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The New Normal in the Northeast:

How Regional Price Has Separated from the Rest of the U.S.

August 11, 2016 | By Robert Applegate

Our clients send us the best questions, and from those questions we develop new products and analysis. Sometimes, we delve deeper into rabbit holes that we hadn’t thought to go down.

This week was one of those examples, when a client asked the following: What is the 'new normal' in the Northeast? Specifically, we were being asked why the summer onslaught of natural gas power demand was not driving prices higher in the Northeast. Also implicit in the question was why gas prices were staying flat in the Northeast while Henry Hub prices were increasing.

In this week’s edition of Get the Point, we answer those questions. We look at how the Northeast as a region has blazed its own trail from the rest of the U.S. in natural gas production, demand and price dynamics, and how its relative energy independence has created a new normal for the region. Also, we'll explain the term “SD basis” and examine what it can tell us about market dynamics.

The story has been told for several years about the huge increases in natural gas production in the Northeast due to the prolific Marcellus and Utica shale plays. As shown in Figure 1, the rapid growth in production has affected the supply and demand balance in the region.

We see that the net supply picture has complete reversed since 2011 and 2012. It should be noted that "oversupply" or "undersupply" in this graph does not count inflows or outflows, nor does it count storage. This is simply the monthly average of gas produced in the region minus the demand in the region on any given day.

Northeast Production Minus Northeast Demand

The most striking thing to note in Figure 1 is the difference between 2012 and 2016.

Year Number of Months with Higher Local Demand than Local Supply
2012
12
2013
7
2014
6
2015
3
2016*
2
2017*
2
2018*
2
2019*
2
2020*
2

In 2012, every month of the year was net short natural gas in the region. In other words, the Northeast needed to import gas to meet its requirements throughout the entire year.

Every year since 2012, the number of months that the region was short gas fell, until this year, when it has leveled off (see Table 1 to the right). The year 2015 was, and should be (barring some unforeseen weather event), the last period that the Northeast was short gas for three months. For 2016 and the foreseeable future, the region’s natural gas demand will only outpace production during the two coldest months of the year, January and February.

Again, the aforementioned data is ignoring gas flows to or from the Northeast to other regions or countries, as well as storage injections or withdrawals within the Northeast. If we add the storage picture within the region to this discussion, those two months of demand outpacing production go away for 2016 and for future years.

In Figure 2, Northeast net storage can clearly be seen as a typical, yearly cycle. During the cold months, the region pulls from storage to meet heating demand, while it saves gas in storage when there is excess in other months. In the past, the Northeast did this by importing gas from the south or west, but in April 2015 everything changed. In April 2015, the production of gas overtook the demand and storage needs of the region.

 Production Minus Demand and Storage

April 2015 is when the Northeast became energy independent with respect to natural gas. Ever since then, the Northeast has been a net exporter of gas all year long. Since the Northeast is now essentially self-sustaining, its prices do not correlate with Henry Hub as directly as they did in the past.

As the relationship between Northeast production and demand and the rest of the lower 48 production and demand devolves, so too does the relationship between the prices in the Northeast and the benchmark price at Henry Hub. This devolution did not fully manifest itself until summer 2015. That’s when the market seems to have become aware of how significantly those dynamics had shifted.

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At that time about a year ago, the market could see record demand coming from summer power burn in the U.S., and Henry Hub prices responded accordingly (see Figure 3). (For more on power burn dynamics see the June 23 and July 21 editions of Get the Point.) Henry Hub gas prices increased from below $2.00/MMBtu in the spring to over $2.75/MMBtu in the summer (red dotted line). The Texas Eastern Transmission Company Market Zone 3 (TETCO M3) price, on the other hand, stayed near $1.50/MMBtu, even through the hottest days of the summer (blue dotted line).

If we compare U.S. production minus demand to Northeast production minus demand, we can see the disconnect. Right at the beginning of June, as summer started and power burn began cranking up, the U.S. supply and demand (or SD) picture showed the demand eating into the supply of gas (red shaded area). But in the Northeast, the dynamic was different: the SD stayed relatively flat (blue shaded area), as shown in Figure 3 via the linear trend lines for the components mentioned above.

In summer 2015 as well as this year, the amount of Northeast production coming out of the ground could easily keep pace with any demand that hot temperatures could throw at it. Part of this is simply due to the abundance of gas already coming out of the ground in the region, but it also can be attributed to the nature of production techniques. Wells drilled but uncompleted (DUCs), as well as the efficiency and pace of how new wells can be drilled, can add production into the market much quicker than previously achieved. This allows producers to rapidly take advantage of price bumps to hedge and bring on new production to take advantage. This highly responsive supply keeps a lid on prices.

 Supply/Demand and Price

There is another, easier way to look at this in the form of cash basis. We can compare the spot market price differential between Henry Hub (the U.S. benchmark) price and TETCO M3, as it represents a nice balance of Marcellus Shale production and Northeast demand. We can call this the “SD basis,” or the production in the Northeast minus the demand in the Northeast compared to total U.S. production minus total U.S. demand. The “SD basis” between the Northeast and U.S. is shown in Figure 4 alongside the cash basis for TETCO M3.

 Supply/Demand "Basis" and TETCO M3 Cash Basis

Seeing the SD basis in the Northeast compared to TETCO M3 cash basis paints a much more striking picture of exactly what has happened in the Northeast. The cash basis value has widened its discount to Henry Hub at nearly the same rate as the difference between U.S. supply minus demand and Northeast supply minus demand has grown increasingly short. It should be evident that the Northeast has fundamentally separated itself from the rest of the U.S. with regards to the gas it produces and needs on a day-to-day level.

The Northeast is now natural gas self-sufficient nearly every day of the year (except for the peak winter months), producing or storing enough gas to meet its demand needs. Thus, it no longer needs gas from anywhere else in the U.S. or abroad. In fact, the region has enough gas to meet its needs and send the remaining volumes to other regions. Pockets of exceptions to this still exist along the Eastern Seaboard, due to logistical issues, but over the next few years when new infrastructure projects go into service, those exceptions will be eliminated.

The relationships discussed above have created a new normal that has separated prices in the Northeast from the rest of the U.S., further increasing the influence that the region has over regional and national natural gas dynamics. Stay tuned as PointLogic continues to monitor Northeast market dynamics and the crossroads that the entire region approaches as winter bears down in a few months.

We would like to thank our client for sending us down this latest rabbit hole. From our Get the Point article last week, Ohio, the Crossroads of the Shale Revolution Part 2we explained how Ohio’s Utica Shale production transformed the market dynamics in the Buckeye State. That article opened up a series of rabbit holes about the Northeast region’s relationship with the rest of the U.S. and how supply, demand and price there will influence the rest of the country. 

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