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Supply and Demand: Natural Gas Storage and Its Significant Impact on Prices

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One of the most closely watched data points in the energy industry is the weekly natural gas storage report that is released by the U.S. Energy Information Administration (EIA) each Thursday at 10:30 a.m. Eastern Time. It’s a useful indicator of supply and demand based on the previous week’s storage activity (injections or withdrawals) and has a very significant impact on natural gas prices.

Recent storage activity this winter has been especially critical. This winter is a perfect example of demand far exceeding supply. Domestic natural gas demand reached 139 Bcf on January 7, an all-time high. The result is significantly higher prices not only in the spot markets, but through the next several months of NYMEX futures contracts as well. This winter is shaping up to be one of the coldest on record and pricing levels for natural gas basis as well as electricity prices through the NEPOOL, NY, and PJM regions are near or at record highs. Although prices may still be a good value when compared to the levels from 2008 and earlier, the NYMEX natural gas traded at a four-year high on January 24, and is up nearly 30% since early-November.

Storage levels are being depleted quickly and the year-over-year deficit is 20% or 600 Bcf. This deficit is likely to increase if near-term weather forecasts are correct. In addition, if winter continues to keep a firm grip on the majority of the country through February and into March, then inventories will likely reach the lowest level exiting winter since 2004. This is remarkable considering that natural gas production is near all-time highs (65-66 Bcf per day) due to rampant growth in shale gas development.

The rise of NYMEX prices for the remainder of the winter makes some sense. But the NYMEX curve falls sharply beyond this winter. The majority of the price premium is in the front months as heating demand continues to draw on the natural gas storage supply. There are lower prices during the shoulder season when heating demand declines and injections commence. As the injection season starts in late April and lasts into October, storage will be replenished in preparation for next winter’s withdrawals. While NYMEX futures for the summer are already lower than the near-term (April-October ~ $4.40 versus Feb-March ~ $5.05 per MMBtu), these summer prices are still much higher than a few months ago before the cold winter. Can prices fall back to the lows of November (April – October traded at $3.63 on November 4, 2013)? While we don’t have a crystal ball, we can note it will be difficult due to the storage deficit. In order to erase or significantly reduce the large storage deficit of 600 to 800 Bcf, additional supply of 2 to 4 Bcf/day is required. Sustained high prices may be needed to continue to incent ongoing shale production growth and to keep power generation away from natural gas, which could result in adequate storage levels for next winter. So, be careful counting on a sudden crash in prices in the spring.

If you’re hoping for good news, look at the NYMEX beyond the next 12 months. Overall, there’s an expectation that storage inventories will eventually normalize and other fundamentals will dictate prices. This is good news, because shale gas production remains the primary price driver, and NYMEX futures for 2015 and beyond are much lower than near-term prices - mostly trading between $4.10 – 4.20 so far this year. This discount of long-term prices may be presenting significant value, especially when considering recent price volatility, as well as long-term bullish impacts of LNG exports and EPA regulations.

While natural gas storage’s price impact is second nature to many in the industry, how it actually works and the importance of having the ability to store gas is not as clear as it might seem. In the most basic sense, gas is stored in the ground throughout the summer months when gas demand is significantly less and is withdrawn during the winter months when gas demand is higher.

Click here for more information about how gas storage works and how gas is stored in the ground via the EIA.

Posted: January 29, 2014