Until this past spring, what was the worst performing commodity over the last 10 years? Crude? Platinum? Pork bellies? Not even close. Natural gas. This was supposed to be the commodity of the century. In our era of green consciousness, natural gas was a sure bet. But a funny thing happened on the way to the pay-off window: supply.
Helped by new technology that enabled drillers to tap reserves never thought imaginable, the market has been flooded with natural gas. The reserves in the Marcellus and Utica shale regions of the U.S. amount to quadrillions of cubic feet of natural gas. There is a backlog of several thousand wells, with some wells in Canada and the U.S. actually being shut off.
Another factor in the “oversupply” is the industry reaction to winter weather. The cold winter of 2014 had sent demand skyrocketing, draining inventories by the end of that heating season. Fear spread that the industry would be unable to fully replenish stockpiles by the following winter. However, that was not the case. The Marcellus and other shale-gas regions were more than adequate. By November 2015, stocks had reached historic levels. But then this past winter’s warm weather produced an opposite effect. There were even scattered reports that Santa Claus was seen sporting a t-shirt on the U.S. east coast, as temperatures reached record highs. March’s natural-gas prices slumped to their lowest in 17 years, reaching 161.
In short, the combination of bloated inventories and unseasonably warm weather as a result of El Nino pressured the market to the point where, for the first time in more than eight years, there are production losses in 2016. This winter, we did not see the traditional big storage draw; there just wasn’t the demand. There was so much natural gas stockpiled that the market was prepared for any weather condition this winter across the United States.
With winter now behind us, we entered the injection season rather than the withdrawal season. In other words, gas stocks in storage began to build up. The stockpile of gas left in storage after the milder-than-normal winter of 2015-2016 has remained at seasonal highs since April and will likely top 2015’s record high at the end of the injection season sometime in the fall, according to analysts.
On the international scene, after the Fukushima nuclear meltdown in 2011, Japan’s demand for LNG skyrocketed. Coincidentally, the shale gas revolution in the U.S. took off, and American suppliers used this opportunity to ship their cheap gas to Asia. Other countries followed suit, especially Australia. This massive supply hit the market at once. Added to that, Asian economies slowed down, further adding to the dramatic drop in prices. As a result, JKM spot prices — the LNG benchmark for Asia — fell to $4.50 per million British thermal units for June 2016 delivery, down three-quarters from early 2014 prices.
There are those who believe that natural gas is following the way of coal. They believe that wind is already competitive with natural gas and that solar power will soon be as well. Natural gas could be on its way out, not just because of global warming or climate change, but because of simple economics.
How desperate was the market? Let’s see how desperate the biggest name in the natural gas industry was. Audrey McClendon was the CEO of Chesapeake Energy Corp (NYSE:CHK). He was probably the individual most responsible for the fracking boom. Earlier this year he was scheduled to testify in Federal court for bid rigging on natural gas leases. This bid rigging would have been an act of desperation for an individual who saw a great empire disintegrate. But a few days prior to his scheduled testimony, McClendon, 56, died, after his 2013 Tahoe crashed into a bridge embankment in Oklahoma City and caught fire. The prevailing view was that he committed suicide.
On the bullish side, the natural gas rig count decreased this past week by one rig to 88. The count for natural gas rigs is down by 128 from a year ago. The number of U.S. oil-drilling rigs is representative of the activity in the natural gas industry. To more fully appreciate this statistic, about five years ago there were some 900 rigs. This is the first time there are less than 100 rigs drilling in thirty years. Very low natural gas prices have contributed to the cut in rigs.
In spite of all the doom and gloom, most industry experts agree that natural gas demand in North America will grow, driven by increasing demand from U.S. industry, power companies, and exports. Average annual gas demand in the U.S. has been increasing by about 2.0 Bcf/d per year.
Exports are also now increasing at a rapid rate. Cheniere Energy began shipping liquefied natural gas in February. The company is expected to ship almost 1 Bcf per day when fully operational. And exports to Mexico are surging.
If the current heat dome continues, then we can have a sharp rally. Because the price of oil is down to $44 per barrel, companies like Conoco Phillips have announced significant capital expenditure cuts for 2016. In fact, according to industry reports, close to 200 companies have filed for bankruptcy since the start of 2015, and unless conditions improve soon, many more will follow. This will cause the rig count to fall even further and thereby accelerate the decline in natural gas production.
What’s a speculator to do? Common logic says to go with the flow. The path of least resistance has certainly been lower for natural gas prices over the past several years. With a guarantee of record stockpiles this year, natural gas can certainly be viewed as a commodity that should be sold short.
At the lows, natural gas was trading at about 1/10 the price that it was trading at 10 years ago. It was trading at about the same price it was trading at 20 years ago, not adjusted for inflation. Since the March lows, gas has rallied about fifty percent, making it the best-performing commodity in the second quarter of 2016. Though it is no longer at its spring lows, if you have a lot of patience and deep-enough pockets, natural gas may be presenting the best opportunity out there in many years. I say “deep pockets,” because if you were to buy it, you must have reserves to absorb the impact of more declines, and funds to add to your position to average out your purchase price. However, the payoff could be immense. The markets are the cheapest when conditions are the bleakest.
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