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Weighing In On Winter: What Happens if Demand is a No-Show?

December 9, 2015 | By Jack Weixel

In this week’s edition of Get the Point, we’ll take a look at natural gas demand for the first month of winter 2015-2016 and expand on just what could happen if weather driven demand does not show up over the next four months.

The month of November 2015 saw 70.4 billion cubic feet per day (Bcf/d) of total lower 48 domestic demand on average, according to PointLogic Energy’s Supply and Demand model estimates. This is 5.2 Bcf/d lower than last November, but higher than recent Novembers. In November 2009, domestic demand averaged only 56.6 Bcf/d and was followed by November 2010 when domestic demand averaged only 62.0 Bcf/d.

To understand why the market is so concerned about the lack of domestic demand this November, it’s important to put these numbers in context: Lower 48 dry production in November 2009 was a paltry 55.7 Bcf/d, with November 2010 showing only a modest improvement to 58.8 Bcf/d. In the past eight Novembers going back to 2008, lower 48 dry production has only been higher than domestic demand once -- in November 2011 by a modest 2.3 Bcf/d. In November 2015, lower 48 dry production averaged 74.2 Bcf/d, or 3.8 Bcf/d higher than domestic demand. 

Lower 48 Dry Prod vs. Domestic Demand (Bcf/d)

Source: PointLogic Energy

In an ongoing trend seen over the shoulder season this year, the National Oceanic and Atmospheric Administration (NOAA) announced that November 2015 was the 13th warmest November on record, with average temperatures 3.0 degrees Fahrenheit higher than average temperatures witnessed this century. This follows an October report which ranked it as the the 4th warmest October on record, and the warmest since 1963

Mean Temperature Departures from Average

Source: NOAA

As PointLogic demand numbers concur, weather-induced residential and commercial (res/com) demand has been slow to pick up steam. November 2015 res/com demand averaged just 25.1 Bcf/d compared to a 33.2 Bcf/d average in November 2014 (an 8.1 Bcf/d difference).

Conversely, power demand has been 3.8 Bcf/d higher November on November, picking up some of the slack from weaker heating demand.

There are numerous factors influencing the increase of gas consumption to generate power. Structural changes,  such as numerous coal plant retirements and increases in intermittent renewable plants such as wind and solar, are a few examples. However, the biggest incentive has been low gas prices. Gas-fired power plants have had higher utilization rates this year as fuel economics have helped extend power demand beyond the core summer months.

Despite the strength in power, the result is that net storage injections for November (through the 27th) came in at 25 Bcf, compared to a net withdrawal of 161 Bcf for November 2014 (through the 28th). That's a gain of 186 Bcf, or about 6.6 Bcf/d of incremental natural gas supply. 

 Source: PointLogic Energy

The Months Ahead

The most important component of domestic demand during the winter is res/com. For example, res/com demand from the Polar Vortex of 2013-2014 used so much gas that it effectively sustained prices for the bulk of 2014 and into 2015 due to the lower storage inventories it caused. The inverse is true as well, with a lack of winter weather and lack of res/com demand causing price depression in future months.  

For the remainder of winter 2015-2016, forward-looking weather forecasts indicate that the massive El Nino pattern that has been evolving all year has now officially become the strongest El Nino on record. NOAA provides the following three-month forecast for average temperatures for December, January and February. 

Source: NOAA

The influence of the strong El Nino is clear in the above map, as forecasters anticipate a warmer than average north half of the country and a colder than normal southern half for the bulk of winter. The northern half includes the densely populated, heavy natural gas consuming regions of the Midwest and Northeast.

With this information, we can make a few predictions about what could happen if a prolonged warm streak continues through the remaining four months of winter.

We begin with November 2015 demand as a marker. What does this year's demand look like compared to prior seasons?

Our last Get the Point submission to explore this topic was from early October, when we introduced a PointLogic forecast that if typical winter temperatures did not occur, res/com demand could fall off by 2.0 Bcf/d compared to winter 2014-2015. This was published before November reared its ugly head and the impact of El Nino was fully understood.

The closest historical reference we currently have that allows us to understand the potential impact of an unusually warm winter occurred during the winter of 2011-2012  the warmest winter in over 60 years. While not an El Nino winter, the parallels from a demand perspective are worth plotting out. In winter 2011-2012, warm weather severely affected the amount of res/com consumption occurring in the lower 48, which fell to 30.7 Bcf/d, or nearly 6 Bcf/d lower than the prior winter.

It’s important to note that since winter 2011-2012, two very important components of demand have changed: power and industrial demand.

