CHICAGO, ILLINOIS - CIRCA 1999: Panoramic view of Chicago Mercantile Exchange in Chicago, IL

Current Trends in North American Trading in Natural Gas

by kirkcoburn
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What is happening with natural gas trading in North America right now? Well, these days, it’s anybody’s guess — COVID-19 has sent the global economy into a recession that’s teetering on a depression, and crude oil prices have dropped to the point that traders were actually selling oil at a loss to avoid having to store the unwanted glut. Prices for natural gas took a tumble, too. But energy analysts and executives are somewhat bullish on the natural gas sector making a decent comeback in Q2 and Q3 ahead of colder weather — unless they see an absolute cratering in demand and are on the bear side.

 2020: An Energy Rollercoaster

Just before COVID-19 and the ensuing global recession took center stage in mid-March, energy news was hyper-focused on the production wars between Russia and Saudi Arabia — both countries were pumping out oil in an already-glutted market, leading to a historic fall in crude prices.

The international market is flooded with both oil and natural gas as a result of fracking in the US — our “energy independence” has put a great deal of downward pressure on prices, to the point that OPEC agreed to limit production as a hedge against further price drops.

This stabilized the energy markets pretty well until several weeks ago, when Russia decided to ignore OPEC’s request to lower production in response to the pandemic. Geopolitical experts opined that Russia’s position was not to annoy the Saudis and take away their market share (that was just a bonus), but a shot across the bow to hurt US shale producers.  Saudi Arabia upped the ante by a cool ten million barrels a day, and voila! Six weeks later, traders are literally selling barrels of oil at a loss to avoid storage headaches.

The mid-April agreement to slash production by close to those ten million barrels a day, spread among OPEC and OPEC plus countries alike, stabilized prices somewhat, but the pandemic has just about halted demand. Energy companies in North America have shuttered, slashed budgets, and laid-off workers. With demand for jet fuel, gasoline, and diesel fuel practically non-existent during the shutdown, even energy giants like Exxon Mobil have shrunk their 2020 budgets for exploration and production.

The US Energy Department estimates US oil production will fall by about two million barrels a day by the end of the year. But independent analysts say it’s more likely to be three million out of the 13.3 barrels produced in January.

How Do Crude Production Shutdowns Affect Natural Gas?

empty highway to Los Angeles during the COVID-19 outbreak

Demand is disappearing relative to supply all over the energy sector — including in natural gas.

North America, led by the US, has faced an oversupply of natural gas for years. The fracking (hydraulic fracturing) boom of the early 2000s meant cheap natural gas, and lots of it.  Adding to that, almost half — 40% — of the natural gas produced in the US is “associated” gas, or a byproduct of drilling for oil.

When companies stop drilling for oil, gas production stops, too. And like crude, there is a lot of natural energy in the continental inventory, be it natural gas, liquefied natural, or shale gas — adding to a global oversupply.

Natural Gas Pricing Pre-Corona Was Kind of a Bust

The hard reality is that oversupply in the US natural gas markets have been trading at depressed levels for years. Before the Corona outbreak, trading hung around below $2 per million British Thermal Units (MMBtu) in the middle of winter, which is generally peak demand season for heating fuel.

Initial worries about the Corona impact caused the price to bottom out at about $1.50 per MMBtu, the lowest level since 1995.  Early April prices had rebounded, if you could call it that, to $1.80 on the NYMEX Henry Hub benchmark.

The Bullish Side

If you can’t rely on data and analysis to figure out trading, there’s always the possibility of a force majeure to force your hand. A couple of days ago, on May 4th, an explosion at the Texas Eastern Transmission Co. (Tetco) pipeline (no injuries were reported) in Kentucky saw higher prices in trading Tuesday morning — the June NYMEX contract price was up a dime to $2.102/MMBtu before trading started. So the potential for supply disruptions and price spikes is always there, but not something to count on.

But back to the supply and demand portion of the program, where we discuss Econ 101, that high demand and low supply make for higher prices, and how those two factors look going into the second half of the year.

