- LNG export demand peaked at 9.5 BCF/day in February 2020 but has since fallen by over 5 BCF/day.
- While weak overseas pricing - in some cases, negative to Henry Hub - has contributed to the drop, record European inventories are and will be a major driver of soft US Summertime export demand.
- Dwindling LNG exports have tightened the European supply/demand imbalance, but it isn't enough.
- Even with the lost LNG export, the pieces are in place for a bull market in natural gas later this summer - but it will need help.
- Cheniere Energy has done what it can to minimize exposure to the downturn in LNG demand, but a prolonged drought will still hurt its bottom line, and the company makes an attractive short above $45/share.
For beleaguered natural gas bulls, 2020 has brought one headwind after another. First, it was an unseasonably mild winter that flipped a long-standing storage deficit to a surplus and sent prices tumbling to 25-year lows. Then, it was COVID-19 which, after a brief period of optimism surrounding production declines, brought temperature-independent losses in industrial and commercial demand that exceeded the drop in supply. Over the past month, the bearish headlines have turned to focus on LNG exports.
LNG exports first became a new source of domestic natural gas demand during the first quarter of 2016 with the opening of Cheniere Energy's (LNG) Sabine Pass plant. Over the next 4 years, exports surged with demand topping out at 9.5 BCF/day in February 2020. Since then, however, gas demand has steadily declined, falling under 8 BCF/day in early April, under 7 BCF/day in early May, and under 6 BCF/day by the middle of last month, cutting the year-over-year gain to less than 1 BCF/day. Then, on June 1, demand tumbled to just 4.3 BCF/day, a new 2020 low and down 1.4 BCF/day from 2019, as shown in the Figures below, prompting a 4.1% daily loss in natural gas on Monday.
Figure 1: Daily US LNG demand by facility. Source: CelsiusEnergy
Figure 2: Daily US LNG demand versus last year. Source: CelsiusEnergy
This is down more than 5 BCF/day from all-time highs in a matter of months and is a serious threat to cancel out production declines and strong powerburn demand that many investors had anticipated would jumpstart a new natural gas bull market.
This article will discuss the reasons for the declines in domestic LNG demand and its potential impact on the supply/demand imbalance.
Historically, the US natural gas supply/demand balance has been largely insulated, driven by temperature patterns and domestic production with imports from Canada and exports to Mexico playing only a small role. Over the past four years, this imbalance has become increasingly tied to global economies as a result of LNG exports. As the Figure below shows, US exports are largely divided between Asia (51%) and Europe (41%) with only 8% staying in the Western Hemisphere.
Figure 3: LNG cargo destinations by continent. Source: Marine Traffic
Thus, in February and March when the global pandemic that is COVID-19 hit, exports, too, took a hit. Foreign natural gas demand plunged, driving down price and compressing margins. These losses were spread out between Asia and Europe. The declines in volumes to Asia have been largely economic: soft demand and weak LNG pricing have made exports non-economical. It is anticipated - and has already been seen - that as Asian economies begin to recover, exports to these countries will rebound quickly as well.
Europe is a bit of a different story and is a more sustained threat to LNG exports than Asia. Similar to Asia, pricing differentials between the US and Europe (UK and Netherlands price points) are below breakeven when accounting for shipping costs. More than that, however, after a surge in imports in recent years, both from the US as well as Russia and the Middle East, and an unseasonably mild winter across key heating demand regions of the continent, European inventories entered the injection season at all-time highs and rose sharply during the first portion of the Shoulder Season.
Through Sunday, May 31, total European inventories stand at 3368 BCF, a massive +1333 BCF or +66% above the 5-year average and +759 BCF or +29% higher year-over-year, as the Figure below shows. This represents 69% capacity, just 2 months into the injection season.
Figure 4: European natural gas inventories over the past year. Source: CelsiusEnergy
These are record highs by all of the major metrics: absolute inventories for May 31, % capacity for May 31, and % surplus or absolute surplus versus the 5-year average for any date. If a storage surplus versus the 5-year average of just +420 BCF or +19% has kept US prices under $2.00/MMBTU, you can imagine the impact of a +1300 BCF surplus on European fundamentals.
As a result, European deliveries have been sharply curtailed. In February, European deliveries averaged 4.0 BCF/day. In May, preliminary deliveries had cratered to just 2.1 BCF/day.
Has it helped? Sort of.
As shown in the Figures below, the surplus versus the 5-year average and, especially, the year-over-year surplus have both flattened and even started to downtrend as bullish daily injections have started to consistently outpace bearish builds. At +1333 BCF, the surplus versus the 5-year average is at its lowest since April 25 while at +738 BCF, the year-over-year surplus is at its lowest since December 11, 2019.
Figure 5: European natural gas storage surplus versus the 5-year average. Source: CelsiusEnergy.Net
Figure 6: European natural gas storage surplus versus last year. Source: CelsiusEnergy.Net
However, with inventories starting the injection season at all-time highs, these slightly, or even moderately, bullish injections are not enough. As the Figure below shows, inventories in 6 European nations are already at or above 75% of working capacity, including Spain (75%), Slovakia (79%), Germany (84%), Austria (85%), Belgium (92%), and Portugal (102%).
