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Why the U.S. Natural Gas Price Squeeze Is On Its Last Legs

by | published December 8th, 2017

American natural gas prices are at their lowest since February.

As I write this, Henry Hub (the primary confluence of pipelines in northern Louisiana at which the NYSE daily futures contract price is pegged) is off 11 cents to $2.79 per thousand cubic feet (or million BTUs), having lost 8.8% in value for the week and 12% for the month.

The reason is simple: overall demand is coming in lower than this time last year.

But that’s not going to last for much longer.

You see, there is a major catalyst in the natural gas market that could soon send prices through the roof in 2018.

Here’s how…

Natural Gas Price Squeeze

The reason why American natural gas prices have plummeted boils down to two things:

  • An excess of supply;
  • And unusually warm weather.

Most of the retreat is tied to the supply side.

Expectations by year-end indicate that natural gas demand will be down 3% with production up 7%.

In a nutshell, that is the reason for the pricing squeeze.

Yet here is where it gets interesting.

Quarterly natural gas production estimates have been trending downward lately.

Current analyst projections average 77.1 billion cubic feet/day (bcf/d) in December and January, lower than the 84.6 bcf/d expected for the figures through Friday of this week.

We are moving toward a supply balance deficit of slightly less than 40 bcf/d. This is the first negative physical balance since mid-March.

The wildcard is now the weather.

Assuming we have a normal winter, there should be a base forming to support a slow rise in price from about $3 per 1,000 cubic feet.

However, this also has a downside.

A stable floor at $3 will encourage some new drilling (since it is marginally profitable in many drilling basins at that price).

But that doesn’t mean there aren’t bullish indicators for American natural gas prices going forward.

Actually, it’s quite the opposite.

A Bullish Case For Natural Gas

Now, both factors I mentioned above (volume in the market and the weather) are expected to provide an improving environment for rising prices.

In addition, drawdowns are increasing from storage, another factor that should stimulate market price, and exports of both pipelined and liquefied volume, are up more than 20% year-on-year.

In fact, according to the EIA, aggregate weekly figures for national demand have been sitting above a nine-year average since late February.

We also have to consider that takes longer to factor in the impact on supply from actual changes in drilling.

And there are two overriding reasons why.

First, at least 80-85% of natural gas drilling expenses are front-loaded.

An operating company has already spent the bulk of its funds before anything comes out of the ground.

Bottom-line considerations oblige that the volume moves into the market to defray expenses even if the price is declining.

Second, primary production flow – especially from shale and tight gas formations – occurs in the first 18 months.

Thereafter, a reduced but continuing flow still takes place. That assumes the company decides not to re-frack wells.

Both take place because recovery of investment needs to occur virtually regardless of the market pricing that exists.

But there is another piece of the puzzle we have to factor in – liquefied natural gas (LNG) exports

New LNG demand is emerging across the board.

We’re talking about everything from LNG export consignments, electricity, industrial use, and vehicle fuel, all of which points toward an uptick in demand moving forward.

And right now, there is one country in particular that is proving even hungrier for U.S. LNG than expected…

The “Red Dragon’s” Natural Gas Dependence

When we look at China, natural gas prices have been skyrocketing.

The domestic market prices are strictly regulated by the government, but the cost to supply is generating a widening deficit and increasing regional shortages.

Unlike the U.S., China is depended upon imports to satisfy the local gas demand.

An acute supply balance problem obliged Beijing earlier this week to order eight regions “regulate” surging gas prices amid winter heating demand and the switch to gas from coal.

According to a National Development and Reform Commission (NDRC) official, the eight regions are the leading natural gas producing regions of Shaanxi, Inner Mongolia, Xinjiang, and Sichuan, as well as the biggest gas-consuming regions Hebei, Jiangsu, Liaoning, and Beijing.

Chinese traders have been buying up LNG cargoes on the spot market, pushing spot prices higher than the prices of the oil-indexed LNG cargos in the long-term delivery contracts.

At the beginning of this week, post regasification wholesale LNG prices in Inner Mongolia were as high as 7,750 yuan ($1,172) per ton (equivalent to $24.06 per 1,000 cubic feet) and 8,050 yuan ($1,217.35) per ton ($25.00 per 1,000 cubic feet) in Shaanxi on Monday.

Price increases, according to the Jiangsu-based LNG price monitor market, ranged between 7.6% and 11.8% in a single week.

As a result, Asia’s LNG spot prices have increased to their highest since January 2015 due to the Chinese demand and strong oil prices.

Further, Chinese LNG imports between January and October of this year (the most recent available) are significantly up soared 47 percent compared to the same period last year, according to Platts.

Initial shipping data for November indicate that Chinese LNG imports hit a record in November, exceeding the 4 million ton level for the first time ever.

The previous monthly record had been 3.7 million tons set in December last year.

Yet, even with surging LNG imports, Chinese regions in the north have been experiencing shortages in gas supplies for weeks.

According to media accounts, there was rationing of natural gas last week Hebei, the industrial province Hebei surrounding Beijing.

Ultimately, China expects to meet its expanding natural gas and power needs by exploiting the world’s largest shale gas reserves.

That will be a boon to U.S. providers of services, technology, and expertise.

As demand continues to accelerate, especially as Beijing increasingly moves from coal to natural gas for electricity production, China will be increasingly relying on LNG imports.

Therein lies a very interesting, and potentially lucrative, U.S.-China trading venue.

Which is something we’ll look to target here at Oil & Energy Investor.

Sincerely,


Kent

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