Market Newsletter – January 2021January 29, 2021
Written by: Luke Nemes, Director, Energy Procurement & Market Intelligence
“Do I contradict myself?
Very well then I contradict myself,
(I am large, I contain multitudes.)”
-Walt Whitman – Song of Myself, 51
The year of 2020 was a difficult, chaotic, and unrelenting year characterized by unfathomable challenges that exposed our collective and multiple vulnerabilities. In my (ongoing) efforts to try to make sense of the fallout from a senseless global pandemic, I have found solace once again in nature’s analogous example, wildfires. Wildfires are still classified by the EPA as natural disasters and require only three necessary conditions for their emergence: fuel, heat and oxygen, with two of those conditions omnipresent in most any landscape. All it takes is one spark, natural or man-made, and provided the other two conditions are just right (dry-enough fuel, increased winds), a once-deciduous landscape can be reduced to char and ash in a matter of hours, undoing centuries of growth. The parallels to the events of 2020, including but not limited to the pandemic, are obvious, and that incredibly reductive power is probably what feels most familiar to any one of us at this juncture, but what happens next is where the lesson lies. Like it or not, wildfires are essential and hyper-efficient recyclers that are necessary for maintaining optimal ecological balance. Following the devastation, a natural pattern of recovery occurs after a wildfire and is referred to as “ecological succession.” This is the process whereby the land, plants and wildlife move through various ecological stages in order to return to a state of relative stability. Homeostasis, balance, stability – that is also what efficient markets crave, and a premise that holds especially true with inherently volatile energy commodities that exist within an increasingly complex regulatory landscape. As we head into 2021, it is crucial to examine both the charred stump and the newly germinated seeds, and to understand the role and influence of each moving forward.
Natural gas was burnt to a crisp throughout 2020 and finished the year with an average price of $2.03/MMbtu, the lowest average price in decades. Forty-six exploration and production (E&P) companies representing around $53 billion in total debt filed for bankruptcy protection last year. While it would be easy to place the blame squarely on the pandemic for the massive wave of E&P bankruptcies, it was not a source of ignition, but instead a hefty gust of wind that stoked the already-glowing embers. One year ago, before the pandemic ravaged the globe, Henry Hub natural gas prices were already well-below the $2/MMBtu mark as a result of rapid supply growth throughout 2018-2019 that significantly outpaced demand, in large part thanks to winter taking consecutive years off (it is still on leave, by the way). Yes, COVID-19 certainly played a part in the extended nosedive through 2020, as it crippled much-needed price-supportive LNG exports for several months while simultaneously temporarily decimating commercial and industrial demand levels, leaving a $1.65/MMBtu price in its wake during the summer. The destruction to E&Ps is evident in the rig-counts – the number of rigs drilling for natural gas began declining in the United States during the spring, reaching a record low of 68 natural gas-directed rigs in July. The rig count stayed relatively low throughout the rest of 2020, but has recently climbed up to 88. Generally speaking, the break-even price for natural gas producers is close to $2.50/MMBtu for dry wells, a price point that was achieved only intermittently throughout 2020 and even now, in the throes of winter, continues to struggle to ascend to that level (Polar Vortex was a bust). With both producers and prices scorched, the natural gas landscape is in the midst of a necessary transformation after years of mismanagement and is primed for regrowth now that the canopy has thinned considerably.
