Record production of natural gas is snuffing out any price rally that might have occurred from the bout of cold weather this winter.
The gas market saw a jolt at the end of December and in early January due to extremely cold temperatures across much of the U.S. This winter was about 13 percent colder than last year, which pushed up residential and commercial gas demand by 3.5 billion cubic feet per day (Bcf/d), according to Barclays.
At the same time, demand continues to grind higher on a structural basis, with more LNG exports leaving U.S. shores and more utilities burning gas for electricity. That led to a sharp drawdown in gas inventories, pushing them 16 percent below the five-year average in the first quarter.
Nevertheless, the price impact was muted. In the past, sever cold snaps have led to sharp price spikes. While that happened in regional spot markets, the price increases were very short-term and nothing like the price increases during the 2014 Polar Vortex. After the cold subsided, Henry Hub spot prices fell back below $3/MMBtu.
Gas traders are so sanguine because the U.S. is producing more natural gas than ever. And 2018 is shaping up to be a record year for new gas output. A mild streak during February eased some pressure on inventories as well.
As a result, the U.S. will likely see “heavy” gas injections during the second quarter, according to Barclays. The bank expects gas inventories to rise at a pace that is 1 Bcf/d higher than last year.Related: $70 Oil Could Spark An Offshore Oil Boom
Barclays sees gas output growing by 6.4 billion cubic feet per day this year. That is an impressive figure, but it will be aided by the fact that a lot of drilled but uncompleted wells (DUCs) could come online in 2018.
Still, Barclays says that record production and higher natural gas prices are not necessarily mutually exclusive. While there isn’t really a bullish case for gas, Barclays says that prices are probably a bit oversold. Inventories will rebuild quickly this spring, but the U.S. will still enter summer months with inventories 17 percent below the five-year average.
Meanwhile, there is a bit of a geographical mismatch between supply and demand, with gas growing at extraordinary rates in the Marcellus Shale and Permian basin, while demand growth is largely concentrated along the Gulf Coast. That could result in some higher gas prices along the Gulf Coast, helping gas drillers there.
But, ultimately, prices will have to go up ahead of next winter in order to adequately replenish gas inventories. If prices were to remain where they currently are, there would be a much larger coal-to-gas switch happening for electricity generation. Leaning harder on gas-fired power plants, made possible by low prices, would result in a smaller gas injection into storage. In other words, if natural gas prices do not rise, the U.S. would enter the winter season with too little gas on hand.
So, Barclays predicts Henry Hub prices will average $3.12/MMBtu over the course of injection season, which lasts until November. Higher prices this summer would turn off some coal-to-gas switching in the electricity sector. For instance, a move from $2.70/MMBtu to $3.00/MMBtu would destroy about 700-800 MMcf/d of gas-fired power burn, which would translate into about 150 Bcf of extra gas to put in storage over the course of the injection season, according to Barclays.
Barclays is not alone in that assessment. “If this winter’s level of year-on-year demand growth can be sustained into the spring and summer, prices may need to move higher to achieve adequate storage levels by the end of October,” said analysts at Mobius Risk Group, according to Natural Gas Intelligence.