Last Thursday (March 28, 2013) the CME Henry Hub natural gas futures contract closed out the first quarter of 2013 at $4.024/MMBtu (prices slipped 9 cents to $4.015/MMBtu Monday). A year ago the futures price was $2.126/MMBtu – about half what it is today. During that same period, US dry gas production has risen by 0.5 Bcf/d to 64.1 Bcf/d and natural gas power burn has fallen by 2.2 Bcf/d (source: Bentek). With production still increasing and demand from power generation falling it seems unlikely that the market can sustain $4/MMBtu prices. Today we look at the supply demand picture at the end of the winter season.
The 25 percent run up in natural gas futures prices that we have seen during the first quarter of 2013 was caused primarily by colder weather increasing demand. The chart below shows US population weighted heating degree days (HDD - see Under the Weather – Cooling Degree Days for a description of how degree days are calculated). There were more HDDs during 2012-13 (red line) indicating that this winter was colder than the winter of 2011-12 (blue line) and you can see that since January temperatures this year have been quite a bit colder than last.
Source: National Oceanic Atmospheric Administration Data from Morningstar (Click to Enlarge)
Winter months generally see withdrawals of natural gas from storage as demand exceeds available pipeline supply from producing regions. Energy Administration Information (EIA) data shows that by the end of last winter (2011-12) natural gas storage had reached record levels for March – about a 40 percent surplus over the average of the previous 5 years. Colder weather this winter increased heating demand enough to whittle away nearly all that surplus over the 5 year average by the end of March. The chart below shows EIA natural gas estimated Lower 48 storage data for this winter (red line), last winter (blue line) and the 5 year average (green line). A larger than expected storage withdrawal last week (March 22, 2013) brought inventory down to within 60 Bcf of the 5 year average (black circle on the chart).
Source: EIA Data from Morningstar (Click to Enlarge)
To delve a little deeper into the factors that have impacted the gas market this winter and have a bearing on what we can expect this summer, we looked at the Bentek Cell Model daily natural gas supply demand balance for March 21, 2013. The table below shows the data with the supply position summarized in the top half and demand at the bottom. The left hand side of the table compares March 2013 against March 2012 and on the right are YTD comparisons. The supply data shows that natural gas dry production increased by 0.8 percent in 1Q 2013 to 64.1 Bcf/d versus the same period last year 63.6 Bcf/d (red circle) and by 1 percent this March versus last (blue circle). These increases in production come in spite of continued reduction in the Baker Hughes gas drilling rig count to a 14 year low (March 28, 2013). Improved drilling efficiency is part of the reason for this apparent contradiction but also new pipeline and processing plant infrastructure coming online is increasing the amount of gas that can be produced from a large inventory of incomplete wells.
Source: Bentek (Click to Enlarge)
Also of interest for natural gas supply is a 58 percent reduction YTD versus 2012 in the liquefied natural gas (LNG) sendout volume (orange circle). The LNG sendout is the amount of gas injected into the pipeline system from LNG import terminals. As we observed in our analysis of natural gas supply constraints in Massachusetts (see The Mighty Algonquin), LNG imports have declined because natural gas prices in the US were far lower in 2012 than other markets such as Europe or Asia, and remain that way.
In the demand part of the Bentek table several items are noteworthy. First is the increase in natural gas exports to Mexico – up 27.6 percent or 0.35 Bcf/d so far in 2013 versus 2012 (brown circle on the table). We outlined the expansion of Mexican demand and increased flows across the border in a blog series this January (see Oh Rio Rio – Gas Across the Rio Grande). The first phases of cross border capacity expansions into Mexico will come online during April 2013 after the recent Federal Energy Regulatory Commission (FERC) approval of the El Paso Natural Gas Willcox Lateral Expansion project. We expect continued expansion of gas exports to Mexico.
Overall US demand for natural gas is higher this year versus last – the table indicates demand up 8.6 percent to 87.3 Bcf/d during 1Q 2013 (green circle). Within the overall demand number however there are big changes in where that gas is being consumed. Residential and consumer demand – mainly home heating - was up 22.4 percent or 0.8 Bcf/d in 1Q 2013 versus the same period last year (yellow circle on the table) and this reflects the cold winter weather that we covered above. Residential and consumer demand is generally not impacted by prices. That is because consumers tend to use heating when it gets cold regardless of price. In contrast the consumption of natural gas to generate electricity or power burn fell during March by 15 percent versus last year or 3.3 Bcf/d (magenta circle) and by 2 Bcf/d in 1Q 2013 versus 2012. The power burn consumption is much more sensitive to natural gas prices because generators will switch to coal when that fuel is cheaper as we explained in “Talking ‘Bout My Generation”.
All of this leads us to a couple of predictions about the gas supply demand position for the remainder of 2013. First the supply of natural gas into the US market looks likely to continue flat or increase slightly during 2013 with new production, processing and transportation infrastructure coming online. Second the demand to soak up that increased supply will not come from power burn if natural gas prices stay at $4/MMBtu because generators will turn to coal at that price level (we will revisit our analysis of coal to gas switching in a forthcoming blog). Reduced power burn so far this year demonstrates that generators are extremely sensitive to price. So far in 2013 reduced demand from power generation has been countered by increased residential and commercial consumption for heating. That heating consumption will decline as temperatures warm up. Which leaves more surplus gas to be injected into storage. Last year the storage surplus at the end of winter had nowhere to go until falling prices led to increased power burn through the spring and summer of 2012. This year if power burn doesn’t ride to the rescue then storage injections will take off again and put downward pressure on prices. Robust production, high prices and lower demand cannot co-exist. Something has to give.
During the spring and summer of 2012 high storage levels weighed on the market and pushed prices to ten year lows. That caused an increase in power burn as gas prices undercut coal – helping to soak up ever expanding shale gas production. The colder 2012-2013 winter temperatures took over in January of this year and heating demand consumed enough gas to bring storage levels back to normal this March. Along the way that demand has pushed up prices to levels that will not encourage power burn this year. The implication for the summer of 2013 is that gas prices will have to fall again to keep the storage surplus in check.
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