Market Newsletter – December 2019December 01, 2019
Another year has come and gone, one that was rife with morphing market dynamics and a shifting regulatory landscape. The waning days of the year provide us with an opportunity to pause, reflect and assess. Søren Kierkegaard concisely captured the inherent challenge associated with reflection and retrospection, and our inevitable attempt to absorb wisdom from each:
It is really true what philosophy tells us, that life must be understood backwards. But with this, one forgets the second proposition, that it must be lived forwards. A proposition which, the more it is subjected to careful thought, the more it ends up concluding precisely that life at any given moment cannot really ever be fully understood; exactly because there is no single moment where time stops completely in order for me to take position [to do this]: going backwards.
One could easily substitute “life” for any commodity futures in the above and the sentiment remains equally applicable. In particular, the persistent nature of time and how its constant plodding requires an ongoing evaluation. With that in mind, let’s jump into the backwards, forwards, backwardation and futures.
One year ago today, natural gas inventories stood at 2,793 bcf. At the time, that represented a 20% deficit to both the prior year’s levels, as well as the five-year average. The 12-mo strip was hovering just above $3, and the front-month (Jan-2018) contract was trading at $3.82/MMBtu. As of today, that script has been completely flipped – inventories stand at 3,411 bcf, a 22% increase to levels a year ago, and almost exactly in line with the five-year average (0.3% deficit). The 12-mo strip is trading at $2.32/MMBtu, and the front-month contract (Jan 2019) last settled at $2.32/MMBtu. It is very rare to see the winter packages trading at or below the same price as the 12-month strip, a weakening in the normal backwardation that is typically present at this time of the year. This does not bode well for the bulls, especially when coupled with the lack of any significant lasting cold on the near-term horizon. Further highlighting the bearish market dynamics, we can turn to a more recent price history, that of the JAN-2019 contract’s recent high of $2.98/MMBtu on November 5th. In just 7 weeks, and as we entered peak demand season, we have seen the price of that contract decrease by over 27% and it continues to slide. This all sets up for a potential move to below $2/MMBtu in March if storage levels remain relatively unscathed throughout the winter. As we move through January, storage levels and price momentum will both be something to keep an eye on for those considering long-term supply contracts for both natural gas and power – we could be encroaching on historic lows in very short order. At a certain point, falling prices will impact production, and we’ve already seen Shell/Chevron write down their assets to the tune of $2/$11 billion, respectively, citing low natural gas prices and excess global supply. This will have rippling effects on Appalachian production and investment in LNG terminals. For now, a long-term full understanding remains a moving target, and Mother Nature will continue to be the driving force in the coming months.
On the regulatory front, FERC has finally weighed in decisively on PJM’s wholesale capacity auctions, the latest of which has been delayed due to disagreement over the proper inclusion of state-subsidized generating resources. Under the plan, these subsidized resources will be subject to a Minimum Offer Price Rule (MOPR), in effort to ensure a level playing field for new market entrants. In essence, the MOPR requires these resources’ bids to be considered as if they were not receiving any external state subsidies, effectively raising their price floor. Other factors to keep an eye on in 2020 are continued nuclear retirements and political undercurrents, as the U.S. presidential election is likely to be a referendum on the future of the US energy output and may inject some significant volatility into the market.