Energy Update | February 25th, 2020

Natural Gas Storage Levels Don’t Justify the Low Price of Natural Gas. In my Jan 20th Energy Update, I

Natural Gas Storage Levels Don’t Justify the Low Price of Natural Gas.

In my Jan 20th Energy Update, I said in over 40 years of trading I observed major bottoms occur when prices decline to an unsustainably low level below the cost of production, and companies are no longer profitable. This is taking place today in Natural Gas with most Exploration and Production companies reporting losses over the last year, and their profit outlook is continuing to deteriorate.

The weaker companies will not survive, and companies who survive will decrease production leading to higher prices. This premise is supported by the latest Baker Hughes drilling data released Feb 21st showing the number Natural Gas drilling rigs are continuing to decline and we now have only 110 active rigs down from 194 rigs a year ago, which is a decline 43.3% year-over-year. The chart below shows Natural Gas prices, which is the largest source of Electricity generation has fallen to near a 20-year low:

Over the last 20-years Natural Gas prices were below $2.00 per MMBtu only 1.8% of the time and the 3 previous occurrences always led to higher prices on average the following 12, 24 & 36 months. This is not surprising since as I said earlier, prices below $2.00 result in weaker companies being forced out of business thereby decreasing competition, and the surviving companies are highly motivated to increase prices to make up for lost profits accrued while prices were low.

In today’s report, I discuss another factor supporting why I believe Natural Gas prices are near a major bottom and will move higher long-term. The price of commodities is primarily based on the supplies available. When supplies are historically high, prices tend to decline, and when supplies are low, prices tend to increase. In the short-term, the inverse relationship between supply and price can move away from the norm, but eventually supplies and prices will return to long-term historical norms.

Therefore, the question is, does the present amount of Natural Gas in storage justify prices below $2.00 per MMBtu?

I believe the answer is a resounding no!

Natural Gas prices started to decline in November due to mild weather and accelerated downward this winter when in December and January we experienced the warmest weather on record for the contiguous U.S. since 1895. This resulted in Natural Gas prices declining and remaining below $2.00 since Jan 17th, but I believe prices will not remain this low much longer.

Quantitative analysis can be used to measure the value of a commodity and using this technique reveals today’s Natural Gas supplies versus price does not justify prices below $2.00, and in fact support prices above $3.00 per MMBtu. The latest EIA weekly storage report has Natural Gas storage at 2,343 Bcf, which is 9.3% above the 5-year average. Also based on present NOAA weather projections Natural Gas supplies near the end of the winter season on Mar 27th are projected to be approximately 1830 Bcf, which would be 7.8% above the 5-year average.


Ending the winter heating season 7.8 % above the 5-year average would justify prices slightly below average, but not anywhere near today’s historically low prices below $2.00 per MMBtu. Extracting Natural Gas using hydraulic fracking increased production 10 years ago and has kept Natural Gas prices lower than the previous decade from 2000 to 2010. The chart of Natural Gas below shows the average price of Natural Gas for the last 20 years:

As you can see in the above chart, the average price of Natural Gas is much lower over the last 10 years. The average price from 2000 to 2010 was $6.00 compared to 2010 to 2020 when the average price was $3.25 per MMBtu. Therefore, an accurate estimate for Natural Gas prices today should only consider the average price over the last 10 years. Using this information is useful in estimating fair value for Natural Gas.

We are expected to have approximately 7.7% more Natural Gas supplies than the 5-year average by the end of the winter heating season, and based on this data we would expect prices to be below the 10-year average price of $3.25, but clearly prices below $2.00 per MMBtu are not justified and I believe we will return at least to the 10-year average price this year.

Another comparison for fair value of Natural Gas is 2016 when we experienced the warmest winter on record, and supplies ended the winter heating season with 2,468 Bcf, which was 45.3% above the 5-year average:

Natural Gas declined to $1.611 per MMBtu on Mar 4th, 2016, which was its lowest price since 2000. The low price was justified by a record amount of storage at the end of the winter heating season. But as you can see in the above chart by the end of the year Natural Gas rallied back to near $4.00 per MMBtu. I am not predicting Natural Gas prices will reach $4.00 per MMBtu this year, although it is possible, but I believe based on present supplies in storage prices are extremely undervalued and will at least return to the average price for the last 10-years near $3.25 per MMBtu.

This report focuses on Natural Gas rates, but it also pertains to Electricity. Natural Gas is the largest source of energy for the generation of Electricity; therefore, they are highly correlated, and based on the empirical evidence reflected in this report, I recommend anyone with agreements in Natural Gas and Electricity expiring within the next 18-months not delay hoping for lower prices. The upside risk is too great to justify waiting hoping for slightly lower prices. 

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

Ray Franklin
Energy Professionals
Senior Commodity Analyst                                                                                                                                                        

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