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Upcoming Winter Ushers in a Market Reset

July 28, 2016 | By Charles Nevle

The upcoming winter ushers in a new period for the gas market, as falling production and increasing demand alter what has been a demand-constrained market into a demand-driven market in which abundant production is not forcing increased use of gas, but rather increasing demand forces an increase in supply.

In March of this year we published, “A V-Shaped Outlook for Natural Gas Production and Prices,” in which we argued that the summer of 2016 would be characterized by a low-price environment due to the storage overhang caused by an unseasonably warm winter. We also discussed the need for a slowdown in production to ensure the ability to exit the summer without bumping into storage capacity limitations. In addition, we argued that after this summer the market should change dramatically, with a need to increase production to satisfy growing demand from the power sector, liquefied natural gas (LNG) and natural gas exports to Mexico.

Much of our discussion since that time has been focused on those production, demand and inventory dynamics this summer. What we will do in this issue of Get the Point is begin to shift focus to this winter and the summer of 2017.

We are currently expecting U.S. gas storage inventories to exit the summer (Oct. 31) with about 4.1 trillion cubic feet (Tcf) and lower 48 dry production volumes of 72.6 billion cubic feet per day (Bcf/d). This will represent the highest inventory on record and a production level that is 1 Bcf/d less than October 2015 levels. Of course, a lot can happen between now and then, and the heavy lifting is on gas-fired power generation demand to keep storage limitations from wreaking havoc on the market, as pointed out in last week’s Get the Point.

Some very interesting things could happen over the winter of 2016-2017 when compared to the prior winter. Remember that last winter was extremely warm, the third-warmest on record, which (in addition to prolific production) drove the large storage inventory balance at the beginning of this summer. Residential & Commercial (ResCom) demand over the winter of 2015-2016 averaged 32.5 Bcf/d, a 4.8 Bcf/d deficit compared to the average of the previous five winters. Extrapolating that 4.8 Bcf/d over the entirety of the winter equates to 725 Bcf less gas burned than average last winter for ResCom.

What is interesting to note about last winter is that despite an extremely low ResCom burn, total demand over the winter was actually greater than the 5-year average by 1.7 Bcf/d. This was due to a strong contribution from the power sector, which saw gains over the 5-year average winter of 4.5 Bcf/d. Low natural gas prices, the retirement of baseload coal-burning facilities and a determined move to new and existing gas-fired electric generation capacity were the main reasons behind the increase. Exports to Mexico also enjoyed a historical rise.

Winter 2015/2016 vs. 5 Year Average

As we look toward the winter of 2016-2017, the equation from last year changes substantially. To begin, Res/Com, assuming a weather-normal winter, will be substantially higher than last winter. Based on PointLogic’s analysis, a return to a normal winter would put Res/Com demand at 36.8 Bcf/d, or an increase of 4.3 Bcf/d over last winter.

The warm winter last year also negatively affected Industrial demand. This fact is lost in the 5-year average comparison because industrial demand has been gradually rising, but that sector took a hit with this past winter’s abnormally low demand to heat factory floor space and related facility level heating load. A return to normal puts industrial demand at 22.6 Bcf/d, an increase over last winter by 0.8 Bcf/d.

Industrial Demand

So far this summer, Mexican exports are averaging 0.5 Bcf/d above summer 2015 and are currently running at about 3.7 Bcf/d. PointLogic expects export growth to continue as infrastructure is built out on both sides of the border to satisfy the increasing reliance of Mexico on U.S. gas due to declining Mexican gas production and that country’s increasing power sector demand. PointLogic forecasts exports this winter to average 3.9 Bcf/d, for an increase of 0.7 Bcf/d over winter 2015/2016 and 0.2 Bcf/d over current levels.

Absent last winter, but currently abundant this summer, are long-anticipated LNG exports. Summer-to-date LNG exports have averaged 0.7 Bcf/d. Train #2 at Cheneire’s Sabine Pass LNG export terminal in Cameron Parish, La. is scheduled to come online in September, doubling current export capacity. PointLogic expects LNG exports to average 1.2 Bcf/d this winter.

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Combining the above elements brings total demand for the upcoming winter, not including Fuel and Pipe Loss, to 90.0 Bcf/d. That's an increase of 7.8 Bcf/d from last winter.

So, what about the other side of the equation – supply?

So far for the month of July, PointLogic is reporting dry production of 73.1 Bcf/d. This brings production in 2016 to-date to an average of 73.4 Bcf/d. This represents a slight 0.1 Bcf/d decrease from 2015 year-to-date levels; if that differential holds, it would be the first decrease in annual lower 48 production in over 10 years.

Dry production had hovered around 50 Bcf/d from 1994 to 2003 before entering a period of decline. The declines resulted from falling conventional production, which led to a huge surge in prices as well as the buildout of LNG import terminals to cover anticipated gas supply needs.

This year’s production decline could not be more different. Suffice it to say, the issue this go-around is not lack of supply, but lack of demand.

PointLogic believes that when we hit this winter, things will change, and they will change in a big and lasting way. This is when the upside of the ‘V’ begins to take hold for production, as the market very quickly shifts from demand-constrained to demand-driven.

Combining the supply and demand considerations above derives the below comparison.

Winter 2016/2017 vs. Winter 2015/2016

The graphic above could not be more different from the comparison for last winter to the 5-Year average shown at the beginning of this article. In terms of storage, this provides a complete reset of the market despite entering the winter with the highest storage inventory on record.

Summer 16 End of Season Storage

As we look past this winter and into the summer of 2017, the demand train will come rolling in with continued growth in LNG and Mexican exports. We are approaching the end of a one-sided demand-constrained market, and this will bring changes in prices, volatility, producer signals, pipeline utilization and storage use patterns.

In upcoming issues of Get the Point, we will discuss these issues as well as further bullish forces gathering for next summer, including the potential of infrastructure constraints on Northeast production growth, in addition to the risk that this changing market dynamic could have on natural gas-fired powered generation load.  

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