Market Newsletter – January 2022March 09, 2022
By Luke Nemes, VP, Business Administration & Market Intelligence
“All situations in which the interrelationships between extremes are involved are the most interesting and instructive.”
― Wilhelm von Humboldt, The Limits of State Action
2021 will undoubtedly go down in history as a year of extreme transitions, regardless of subject matter. Amid the now-familiarized “K-shaped” economic recovery, nations and industries found themselves on either side of the pendulum as the recovery birthed historic spikes in producer and consumer prices, vast labor shortages across industries, and a global supply chain clog that still pervades today. The impacts of climate change arrived forcefully at our doorsteps, as wildfires, floods, hurricanes, and tornadoes devastated communities and local economies. Winter Storm Uri cost impacts were estimated to be around $195 billion, making it the costliest winter storm on record. The Suez Canal was blocked for nearly a week after a container ship ran aground. Decentralized networks and digital currencies boomed as meme stocks, coins and NFTs led the way in further digitizing our collective existence. Facebook became Meta in lockstep with the release of The Matrix Resurrections while plutocrats propelled themselves into space on the heels of unimaginable wealth amassment. People left their jobs in droves during the “great resignation” resulting in the highest “quit rate” since the government started keeping track two decades ago, all while the Consumer Price Index For All Urban Consumers (CPI-U) posted its biggest 12-month increase since 1982, according to the US Bureau of Labor Statistics. Energy commodities certainly played a part in this increase; over the past 12 months, the energy index was up by 33.3 %, while the food index increased by 6.1%. For each of these components of the broader CPI-U, these were the largest 12-month increases in at least 13 years. The omicron variant has re-injected swaths of uncertainty into markets and “will infect just about everybody” in Fauci’s latest statement as the US is averaging north of 750,000 new cases/day. If 2021 was the year of the extreme, Humboldt begs us to investigate it as an interesting and instructive opportunity. Granted, that is a rosy summation of a year hallmarked both by scarcity and a general disengagement from reality, but also perseverance and hope. The task at hand is to understand how 2022 may be different, and even if it won’t be, our examination of the past will always be useful in informing our future approach – and for our purposes, Humboldt’s proclamation is especially applicable when it comes to procurement of energy commodities.
In 2021, the NYMEX monthly settles ranged from $2.47/MMBtu – $6.202/MMBtu. The resulting $3.732/MMBtu price spread (and implied volatility) is, in a word, extreme – both generally speaking when dealing with a $3-$4 commodity, and historically speaking, as the previous three calendar years averaged $1.70 high-low spread in comparison. There is obvious context absent from this rudimentary viewpoint (you can find that context here and here), but the most interesting aspect of these data points is that the annual low settlement occurred January, smack-dab in the middle of peak demand season for the underlying commodity, while the highest settlement occurred in October when demand for the underlying commodity is typically near its floor. The resulting instruction then, is simple: habitual or traditional procurement strategies must be reconsidered as both risk and opportunity presented themselves in non-traditional periods throughout 2021.
The dominating stories as it pertains to natural gas fundamentals throughout 2021 can also be characterized as extreme, and they are as follows: i) a rising storage deficit emerged in February and was subsequently exacerbated by extreme weather events (Winter Storm Uri/Hurricane Ida); ii) significantly muted natural gas production relative to prior years as struggling E&P companies demonstrated fiscal restraint to improve balance sheets (reduced capex) and return cash to investors; iii) seven-year highs achieved in natural gas futures arriving in late-summer/early fall; iv) gas-tocoal switching exhaustion during the summer accompanied by domestic coal supply shortages; v) record LNG exports, full-utilization of increasing export capacity, and record prices in competing Asian/European markets for US LNG; vi) extreme scarcity premiums priced into the winter 21/22 contracts due to legitimate shortage fears; and finally vii) October21-December21 registering as the second-warmest fourth quarter in the past 40 years, sending NYMEX natural gas winter risk premiums hurtling lower for the most precipitous price plunge of the past decade and course-correcting the storage trajectory for 2022. With the exception of item vii, these are all individually
incremental bullish factors, but the sum of the parts resulted in one of the most volatile years in recent history for energy commodities.
With the seven pillars of extremity that housed a volatile 2021 delineated, prudence (and Humboldt) requires that we investigate them on a forward-looking basis, and there have been material updates to the outlooks and impacts of each: i) a rising storage trajectory following an extremely warm December has flipped the storage deficit to a surplus (for now, more on this later); ii) after fading from its late-November peak for the first three weeks of December, natural gas production briefly surged higher in late December heading into the new year – over the next year, growing production in the Haynesville shale dry gas and surging associated gas from the oil-driven Permian basin could add 3.0 Bcf/d of supply; iii/iv/vi) after racing to seven-year highs earlier this autumn, much-warmer-than- normal weather and growing gas production have led to a rising end-of March storage trajectory, and a market re-pricing of winter risk as supply scarcity fears have faded – the January-March 2022 contracts plummeted $1.40/MMBtu over the past month or so (-28%), giving back more than half of total gains of the past twelve months;
v) while LNG feedgas demand is repeatedly setting near-term record highs, once Calcasieu Pass is up and running no new facilities are expected until 2024 – in 2024, only one new train, Golden Pass Train 1, is anticipated online and could add 0.8 Bcf/d; vii) while October21-December21 registered as historically warm, January is on pace for the
coldest since 2014, supporting a NYMEX rebound of $0.75 cents since the start of the year to $4.55/MMBtu as cold temperatures in major heating demand regions coupled with lower production in January output due to well freeze-offs currently supporting the market. Finally, after racing up to almost $8/MWh in September 21 on the heels of wind output disruption following Winter Storm Uri in TX, in addition to increased purchasing from both voluntary and compliance buyers, REC national wind REC prices have returned closer to $4-$5/MWh (vintage being primary price variable).
In the weeks ahead, winter weather will remain the primary market catalyst and its impacts on withdrawals and production will be critical. Currently, expectations are for significant triple-digit weekly withdrawals from storage over the next 4-5 weeks. As a result, within the next 2-3 EIA reports, we could see the storage deficit reemerge and the market continue to test higher in early 2022. Beyond that, end users may begin to benefit from supply increases outweighing demand growth over the next 12-24 months, leading to potential downdrafts in NYMEX futures pricing and wholesale electricity across most ISOs. End users should remain vigilant and alert to the current upside price risks for near-term unhedged exposure while keeping an eye to the end of winter/early spring for 2023 and beyond.