Early Winter Kick in the Gut for Natural Gas Prices

Natural gas prices got a kick in the gut last week.

NYMEX prices fell to $2.28/mmBtu, the lowest November level since 2015. Gas prices have been less than $3.00 since late January and are now 15% less than the 13-month mean price of $2.53 (Figure 1).

Figure 1. Natural gas price fell to lowest November price since 2015–$2.28/mmBtu on November 29 was one standard deviation (SD) less than the one-year mean of $2.53/mmBtu. Source: Quandl and Labyrinth Consulting Services, Inc.

Over the last 20 years, only November 2015 average gas prices were lower than this year (Figure 2). That’s pretty bad but it’s even worse because weather this November was normal but 2015 was one of the three warmest U.S. winters on record.

Figure 2. Only November 2015 U.S. natural gas prices were lower than November 2019. 2019 weather was normal but 2015 was the third warmest November on record. Source: EIA and Labyrinth Consulting Services, Inc.

The main reason for low prices is record gas supply. Dry gas production has surged 25 bcf/d since January 2017 to a record 95.5 bcf/d (Figure 3). The dramatic increase in output resulted from new pipeline capacity from the Marcellus and Utica plays in Appalachia and because of gas associated with tight oil production.

Figure 3. U.S. dry gas production has increased 25 bcf/d since January 2017 to a record 95.5 bcf/d. Production growth has slowed by 0.5 bcf/d since July 2019. This is because of less capital for drilling and does not reflect depletion. Source EIA STEO and Labyrinth Consulting Services, Inc.

At the same time, supply growth seems to have peaked and declined in recent months. This reflects less capital available for drilling and not depletion of shale gas reserves. This is not the first time that production growth has fallen. In fact, growth had fallen to – 2.09 bcf/d by March 2017 just before the largest expansion of production in U.S. history.

Shale gas now accounts for 79% of U.S. production and associated gas from tight oil plays has been the largest component of shale gas growth over the last 12 months (Figure 4).

Figure 4. Associated gas from tight oil plays is the largest component of shale gas growth over the last twelve months. Source: EIA and Labyrinth Consulting Services, Inc.

Associated gas has increased 4.19 bcf/d year-over-year and that is 40% of shale gas’ 10.36 bcf/d growth. Marcellus has increased 2.85 bcf/d for 28% of growth and Haynesville is third at 2.3 bcf/d and 22% of growth. Conventional gas, by contrast, has decreased -2.2 bcf/d.

All of this new production and resulting low gas prices is great for consumers but not for gas-weighted E&P companies. More than three-quarters of shale gas companies had negative cash flow in the third quarter of 2019 (Figure 5).

Figure 5. Seventy-seven percent of shale gas companies had negative cash flow in the third quarter of 2019. Cash flow has a fair correlation with net income. Source: Yahoo Finance and Labyrinth Consulting Services, Inc.

Chesapeake, Range Resources, EQT, Antero and Gulfport all had negative net income. It is difficult to imagine a bright future for EQT with -$361 mm or Antero with -$879 mm in net income in Q3 2019.

There are some analysts who believe that abundant, new shale gas supply has led to an end-of-history phenomenon in which storage inventories no longer matter. These are probably the same people who thought that rig counts had become irrelevant several years ago because of improved well performance.

Increased wellhead production has reduced market supply concerns. Negative comparative inventories approaching winter heating season have become more normal in recent years. The correlation between comparative inventory and price, however, has not changed (Figure 6).

Figure 6. Comparative inventory is the the best reflection of a price signal to natural gas markets. Source: EIA and Labyrinth Consulting Services, Inc.

“Just-in-time” natural gas supply does not diminish the importance of inventory. Last winter, 1.4 trillion cubic feet of gas were withdrawn from storage from November through February.

Day of Reckoning

Shale gas plays are in trouble. Few imagined that gas from tight oil plays would become their largest growth component. It may be that declining tight oil rig count and production will be the most meaningful element in lower gas production going forward.

After the last industry downturn, dry gas production decreased almost 5 bcf/d from April 2015 to January 2017 (Figure 7). That may be a reasonable guide for what to expect over the next year or two.

Figure 7. Most gas price fluctuation is because of weather, not supply. Dry gas production decreased -4.7 bcf/d from April 2015 to January 2017. Source: EIA STEO and Labyrinth Consulting Services, Inc.

But it’s important to note that the improvement in gas prices by early 2017 had little to do with lower supply. The winters of 2014-2015 and 2015-2016 were the warmest of this century and gas prices followed lower consumption. Since then, winter weather has returned to normal and gas prices have been stable except for price spikes during brief periods of extreme weather.

There are factors now that were not as relevant in 2015-2017. Despite poor financial performance, Appalachian producers have send-or-pay contracts with pipelines that obligate them to deliver certain volumes. Bankruptcies may disrupt some of these contracts but poor financial performance neither seems deep nor widespread enough to suggest serious supply changes for now.

New take-away capacity from Permian and Bakken associated gas production will increase production even with lower rig counts at least in the short term. Net gas exports have reached 6 bcf/d and liquefaction capacity is growing at U.S. export terminals.

Almost 6 years ago, I stated that shale plays were a retirement party for the U.S. E&P industry. I neither questioned the resource volumes nor the effectiveness of the new technologies. I doubted the underlying economics of the plays because of the cost of the technology. That is as true today as it was then.

The flow of outside capital has always been the key to the continuation of the plays. Not the geology. Not the economics. Other people’s money.

Now, many think that the day of reckoning has arrived; that investors have voted with their feet; that there will be no more capital until the companies demonstrate positive cash flow.

I am skeptical.

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