Natural gas prices are back in the doldrums after a brief rally this winter. Output is high and demand is tapering off as spring weather arrives across the U.S. And there’s a genuine risk that prices could fall even further, depending on the weather this summer. What does it all mean for energy producers and investors?
Natural Gas Prices: Apocalypse Soon?
Gas prices are in the basement. At $1.86 per million British thermal units (MMBtu), the benchmark futures contract is back near the lows it reached last December, when an unusually mild start to winter quashed heating demand throughout much of the country. February saw gas futures tumble all the way to $1.64 per MMBtu, the lowest closing price in 17 years. The average rates paid by homeowners, manufacturers and power plants are also trending lower.
And spring is unlikely to bring much relief for gas producers. The arrival of mild weather marks the start of the “injection season,” when heating demand subsides and excess gas production goes into underground storage for later use. This year, that process will begin with gas stockpiles still elevated compared with their seasonal average because of the relatively mild winter of 2015-16.
At the beginning of winter, which was shaping up to be a warm one, we did some back-of-the-envelope calculations and figured that gas stockpiles might fall to about 2.4 trillion cubic feet (TCF), which would be far higher than normal. Last week, the Department of Energy estimated that stockpiles will indeed bottom out around that level by late this month. By comparison, stocks fell all the way to 1.5 TCF last spring, after the much colder winter of 2014-15.
Bulging spring storage levels mean the gas glut could reach epic proportions later this year. If gas demand stays week during spring and summer, there is some chance that energy producers might run out of physical space to store their surplus output. According to the DOE, the U.S. has enough storage capacity to hold somewhere between 4.3 TCF and 4.7 TCF of gas. In other words, available storage will already be half-full at the start of injection season and could approach its limit by the time cold weather returns in the autumn. If there’s even a risk of storage overflowing, gas prices could plummet from today’s already depressed levels.
Demand: Heating Up?
Only a jump in gas demand looks capable of giving prices any lift this summer. Normally, you would expect low prices for a commodity to curtail new production and bring the market back into balance. But U.S. gas output remains resilient, even as the number of rigs drilling for gas continues to drop. Energy firms continue to drill more efficiently, extracting more gas per well as they race to cut costs amid low prices. The DOE estimates that gas output will hold pretty steady this year, increasing by a bit less than 1% from last year’s record high.
Demand could soar if the summer of ’16 turns out to be a scorcher. For the first year on record, natural gas will generate a larger share of the nation’s power than coal will. (A decade ago, King Coal accounted for half of all generation.) So when the mild temperatures of spring give way to summer heat, more of the nation’s air conditioners will be running on electricity supplied by gas-fired plants than ever before.
An average summer probably won’t suffice to stoke up natural gas prices. Bentek Energy reports that from November 2015 through February 2016, the U.S. electric sector increased its gas consumption by 17% compared with the same period a year ago. Returning to our back-of-the-envelope math, we figure that if that trend continues this summer, power plants will burn an extra 785 billion cubic feet of gas. That still wouldn’t be enough to keep gas stockpiles from swelling to about 4.2 TCF by autumn — a record high, and perilously close to the nation’s maximum gas storage capacity.
But a brutally hot summer would send demand for gas into overdrive, keeping stockpiles from ballooning too much. If power plants have to burn 20% more gas this summer than last to keep up with electricity usage, stockpiles would probably only reach about 4 TCF: close to their record peak in 2015, but manageable. If gas usage jumps by more than 20%, stockpiles will fall short of the 4 TCF mark, which could be bullish for prices.
Forecasting the weather three months in advance takes a lot of guesswork. But for what it’s worth, the National Weather Service’s Climate Prediction Center sees warmer-than-average temperatures across the entire continental U.S. for the months of June, July and August — exactly what it will take if gas prices are going to stage any sustained rebound this year.
A Word on Oil Prices
Crude oil isn’t waiting for the weather: It’s already rallying. After hitting a low of about $26 per barrel in February, benchmark West Texas Intermediate (WTI) has climbed back to $40 per barrel. Many analysts attribute the price appreciation to recent talk from OPEC and other big oil-exporting countries about a possible production freeze to tackle the output surplus that has been weighing on oil prices for almost two years.
We had been expecting a bit of a rebound for oil, figuring that WTI would return to a trading range of $35 to $40 per barrel sometime this spring. But we wouldn’t rule out yet another price plunge at some point. Even if OPEC, Russia and other oil exporters agree to keep their output steady, global production will continue to outpace global demand. And while output in the U.S. is starting to decline, the drop has been small so far. So crude continues to pile up in storage.
Until oil inventories start dropping, WTI will struggle to mount a sustained rally. If stockpiles keep growing, the same fears stalking the natural gas market about running out of storage space could infect oil traders, too.