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What Could Happen to Gas Inventories If this Winter Is Warm?

September 29, 2016 | By Kevin Adler and Robert Applegate

U.S. natural gas inventories have retreated from the robust surplus levels that were observed near the end of the 2015-2016 winter heating season. From their peak, inventories have retreated by nearly 830 billion cubic feet (Bcf), through Sept. 16, and optimism is rising in the industry that this winter will continue the trend and yield a significantly tighter market heading into next summer.

This optimism is based on many factors, one of which is that gas demand this winter will be higher than last year’s because last winter was unusually warm. A “normal” winter would cut into gas inventories, as residential heating demand would rise. But tomorrow’s weather might be uncertain, and the weather two or three months from now is still nearly unknowable. This raises the following question: What would happen to gas inventories if we have another warm winter?

In this issue of Get the Point, we consider alternative weather scenarios for the 2016-2017 winter and what they could mean for the U.S. gas industry.

Winter Heating Demand

For those tracking natural gas demand, the official winter heating season is Nov. 1 through March 31. Typically gas demand in the residential and commercial sector, or Res-Com, begins to rise gradually in September as cool weather enters northern parts of the U.S., but it really picks up velocity when winter arrives in most of the country a couple of months later. This pattern is captured by PointLogic’s Res-Com demand data, as shown for the last eight years in the graph below.

Res-Com gas demand peaks every winter, and the winters with the highest demand in the last eight years were 2013-2014 and 2014-2015.

Res-Com Demand Since Nov. 2008

Source: PointLogic Energy

The magnitude of the increase in Res-Com demand in the winter is critical to balancing the gas markets each year. During the heart of the winter season, Res-Com is the largest demand sector for gas, surpassing electric power, industrial production or exports.

To accurately project gas demand in the winter, getting the Res-Com number right is crucial. That’s why PointLogic uses a 330-city temperature model to get accurate, granular information that we feed into our model for how gas demand in different parts of the country reacts to temperature variations.

Using historic temperature data, we projected gas demand across the U.S. for the 2016-2017 winter as the following:

Winter 2016-2017 Res-Com Gas Demand (PointLogic Energy forecast)

    November: 27 Bcf/d
    December: 38.7 Bcf/d
    January: 46.1 Bcf/d
    February: 42.7 Bcf/d
    March: 29.5 Bcf/d
    Average: 36.8 Bcf/d

Impact on Inventories

Thanks to surging Res-Com gas demand, winter is when inventories traditionally decrease rapidly, so that they can be rebuilt in the spring and summer. However, that didn’t happen last year, as the U.S. experienced the warmest winter on record. In fact, gas inventories actually increased last year until late November – a nearly unprecedented event – and then fell at a much slower rate than in a typical year.

At the same time, gas production was strong. The result of weak demand and strong production is that inventories stayed well above historic norms week after week, and they ended the winter 2015-2016 season at a near-record 2,467 Bcf. Only winter 2011-2012 ended slightly higher, at 2,473 Bcf.

The graph below shows winter Res-Com demand for each of the last eight years, with last winter in red. Note that demand for gas in winter of 2015-2016, while weak, isn’t an extraordinary outlier. It sits in the midpoint of the 2011-2012 and 2012-2013 winters.

Res-Com Demand Winter Seasons Since 2008-09

Source: PointLogic Energy

From Oct. 1, 2015 through March 31, 2016, Res-Com demand averaged 32.6 Bcf, or a total of 4,917 Bcf for the five-month (151 days) period. The average over the last eight years, including last winter, was 36.6 Bcf/d. To put it another way, over the typical 151-day winter season (or 152 days during a leap year), Res-Com demand on average for the last eight years was about 604 Bcf higher than it was last winter. That figure represents drawdown of inventories that would happen in a typical year but did not occur last winter.

The graph belows show end-of-winter inventories for each of the last eight years, plus the PointLogic baseline projection for March 31, 2017.

U.S. Gas Inventory, End of Winter Since 2009

Source: PointLogic Energy

The good news for the industry is that much of the excess that started this summer has been eliminated. Gas in storage on April 1, 2016 started more than 1,000 Bcf above the eight-year average, but about 830 Bcf of that excess was whittled away as of the week ended Sept. 16, 2016, because a hot summer helped to set record natural gas demand from the power sector.

