What are the main drivers of natural gas price and volatility?
Simply put, the primary driver in determining the price and volatility of natural gas pricing in the United States for decades has been storage:
- the amount of inventory available for higher demand periods to withdraw out of storage
- the amount of space left to inject into storage during periods of low demand
During the winter months, domestic demand exceeds supply during the average winter day, making storage a determining factor in price and volatility. This means that natural gas storage must be full enough to meet the demand during the winter. Likewise, domestic supply has historically exceeded domestic demand in the summer, allowing storage to fill up each summer to prepare for the next winter. The most recent EIA storage data for the week ending 7/31/2020 reported an injection of 33 Bcf placing nationwide storage at 3,274 Bcf, 601 Bcf (22.5%) ahead of the same week last year and 429 (15.1%) ahead of the five-year average and seen in the chart below (dashed line).
This high inventory level with 13 weeks left in the injection season supports why gas prices have been low since the end of winter with an average NYMEX monthly settlement price from April through August of $1.70/MMBtu. However, forward pricing for the winter (as of 7/30/2020) is well over a dollar higher, averaging $2.79 while calendar year 2021 is averaging a price of $2.695, a dollar higher than this summer so far.
So, if storage inventories are way ahead, why is pricing much higher this winter and through 2021?
Here’s where the simple way of looking at storage levels to gauge forward price risk gets complicated. Since the U.S. began exporting both natural gas (via pipeline and LNG) and crude oil, the potential impact to domestic storage no longer is determined by our own supply and demand, but rather the demand for oil and natural gas around the world. Making a forecast of storage levels headed into winter is somewhat predictable due to the short time frame (13 weeks of injection left) while the demand for natural gas this winter, the final inventory at the end of winter, and the supply/demand balance the summer of 2021 is much less transparent. One such forecast from Bloomberg is shown below and shows a scenario of anticipated storage levels through the end of 2020 (green line) and what storage levels would finish at the end of March 2021 (1,700 Bcf- Red ling). With much lower injections next summer, this would leave us headed into the winter of 2021-2022 at 3,400 Bcf, 900 Bcf lower than this winter.
Multiple factors play into this low storage balance headed into the winter of 2021 which the U.S. has little to no control over. Three of the biggest unknowns include:
- Weather – A hot August in 2020 could pull the starting winter balance down without requiring production to decline but a subsequent cold winter would place the end of winter balance even lower, putting a higher price risk through 2021. A mild remaining summer and another mild winter would reduce demand, reduce gas prices, and delay increases in supply into 2022.
- Crude oil prices – Most U.S. producers do not make money until the price for a barrel of WTI crude hits the $50-$60 range. Current forward price of WTI crude is in the $40-$46 range through 2024. Approximately 10-15% of all gas production is associated gas which comes from crude oil production. Absent an increase in crude production, this incremental associated gas is unlikely to make it out of the ground.
- LNG exports – In February 2020, LNG exports averaged 8.3 Bcf/day and 86.4% capacity utilization. Exports averaged only 3.33 Bcf/day (31% of capacity) for July. Current international gas prices do not pencil economically in the spot market nor in the forwards until October/November. Should international LNG prices become economical again for U.S. exporters in Europe and Asia, gas will again ramp up quickly via exports.
Simply put, the short-term price of natural gas is still linked to storage levels. The actual natural gas inventory status combined with the anticipated inventory status headed into or out of the winter season still drives natural gas pricing over the next 12-18 months. What has changed are the variables that impact how much storage is available for injection or withdrawal. The new world of external variables is here. It is important to realize the new risks that exist and develop a strategy that manages those variables based on the goals of your company. Please reach out to your Edison Energy Manager for a discussion on the options available.
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