Empirical Evidence Structural Imbalance is Tightening Supplies & Supporting Prices

My reports focus on Natural Gas because it is now the largest energy source for the generation of Electricity; therefore,

My reports focus on Natural Gas because it is now the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity rates are highly correlated.

In my Feb 1st Energy Alert, I said further price decreases will be limited by structural imbalances in supply and demand.” In today’s report, I give empirical evidence supporting this claim, but first, I will define an important measurement of demand, a “Heating Degree Day” (HDD), and its effect on the demand of Natural Gas.

Heating Degree Day (HDD) is designed to measure the demand for energy needed to heat a building. HDD is derived from a measurement of outside air temperature. HDD is the number of degrees a day’s average temperature is below 65o Fahrenheit, the temperature below which buildings need to be heated. The higher the HDD, the higher the demand of Natural Gas for heating.

How can HDDs be used as empirical evidence to support my assertion structural imbalances are tightening supplies?

 Answer: By using HDD as a comparative analysis tool.

Last year, due to an El Nino, we experienced an extremely mild winter, which resulted in Natural Gas’s storage ending the winter heating season at the highest level in history. This was primarily a byproduct of low HDDs resulting in low heating demand. But how does this information support my claim we are presently experiencing structural imbalances? The answer is found in a comparative analysis of heating demand.

The National Oceanic Atmospheric Administration (NOAA) recently reported Heating Degree Days (HDDs), for the heating season thru Feb 4th, were the same as last year, for the same period. Given this fact, if all other supply/demand factors were equal, we would expect the draw of Natural Gas this winter would be similar to last winter. But as you can see below this is not the case:

Last winter, from 10/30/15 thru 2/5/16, 1,067 Bcf was drawn from storage.

This winter, from 10/28/16 thru 2/3/17, 1,404 Bcf was drawn from storage.

A storage draw 337 Bcf greater than last year is a huge difference, which cannot be fully explained by HDDs. Clearly something else is taking place. In my Feb 1st Energy Alert, I said on the supply side, US Natural Gas production is presently near 70 Bcf/d, and although production is expected to rebound to average 74 Bcf/d in 2017, this is still well below last year’s average production.

On the demand side, LNG exports and new pipelines to Mexico are increasing demand for Natural Gas, which are compensating for decreased demand due to mild weather. Therefore, this winter’s draw of storage 337 Bcf greater than last year while the HDDs were the same for both years is empirical evidence a structural imbalance in supply and demand is currently in place.

But is there empirical evidence the structural imbalance in supply and demand is limiting further price decreases?

Answer: Found by reviewing recent response in prices to low HDDs.

Since writing my Feb 1st Energy Alert, HDDs continued to decline versus last winter, but as you can see below Natural Gas prices remain above key support near the 200-day Moving Average.

Since Feb 1st, prices have consolidated above the 200-day Moving Average, as shown by the blue circle. NOAA continues to forecast mild weather for much of the United States over the next 2 weeks, which will keep HDDs and heating demand low. Heating demand is a major driver of prices during the winter months, but if prices continue to hold above key support, it is a strong signal the next major move will be higher prices.

Although near-term news is negative, the market is forward looking and from a longer-term perspective is signaling structural imbalances in supply and demand will eventually lead to higher prices. The question of when higher prices arrive cannot be answered with absolute certainty, but history teaches us the final highs will be well above present levels, and reached due to an event. The event will likely be weather related such as a warmer than normal summer or colder than normal winter, but it also could be due to a geopolitical event.

The 6-year chart of Natural Gas below shows extremes in pricing reached during weather events:

As you can see in the above chart, the last full price cycle began after a mild winter in 2011/12, and was completed after the cold winter of 2013/14. The present cycle, also began after a mild winter in 2015/16, and is still in progress. The final highs in the present cycle will likely be reached due to a warmer than normal summer, or milder than normal winter.

At this point, no one knows what will trigger the finals highs in this price cycle, but the point is, when Natural Gas is experiencing structural imbalances, it is not a question of if, but when prices will surge to their finals highs. Therefore, based on the empirical evidence that we have structural imbalances in supply and demand, and prices continue to hold despite negative news, I believe it is prudent to reserve rates in the forward markets near present levels.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities now. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.


Ray Franklin
Senior Commodity Analyst

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