U.S. gas prices at multi-year highs will protect stocks: Kemp



(John Kemp is a Reuters market analyst. The views expressed are his own)

By John Kemp

LONDON, July 22 (Reuters) - U.S. natural gas prices have surged to multi-year highs which will conserve scarce stocks, encourage more gas-focused drilling and promote a temporary switch back towards coal-fired generation this summer.

Front-month futures prices for gas delivered at Henry Hub climbed to over $3.95 per million British thermal units on Wednesday, the highest since late 2018 and before that late 2014, up from just $1.68 a year ago.

In contrast to crude oil, gas futures typically trade in contango, with nearby contracts trading at a discount to later-dated ones, driven by the greater technical challenges and cost of storing a gas rather than a liquid.

But the six-month calendar spread has narrowed to just a 9 cent contango, in the 76th percentile, compared with a contango of $1.11 a year ago, in the 2nd percentile for all trading days since 2010.

The epidemic depressed gas consumption in the second and third quarters of 2020 and led to a large build up of inventories (Link).

Late last year, working stocks in underground storage had risen to almost 4,000 billion cubic metres, according to data from the U.S. Energy Information Administration ("Weekly natural gas storage report", July 22).

But ultra-low prices depressed drilling and production through the second half of 2020 and into 2021, curbing the stock build and holding inventories just below the previous record.

Then the blast of cold weather that hit Texas in February accelerated the rebalancing process by boosting consumption and more importantly leading to a large loss of production as wells froze off.

By April, stocks had fallen below the five-year average, since when prices and spreads have climbed sharply higher to conserve the remaining inventories.

Rebalancing has been helped by close to average temperatures the most populous areas of the United States since June, notwithstanding the heatwave in the Northwest, limiting overall electricity use from air-conditioning.

PROTECTING STOCKS

In the short term, higher gas prices will encourage power generators to run gas-fired turbines for fewer hours over the next few months, running coal-fired units instead, to reduce gas combustion.

In the medium term, higher prices should encourage a faster rise in gas-directed drilling and production, which will filter through in the first half of 2022.

So far, rig counts and output have barely recovered from last year's slump. The number of gas rigs has risen by just 36 or 53% from its cyclical low in July 2020, compared with an increase of 199 or 110% in oil-directed rigs.

As a result, gas production in the three months between February and April was unchanged from the same period two years earlier, after growing rapidly at an average rate of 4.6% per year between 2010 and 2018.

If higher prices are sustained, however, there is scope for the rig count and output to increase significantly. The last time prices were at current levels, in late 2018, the number of active rigs was almost double, at nearly 200.

Since then, the industry has consolidated and many of the larger producers are focused on returning money to shareholders and strengthening balance sheets, rather than growing production.

Nonetheless, prices are sending a strong signal about the need for higher output, with a return to significant production growth likely over the next 12 months.

Related columns:

- Rising U.S. gas prices will encourage more coal burning (Reuters, May 14)

- U.S. gas stocks and prices normalise after cold snap (Reuters, March 16)

- Big freeze rebalances U.S. gas market (Reuters, Feb. 26)
Editing by David Evans

Disclaimer: The XM Group entities provide execution-only service and access to our Online Trading Facility, permitting a person to view and/or use the content available on or via the website, is not intended to change or expand on this, nor does it change or expand on this. Such access and use are always subject to: (i) Terms and Conditions; (ii) Risk Warnings; and (iii) Full Disclaimer. Such content is therefore provided as no more than general information. Particularly, please be aware that the contents of our Online Trading Facility are neither a solicitation, nor an offer to enter any transactions on the financial markets. Trading on any financial market involves a significant level of risk to your capital.

All material published on our Online Trading Facility is intended for educational/informational purposes only, and does not contain – nor should it be considered as containing – financial, investment tax or trading advice and recommendations; or a record of our trading prices; or an offer of, or solicitation for, a transaction in any financial instruments; or unsolicited financial promotions to you.

Any third-party content, as well as content prepared by XM, such as: opinions, news, research, analyses, prices and other information or links to third-party sites contained on this website are provided on an “as-is” basis, as general market commentary, and do not constitute investment advice. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, it would be considered as marketing communication under the relevant laws and regulations. Please ensure that you have read and understood our Notification on Non-Independent Investment. Research and Risk Warning concerning the foregoing information, which can be accessed here.

We are using cookies to give you the best experience on our website. Read more or change your cookie settings.

Risk Warning: Your capital is at risk. Leveraged products may not be suitable for everyone. Please consider our Risk Disclosure.