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Natural Gas Market Update

Oil is the world’s most traded commodity, and as an energy analyst, I spend more time talking about it than any other energy source. Natural gas is often an afterthought in stories that are focused on oil. But the U.S. natural gas renaissance is every bit as interesting as the crude oil story. So today let’s catch up on the natural gas market. 

It has been a remarkable ride over the past decade. In the first half of the previous decade, it was widely believed that a U.S. natural gas crisis was imminent. Gas production had been in decline since the 1970s, and many were certain that the outlook was grim.

But legendary oilman George Mitchell was experimenting with a combination of hydraulic fracturing and horizontal drilling, and during the last decade, the shale boom was born. The first successes were in U.S. shale gas plays. In 2006, production turned up and climbed for ten straight years to a new all-time high. Production in 2015 was 50% higher than in 2005 as a result of the gas unlocked from shale.  

This surge of production had a big impact on prices. The spot price of natural gas was persistently above $5 per million Btu (MMBtu) prior to the boom — sometimes spiking much higher — but dropped below $2/MMBtu in 2012 and again in 2016. (Production finally declined by 2.2% in 2016 as natural gas prices languished at decade-long lows).

 

The average monthly spot price of natural gas. Source: Energy Information Administration.

Price fluctuations are driven in part by natural gas storage, which is seasonal. Producers use a system of underground pressurized storage that builds inventories until mid-fall, which are then depleted through the winter. Natural gas is stored in depleted oil or gas reservoirs, in natural aquifers, or in salt caverns.

Low prices in 2016 were driven by mild winters and record production, which kept these storage levels at the top of the maximum seasonal range for nearly the entire year.

So where do things currently stand? A year ago, natural gas prices were hovering just above $2/MMBtu. On one of my slides at last year’s Investing Daily Wealth Summit, I wrote that natural gas had “much more upside than crude” (which was then trading at $49/bbl). Today, natural gas is trading more than 50% higher than a year ago at $3.28/MMBtu, while oil is trading a hair above $49 a barrel.  

Production is still down year-over-year, but natural gas rig counts have doubled from a year ago. This will likely help stem the production decline over the next year. Inventories are slightly above the average for this time of year, which is mildly bearish for prices. But over the next few months, the summer weather will be the strongest driver of natural gas prices. If it’s a long, hot summer, there will be a higher demand for natural gas from utilities. If summer is mild, high production will keep inventories at a high level and prices will be under downward pressure. 

Investors should probably plan for natural gas prices to remain in the current range for the rest of the year. Although there will be some improvement in local pricing in the Marcellus and Utica shales as new pipelines come online and alleviate a bottleneck that has existed for several years. This will benefit producers in these regions.

Next week in The Energy Strategist I will highlight the oil and gas companies that managed strong cash flow and profitability during the most recent quarter. Consider subscribing for guidance on which of these companies belong in your portfolio.

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