Natural Gas Update
Two weeks ago I wrote about the abnormal situation with natural gas inventories in Natural Gas Inventories are Headed Toward Zero. I got a number of questions and comments about that essay, and since then we now have another two weeks of inventory data, let’s update the picture.
First, I want to deal with some misconceptions that a few people had. I don’t think we are going to run completely out of natural gas in storage. My point was that this winter marked the sharpest decline trajectory and we have made the largest ever withdrawals from storage in history, and barring a sudden warm spell we are going to go into injection season with very low natural gas inventories.
This has implications. Why? Because historically a significant deviation of inventories from normal will have a lingering impact on natural gas prices.
To address the second misconception, that doesn’t mean I believe natural gas is going to be $10/MMBtu for the rest of the year. It could spike to that level briefly, and has already spiked above $8/MMBtu twice (February 5th and 10th), but this is not my thesis. Natural gas prices have pulled back somewhat in recent days, leading one person to essentially say to me on Twitter “See, you were wrong about natural gas prices. They are pulling back and will probably settle in between $4 and $5 for the year.”
My Point Exactly
But you see, that’s exactly my point. Nobody was talking about $5 natural gas six months ago. Previously I highlighted some reasons I believe that gas is going to trade up into the $5-$6 range over the next 3 to 5 years, and I did predict higher natural gas prices for this year. But those predictions are based on long-term drivers. One thing I said when I predicted higher natural gas prices for this year was that short-term weather events can override these long-term drivers. Even though I foresee $6 gas in 5 years, that won’t be a straight trajectory. A very warm winter could have dropped gas prices below $4 for the rest of the year, and I would have been wrong in my prediction (even though I think I am right on the long-term drivers).
Instead, we have seen an extremely cold winter, so the long-term AND short-term factors are both lined up in the direction of higher natural gas prices. Thus, instead of seeing gas between $3 and $4 this year, we are going to see natural gas over $4, and I am 99 percent sure now my prediction for the year will end up correct.
The Latest Inventory Report
So where do things stand? Today the Energy Information Administration (EIA) released its latest Weekly Natural Gas Storage Report covering inventories through the week ending 03/07/14. Previously I had written that we were on track to drop below 1 trillion cubic feet (tcf) of storage at the end of February, but the week I wrote that it warmed up a bit and we had a light draw from storage. The most recent week the draw was relatively large, and that left the country just a hair over 1 tcf (1.001 tcf to be exact) — and 49 percent below the level at this time last year.
Right now, the draw down over the winter stands at 2.8 tcf — the largest withdrawal ever recorded. During the lowest inventory level on record — the 2002-2003 winter — the draw down was 2.5 tcf. In 2002 inventories started out at 3.2 tcf, while our present winter inventories started out at 3.8 tcf. Had we started the present winter out at the same point as that winter 10 years ago, we would be literally out of gas in storage this week or next week.
Projecting the Future
As it stands, inventories will still be uncomfortably low for the rest of the year. Yes, we will begin to strongly build inventories within the next month, as we do every year. But my point has been that we do so from such a low starting point that we will probably be below the average for the rest of the year. The EIA has just published a new Short-Term Energy Outlook that highlights exactly what I have been saying:
The EIA projections are that we will have a negative deviation from the average not only going into the winter of 2014-2015, but all the way until the winter of 2015-2016! The inventory situation could normalize if next winter is abnormally warm, but if we have a normal winter inventories will still be lower than average all winter, and if we have a winter resembling this one we are going to be looking at natural gas prices north of $10/MMBtu.
Conclusions
In 2013 the average closing price for Henry Hub natural gas was $3.73/MMBtu. I predicted the average would be higher this year, and as a result of the very cold winter I think it’s a pretty sure thing at this point. I would guess we will end up averaging something like $4.50/MMBtu for the year, which is money in the bank for many natural gas producers. In fact, the latest monthly Short-Term Energy Outlook (STEO) released Tuesday by the EIA projected the average for 2014 at $4.44/MMBtu, which is 6 percent higher than their forecast from February’s STEO.
I don’t think the market has priced in the likelihood that the natural gas inventory picture is going to be tight for quite some time. Some natural gas producers have even sold off recently, even though I think they will have stronger financial performance than a year ago (even if their production is flat). It could be a good time to go bargain hunting.