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Is The Era Of Cheap Natural Gas Over?

Oct 11, 2016

 

Before there was a boom in oil production in the United States, the shale gas revolution led to massive flood of new supply, which sent prices careening downwards. Natural gas spot prices are always volatile, but have largely traded below $3 per MMBtu since 2014. With prices so low, companies pared back drilling plans and focused much more on liquids-rich and oil-heavy shale plays.

But a funny thing happened: instead of a subsequent crash in natural gas production as drillers pulled rigs from the field, output continued to rise, setting new records along the way. Part of that had to do with impressive advancements in drilling technologies and techniques, allowing companies to extract more gas for less money and with less effort. Another reason that gas output kept climbing was because a lot of gas is produced in conjunction with oil. The drilling frenzy for shale oil ensured that the gas kept flowing.

But the crash in oil prices put that to an end. Both oil and gas rig counts plunged, and natural gas production finally peaked in the U.S. and begun to decline. After hitting a high watermark in February 2016 at 92 billion cubic feet per day (Bcf/d), production has since shrunk by 5 percent. 

Meanwhile, on the demand side of the equation, the trajectory is only on the upswing. Years of low natural gas prices have led to a huge uptake in the electric power sector, hollowing out the coal industry, and leading to the construction of new gas-fired power plants at a frenzied pace. In years past, existing natural gas plants were simply used more, as low spot prices meant gas plants were cheaper to run than coal plants. But now an entirely new generation of power plants is coming online, which will ensure demand continues to rise into the future. The new plants are like a one-way ratchet, ensuring a structural increase in demand and not just a cyclical increase, as John Kemp of Reuters recently noted.

The U.S. has seen 25 gigawatts of new gas-fired electrical capacity added since 2012, bringing the gas fleet up to 448 GW. Another 11.5 GW will be commissioned by the end of next year as well. This is happening at the same time that utilities are rushing to shut down old coal-fired power plants, many of which have become unviable in a world with cheap gas and increasingly cheap renewable energy.

In short, the market for gas is seeing rising demand and falling supply, a recipe for a much tighter market. But that landscape is a 180-degree turnaround from what many analysts thought as recently as a few months ago. Last winter, mild temperatures led to lower-than-expected demand, and the record levels of production caused inventories to swell to levels not seen in years. On the heels of that incredibly bearish trend, prices dropped to their lowest point in nearly two decades in March. It was not hard to imagine several more years of rock-bottom prices.

But the most recent summer saw an unusual phenomenon play out, altering the expectations for natural gas prices. A time of year when inventories typically build, ahead of the annual spike in winter demand, the U.S. saw extraordinarily tepid increases in storage. That should not be surprising given that production began falling this year, but the weak summer storage build did catch the market off guard. Now natural gas prices have risen to $3/MMBtu for the first time in nearly two years. On Monday, during midday trading, Henry Hub was up another 2.6 percent to $3.28/MMBtu.

Things could grow tighter still as the same trends that led to the market to tighten are not going away: supply is falling, demand continues to rise (and will spike in the winter for heating needs), and storage levels are converging back towards average levels.

The era of sub-$3/MMBtu gas could be over for a while.

 

 

Cunningham, N. (2016, October 10). Is The Era Of Cheap Natural Gas Over? Retrieved October 11, 2016, from http://oilprice.com/Energy/Gas-Prices/Is-The-Era-Of-Cheap-Natural-Gas-Over.html