Natural Gas Settles Near Multi-Month Low Ending Three-Week Rally
Natural gas prices finished the week lower by 27.3c to $2.137/MMBtu, erasing all of last week’s gains. Price is trading near the bottom of a multi-month range where it has been unable to move considerably higher or lower since February. Gas prices fell across the curve, with the Winter ‘23/’24 strip off by 14c to $3.442/MMBtu and the Summer ’24 strip down 12c at $3.263/MMBtu.
Consistent oversupply continues to plague the market, with production holding near all-time highs and weather-driven demand at a seasonally low level. Our calculation of the weather-adjusted supply and demand balance, which removes the effect of weather, continues to show the market averaging 2-Bcf/d oversupplied. This condition of oversupply has been present since the fall of 2022 and, apart from a few data points, has only shown a looser-than-normal market. With LNG feedgas volumes near total capacity, one of the only ways for the market to balance itself will be through increased gas burns in the power sector which requires low gas prices.
In the news this week, it was reported that the state of New York has passed a statewide law banning the installation of natural gas appliances in new construction. The law will take effect in 2026 for buildings shorter than seven stories and taller buildings in 2029. While the law exempts critical infrastructure, restaurants, and manufacturing facilities, it does not allow local or county governments to override it. Several cities across the US have instituted similar bans, although this is the first to be enacted on a statewide level.
AEGIS recommends hedging summer months using swaps and winter months using costless collars. A swap will provide more protection, while a collar will allow for participation in any potential upside. The reason for utilizing a costless collar in the winter months is due to elevated levels of call skew or the relative expensiveness of call options to put options, which allows for a higher floor price in the collar.
To see details on factors we believe are affecting gas prices and trade recommendations, click the "Read More" button on the Factor Matrix section in the AEGIS Research Module.
Natural Gas Factors
Price Trend. (Bearish, Mostly Priced In) Gas posted an 11% loss this week. June '23, gas lost 27.3c week-over-week to settle at $2.137 MMBtu. Moderate weather, in addition to fluctuating power demand and storage levels, have been the primary factors affecting the price trend this past week.
S&D Balance. (Bearish, Priced In) The weather has been the focus of gas prices for months, but we estimate that the weather-adjusted S&D means the market is slightly loose. Lower usage due to warm weather was a factor in causing a drop in demand. This week's inventory report (build of 54 bcf) helped push the storage to a surplus of 341 Bcf to the five-year average. Furthermore, the bearish weather forecast, compounded with less power demand, could increase the surplus.
Weather. (Neutral, Neutral) Bearish weather has been a major driver in prices this year. Despite the freeze-off in late December, January through March was the hottest since the early 2000s. The cold pattern in the Eastern US and west of the Rockies is subsiding, with below-average temperatures expected to reappear around May 19. While the central US will experience warmer weather, the West will remain cooler than usual. Average weekly temperatures are expected to rise over the next two weeks, each reaching new seasonal peaks. As temperatures become milder, demand across the Lower 48 is expected to weaken over the next two weeks.
Storage Level. (Bearish, Priced In) The storage level is a mostly bearish priced-in factor because, under normal weather conditions, a tight S&D balance could lead to a lower end-of-winter storage number than expected. But recent bearish weather and less-than-expected inventory withdrawals could decelerate the storage levels. Relatively smaller withdrawals and an unexpected build have pushed the storage levels to the five-year average to a 341 Bcf surplus. Before warm weather struck in August and September, the market generally agreed that the gas S&D was tight and that we could see a supply shortage by the end of the winter season. While those concerns have abated, January-March weather (bearish) could cause the end-of-season inventory number to be nearly 400 Bcf above the five-year average as the withdrawal season progresses.
Coal Availability. (Bullish, Priced In) Global coal prices remain high, making it harder to switch from coal to gas. The war in Ukraine was the major factor behind this change, and Europe is trying to secure a substitute for Russian coal because of the sanctions. A lower coal supply means less substitution potential. This should continue to support gas. Coal prices have been on the rise in the past month and have surged by nearly 50%, and that coincided with the relatively lower gas prices is a bullish factor for gas-fired power generation.