Figure 7: European by country. Source: CelsiusEnergy.Net
Thus, even with the tightening supply/demand imbalance, European inventories are still on pace to easily eclipse working capacity. As the Figure below shows, at the current pace of injection, I am currently projecting storage to top the estimated working capacity of 4470 BCF by late August and peak in late October near 5544 BCF, 112% of capacity.
Figure 8: Projected European natural gas inventories. Source: CelsiusEnergy.Net
My projected peak has been downtrending, after reaching as high as 5700 BCF back in early May as shown in the Figure below, but is not declining fast enough.
Figure 9: Trend in projected peak European natural gas inventories. Source: CelsiusEnergy.Net
What does this mean for US natural gas demand? Some other intervention must take place. An anomalously hot summer would be the most expeditious solution. More likely, however, we will see further cancellations, both from the US and from Russia/Middle East. It is therefore very possible that average daily feedgas demand of 4.5-5.0 BCF/day will be the new normal for the next 2-3 months, at minimum.
How will this affect the US natural gas supply/demand imbalance? These numbers are, worst-case scenario, around 5 BCF/day below year-ago levels. After the big late-May supply drop, US production has recovered slightly to around 90.5 BCF/day, close to flat versus last year. Year-over-year changes in imports from Canada and exports to Mexico largely cancel each other out and are a wash. Over the last 2 weeks, powerburn has averaged 4.40 BCF per gas-weighted cooling degree day (GWCDD) compared to just 3.92 BCF per GWCDD last year, an improvement of 0.48 BCF per GWCDD. Once average daily GWCDDs top 10 GWCDDs/day in late June, powerburn could be up over 5 BCF/day year-over-year, assuming normal conditions. This will effectively cancel out the year-over-year decline in LNG demand, leaving the supply/demand imbalance flat versus last year. However, last year's imbalance was loose versus the 5-year average and, similar to Europe, inventories are sufficiently elevated after the mild US winter that this scenario of a flat year-over-year imbalance is decidedly bearish. The bulls need more.
A bull market will, therefore, be dependent both on an unusually hot summer to boost GWCDDs to take further advantage of the strong per degree day powerburn demand and, more reliably, a continued drop in production. At this time, I am modeling production sliding to around 85 BCF/day by the end of the year given the ongoing drop in the rig count, which should help to significantly tighten market, even with the losses in LNG demand. Before Monday's sharp drop in LNG demand, I was modeling injection season-ending inventories near 3750 BCF. With the latest decline in exports, this projection has jumped to around 4000 BCF, around 250 BCF above the 5-year average and the highest mark on record. However, it remains far below the estimated storage capacity of 4600-4700 BCF. Nonetheless, season-ending inventories above 4000 BCF will be hard-pressed to support a significant rally. I feel that a season-ending storage level under 3800 BCF plus a tight market heading into the injection season will be necessary to drive prices higher, given the steep contango present in the futures market. The additional 200 BCF drop will require GWCDDs to average around 2.75 GWCDDs above-average throughout the summer - or for the per GWCDD powerburn to rise further. Not impossible, but a tall order. For this reason, I am skeptical that natural gas is in position to stage a sharp rally at this time and have not been adding to my longstanding natural gas long position via buying UNG or UGAZ (or shorting DGAZ) at these levels. That said, if and when LNG demand does rebound, the commodity could jump sharply given the other bullish elements I discussed above. Thus, I remain long natural gas but don't want to try to time the rally given the steep contango in the market. I there have most of my long holdings in E&P equities, namely Cabot (COG) and Southwestern (SWN).
One of my largest positions, however, is short Cheniere Energy. Cheniere is the largest domestic LNG exporter and operates Sabine Pass and Corpus Christi. Between the two plants, the company can routinely export 5.5-6.0 BCF/day of LNG. With weak pricing, soft global demand, and bloated inventories, as discussed above, LNG exporters are hurting for business. Cheniere reported that 10 cargoes were cancelled in June and another 17 for July - although Bloomberg reports the actual number could be higher. And with the European supply/demand imbalance still not sufficiently tight, further cancellations into August, September and October seem likely. To be fair, the company had a very strong (pre-COVID) first quarter and has largely locked in long-term contracts that insulate it from periods such as this with uneconomical pricing. And those customers that cancel contracts must pay a hefty fee. However, the company still does have roughly 15% exposure to the open market without a supply agreement. As shown in the Figure to the right, the company has weathered the turmoil reasonably well - perhaps too well.
Figure 10: Cheniere Energy 1 year history. Source: Yahoo Finance
After reaching a 52-week high of $66/share in January, shares dropped by 50% when markets were steamrolled by the COVID-19 panic, in line with or slightly superior to the rest of energy sector. However, shares have since rallied by 40% to $44.50/share, even as US LNG demand has plunged. I respect the company's strong baseline fundamentals and foresight in long-term contracts but feel that, eventually, the threat of a prolonged period of weak LNG demand, which investors seem to be discounting, will weigh on the company, even with its limited exposure. I am maintaining a downside price target of $35/share.
For those interested, I publish daily LNG feedgas demand numbers on my site Celsius Energy bright and early at 12:00 AM EDT for the next day as well as daily European storage numbers, updated for the previous day around 5 PM EDT.
This article was written by
Analyst’s Disclosure: I am/we are short LNG. 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.
I am also short DGAZ and long COG and SWN.
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