US natural gas prices are surging as cold weather eats into inventories, tightening the market much more quickly than many analysts had expected.
The blast of Arctic weather in December put a strain on natural gas markets, with millions of people cranking up the heat to keep warm. The EIA reported a surprise drop in storage levels in the week ending on December 16, falling by 209 billion cubic feet. That decline puts total storage levels at 3,597 Bcf, or just a small 78 Bcf above the five-year average.
Such a scenario was unlikely earlier last year, when the U.S. was emerging from peak winter demand season with record levels of gas sitting in storage. Flush with supply, prices crashed below $2/MMBtu. But natural gas production suddenly started to fall after years of blistering growth, upending forecasts calling for years of oversupply. Meanwhile, demand continues to rise as gas-fired power plants replace coal, so while natural gas consumption is highly seasonal, the seasonal peaks are getting taller and the valleys are getting shallower. Structural demand will continue to rise.
By mid-December, Arctic weather descended on much of the U.S., pushing temperatures to extremely low levels. As a result, the heating degree days (HDD) – a measure of demand for gas pertaining to home heating – was 11% above average.
But seasonal shifts still matter. In the first three weeks of December U.S. natural gas consumption averaged 92 billion cubic feet per day (Bcf/d), up 21% from year-ago levels and also 17% above the five-year average. In other words, the U.S. is consuming natural gas at record levels, leading to a much faster drawdown in inventories than had been predicted.
The end result is that natural gas prices are surging, topping $3.70 per million Btu (MMBtu), the highest price in years. The tightening of the market and the rise in prices is a godsend for struggling gas drillers, which had fallen out of favour with investors in recent years because of persistently low prices. Chesapeake Energy, one of the largest natural gas producers in the U.S., has seen its share price spike by more than 300% in the latter part of 2016, and it’s also up by more than a third in just the past few months, reflecting the rise in gas prices.
As the market improves, natural gas drillers are starting to do something that they have not done in years: add rigs back to the gas fields. Natural gas production climbed for years, right through until early 2016, even though gas producers suffered from years of low prices. The reason is that even as natural gas drilling stopped growing, the mad dash for oil led to rising output of associated gas. So even as the gas rig count fell, output did not, that is, until the crash of oil prices led to a drying up of oil drilling.
Now, rising gas prices could lead to an uptick in gas drilling as companies once again return to targeting gas formations specifically. The gas rig count is now up to 129, up more than 30% in just the past few months. Most of those extra rigs have been deployed in the Marcellus and Utica Shales in Pennsylvania and Ohio, along with the Haynesville Shale in Louisiana, a few of the most gas-rich areas of the country.
The coal industry could get a temporary reprieve with higher natural gas prices. 2016 is expected to be the first full-year in which gas controlled a larger market share than coal, and while the trend towards gas is expected to continue, coal plants could be called upon more often in the near-term because of tightening gas supplies.
While drillers and coal miners are excited about rising gas prices, costlier gas is not good for many others. Petrochemical companies, using gas as a feedstock for a range of products including plastics and fertilizer, will have to pay more. So too will consumers. LNG exporters, depending on how their contracts are structured, could take a hit. U.S. LNG could become less competitive abroad.
It remains to be seen if output will rebound quickly. If not, a cold winter and rising structural demand for gas could see further gains in prices, potentially topping $4/MMBtu before the start of injection season in the spring. Regional bottlenecks could emerge once again, with prices temporarily spiking much higher. In the winter of 2014, bottlenecks and shortages led to a massive price spike for New England, which is less likely but not entirely out of the realm of possibility either.
The shale gas revolution made headlines long before the boom in oil drilling. Shale gas could once again become a point of focus for the industry.