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Natural Gas Yin-Yang, or the Duality of Supply and Demand in the North American Natural Gas Market

September 22, 2016 | By Jack Weixel

What does a central tenet of Chinese philosophy have to do with the North American natural gas market? The concept of yin and yang relates to how two opposing forces in the natural world may actually be complementary. Examples include light and dark, fire and water, dogs and cats, and Hilary Clinton and Donald Trump.

The duality of the yin and the yang can also be applied to the forces of supply and the forces of demand in the North American natural gas market -- after all, what are economic principles if not an extension of the philosophical? In this week’s Get the Point we will review how supply and demand have interacted this summer and provide a preview of how the market may behave over the upcoming winter. This article can also be considered a preview of content that will be on display at our upcoming Natural Gas Next conference workshop series beginning in New York City on Oct. 5.

Start of Summer 2016 Storage Injection Season

At the end of March 2016 (the beginning of the summer storage injection season), the third warmest winter on record left the lower 48 U.S. with over 1,000 billion cubic feet (Bcf) more gas in storage than it possessed at the same time the prior year. That year-on-year storage surplus has now eroded to just 184 Bcf through 24 weeks of storage injection.

Storage injections over the summer season have averaged 35 Bcf per week less than the same span of weeks seen last summer. The primary driver, or yin, of that declining inventory balance has been excess demand when compared to last year. According to PointLogic Supply and Demand estimates, gas burned at power plants has increased by 2.5 Bcf/d compared to last summer-to-date. Gas exported from the lower 48 (to Mexico and via Cheniere’s Sabine Pass LNG liquefaction facility) has increased by 1.1 Bcf/d.

As it relates to yang, or the supply side of the balance, dry production of natural gas in the lower 48 has decreased an impressive 1.4 Bcf/d.

Summer TD Production vs Demand (Bcf/d)

Source: PointLogic Energy Supply & Demand

As illustrated in the chart above, production (supply) and demand have returned to a more complementary relationship. Demand has increased summer-on-summer, when previously it ran at a deficit, while production has declined to meet demand at a level the market can bear.

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Looking further back in time on the chart, we can see the summers of 2007, 2008 and 2009 when demand was higher than production. This imbalance was corrected in summer 2010 (during the early years of the shale revolution) when production increased to meet demand. This pattern repeated in summer 2011 and summer 2012 before production truly accelerated faster than demand during the summers of 2013, 2014 and 2015.

For a brief period of time, production was driving demand, a “supply pull” impact. During this period, we have experienced an excess of natural gas supply, which ushered in new period of surging demand in the forms of gas for electric power and exports.

Where Demand Goes, Production Will Follow

Now that relative balance, or equilibrium, has been reached in the market, what does the future hold for natural gas demand?

The Energy Information Administration (EIA) estimates that through the end of this summer season and winter 2016/17, approximately 5.7 gigawatts (GW) of new natural gas generation will come online, paired with just 0.9 GW of coal or natural gas retirements. Summer 2017 holds even more promise for natural gas demand, with 9.8 GW of new build gas-fired generation and 2.7 GW of coal retirements.

Power Gen Additions and Retirements (GW)

Source: Energy Information Administration

Assuming a 50% capacity factor and 7.5 heat rate on new generation capacity, these new builds and retirements will equate to about 0.9 Bcf/d of incremental gas demand in summer 2017 and the gas equivalent of nearly 0.3 Bcf/d of coal retirements.

Power Gen Additions and Retirements (Bcf/d)

Source: PointLogic Energy

For next summer, this could result in a potential increase in power demand of nearly 1.2 Bcf/d, assuming that most of the coal that is retiring is replaced by existing natural gas and that newly built gas-fired generation is utilized at the assumptions in the conversion. For the purposes of our forecast, PointLogic has pared down this number to an even 1.0 Bcf/d.

The swing upwards in power burn is not just a theoretical forecast based on facility construction and retirements. Over the course of the past 10 years, power demand during the summer on a degree day-equivalent basis has increased substantially. Whether through additions to gas-fired generation capacity, coal retirements or the attractive price of natural gas compared to coal, power demand each summer has been increasing at an exponential rate.

