Commodities: Market fundamentals support low natural gas prices

By Ben Straus, U.S. Energy Services | January 23, 2015

Oversupply in the natural gas market is likely to lead to lower prices this summer. While lower drilling rig counts are anticipated due to the weak price environment for both crude and natural gas, 2014’s record production growth leaves the market well positioned to coast into stronger annual production even if the month to month gains flatten out. While the market is not currently looking as oversupplied as it was in 2012, similar dynamics are emerging in the market fundamentals to support the view that prices still have additional room to fall.

Natural gas production hit new highs (again) in December of 2014, capping off an impressive year of growth. According to U.S. Energy Information Administration data, natural gas production grew from 60.96 Bcf per day in December of 2010 to 65.62 Bcf per day in December of 2011, or 7.6 percent. From December 2013 to December 2014, dry natural gas production rose almost 12 percent, according to data from Bentek Energy. Low crude and natural gas prices are already driving drilling rig counts lower and concurrently dropping expectation for future production growth. However, even with stationary production, the peak production level of 2014 could carry the market to an average annual production rate in 2015 that is more than 4 Bcf per day higher than the level in 2014.

Production gains helped to alleviate the bullish concerns regarding a massive storage inventory deficit coming out of the prior winter. With higher production slated for 2015 even a repeat of that scenario leaves the market positioned for more supply than storage capacity can comfortably handle. The market is already showing signals that prices will need to fall this summer to avoid running out of space in inventory. Looking at the different segments of natural gas demand shows the signal that prices will likely need to remain below $3 MMBtu for the first half of the summer at a minimum. January weather for 2015 has been roughly comparable to 2014 in terms of temperature as reflected by demand from residential and commercial consumers, up 2 percent through Jan. 20. However, power generation demand has posted outsize gains in comparison, up 12.9 percent versus the prior January. A key feature of the natural gas market revealed in the oversupplied year of 2012 was the capacity for power generation demand for natural gas to increase if prices dropped to a sufficiently low level to compete with coal-fired generation. Similar to 2012, power generation demand differentials started to kick up in January and continued to rise through the spring as prices fell lower. While the path of prices may not be identical to 2012, evidence is emerging that suggests that similar dynamics are in play, and lower prices will likely be needed to keep the market balanced.