Power. (Bullish, Surprise) As gas prices have declined, it should be supportive of increased coal-to-gas switching. We are seeing signs of this as coal's share of the power stack has declined relative to natural gas. This is one of the largest bullish factors and one of the main ways that the market can deal with oversupply.
Dry Gas Production & Associated Gas Production. (Bearish, Surprise) These are the most critical drivers of gas prices outside of weather. A material increase in either would pressure prices lower and loosen the supply-demand balance. These are also longer-lasting factors that can weigh on prices for years. Production was on the rise heading into year-end, mirroring the late push observed in 2020, particularly in the Appalachia, Haynesville, and Permian. Producer discipline, takeaway capacity constraints in some basins, and gas prices will likely drive production growth moving forward. The recent weakening in Waha forward prices may be a market signal that associated gas production could grow and face takeaway capacity constraints in 2023.
Supply Chain Constraints. (Bullish, Surprise) Several pipelines responsible for carrying gas from the Permian basin to other demand centers are currently running at limited capacity. If these constraints persist through this year, when Permian output is expected to rise, they will act as a bullish factor since they limit the takeaway capacity from Waha to Henry Hub. Additionally, U.S. producers are struggling with supply chain disruptions, such as a shortage of workers, and equipment, a scarcity of sand for fracking operations, and high metals prices, to take advantage of increased global demand and high oil prices. These constraints could influence driving the prices up.
Kinder Morgan's Permian Highway pipeline, which was expected to be operational in November 2023, will now be delayed until December. The company cited supply chain constraints as the reason for the delay. This announcement led to a surge in trading activity in both the Waha and Houston Ship Channel basis markets.
LNG. (Bullish, Priced In) LNG feedgas demand has consistently exceeded 12 Bcf/d since the start of December 2021. As consumers avoid Russian fuel, demand for U.S. LNG is surging, reviving several long-stalled U.S. export projects. However, these projects will not be operational until at least 2024. Sabine Pass's Train 6 and Calcasieu Pass have finished construction and started operating in 2022. There is going to be a lull in new feedgas demand until ExxonMobil's Golden Pass facility comes online in 2024. The export arbs to Europe and Asia remain wide open with other global benchmark prices at near-record levels. Feedgas levels in April 2023 reached a record high close to 15 Bcf/d, as Freeport LNG has ramped up to full capacity.
Renewables. (Mostly Bearish, Priced In) Renewables remain a perennial threat to gas prices and gas's share of the power stack. Renewable capacity additions in 2023 are expected to set a new record and are now the second-most prevalent source of electricity generation. Still, renewables have proven unreliable at times, which has exacerbated the global energy squeeze as gas usually serves as a flex-fuel when other sources underperform. We think this is priced in, but the effect at the summer peaks on gas generation has some bearish potential. Supply chain constraints have escalated lately, with crucial solar materials, including polysilicon, steel, aluminum, semiconductor chips, copper, and other metals, becoming scarce and expensive.
Hedging. (Bullish, Surprise) Extreme volatility has driven great uncertainty and resulted in changes in how producers and consumers execute and plan their hedging strategies. Over the past year, we have seen trends in hedging volumes that showed producers not hedging as much when the prices are high. Our data suggests the industry is underhedged compared to historical levels, despite the bearish/neutral sentiment related to the lack of demand growth. Hence, we believe this factor to be a bullish and volatile one.
Commodity Interest Trading involves risk and, therefore, is not appropriate for all persons; failure to manage commercial risk by engaging in some form of hedging also involves risk. Past performance is not necessarily indicative of future results. There is no guarantee that hedge program objectives will be achieved. Certain information contained in this research may constitute forward-looking terminology, such as “edge,” “advantage,” ‘opportunity,” “believe,” or other variations thereon or comparable terminology. Such statements and opinions are not guarantees of future performance or activities. Neither this trading advisor nor any of its trading principals offer a trading program to clients, nor do they propose guiding or directing a commodity interest account for any client based on any such trading program.