(John Kemp is a Reuters market analyst. The views expressed are his own)
* Chartbook: tmsnrt.rs/2CPw57U
By John Kemp
LONDON, April 3 (Reuters) – U.S. natural gas prices remain mired below $3 per million British thermal units despite a relatively cold winter that has left the volume of gas in storage well below normal for the time of year.
Futures prices for natural gas delivered to Henry Hub in June 2019 are just over $2.70 per million BTUs, down from $2.90 in the middle of March, and have remained well below $3 throughout the last two years.
Gas prices have remained relatively low even though a much colder winter in 2018/19 than in the previous three years pushed up consumption sharply and depleted inventories.
Working stocks in underground storage fell to 1,107 billion cubic feet by March 22, 21 percent below the year-earlier level and 33 percent under the prior five-year seasonal average.
Stocks are now at the lowest level for the time of year since 2014, despite a 13 percent increase in consumption in the last five years (“Monthly energy review”, U.S. Energy Information Administration, March 2019).
Spot prices spiked briefly in October and November, reaching more than $4.80 at one point, and again in January to $3.60, but otherwise the market has not signalled any shortage.
The combination of generally low prices with occasional spikes is the result of two trends: internationalisation of the U.S. gas market and the increasingly dominant role of gas as the marginal source of electric generation.
U.S. gas production has recently been rising at an annual rate of 13-14 percent, outstripping the increase in domestic consumption, and it hit a record of 2,755 billion cubic feet in December.
Gas production has been surging despite relatively low prices because of the remarkable productivity of new shale wells and large increases in drilling and completion efficiency.
At the same time, the country’s gas exports have accelerated and are rising at an annual rate of around 20 percent, reaching a record of 363 billion cubic feet in January.
As a result, the U.S. gas market is moving from an almost entirely closed system to one that is much more open to international trade and linked to markets overseas, with an impact on pricing behaviour.
In the past, the seasonal balancing of production and consumption was achieved almost entirely through changes in domestic inventories, but it can now be spread across a much larger international market.
Most of the time, price changes in a larger (internationalised) market can be more muted than in a smaller (purely domestic) one as there is more flexibility to meet seasonal variability in consumption.
While the market has become more internationalised, gas has also become increasingly important as the dominant source of electricity generation (tmsnrt.rs/2CPw57U).
Gas-fired power stations accounted for 34 percent of all electricity generation in 2018, up from 26 percent in 2014, the U.S. Energy Information Administration says.
More importantly, gas has become by far the most important source of marginal generation during periods of exceptionally high electricity consumption, either during the winter heating season or the summer cooling one.
In the fourth quarter of 2018, gas consumption was running at record rates for any given level of overall heating demand because of its growing role in power generation.
As gas-fired power plants have replaced older and less efficient coal-fired units, almost all the extra generation during periods of intense cold comes from gas-fired units.
The result is that gas consumption now increases significantly faster than overall heating demand during severe winter weather, with prices spiking to enforce conservation and switching to coal.
STOCKS AND PRICES
The gradual internationalisation of the U.S. gas market coupled with its growing dominance in the electricity system is changing the relationship between gas stocks and prices.
At low to moderate levels of heating demand, there is now a much lower call on gas in storage as a result of the big increase in production relative to domestic consumption (internationalisation dominates).
In effect, if temperatures track their long-term seasonal averages, withdrawals from storage now start about one week later and finish one week earlier each year, significantly reducing winter pressure on gas inventories.
But at very high levels of winter heating demand, the growing reliance on gas for power generation can still lead to a large storage drawdown (marginalisation dominates).
Most of the time, the market is now comfortable carrying lower inventories than before, even as prices remain weak.
But in periods of exceptional cold, inventory draws become much larger, the market tightens rapidly, and prices are still liable to spike.