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Natural Gas Storage Analytics:

Dynamics of Price Volatility and Relative Storage Inventory

April 21, 2016 | By Callie Kolbe

The Energy Information Administration (EIA) Weekly Natural Gas Storage Report for the week ended April 8, 2016 showed U.S. natural gas inventory at 2,477 Bcf, a staggering  956 Bcf above storage levels seen last year at this time and 849 Bcf above five-year average storage levels. This also represents the largest natural gas storage surplus since April 2012.

The lower 48’s large storage surplus is a stark realization of an imbalance in the current market. How long this balance will remain will be determined by factors such as how long natural gas production is sustained, whether warmer weather patterns will significantly increase demand for natural gas and how much baseline demand growth can occur.

Previous editions of the Get the Point have discussed how this balancing act might shape up this summer (What Difference Does April Make? and Natural Gas Demand Analytics, Part 3). This week’s edition will look at the relationship between storage inventories and prices, and conceptualize how quickly natural gas prices may respond to changes in supply and demand in the market.

Lower 48 Storage Inventory

Price fluctuations help the natural gas market to correct for unbalanced supply and demand. However, a lower or higher price in the market does not immediately dictate whether the market is more or less volatile. Volatility is separate concept, and large monthly swings can occur when prices are high as well as when prices are low.

This Get the Point will pay particular attention to price volatility and how it relates to relative levels of storage inventory. In practice, there is a standard operation to measure historical price volatility. We’ll avoid delving too deeply into the math behind this measurement, understanding that the underlying operation allows for a clean comparison of monthly volatility over a period of time.

Natural Gas Price and Volatility

For this analysis, monthly Henry Hub volatility is calculated from daily spot prices covering the period from January 2010 to the beginning of April 2016. Figure 2 (depicted above) details Henry Hub natural gas average monthly spot price (the blue line) and volatility (the red line) since 2010. In general, there is no clear increasing or decreasing trend in volatility levels over the last six years despite an overall annual decline in Henry Hub prices since 2013.

There are, however, some familiar trends within each year that emerge when looking at volatility on a seasonal level. The volatility graph above depicts that the highest volatility takes place from December through February. To put it another way, the highest volatility levels, regardless of the year, trend in line with the coldest average monthly temperatures. Figure 3 below shows the average monthly temperature in degrees Fahrenheit for the top ten coldest months in 2010-2016, and the second column ranks the volatility level associated with that month. Out of the top ten coldest months, nearly 80% also corresponded with a volatility level that ranked within the top 20 highest. These large price swings in the winter months make sense as they reflect the market trying to quickly supply heating demand.

 Top 10 Coldest Months and Volatility

Source: PointLogic Energy

Ordering the months by the highest levels of volatility uncovers that price volatility does not follow temperature patterns alone. Figure 4 (below) details the top 20 highest volatility levels from 2010-2016 and the corresponding temperature rank. Many are the same winter months noted above. Yet, some of the warmest months on record also match up with high volatility levels. However, nearly 50% of the months which experienced high levels of volatility do not match up with months that are remembered for being way too cold or way too hot.

 Top 20 Highly Volatile Months

Source: PointLogic Energy

Those remaining months which feature high levels of volatility and do not typically incur temperature extremes (November, March and April) serve as key months for storage operators. Their volatility indicates that a strong connection exists between erratic prices and storage dynamics.

 Price Volatility and Inventory Comparison

Figure 5 (above) examines monthly price volatility next to storage inventory levels relative to the prior five-year average. The green bars reflect periods of time when storage inventories were above the prior five-year average, and the red bars reflect times when inventory levels are below prior years.

The visual suggests a complex relationship between natural gas price volatility and the relative level of natural gas in storage. For example, during the winter of 2011-2012, storage inventory across the lower 48 began the season relatively in line with the prior five-year average and grew to nearly 60% above the prior rolling average amid very mild winter demand that year. The monthly volatility measure increased throughout the season and peaked at over 70%.

Regardless of whether storage inventory sits above or below the prior five-year average, the linkage with volatility seems to remain intact. In looking at the winter of 2013-2014, storage levels plummeted from a starting level in line with the prior five-year average to over 50% depleted by the end of the heating season. Volatility peaked at well over 100% that season and averaged nearly 40% higher than the prior summer season (2013) when inventory stayed in line with the relative five-year average.

The rate at which storage inventory levels move away from prior levels also seems to play a role in determining periods of high volatility. Teasing out the magnitude of the relationship between relative storage levels and pricing volatility is layered. Specifically, the graph illustrates that time adds another dimension the relationship. It is often the case that the relative storage level peaks or bottoms out nearly one or two months after the pricing volatility has peaked.

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Inventories, Price Volaility and This Summer

What should we learn from these variations in volatility across time periods in the natural gas market? How does it apply to this summer?

In the short-term, the degree of the price response, or volatility, is driven by transportation constraints, fuel switching capabilities and weather patterns. One just needs to look at February 2014 during the Polar Vortex to see that relationship. However, looking at longer-term volatility trends helps us to consider what role storage inventory plays in volatility and how quickly that volatility might change this summer. Over the last two months, volatility levels have flattened out and resemble how volatility functioned during the spring of 2012, the other time when inventories were at approximately today’s high levels. This indicates the perception that spot prices will remain consistently low in the near term.

However, as summer picks up storage operators will increasingly introduce a game of “Goldilocks.” They will inject at a slower pace in order to meet cooling demand, but they will also not want to inject at too slow of a pace because they need to ensure that inventory remains at relative thresholds to meet next winter’s heating demand. Meanwhile, contractual obligations will limit operators’ ability to take advantage of the spread. Other participants in the market, however, can "buy" summer months and "sell" the winter as they see those balances tighten (either demand or supply driven). If either desire pulls the market in too tight from a supply/demand perspective, price volatility will peak and the earlier summer-to-winter spreads will be squeezed and become a distant memory.

Keep up with future editions of Get the Point as the PointLogic team takes you through natural gas fundamentals driving the market throughout what promises to be a very exciting summer.  

 

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