Immediately following that winter, as gas prices dipped to sub $2.00/MMBtu, a modest industrial renaissance occurred that has seen more industrial end use of natural gas as a feedstock and fuel source in various manufacturing applications. Power generation from natural gas has seen a similar surge in use as prices have dictated switching from coal to natural gas as a baseload generation source. Regulatory initiatives such as the now defunct EPA MATS rule and expectations that coal plants will be further regulated (such as through the proposed Clean Power Plan) have incentivized power generators to rely on natural gas even more strongly. In 2016, more than 19.6 GW of new gas-fired capacity is on deck to be put into service. Given these changes, our scenario will ignore power and industrial demand numbers from 2011-2012 and focus on res/com demand.

If res/com demand in winter 2015-2016 were to be a no-show and look more like winter 2011-2012, res-com demand would average only 30.7 Bcf/d -- a 10.0 Bcf/d decline from winter 2014-2015. Calculating the net total change in demand over the 151 days of winter this season (2016 is a leap year), this equates to an incredible 1,500 Bcf of gas not removed from storage strictly due to lower res/com.

But no full analysis of supply and demand is complete without incorporating other components. Most notably, U.S. exports to Mexico have continued to increase this year, and the prospect of LNG exports has emerged as a vital source of demand, one which many producers are taking direct aim. PointLogic Energy projects that these two components will combine to add an incremental 1.3 Bcf/d of demand.

Keeping power and industrial demand within their recent historical trajectory also increases season-on-season demand, as illustrated in the chart below. 

Supply and Demand Winter 15/16 vs. Winter 14/15 (Bcf/d)

Source: PointLogic Energy

In the above scenario, with res/com demand mimicking winter 2011-2012, the total impact to the demand side of the equation is a staggering 6.9 Bcf/d after we account for gains in power, Mexican and LNG exports. With production and supply assumptions layered in, the net impact to the market is 7.4 Bcf/d of incremental gas on hand, which over the course of 151 days of winter yields an extra 1,174 Bcf.

Storage withdrawals in winter 2014-2015 were 2,150 Bcf, which would imply that storage withdrawals in winter 2015-2016 would equal only 976 Bcf.

As of Nov. 1, EIA reported 3,931 Bcf of working gas storage in the ground. If net withdrawals through March 31 are only 976 Bcf, then March carryout would be a staggering 2,955 Bcf. This amount of storage is unprecedented and would trump the record March 2012 carryout of 2,472 Bcf by nearly 20% (483 Bcf).

Can the market really handle that amount of excess gas? In April 2012, Henry Hub gas traded below $2.00 per MMBtu for 16 days during the month, with its lowest print price at $1.82 on April 20. If 483 Bcf more gas is on hand at the end of March 2016, prices could fall even further, with the prospect of $1.00 natural gas becoming a grim reality.

But, surely res/com demand will be higher than winter 2011-2012?

Let’s quickly plot that scenario by looking at the average res/com demand of the weakest three winter seasons since winter 2007-2008. These are (in order) winters 2011-2012, 2012-2013 and 2009-2010. Average res/com demand for these winters comes in at 34.1 Bcf/d, which is 6.6 Bcf/d less than winter 2014-2015. Adjusting our chart yields the below balance.

Supply and Demand Winter 15/16 vs. Winter 14/15 (Bcf/d) Second Scenario

Source: PointLogic Energy

In this scenario, the total oversupply situation has been reduced to 4.0 Bcf/d, which over the course of 151 days of winter, yields “only” 604 Bcf of excess gas available compared to winter 2014-2015. Applying this number to 2014-2015 withdrawals of 2,150 Bcf means that winter 2015-2015 withdrawals would be a more reasonable 1,546 Bcf. This equates to an estimated March carryout of 2,385, or 87 Bcf lower than record levels seen at the end of March 2012. 

Storage Inventory (Bcf)
Source: PointLogic Energy

Nonetheless, a March carryout of 2,385 Bcf would likely knock Henry Hub below $2.00 in April 2016, as occurred in April 2012.

However, that’s a relatively optimistic scenario. Our analysis indicates that carryout inventory could be higher, perhaps approaching 2,955 Bcf, which would imply that Henry Hub could get destructively lower, falling successively past the $1.80, $1.60 and $1.40 marks. Through Dec. 9, res/com has only averaged 30.3 Bcf/d this month and is expected to be even lower in the next several days. Furthermore, the price of April 2016 natural gas on the forward curve has fallen below $2.23, which is the lowest that particular contract has ever traded.

The bottom line is that res/com demand’s importance in the winter is paramount. A weak winter and the dearth of demand that it begets is much more significant to the natural gas market than any other facet of demand. It’s more important than any power plant conversion, coal-to-gas switching calculation, LNG export project, or pipeline expansion.

Winter and res/com demand serve as a friendly reminder that, ultimately, the market is dependent on weather, and that when the possibility of a no-show is on the horizon, panic is justified, as are historically low prices. Stay tuned to Get the Point as we monitor winter res/com demand and storage and price implications throughout the winter withdrawal season. 

 

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