Natural gas prices shot up by more than 16 percent in recent days, pushed higher by colder temperatures.
As is the case in the crude oil market, the bust in natural gas has now seemingly come to a close. The recent uptick in prices is the result of larger trends and not just a short-term reaction to a cold snap. While prices wallowed beneath $2/MMBtu a year ago, analysts now say they should hold above $2.50/MMBtu for the foreseeable future.
Market tightens
U.S. natural gas production topped off in late 2019, not coincidentally coinciding with a sharp decline in prices, which bottomed out around $1.50/MMBtu. Bloated inventories and low prices hollowed out the market, while the crash in crude oil prices also pushed down associated gas production. The dual busts forced Permian oil and Appalachian gas drillers alike to scrap rigs.
By late 2020, however, things started to tighten up. More gas-fired power plants have structurally increased consumption with each passing year, replacing shuttered coal plants (although gas is facing a rapidly growing threat from renewable energy). Exports of liquefied natural gas (LNG) resumed in the second half of 2020 – after a barrage of cancellations in the second and third quarters – diverting some supply abroad.
Those ingredients set the stage for the recent price jump, sparked by a cold snap. But transient weather aside, analysts think the slightly higher prices are here to stay.
In a recent note to clients, Goldman Sachs said that prices will have to increase even further in order to prevent a storage crunch next winter. Because demand is steady and production has not returned to the 2019 peak, inventories could drain lower than in recent years. The current path regarding inventories has the market facing “a sizable deficit ahead of next winter,” Goldman analysts wrote.
If prices track what they are currently trading for on the futures market – with Henry Hub below $3/MMBtu during the upcoming summer months – then the U.S. is facing a “600+ [billion cubic feet] deficit” by the start of winter heating season in November. “As a result, we maintain our view that higher US gas prices are needed this coming summer to lower expected demand and increase expected supply in order to take end-Oct21 and end-Mar22 storage to more comfortable levels,” the investment bank concluded.
Translation: Natural gas prices are likely heading higher. Goldman Sachs forecasts natural gas prices averaging $3.25/MMBtu in the summer.
The bank also said that incremental production increases would likely come from the Haynesville shale, rather than Appalachia. Haynesville drillers have been price sensitive, increasing output in the second half of 2020. Meanwhile, Appalachia is bottlenecked with several pipelines facing delays. The Mountain Valley Pipeline, a high-profile project to send Marcellus shale gas to the southeast, has run into a thicket of legal problems. Its completion has been delayed, and there is an outside chance that it gets permanently sidelined.
Higher prices, but upside limited
The return of $3 gas appears reasonably likely, but Goldman analysts cautioned that production remains as one of the big uncertainties in its forecast. Specifically, the recent rise in crude oil prices could spark more drilling in the Permian basin, bringing more associated gas online. That could cap the price rally. It’s a weird quirk in U.S. energy markets these days when high oil prices are a negative force for natural gas.
At the same time, it remains to be seen if higher prices can turn the finances of Appalachian shale companies around. Last year was a rough one for shale drillers, but their financial woes long predated the pandemic. An uptick in prices won’t suddenly result in a windfall, but it may stop the bleeding. Likewise, if E&Ps respond to higher prices by recklessly returning to aggressive drilling, a familiar wave of red ink may quickly return. The scars from a decade of debt-fueled drilling may prevent such a return to old ways.
While the prospect of more supply is one factor that could limit a sustained increase in prices, another is the fact that competitors start to eat away at gas demand once prices rise past a certain threshold. Utilities can lean harder on beleaguered coal plants, for example. A report from Bank of America Merrill Lynch says that the volume of gas burned in power plants would be 1 billion cubic feet per day (Bcf/d) lower in the summer if prices are $3.10/MMBtu rather than $2.65/MMBtu.
In the longer run, these seasonal dynamics and minor price changes are a sideshow. Renewables are set to eliminate coal and increasingly take market share away from gas. A new report from Morgan Stanley predicts the complete zeroing out of coal from the U.S. power sector by 2033, replaced mostly by the rapid growth of solar and wind. The investment bank predicts that renewables will account for 39 percent of the power grid by 2030 and 55 percent by 2035.
However, the Biden administration has a goal of making the power grid 100 percent renewable by 2035. While that remains a tall task, the trajectory is clear. The writing has been on the wall for coal for years; but the demise of natural gas from the power grid is becoming increasingly visible as well, just over the horizon. Market conditions increasingly favor this path. A federal policy push will solidify it.
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