If there was ever any doubt about nature’s infinite ingenuity and preparedness (it has after all, quite literally seen it all) there are certain pine trees whose cones only fall, and the contained seeds only propagate, after exposure to incredibly high heat that melts the resin they are encased in. Similarly, the fetters on LNG exports have been loosed by the heat from low domestic prices, strong European and Asian demand, and gradual increases to export capacity. Bitter cold weather is expected to continue in Asia and is increasingly penetrating Europe, sending prices for electricity, pipeline gas and LNG up sharply on both continents. In early January, electricity prices in Japan set an all-time record and natural gas prices in Spain reached $18.50/MMBtu. Furthermore, after reports of LNG cargoes selling for $20.00-27.00 in Asia, a sale has been reported in the “mid-$30s.” The combination of additional cold weather in Asia, drawing LNG away from Europe, and increased European heating demand could deplete European storage rapidly. Storage is already 25% below year-ago levels and is already below the five-year average. The depletion of European storage and the desire to avoid price spikes next winter is likely to create strong demand for US LNG during this year’s injection season, increasing the upward pressure on US natural gas prices throughout 2021. In the wake of this allegorical wildfire, the domestic natural gas landscape has created an oasis for a new a variety, and one that will continue to compete for resources with the native species. So long as spreads to both Europe and Asia for March delivery remain healthy at well over $4.00 each, LNG exports will continue to support higher domestic prices heading into the summer. Morgan Stanley has recently stated that “this removes a risk that has been a key overhang of global LNG prices in each of the past two years…as a result, we now expect U.S. export arbitrages to remain open during the upcoming summer, reducing the risk of cargo cancellations and supporting higher prices.” All six U.S. LNG export facilities operated near full capacity in December exporting a record 89 cargoes (91% utilization of peak LNG export capacity).
Much of the optimism for natural gas prices in 2021 is tied to this confluence of more disciplined production (read, lower for now and higher in 2nd half of the year), LNG exports continuing to exceed prior year levels, and lower 2021 end of season storage levels (a 12% decline expected from 2016-2020 average). Indeed, EIA’s annual average price forecast for 2021 currently hovers around $3.01/MMBtu and its 2022 forecast, while preliminary, calls for an even more elevated price of $3.27/MMBtu. With that writing on the wall, if we take a look at where the current NYMEX forwards are, we find that the balance of the 2021 curve is hovering around $2.75/MMBtu while Cal-2022 is trading at $2.65/MMBtu. Compared to the EIA price forecasts, both Bal-2021 and Cal-2022 are trading at a discount – winter’s nuggety kernel remains readily available for end-users with unhedged exposure. It would appear that our new landscape is primed for new, controlled, and sustainable growth, but we must not overlook the wildlife that also calls the forest home.
After the fire, the first species to return to the scorched areas are wood-boring insects, then birds and small mammals – they all depend on what the forest provides for their survival. For purposes of this illustration, we will collectively call them federal regulators. The past month has seen an incredible amount of policy and regulatory upheaval at the direction of our great nation’s previous and current administrations. Firstly, the December COVID-19 relief bill extended key renewable tax credits and additional funding for energy storage and efficiency projects. This should foster build-out in low-cost renewable resources, which will continue to compete with traditional fossil fuel generation resources. Secondly, President Biden appointed Commissioner Glick to serve as FERC chairman – this will undoubtedly have bullish impacts to the future of natural gas prices as policy will refocus on transmission upgrades and clean energy integration. The most immediate impact from Commissioner Glick’s appointment will be delays surrounding further construction on Mountain Valley Pipeline, which will increase upside price risk to natural gas and electricity outside of the northeast. The result may be a growing divide between Appalachian markets (and northeastern ISOs with access to low-cost shale production) and the rest of the country. Thirdly, the DC Court of Appeals has struck down the Trump administration’s Affordable Clean Energy rule, teeing up more stringent emissions standards and clean air requirements – though it should be noted any price impacts are likely several years down the road. Finally, the US has imposed sanctions on the Russian pipe-laying vessel “Fortuna” for its involvement in the Nord Stream 2 pipeline. The controversial €10-billion ($11-billion) Nord Stream 2 pipeline, which is majority owned by Russian gas giant Gazprom, will run 1,200 kilometers (745 miles) beneath the Baltic Sea and is set to double Russian gas shipments to Germany, Europe’s largest economy. Washington has said that the Nord Stream 2 would make Europe more dependent on Russian gas, undermining EU energy security. At the same time, however, the US is trying to promote sales of its own liquefied natural gas (LNG). The future remains uncertain, although “Fortuna” has recently resumed activity in defiance of the sanctions – project prevention (bullish) or completion (bearish) would have significant implications on the future of LNG, domestic production, and prices. Kremlin spokesperson Demitry Peskov has acknowledged that sanctions might still be successful in preventing the project from being completed.
Forests tend to heal themselves after a wildfire without much intervention required. That said, there is always the potential for landscapes to transform completely. Change remains the penultimate constant for energy commodities, and 2021 should prove to be no different. Happy New Forest!