January 2018, Vol. 245, No. 1
Features
Are Natural Gas Prices Ready to Explode?
American natural gas prices are at their lowest since February. As I write this in mid December, Henry Hub is off 11 cents to $2.79 per thousand cubic feet (or million BTUs), having lost 8.8% in value for the week and 12% for the month.
The reason is simple: overall demand is coming in lower than the same time in 2016. But that’s not going to last for much longer. There is a major catalyst in the natural gas market that could soon send prices through the roof in 2018.
Natural Gas Price Squeeze
The reason why American natural gas prices have plummeted boils down to two issues:
nAn excess of supply;
nAnd unusually warm weather.
Most of the retreat is tied to the supply side. Expectations by year-end indicate that natural gas demand will be down 3% with production up 7%. In a nutshell, that is the reason for the pricing squeeze.
Yet here is where it gets interesting. Quarterly natural gas production estimates have been trending downward lately. Analyst projections average 77.1 Bcf/d in December and January, lower than the 84.6 bcf/d expected for the figures through Dec. 15. We are moving toward a supply balance deficit of slightly less than 40 Bcf/d. This is the first negative physical balance since mid-March.
The wildcard is now the weather. Assuming we have a normal winter, there should be a base forming to support a slow rise in price from about $3 per 1,000 cubic feet. However, this also has a downside. A stable floor at $3 will encourage some new drilling (since it is marginally profitable in many drilling basins at that price). But that doesn’t mean there aren’t bullish indicators for American natural gas prices going forward. Actually, it’s quite the opposite.
A Bullish Case for Natural Gas
Now, both factors I mentioned (volume in the market and the weather) are expected to provide an improving environment for rising prices. In addition, drawdowns are increasing from storage, another factor that should stimulate market price, and exports of both pipelined and liquefied volume, are up more than 20% year-on-year.
In fact, according to the EIA, aggregate weekly figures for national demand have been sitting above a nine-year average since late February. We also have to consider that takes longer to factor in the impact on supply from actual changes in drilling.
There are two overriding reasons why. First, at least 80-85% of natural gas drilling expenses are front-loaded. An operating company has already spent the bulk of its funds before lifting anything out of the ground. Bottom-line considerations oblige that the volume moves into the market to defray expenses even if the price is declining.
Second, primary production flow – especially from shale and tight gas formations – occurs in the first 18 months. Thereafter, a reduced but continuing flow still takes place. That assumes the company decides not to re-frack wells. Both occur because recovery of investment is necessary virtually regardless of the market pricing that exists.
But there is another piece of the puzzle we have to factor in – liquefied natural gas (LNG) exports. New LNG demand is emerging across the board. We’re talking about everything from LNG export consignments, electricity, industrial use, and vehicle fuel, all of which points toward an uptick in demand moving forward. And right now, there is one country in particular that is proving even hungrier for U.S. LNG than expected.
The Red Dragon’s Natural Gas Dependence
When we look at China, natural gas prices have been skyrocketing. The domestic market prices are strictly regulated by the government, but the cost to supply is generating a widening deficit and increasing regional shortages.
Unlike the U.S., China is dependent on imports to satisfy the local gas demand. An acute supply/balance problem obliged Beijing to order that eight regions “regulate” surging gas prices amid winter-heating demand and the switch to gas from coal.
According to a National Development and Reform Commission (NDRC) official, the eight regions are the leading natural gas-producing regions of Shaanxi, Inner Mongolia, Xinjiang, and Sichuan, as well as the biggest gas-consuming regions Hebei, Jiangsu, Liaoning, and Beijing.
Chinese traders are buying up LNG cargos on the spot market, pushing spot prices higher than the prices of the oil-indexed LNG cargos in the long-term delivery contracts. Post-regasification wholesale LNG prices in Inner Mongolia last month were as high as 7,750 yuan ($1,172) per ton (equivalent to $24.06 per 1,000 cubic feet) and 8,050 yuan ($1,217.35) per ton ($25.00 per 1,000 cubic feet) in Shaanxi.
Price increases, according to the Jiangsu-based LNG price monitor market, ranged between 7.6-11.8% in a single week. As a result, Asia’s LNG spot prices have risen to their highest since January 2015 due to the Chinese demand and strong oil prices. Further, Chinese LNG imports between January and October (the most recent available) are significantly up, having soared 47% compared to the same period last year, according to Platts.
Initial shipping data for November indicate that Chinese LNG imports hit a record in November, exceeding the 4-million-ton level for the first time ever.
Ultimately, China expects to meet its expanding natural gas and power needs by exploiting the world’s largest shale gas reserves. That will be a boon to U.S. providers of services, technology, and expertise. As demand continues to accelerate, especially as Beijing increasingly moves from coal to natural gas for electricity production, China will be increasingly relying on LNG imports.
Therein lies a very interesting, and potentially lucrative, U.S.-China trading venue.
Author: Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment.
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