Commentary – North American Natural Gas: Tallying Up the Bullish and Bearish Records

Photo: ARC Financial
Photo: ARC Financial

North American natural gas markets are having a record breaking year. While some of the new (and potentially new) records are bullish, there are also several bears. Let’s look at a list of this year’s new records, so that we can keep a tally of the bulls and the bears:

Bearish: US natural gas output hits an all-time high in April

According to data from Bentek, US natural gas production reached 73.4 Bcf/d on April 25th of this year. This is the highest level ever recorded and a whopping 16.5 Bcf/d higher than the average production level five years ago. On the bright side for producers, output growth has taken a pause since April. Average production in November 2015 was 71.3 Bcf/d, a full 2.1 Bcf/d below the peak.

Bearish: Record high US natural gas storage level

As of November 20th, US natural gas storage reached an all-time high of 4,009 Bcf. Before this year, 2012 was the highest storage level on record at 3,928 Bcf.  If you recall 2012, that was when the combination of high storage and warm weather weakened natural gas spot price to the lowest point in the past decade, closing at $US 1.82/MMBtu on April 20, 2012.  Today’s price is $US 2.09/MMBtu.

Bullish: Lowest ever US natural gas drilling activity

Only 189 rigs were drilling for natural gas at the end of November. This is the lowest level since at least 1987, when Baker Hughes first started tracking natural gas directed drilling.  In theory, less drilling should crimp natural gas production. But, since shale gas took off in 2007, American producers have defied gravity by steadily increasing their output while reducing drilling rates. However, this time could be different, especially when you consider that the gas associated with producing oil should also be falling off.

Bullish: Natural gas is becoming the top fuel for US power generation

When the natural gas markets are oversupplied, the ability for cheap gas to steal market share from coal has helped to soak-up the surplus.  This year is no exception. In April, for the first time, natural gas beat out king coal as the top fuel used for generating power in the US. In July, natural gas use exceeded coal a second time when 35.0% of US power was generated with natural gas compared with 34.9% from coal.  One warning, this bullish dynamic has limits. As natural gas takes a greater share of total power generation, the structural limit for substituting more natural gas for coal will eventually be hit. After that, lower natural gas price will no longer spur new demand from power generators.

Looking forward into 2016, natural gas markets may not be done with their record breaking streak. The top contenders for new records this winter include:

Bearish: Chance for a record breaking warm winter

In November, the NOAA issued a warm weather advisory, stating “Most models indicate that a strong El Niño will continue through the Northern Hemisphere winter 2015-16, followed by weakening… during the late spring or early summer.” They went on to further mention: “this El Niño could rank among the top three strongest episodes…going back to 1950.”  The last two major El Niño events were in 1982-83 and in 1997-98. If this upcoming winter is similar to the past two events, we estimate that wintertime demand would be about 3 Bcf/d lower than would be the case otherwise.

Bearish: Possibility of a new low for natural gas price

As previously mentioned, April 2012 marks the lowest natural gas price in the past decade.  With storage already surpassing 2012 levels and an outlook for warm weather, it is possible that Henry Hub natural gas price could dip below the 2012 low point this winter.

Natural gas markets have had a record breaking year. So far in 2015, the bullish and bearish records are tied up. Depending on this winter’s weather and the future path of US production, it is possible that a few more bearish records will be added in 2016. The silver lining is that weak prices will eventually fix the glut and bring the market back into balance. Normal never looked so good.