Natural Gas Bottom Line
The October contract for natural gas roared back to life this week, gaining 40c from its lows this week, and about 15c from last Friday’s close. So, what did Cal ’21 do? Very little. That’s OK. It hadn’t dropped much on weakness, either. The tenors past December 2020 are largely ignoring the volatility in the short term.
Futures values are holding firm, and our bullish point of view for Cal ’21 is still affirmed by the options market, it seems. Call skew is still pronounced, and it gives gas producers good value to hedge using costless collars. It’s not changed much since last week, despite the rally in near-term prices.
Intraday Friday, 1Q2021 swaps (for a producer, in the bilateral market) were bid near $3.28/MMBtu. A representative collar would be priced at $3.00 X $3.91. That’s still great value, providing a floor of $3, with upside near $4.
That’s 1Q, but we think swaps are the better choice for November and December gas, for a couple of reasons. First, that excellent call skew for 1Q is non-existent for November and December. That automatically makes us shy away from collars. (In fact, if you want to add Winter strip hedges, consider using collars for Jan-Mar and swaps for Nov-Dec, unless you would like to use the 1Q values to uplift the weaker Nov-Dec leg. Give us a call to discuss.)
Second, our fundamental outlook suggests November and December gas prices are still vulnerable. Even if storage limits aren’t reached (we think they might get close), the winter will start with maybe 200 Bcf of “extra” supply waiting to be withdrawn from storage. It will take some time for a tight supply-demand balance to work off that excess.
By the way, if you still need Summer ’21 hedges, the swaps are still around $2.81. If you’re bullish like us, and your financials would support it, the collars at $2.50 X $3.17 would provide exposure up to the levels where we would expect to see a lot of selling and price resistance.
Natural Gas Factors
Dry Gas Production & Associated Gas Production. These are the most important drivers of gas prices in the next 18 months. Production in 2021 could be 5-7 Bcf/d lower than in 2019, while demand would be higher than in 2019, under normal weather conditions. We think these Factors together are mildly priced-in, but not fully.
Storage Level. Storage-capacity concerns are alive and well. Most U.S. regions have injected at a quick pace and are at-risk of reaching limits before November 1. This is a short-term issue; once withdrawals begin in mid-November, storage limits cease to be a limiting force against gas prices. After mid-December, the excess inventories work as a buffer against rallies in the cash and prompt market.
Canada. Imports from Canada this fall and winter could be a bearish surprise. Eastern Canada storage is extremely high.
Mexico. Guessing at the timing of Mexico pipeline and power plant completion is difficult, but infrastructure plans within that country could expand U.S. exports to the south. This summer already showed record-high flows, and this winter may bring some bonus demand, too.
Oil Price. Lower oil prices take away the risk of associated-gas production growth. WTI in the upper $30s does not encourage oil or associated-gas production growth, in our view. If prices move higher, expect more gas supply; if WTI weakens, expect less gas supply.
LNG Arbitrage. Even as Cameron LNG remained offline after Hurricane Laura, gas flows to LNG plants increased to near 8 Bcf/d, or 80% industry-wide utilization. In other words, if Cameron LNG were running, utilization could have been near 100%. Even at 80% utilization, AEGIS believes the demand would support higher gas prices this winter.
Further, spreads from the U.S. to Asia and Europe have widened since earlier this year, relieving some pressure for foreign purchasers of U.S. LNG to cancel cargoes. We moved this Factor to a Bullish/Surprise, rather than Bearish/Priced-In.
COVID-19 Demand/Economy. While the worst of COVID-19’s impact on gas prices seems to be over, this bearish factor could become more priced-in very quickly if another lockdown or similar type event is imposed. Further, it is yet unknown how space-heating demand will perform when the weather gets cold; many workers are at home rather than in commercial buildings, and commercial vacancies have increased.
Election. Democrat and challenger Joe Biden has a popular-vote lead in many poll/survey samples. His energy platform would add costs to produce oil (and, therefore, associated gas) and subsidize competing fuels. Gas may benefit from fewer coal plants in operation and more off-peak demand from electric vehicles. Still, many of Biden’s policies would not have immediate effect. It would take time. In our view, a Biden presidency would support prices, because supply growth would be more difficult. However, E&Ps would find operating difficult if some of Biden’s platform ideas became law or policy. You can learn more about how the upcoming election may impact prices and the industry in our Election-Risk Tracker.
We continue to monitor oil, gas, NGLs, regional markets, jet fuel, and interest rates for hedging opportunities. To learn more and see AEGIS opinion and recommendations, go to AEGIS View publications, or contact email@example.com. Like what you see? Share this article with the button on the bottom right of your desktop. Market questions or comments? Contact us at firstname.lastname@example.org.