With Labor Day looming, it’s obviously time to start thinking about winter. Obvious, that is, if you follow that battered, crushed, flayed corner of the energy market called U.S. natural gas.
America is awash in the stuff. Production will jump 10 percent this year, according to the Department of Energy, hitting a new record— just ahead of probably hitting another one in 2019. Export terminals can’t be built fast enough. This isn’t helpful for the dogged, if shrunken, cohort of gas bulls still out there.
What is helpful, though, is that, for all the gas coming out of the ground, there’s a surprising shortage of it underneath — in storage.
That’s right: We’re only a few months away from reminiscing about the heat instead of complaining about it, and the gas tank looks light. Stocks are 20 percent below the five-year seasonal average, something that’s only happened in three other periods since the beginning of 1999:
Ordinarily, this would light a fire under gas prices, as it did late in the winter of 2013 and 2014.
But, as I wrote here three months ago, something has put the market in a coma; futures have traded below $3 per million BTU for most of the year. That something is associated gas, the stuff that gets produced alongside oil and which is spewing out of the Permian shale basin, among others. This isn’t dictated by gas prices, so the usual signals to producers aren’t working. It’s no accident that the breakdown has coincided with the discount at which gas trades in west Texas blowing out beyond its usual limit of around 50 cents per million BTU to as much as $1.40.
Still, with storage having dropped below even the minimum level expected for August and winter not far off, it is striking that prices are still so moribund. The market is implicitly taking the view that even if the usual buffer against a cold snap looks thin, the frackers can bring on enough new supply to fill the gap. Similar thinking has helped to cap the rally in oil prices even as those stocks have drained and supply risks around Venezuela and Iran have sprung up.
It sets up a risky dynamic in the U.S. gas market this winter. Dedicated gas frackers can respond relatively quickly to higher prices and there was about six months-worth of drilled but uncompleted wells in the Appalachian region at the end of July. But quickly isn’t the same as instantaneous. Throw in the bottlenecks affecting Permian oil production (and thereby, potentially, gas too) and there’s a decent risk of gas-price spikes this winter.
The wrinkle in all this is that even a winter spike may not do much for the stocks of dedicated gas producers. Amid broad ambivalence toward the E&P sector in general, gas producers haven’t fared well even when prices spiked briefly during the past two winters.
This makes sense. There is a chronic imbalance in U.S. gas supply versus domestic demand that exports are only beginning to close. Any spike in gas prices is bound to draw a supply response from shale producers within the space of six months at the most; not quickly enough to prevent the spike but enough to suppress prices (and earnings estimates) later in the year.
Meanwhile, the most notable aspect of E&P earnings season was a general hike in investment budgets. Inflation and slowing productivity growth mean that won’t translate one-for-one into increased production. But it certainly won’t take it down. Much of it is focused on oil, of course, but that exacerbates the associated-gas problem.
Moreover, gas producers themselves aren’t taking their cues either. There was time when sub-$3 gas would have sent these companies running for cover, if not to bankruptcy court.
But Credit Suisse noted in a recent report that all but one of the gas-weighted E&P stocks it covers are targeting double-digit production growth assuming prices below $3. Years of misery have forced the industry to make do with less. The Energy Information Administration notes in its latest short-term outlook that for a group of 22 gas producers, cash flow from operations exceeded capex in the first quarter of 2018 for the first time in five years. Winter is coming, for sure, but it’s been nothing but winter for these guys for years on end. And they’re still going.