Opinion

The Days of Cheap Natural Gas Are Over


Natural gas prices averaged a little more than $2.50 per mmBtu (million British Thermal Units) in 2016. Those days are over. Prices will average at least $3.50 to $4.00 in 2017.

Prices have more than doubled since March 2016 but gas is still under-valued. Supply is tight because demand and exports have grown and shale gas production has declined.

In April of last year, I wrote that natural gas prices should double and they did. Henry Hub spot prices increased 2 1/2 times from $1.49 to $3.70 per mmBtu and NYMEX futures prices doubled from $1.64 to $3.30 per (Figure 1).

Figure 1. Natural Gas Prices Have More Than Doubled Since March 2016: The Days of $250 Gas Are Gone. Source: EIA and Labyrinth Consulting Services, Inc.

Nevertheless, gas prices are still too low. Storage was at record high levels throughout 2016 reaching 4.1 Bcf (billion cubic feet) and 84% of working capacity in mid-December. Storage has fallen 1.1 Bcf in the last month to 61% of capacity. That is below the 5-year average (pink, dashed line in Figure 2).

Figure 2. Gas Storage Levels Have Fallen 1.1 Bcf To Below the 5-Year Average. Source: EIA and Labyrinth Consulting Services, Inc.

Comparative inventory (C.I.) trends are the best indicators of gas price. These compare current storage to a moving average of levels for the same date over that last 5 years and correlate negatively with spot prices (Figure 3). C.I. fell 120% from May to December 2016 and gas prices doubled.

Figure 3. Comparative Inventories Have Fallen Sharply Since May. Source: EIA and Labyrinth Consulting Services, Inc.

There are occasional short-lived excursions from the correlation. These typically occur when the market believes there is sufficient supply for the winter heating season in September or October. The market over-shoots with lower prices that are later corrected upward.

The November 2016 price drop shown in Figure 3 is an example of this phenomenon that occurred outside of the normal September-October pattern. A similar price drop began in January 2017.

Figure 4 shows the November and January price drops as departures from comparative inventory vs. spot price trend lines.* The current trend line (May 2016 – January 2017 in red) closely resembles trends for periods when gas prices were $4.00 per mmBtu or higher (August 2011 – March 2013 in orange and March 2013 – March 2014 in purple).

Figure 4. Natural Gas Is Undervalued By $0.50 – $1.00/mmBtu. Yield curves show relevant trend lines for current natural gas prices. Source: EIA and Labyrinth Consulting Services, Inc.

Recent price drops partly reflect market expectation of increased gas production in the Marcellus Shale play because of new 2017 pipeline capacity. They also suggest that the market anticipates greater tight oil and associated gas production following OPEC production cuts.

Figure 4 suggests that current gas prices are under-valued and should be at least $3.75 and probably closer to $4.00 instead of $3.27/mmBtu, last week's average spot price.

Supply and demand fundamentals also support higher prices. Gas production has been declining since February 2016. At the same time, net imports are decreasing as pipeline and LNG exports increase.



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