Yes, North American inventory is top-heavy, and production is at a near-standstill. There are experts who still believe that gas will recover much faster than oil. The gas data firm Enervus predicts that production will fall from the current levels of roughly 95 billion (with a B) cubic feet (Bcf)per day to around 90 Bcf by year’s end.  This would eat into the surplus fairly quickly, so that gas markets would shorten up considerably by the coming winter.

Going out further on that positive limb, Enervus projects prices to just about double, from the current $2/MMBtu to over $4/MMBtu. The real bullish analysts over there are saying $4.50, but that’s just crazy talk. Maybe. If dwindling supply does create more demand, Enervus sees more incentive for drilling and production growth in shale gas places like the Marcellus, Utica, and Haynesville basins.

Goldman Sachs, never one to miss a carcass-picking party, is also hinting at a tighter market in natural gas as production falls and demand picks back up. Their analysts look out further than Enervus into summer 2021, where they forecast supply levels hitting some sort of equilibrium after the topsy-turvy insanity of 2020. On the other hand, Goldman isn’t quite as bullish as Enervus, suggesting prices will top out at $3.50/MMBtu by the winter.

A Silver Lining …of Sorts

Low gas prices have been a drag on the commodities markets for years, and if prices were to double, that would be a huge feather in the industry’s cap (not to mention all the jobs that would come roaring back).  This didn’t make a lot of news, but the oversupply at the Permian Basin has gotten so bad that they burned off the gas at the wellhead.  On May 5th, several producers at the Basin agreed to more cuts in production.  A natural gas burn is the last resort for an oversupplied market as it’s expensive and environmentally harmful, so this week’s strategic cuts should eradicate the need for additional burns.

The bear side of the market is a little more nuanced than the simple economics of the projected coming of the bulls. Again, the reality bites. Traditional energy companies — Exxon Mobil, Chevron, BP, and the like — have billions in untapped carbon-based reserves either underground or underwater.

Wall Street refers to these as “stranded assets” — reserves that will never be recovered and which have led to investment firms’ bear attitude towards traditional energy companies. Carbon energy has been in a five-year bear market against a decade-long rally for almost every other industry in the world, and the collapse of demand from the Corona pandemic hasn’t improved the overall outlook.

So, will natural gas go the way of newspapers and department stores (at the moment, Neiman-Marcus is a breath away from bankruptcy), or will it be the easy default option when the economy opens again?

A point in natural gas’s favor is that research and development into renewable source hasn’t fared well during the pandemic. R&D money for clean energy is hard to come by on a good day, and tanking stocks for oil giants and environmentally conscious VC funds hasn’t exactly filled the coffers of the mad scientists.

Genscape’s senior analyst Rick Margolin is at least a baby bear on the natural gas markets. He is forecasting overall growth for 2020 but a decline for 2021.

“Though we still expect Cal 2020 to post overall year/year growth from Cal 2019, by September we expect to see the first signs of same-month year/year declines, and winter 2020/21 will show declines to winter 2019/20,” Margolin said. “Our Cal 2021 production forecast has been revised down exponentially more, by about 5.6 Bcf/d from previous. At current forward curve prices, there are a handful of prominent basins whose rig counts are projected to drop to zero.”

Adding to this projected decline in production, Margolin projects a substantial drop in demand from permanently closed businesses, as well as shuttered school districts.

The Long and Short of Natural Gas Trading

Natural gas could easily be in the enviable position to lead the broader post-COVID energy sector.  If, as Enervus predicts, gas prices double in the next year, that will have a tremendous impact on the overall viability of the US oil and gas industries. Independent producers make up 83% of domestic oil output, but they comprise an even larger share of gas production. Energy in the US is an industry that employs over 4.5 million people, and getting those folks back to work will make energy a leading player in the broader economic recovery. And this is a conversation we can continue in the comments or if you message me from here.

What does this have to do with venture capital and the opportunities in natural gas as an entrepreneur? Stay tuned. I will fill in the pieces.

My final words of advice? Buy low. Sell high. You heard it here first.

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