Market Newsletter – July 2020July 28, 2020
“Before emptying, there must be fullness
Before shrinking, there must be expanding
Before falling, there must be ascent
To destroy something, lead it to it extreme
To preserve something, keep to the middle”
– 365 Tao Daily Meditations, “Opposites”
In many regards, the natural gas market has arrived at its points of extrema, and a point of inflection drawing near. And like all things, in arriving at extrema, the natural gas market is poised to move towards the opposite. A spring recoils when pulled taut and released, black defines white, absence defines presence. Alternation is a natural occurrence, and its prevalence in any context provides evidence of a functioning whole. For example, the firing of pistons in an engine only creates the intended motion with both expansion and compression, as each is necessary to turn the crankshaft (disclaimer, I am not a selfprofessed gearhead). In kind, the natural gas market should be viewed as a functioning whole made up of expanding and contracting fundamentals, and it is poised for significant motion in the coming months.
With respect to the extrema, we can start with working underground storage, as a whole. In its June Short-Term Energy Outlook (STEO), the EIA forecasted that total working natural gas in underground storage in the Lower 48 states would reach a record level of 4,089 billion cubic feet (Bcf) by October 31, 2020. This forecasted storage level would fill the Lower 48 states’ natural gas storage facilities to 87% of their design capacity of 4,693 Bcf and nearly 96% of their demonstrated peak capacity of 4,261 Bcf. As recently
as last week, there were legitimate concerns of hitting storage capacity (tank top) though those concerns have now largely been assuaged by repeated muted injections throughout July and optimism surrounding LNG cargoes scheduled for delivery in Sept-Oct. The storage “piston” almost fired clear out of the engine block, and potentially would have, if not for a combination of oil and gas rig counts (indicators of future output) falling to record lows, in addition to significant power burn throughout the month to meet recordsetting
July heat. A good reminder that equilibrium can be achieved even with extrema (equal and opposite) present in the data. The bearish headwinds are running out of steam, as we’ve seen the natural gas surplus levels continue to decline week-over-week, and now sit at what is still a healthy 23.9% surplus when compared to year-ago level; however, compared to a height of 79.5% surplus at the end of March, it is clear that production cuts have continued to stall injection activity during the remainder of the injection season. Another bearish “piston” that is set to reverse course is LNG exports, which have likely already reached their bottom – on average, exports are down 50% in 2020 (3.2 Bcf/d) when compared to 2019. By September, current forecasts show demand rising steeply to over 7 Bcf/d, with the potential for new daily export demand records during the fourth quarter. Already, LNG economics indicate there will not be any cancellations in October. U.S. LNG demand from leading consumers in Asia and Europe is gradually recovering with prices on both continents recently trading at a premium to the U.S. benchmark. Although exports have been dropping throughout 2020 and individual projects have been impacted by rejections, U.S. exports and deliveries to Asia and Europe remain much higher than a year ago.
The dissipation of each of these bearish headwinds that have persisted since March, and have kept natural gas prices sub-$2/MMBtu and at the lowest levels in decades, will continue to keep producers at bay. The price of the commodity has also likely reached its extrema, settling at a cyclical bottom as low as $1.48/MMBtu at the end of June, while the most recent low settled at $1.64 for the prompt month contract. And we see the impact that this has had on both production and exports, as low prices have curtailed additional capex investments from all the natural gas producers, which inevitably foreshadows lower and lower production levels, the primary determinant of a forthcoming rally. The setup for it cannot be ignored: annual growth rate is projected to be negative, production has already reached a major long-term peak and is projected to decline in 2020, the EIA expects dry natural gas production to continue to decline through the end of 2020, and forecast dry natural gas production in the United States currently averages 89.2 Bcf/d in 2020, down 3.0 Bcf/d (3.2%) from 2019. Furthermore, the EIA forecasts the low point in natural gas production to occur in the second quarter of 2021 at an average of 83.3 Bcf/d, which would be down 12.7 Bcf/d (13.2%) from the fourth-quarter 2019 peak. Contrast this with the expectation that domestic natural consumption should continue to expand over the next three months (albeit slowly), and the bulls should gain a stronghold in the natural gas market in short order. Of course, there are unknown variables that will influence the pace and angle of price ascent for natural gas – the duration and geographic influence of COVID-19 protocols, August heat and associated power burn, and upcoming winter weather could all mute or exacerbate the fundamentally undersupplied market. What is known is that we are on the verge of a price rally that could begin as soon as this October – what is full has been emptying, what has expanded has been shrinking, and what has fallen will soon ascend. Destructive extremes have defined 2020 thus far, and what follows in the near future and throughout 2021, will likely be a return to the middle. Keep in mind that a return to the middle ($3/MMBtu) will require lots of torque generated by opposing pistons, so the likelihood of extreme volatility is going to be enhanced.