This article is adapted from Edison’s Monthly Monitor Report – April 2020, a comprehensive assessment and analysis for the natural gas, electric, and crude oil markets. To download the complete report, please click here.
In the past month, the energy markets have gone crazy with unprecedented changes to energy commodity prices and impacts to traditional fundamental price movers. On March 5, after OPEC+ member Russia would not agree to discuss additional production cuts of crude, Saudi Arabia declared an all out price war by increasing production and slashing prices to their customers. The impact to U.S. based WTI crude was evident when the price on 3/5/20 opened prior to the OPEC meeting at $47.13 per barrel, plummeted for several days to an intraday low of $19.46/bbl on 3/20, then slightly recovered to close on 3/25/20 at $23.36, a 50% drop in just over 3 weeks! So shouldn’t one expect a similar free-fall reaction out of the natural gas market? The short answer is no, not really. As we wrote about in the Monthly Monitor last month, the profits from a barrel of WTI crude prior to the recent drop had allowed significant amounts of associated gas to be produced from oil wells and sold at minimal prices into an already oversupplied gas market. In other words, the price of gas does not really matter for many oil focused producers as long as the oil can be sold to cover the loss of natural gas sales. The chart below shows the price per MMBtu differential between crude and natural gas and tightening of prices between these two commodities from $9.73/MMBtu in July 2018 to $2.38 as of March 25, 2020.
Based on a conversion of 5.551 MMBtu per barrel of crude oil
Under this logic, if you take the profitability of crude away, the amount of associated natural gas would decrease, which would have a bullish impact on gas prices. This is playing out today in what the market anticipates happening. The gas market is very comfortable that winter demand is over, production is still high, storage is 863 Bcf ahead of year onyear and 292 Bcf ahead of the 5-year average for storage this time of year, so supply is plentiful near term. It is still early to know the actual impact COVID-19 has had on industrial demand across the country or how long it might last, but we know from both voluntary and state man-dated shutdowns that industrial demand is down and that power demand for natural gas is weak as well. Short term, the gas market is not just weak, it is way oversupplied. However, the impact of historically low near term prices of both crude and natural gas also means long term supply concerns for natural gas.
Ten oil majors including Chevron, Exxon, and Shell, recently announced nearly $30 Billion of capex cuts in the past few weeks due to the multi-year gas lows, now coupled with the recent crude drop. In an attempt to avoid bankruptcy, dozens of independent producers have also announced tens of billions of dollars of capex cuts after seeing their stock prices plummet from 50-90% since the beginning of the year. This concern is growing in the market as excess supply over the next several months gives to anticipated declines in production in Q4 2020 and into 2021.
Visually this is seen in the price spread between the April 2020 (oversupplied month with little demand) and the January 2021 (potentially undersupplied month with high demand). In the chart below, you can see that the spread growing significantly since early this month when COVID-19 reduced short term demand and sliding crude prices brought the longer term gas supply concerns into the mix. The Apr20-Jan21 price spread was just $0.55 back on January 10, 2020 and as of March 25, it had nearly doubled and blown out to $1.06. This gap should encourage large injections into storage starting in April and help mitigate a portion of the supply surplus short term. However, storage can only hold so much, so demand will need to bounce back in some form to prevent gas price weakness, especially in the spot and Q2 forward markets.
A truce to the crude oil price war could squeeze the winter / summer spread from further widening by increasing potential for associated gas from oil down the road. However, a quick end to the demand killing impact of COVID-19 on natural gas without a corresponding crude price increase would only exacerbate the growing concern that natural gas production declines would be in our future and growing the contango market that has already developed.