Since November 2011, natural gas prices declined nearly 50% to lows back in April as one of the warmest winters in decades contributed to an oversupplied market. Just four weeks ago, front month natural gas fell to a 10-year low of $1.907/MMBtu. Three key themes contributed to significant moves lower in natural gas prices:
1) Weather: A majority of the U.S. was warmer than normal during the winter of 2011-2012 resulting in much lower heating degree day levels. A heating degree day is the number of degrees that a day’s average temperature is below 65oFahrenheit, the temperature below which heating demand occurs. For the November to March timeframe, the national population-weighted heating degree days were down between 13-36%.
Fluctuations in temperatures are one of the key reasons for volatility in both gas and electricity markets. Natural gas fuel prices are keenly sensitive to winter weather as demand increases for heating needs. Despite a small percentage of buildings heated with electricity, power prices are also often tied to winter weather as prices reflect the operating cost of marginal natural gas generators. In response to the below-normal heating demand this winter, index power prices fell an average of 19% vs. last winter and forward power prices declined approximately 15% since November 2011.
2) Underground Natural Gas Storage: As winter weather demand was virtually nonexistent this year, the need for natural gas to supply winter heating use fell as well. During a typical winter, natural gas is withdrawn from underground storage reserves in order to meet heating related demand. This winter, storage withdrawals were consistently lower-than-normal. From November 2011 to March 2012, natural gas demand fell 5% from a year earlier as production grew by 8%. As a result, total underground storage swelled to record levels for that time of year. At the end of March, which marks the traditional end to the winter heating season, natural gas inventories totaled 2,479 billion cubic feet, 52% above year ago levels and 55% above the 5 year average. Natural gas prices faced bearish pressure in the wake of this supply glut and the lack of supportive near-term fundamentals.
3) Production: Natural gas production has steadily increased to current record levels as drilling technology has made the process of extracting natural gas from shale fields more efficient and economical. Total natural gas output in the United States is 72.32 billion cubic feet per day, near all time highs and approximately 10% above year ago levels.
As natural gas prices declined over 40% this winter producers began to scale back drilling operations. Since October, the number of rigs drilling for natural gas have declined from 936 to a ten year low of 600, a 31% decline. In the same timeframe, oil rigs have risen by 45% as producers shifted drilling operations to capitalize on products priced off of crude oil which exceeded $100/barrel this winter. Despite this significant decline in rig counts, natural gas production continued to gain this winter due to associated gas production from oil drilling. It is estimated that the amount of natural gas produced from eight oil rigs is equivalent to that of one natural gas rig.
Since the end of winter, natural gas prices have recovered following a seasonal run-up and increased demand. Despite generally low electricity demand amid mild winter weather, demand for natural gas picked up as generators switched from coal to natural gas for power generation. Natural gas generation climbed above the five-year average in March as generators placed greater focus on the lower cost fuel input. In recent weeks this continuing trend has contributed to an upward move in prices as the market started to view the supply/demand balance as tightening.
Historically, energy prices follow seasonal demand patterns which rise during the summer and winter months and drop in the spring and the fall. The month of May traditionally reflects a steep run-up as prices gain in anticipation of summer cooling demand and hurricane forecasts. Since hitting 10-year lows at the end of April natural gas prices have corrected, with front-month prices increasing over 40% amid consecutive weeks of below-normal storage injections (as a result of increased demand for gas fired generation), expectations that production may be slowing and warmer-than normal summer forecasts indicating a boost in power demand. Forward power prices have also followed, gaining an average of 4-5% since April lows.
Sources: NYMEX, EIA, Baker Hughes, NOAA