Anything but therm in the US | FT Alphaville

Anything but therm in the US

Natural gas prices in the United States are falling, and falling much more than usual. The benchmark Henry Hub contract traded on Nymex closed at six-year lows of $3.840 per mmBtu on Tuesday, even despite below-average temperatures which are usually supportive to prices.

Higher than expected supplies of natural gas in storage at the start of the year, meanwhile, are not being drawn down as quickly as usual. According to JBC Energy this has much to do with a marked reduction in industrial consumption and insufficient production cutbacks to compensate for the demand shortfall. As they explain:

 Henry Hub natural gas prices continued their downward trend yesterday falling to its lowest level since November 2002. Supply growth in the US has outstripped demand growth in recent years and the economic downturn has compounded matters as industrial users reduce their natural gas requirements. Some relief could be in the offing as producers such as Chesapeake Energy cut back on production, although at the moment the product has very little support and could fall even lower in the near future.

Natural Gas Nymex prices

The natural gas price declines come in contrast to some recent strength in WTI crude futures — the disconnect in part reflecting the presence of Opec in the crude market as  supply-and-demand balancer of first resort, a blessing for those dependent on higher prices to achieve profitability in the current climate.

This is not quite the case for natural gas markets.  As natural gas is fixed to set supply sources in the US (unless it arrives in liquified natural gas form) it has far less flexibility in ajdusting import volumes to meet demand than oil. If producers oversupply there is no choice but for the price to fall sharply, as the overall system must stay in balance. If the gas is not being used, it must be stored.  If storage is full, it’s a very very bearish signal, and prices can very suddenly collapse.

The norm in the gas markets is also for producers to take supply offline during the summer maintenance period when there is a general reduction in demand because of higher temperatures (air conditioning regions an exception). What supply is leftover after meeting demand then goes to building up storage for winter use, when demand conversely shoots up because of longer nights and colder temperatures. The trend, accordingly, has always been for prices to fall in the summer and rise in the winter.
The problem this time is that storage is not being drawn as sharply as usual. The trend has therefore been reversed rather dramatically. According to Reuters, even if drawdowns for the rest of winter match the five-year average pace, inventories would still end the heating season at 1.576 tcf, some 16 per cent above normal. That is more than a comfortable level to start the April-through-October stock building season, which means producers will most likely have to take more supply offline than usual over the maintenance period. The alternative would possibly be a price collapse.

Another point worth noting is that while production cutbacks may have been insufficient to match the recent reduction in demand, the industry has been more succesful at cutting back rigs – an indicator of future supply rates. Rigs are down 48 per cent below their five-year norms already. Accordingly, the Energy Information Administration now expects production in 2010 to fall by 0.8 per cent. In contrast, it sees production in 2009 remaining flat.