Natural Gas: Oversupplied But Underprepared For Winter

Includes: UNG
by: Energy Evidence

Supply: Natural gas production growth still exceeds high expectations.

Demand: Frigid November kept low inventories from recovering.

Outlook:  Cold anomaly in Jan/Feb/Mar could shock gas markets.

In early November I argued that only serious cold could save gas prices this winter. Since then, the winter strip has rallied over 40%, and inventories remain low.

Production continues to grow, outpacing EIA (and many independent) projections. The EIA raised output estimates through 2019 again in November. Dec '18 estimates rose by 1.75 BCFD, and full year 2019 increased by 1.63 BCFD, from 91.11 to 92.74 BCFD.

EIA Natural Gas Output Projections But a cold November capped a long run of bullish weather, driving heating demand well above normal. Using the NOAA CPC numbers, October Heating Degree Days were about +18 and November about +94 vs normal. That would normally translate to over 200 BCF in incremental demand among heating, electric, and industrial.

NCEP HDD anomaly Source: National Center for Environmental Prediction Gas Utility Weighted HDD

Consequently, inventories didn't recover to a level that provides an adequate buffer for a severe winter. As of the last EIA weekly inventory, supplies sat 704 BCF below last year.

EIA Working Natural Gas Inventory

This presents the prospect of exiting December with around 2,500 BCF remaining if current mid range forecasts verify are on target. Is that enough to cope with most winter scenarios?

I don't think so for a few reasons. But first let's define "cope". We have seen end of winter storage drop to about 750 BCF in '03, and 850 BCF in '14. Things were different then, but nevertheless, the front month briefly broke $9 in '03 and $6 in '14.

How were things different? Both supply and demand were much lower in '03, the US was a net importer, etc. In '14, the shale boom was underway but gas was not yet the dominant force in power generation, and consequently electricity generation demand was highly elastic. Today, gas is steadily replacing coal in baseload generation so high gas prices don't destroy as much demand.

This phenomenon isn't uniform, but we see it in many major markets. ERCOT (most of Texas) is illustrative, with November gas demand holding it's own against coal despite the price increases. We may see gas cede some market share over time, but in the near term there hasn't been a strong demand decline from power generators in most markets.

The ERCOT Monthly Demand and Energy Report shows that over the last three months, gas has taken more than 0.5 BCFD more of the carbon fuel power market than in '18.

ercot demand and energy report Approximate BCFE calculations are my own, based on the ERCOT Demand and Energy Report for November 2018, using 125GW/BCF.

As gas demand for power burn becomes less price elastic, it requires a larger price response to generate demand destruction. Once coal's potential to replace gas is reached, the next price sensitive demand sources are imports/exports. At what price would LNG cargoes be delayed, and could that even be done in the short term?

Without offering a false precision about weather probabilities for the next 100 days, I do note that:

Last year we drew nearly 900 BCF from storage in January. It was cold, but not much colder than average. If we repeated that performance this year, inventories could fall below 1,600 BCF to begin February. The market would have a difficult time tolerating that shortage without generating a strong price signal.

I do not see such a price spike as probable. In fact, with average weather and a market that is perhaps 5 BCFD oversupplied relative to last year I see ending inventories in the 1.1 - 1.3 TCF range in March. But a weather demand variance of +300 to +400 BCF is not rare. Any gas bear would be a fool to discount it.

The lack of volatility and the sadly low strip through 2020 is a strong indicator that the market agrees we are only facing a short term risk. And gassy equities certainly have not participated in any winter rally along side the winter futures strip. Big Marcellus tenants like RRC, AR, COG, EQT, and SWN have all been badly battered (oil's crash hasn't helped) despite the gas rally. (Permian prices are too heavily discounted to consider those gas producers for now).

Any temptation to speculate in UNG, UGAZ or the commodity itself should be tempered by the equal probability of anomalous warmth in the remainder of winter. That is a bloodbath we have witnessed (Mar '16 touched $1.56).

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.

Additional disclosure: I periodically hold structured long and short positions in natural gas futures and their derivatives