Summer TD Burn per Degree

Source: PointLogic Energy

The graph above shows that summer 2016 burn has run a little more than 2.0 Bcf/d higher than 2015 at temperatures ranging from 59 to 71 degrees Fahrenheit. This reflects the increasing amount of gas available to burn vs. any prior year. EIA data echoes this, noting in a recent Electric Power Monthly that lower 48 generation from utility-scale electric generators during June 2016 increased by nearly 9% to 132.4 GWh. During the same month, coal use declined nearly 8% to 116.4 GWh.

U.S. gas exports are also up – rising by a combined 1.1 Bcf/d over 2015. The largest increase has occurred with the introduction of liquefaction facilities at Sabine Pass to move gas out of the country as LNG. With expansion of the facility to include two more trains (Trains 3 and 4) by next summer, PointLogic expects that an increase in demand is imminent compared to prior-year periods. Gas exports to Mexico also are up by nearly 0.5 Bcf/d as more pipeline expansion projects have opened to feed electric power projects being built by our southern neighbor.

Storage Surplus Tempers Production Response, but for How Long?

With such a large surplus of storage gas to begin the summer, production has been forced to slow down, even in the face of increasing demand. As noted earlier, U.S. dry gas production dropped by 1.4 Bcf/d during summer 2016 to-date vs. summer 2015 to-date. However, this slowdown cannot last forever. A 1,000 Bcf “excess” storage inventory surplus has been reduced to less than 200 Bcf over 24 weeks of summer injections this year. Over the final seven weeks of summer, PointLogic expects inventories to continue to trail last year, and thus to finish very close to levels seen at the end of last summer, right around 4,000 Bcf.

With demand showing no signs of stopping and the prospect of normal winter weather back on the horizon, PointLogic believes that a production resurgence will be necessary in order to keep up with demand, so that yin and yang restore a semblance of balance. The chart below reflects PointLogic’s forecast for winter 2016/17 supply and demand balance compared to last winter.

Supply vs Demand

Source: PointLogic Energy Two Year Balanced Supply and Demand Forecast

The differences between the two yearsis stark. On the supply side, production must rebound by at least 1.6 Bcf/d compared to last winter in order to counter rising demand from all sectors. PointLogic also expects that Canadian imports will rise due to an oversupply situation in western Canada, where, according to Enerdata Canadian storage statistics, inventories in the Western provinces (the main artery for existing Canadian imports) are nearly close to storage capacity limits.

On the demand side, the rebound in residential and commercial demand (Res-Com) due to a normal winter is the largest factor, as we anticipate a gain of 3.5 Bcf/d compared to last winter. Power demand and exports also play a part, up by 2.7 Bcf/d combined. The net effect is that over the course of 151 days of winter, the market will run 4.5 Bcf/d short, resulting in an extra 676 Bcf of gas that must be withdrawn from storage.

Supply vs Demand

Source: PointLogic Energy and EIA

Due to weak winter demand last year, the lower 48 U.S. withdrew a measly 1,490 Bcf over the course of winter 2015/16, its lowest winter withdrawal amount in recent memory. Assuming that an incremental 676 Bcf of gas must be withdrawn to cover normal winter demand and increased gas demand for power and exports, the lower 48 will withdraw 2,166 Bcf of gas over the course of winter 2016/17. This will leave the lower 48 U.S. with 1,834 Bcf of storage in the ground. That storage figure would represent a 646 Bcf deficit to the start of summer 2016 but remains 186 Bcf above the 5-year average. Should a colder-than-normal winter arise, storage inventories could end March closer in range to the 5-year average.

Natural gas supply and demand do not exist separately in a vacuum. When one factor goes down, the other is constrained by market forces and must also decline. In the case of this coming winter, as demand climbs, so must supply. Such is yin and such is yang, two opposing forces that are interconnected and ultimately dependent on one another.

Where there is shadow, there must also be light. Stay tuned to PointLogic as the winter of 2016/17 takes shape and these market forces continue to do battle to reach harmony and ultimate balance.

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