as cold weather is set to sweep much of the country, putting a strain on already low storage levels.
We are heading into the winter season with natural gas inventories at their lowest level in 15 years. Natural gas inventories stood at 3,143 billion cubic feet (Bcf) for the week ending on October 26, or about 623 Bcf lower than at this point last year and 638 Bcf below the five-year average.
As the chart shows, natural gas inventories ebb and flow with the seasons – drawing down in the winter as American households crank up the heat, and rising again in warmer months as demand slows.
This year has been an interesting one for gas markets. U.S. production continues to break records, with surging output in the Marcellus and Utica shales, as well as skyrocketing gas production in West Texas as Permian drillers pull out gas along with crude oil.
However, higher levels of gas exports in the form of LNG, higher power burn in gas-fired power plants for electricity, and higher demand for gas in petrochemicals and other industrial uses have all led to structural increases in demand. Add to that the seasonal factors – hot temperatures this summer, which stretched into fall, and now, a coming blast of cold weather. In many parts of the country, autumn seemed a little shorter than usual, sandwiched between a long summer and a rapidly approaching winter.
Tight inventories and a bout of cold weather led Henry Hub natural gas prices to jump at the start of November by nearly 8 percent. In fact, prices jumped $0.28/MMBtu on November 5, the largest daily increase in two years. At $3.50 per million Btu (MMBtu), natural gas spot prices are up 15 percent in the past two months, and they are also at their highest level since last January.
The price increases are magnified by the low inventory levels. At 15-year lows, the small buffer has left the market rather jittery.
“A hint of cold weather fueled another big leg-up in the ongoing gas market rally, which does not appear to need much prodding to stoke further enthusiasm,” Barclays said in a note on Wednesday.
The volatility will probably carry through much of the winter, and a cold snap could even send prices up to as high as $5/MMBtu, Bank of America Merrill Lynch argued in an October report.
However, that is not guaranteed. Above-average temperatures this winter are also possible, which would do the opposite to the market – relieving it of pressure and sending prices back down. “But beware the weather-driven risk premium in natural gas markets, as the price support it yields can disappear just as quickly as it emerged,” Barclays warned. “[T]he weather effect should cut both ways, and the market is prone to a downside correction should weather turn warm again.”
The bank noted that last winter, an Arctic blast left much of the country frozen, and record consumption led to soaring natural gas prices in January and early February. Fears of inventories falling too fast kept prices high, but the weather quickly turned warmer, “with short-sleeved shirts being worn on the streets of New York and Boston in mid-February,” Barclays pointed out. Gas prices fell back from over $3.60/MMBtu to just $3/MMBtu in a matter of days.
The same could happen this winter. Moreover, the higher gas prices rise, the more utilities switch to other sources of generation, including coal. That also undercuts demand on gas, relieving some of the market pressure. “Our analysis shows that gas-fired power plants are out of the money versus Powder River Basin coal-burning steam units by a wide margin and have been since the spring. To compete, gas prices would have to fall to about $2.75,” Barclays said.
The investment bank acknowledged that bullish sentiment has taken hold in the near-term, largely unavoidable because of the low inventory levels. But the bank also argued that some of this is “transient,” and that surging natural gas production should restore supplies in the coming months.
As is always the case, the gas market is at the mercy of Mother Nature to a large degree. But, what makes this year different from last year – or even several years prior – is the fact that inventories are at a 15-year low. That leaves a lot more upside risk.