Before you continue reading, we strongly recommend that you review two of our previous articles -- "The Importance of the End-of-Season Storage Forecast" and "The Logic of This Injection Season" -- in order to understand the rationality behind natural gas analytics and trading.
In this article, we will present the results of our latest very long-term storage forecasting model (VLTSFM). Just like a standard end-of-season storage index, VLTSFM is a comprehensive cycle model based on multi-parameter inputs (see the diagram below).
Source: Bluegold Research
We have made two runs:
Modeled Weather. The weather forecast is derived from the latest 46-day ECMWF predictions on cooling and heating degree days + long-term CFSv2 model results + a hybrid of private models. Production is projected to rise to 73.3 bcf per day in August and to 75 bcf per day in December. Power plant outages are derived from the planned three-month schedule, then assumed to run at historical average. The exports and imports forecast is derived from pipeline nominations and vessels tracking (three-month forecast has 70% of certainty). After the third month, external trade variables are kept constant.
Normal Weather. This scenario assumes 10-year average number of total cooling and heating degree days. Supply side dynamics are the same as in the first scenario. As you can see from the chart below, under modeled weather scenario natural gas storage drops to just 204 bcf by the end of March 2018. And even under normal weather conditions, inventory is still projected to stay below 1,000 bcf mark.
Source: Bluegold Research
This is an exceptionally bullish forecast. What does it mean? First of all, it means that precisely because of its bullishness, this forecast will not materialize. That's not because the forecast itself is wrong, but because market participants will notice it in advance and will drive up the price of natural gas. Higher prices will lower demand in the midterm and stimulate the supply in the long term.
That's why today's price action in natural gas is an abomination. Lower prices will only exacerbate the situation and will result in an even more bullish long-term storage forecast. That's because lower natural gas prices will push the NG-coal spread lower and therefore will drive consumption in the electric power sector higher. Consumption in the electric power sector makes up the lion's share of total demand during the injection season (see this chart). Therefore, higher consumption in the electric power sector will increase aggregate demand and push storage flows lower. In addition, lower prices will discourage production. Indeed, according to Reuters, U.S. shale firms are now more exposed to falling oil prices.
In order to avoid a distressed supply situation in future, either natural gas prices should go higher or weather should cooperate. That means we need to get both: a cooler summer and a warmer winter. Higher production growth would also help, but it cannot be increased with a press of button. Given the latest forecasts and assuming that market wants to see 3,800 bcf in storage by the end of October 2017, we estimate the balancing price to be (at least) $3.30 per MMBtu in June and July.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.