US GAS MARKET CONTANGO LEAVES QUESTIONS AROUND PRODUCTION, STORAGE
By Samer Mosis, natural gas pricing specialist
Welcome to The Snapshot, a series examining the forces shaping and driving global commodities markets today.
Since the start of the year, abnormally warm weather patterns have weighed heavily on natural gas futures, with NYMEX natural gas prompt month contract losing over 90 cents, or 25%, since peaking at $3.93/MMBtu in late December.
Simultaneously though, looking further down the curve, the winter 2017-2018 strip has steadily strengthened since October, putting the market in a steep contango up to January and February of 2018.
What’s underpinning this contango market? Well, contango markets generally arise from a perceived or expected supply-demand imbalance, a dynamic that is abundant in North American natural gas markets.
From a bullish perspective, demand is expected to average around 95-Bcf a day across the 2017-2018 winter months, nearly 6-percent higher than the 5-year average and 4-percent higher than this winter.
US gas production is expected to increase 1% in 2017 compared with 2016: Platts Analytics’ Bentek Energy
Yet production throughout this summer’s critical injection period is only expected to grow 1% above last year, Platts Analytics’ Bentek Energy data shows. This supply-demand imbalance may spell trouble for natural gas stocks going into next winter.
According to the latest Platts Analytics projections, working gas storage levels are expected to rise to just 3.4 Tcf at the end of injection season. That is 12% below the corresponding level last year, 5% below the 5-year average, and the lowest ending-October level since 2008.
At the same time, this contango structure bolsters the economic incentive to drill, and, as bears will tell you, this could alleviate supply side shortages and effectively cap gains for the bulls out there.
Natural gas drilling growth across the US averaged 16% in Q4 2016: Platts Rig Data
In fact, there has been significant growth in natural gas drilling across the US, averaging 16% in Q4 2016, according to Platts Rig Data. The most prolific growth has been in the Marcellus play, which saw 27% growth during that same period.
Platts’ Well Economics Analyzer suggests that growth in the Marcellus will continue as the play’s Internal Rates of Return rose nearly 6 percentage points from January to February, the largest comparable growth in the US.
All of this said though, production is one thing, while midstream transportation is another. Market participants have voiced serious concerns about infrastructure bottlenecks that could undermine production growth in some areas. This is not new for Appalachia, where Dominion South saw a price slump in September and October that drove cash markets to record lows of $0.30/MMBtu. This in turn brought what had been sustained double digit year on year production growth to an abrupt halt.
Collectively, while these fundamentals paint a picture of a market that expects to see improvement after a prolonged commodity slump, the interaction of these fundamentals themselves may paint a more bearish picture than recent forward market movements suggest.
Until the next Snapshot- we’ll be keeping an eye on the markets.