Winter 2016-2017 Weather and Res-Com Projections

Now we’re nearing the start of the 2016-2017 winter season, and the question is whether strong Res-Com demand will continue to cut into the excess inventories. If so, gas prices could continue to improve and new gas production could be incentivized.

Looking ahead to the upcoming winter, PointLogic incorporated into our model assumptions about the weather and temperature impact on Res-Com demand. Our baseline model (which is updated and provided to clients every month) assumes that temperatures will match the eight-year average. This is a reasonable expectation, and there is no firm information that would suggest selecting another number.

As discussed above, for our baseline model, updated as of Sept. 16, we are projecting an average Res-Com demand of nearly 36.8 Bcf/d for the winter of 2016-2017.

But what if the U.S. experiences another warm winter? What would that do to Res-Com demand?

In this Get the Point, we consider two other weather scenarios and model the impact on demand and inventories: 1. A repeat of the very warm 2015-2016 winter, and therefore demand of 32.6 Bcf/d; and 2. A midpoint between the eight-year average and the 2015-2016 winter, or demand of 34.7 Bcf/d.

The table and graph below show the difference on a month-by-month basis for November 2016 through March 2017.

Baseline Winter 2016-2017 projection, vs. 2015-2016 Actual, vs. Midpoint (Bcf/d)

Res-Com Projections Winter 2016-2017

Source: PointLogic Energy

The data show a significant change in gas demand if the U.S. experiences another warm winter. If our winter 2016-2017 matches last year’s warmth, demand from the Res-Com sector would be about 32.6 Bcf/d, or 4.4 Bcf/d less than anticipated. For the full winter, that’s about 674 Bcf. If the winter 2016-2017 is the midpoint between a very warm winter and an average winter, Res-Com demand would be about 34.7 Bcf/d, or a reduction of 2.3 Bcf/d from the baseline. For the full winter, that’s about 356 Bcf.

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Lower demand would equate to lower storage withdrawals and potentially leave the market with another year of very high inventories. Using our baseline temperature forecast, PointLogic is projecting with the average winter that the gas inventory as of March 31, 2017 will be 1,698 Bcf. This would improve upon rebalancing the market to historic norms, and it would represent a 31% decline from the inventory level of 2,467 Bcf on March 31, 2016.

But if the winter is as warm as last year, our model shows inventories would end the 2016-2017 winter at nearly the same point as they were a year ago: 2,372 Bcf. If the winter was merely the midpoint between last year and the 8-year average, inventories would be 2,054 Bcf.

Will It Happen?

PointLogic cannot predict the weather. We have used the eight-year, 330-city average temperatures as our baseline for predicting Res-Com gas demand in the 2016-2017 winter. In doing so, we see inventories falling significantly from November through March and helping to sustain the price recovery that gas has experienced this year.

But recent history suggests that temperatures are on the rise – and this is a risk factor that should be taken into account. According to NASA’s Goddard Institute for Space Studies, August 2016 marked the 11th month in a row when worldwide temperatures set a record. These are record temperatures each month, not merely temperatures above average. September looks like it will continue the trend, at least in the U.S.

If the case for inventory movements this winter was built only on Res-Com demand, it could be argued that a significant high-side risk is present. But other factors also will come into play.

For example, the sustained hot weather in September has produced a stronger power generation demand number than is typical at this time of year. This occurrence has had a positive impact on gas demand at this time of thus limiting the typical early ‘shoulder season’ injection increases. Over the last eight years, injections from mid-September through mid-October have averaged 97 Bcf per week; this year, they’re on track so far at about 50 Bcf/week.

Other factors could support more gas demand this winter, too, such as continued increases in U.S. gas deliveries to Mexico and LNG exports around the world. Also, the production side could come into play: if gas demand is not strong, it’s possible that operators will reduce their production, as we’ve seen with a 1.4 Bcf/d dry gas production decline during the 2016 summer as compared to the prior year. With spot gas prices in the Northeast production region dipping below $1.00/MMBtu recently, it is possible that price signals will discourage additional production in the short term.

To conclude, this winter’s Res-Com demand is just one factor that will affect the market in the next six to eight months. At PointLogic, we’re carefully watching which factors will be most important, and how the market will adjust.

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