This post by Jeff Bolyard, Principal, Energy Supply Advisory, is featured in our May 2023 Monthly Monitor, which includes articles and analysis for the natural gas, electric, crude oil, and sustainability markets. To read the full newsletter, click here. To sign up for the Monthly Monitor distribution list, click here.
Economics classes in college help both students and energy traders understand that the supply/demand fundamental drivers of how commodities markets work could be summed up in one of two statements: The cure for high prices is high prices, or the cure for low prices is low prices.
For both statements, the theory is that markets will correct themselves, absent outside influences (another topic for another day), by increasing or decreasing supply or demand to change the price trend.
The current natural gas market falls into the low-price environment statement. While good news for natural gas buyers in the short term, the longer-term picture is beginning to perceive higher price risk as forecasts of production growth in the future are being adjusted downward. This is exactly where the natural gas market is today.
The chart below shows forward natural gas NYMEX pricing intervals, comparing forward pricing for June 2023 – December 2027 to August 2022 (orange line) and May 2023 (blue line).
In August 2022, the market was backwardated with pricing at multi-year highs in the near forwards but trending lower over time (dotted orange trend line). On 8/23/22, the Jun’23 – Dec’23 NYMEX averaged $5.79/MMBtu. Current forward prices on May 2, 2023 (blue line), were driven down by one of the warmest Q1 starts in decades, causing prices to drop over $3 to an average of $2.68/MMBtu for the same period.
Between these two time periods, production had also increased, and storage had flipped from a significant deficit to a surplus. However, as the chart shows, once you get past the next fifteen months, the prices have tightened, with the average price spread between these two intervals at just $0.39 by 2027.
This former backwardated market last summer flipped to contango (higher prices as time extends into the future). The picture of these two opposing trends is an indication that the market is sending fundamental signals that the current low-price environment is starting to correct itself. In other words, curing the current unsustainable low-price environment with very low prices in the short term should attract future investment once prices are high enough in future months.
The real question being asked is, “Does the market believe contango pricing in the forwards translates into enough production growth to meet the expected increased demand coming due to low prices?”
According to BNEF forecasts, natural gas production during the summer of 2023 should decline by 1.1 Bcf/day. For the upcoming winter of 2023-2024, BNEF anticipates a reduction of 1.75 Bcf/day compared to ’22-23 winter production levels from the previous forecasts. Similar forecast reductions of supply have recently been provided by the Energy Information Administration (EIA).
At the risk of sounding like a broken record, take what the market gives while it is giving if you don’t want to wait and see what the market will dish out next.
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