If I Could Turn Back Production – How Increasing Natural Gas Output Defies Price Signals

The natural gas market just managed to dodge a collision this summer between excess gas supply and available storage capacity. Now about a month into the gas winter season, storage inventories are still near record levels after topping 4.0 Tcf just two weeks ago. The Henry Hub CME/NYMEX January contract price closed yesterday (December 2, 2015) at $2.165/MMBtu, historically low even as we head into the highest demand months of the year. It’s now clear that 2016 will inherit this bearish market unless there is a Polar Vortex Tsunami in January and February. But what does this mean for producers, and how much will demand respond? In today’s blog, we begin a series on potential scenarios for the 2016 gas market balance.

Recap 2015

Before we get to 2016, first let’s recap what has been throwing the market out of balance and how it righted itself this year – sort of.

In Hazy Shade of Winter we explained how excess supply this summer led storage inventories to record highs despite higher power burn demand. As the injection season started in April, the market was already strapped with a 600-Bcf storage overhang from last winter and debate and speculation swirled around whether production would decline with falling rig counts and how demand would respond to lower prices. Hindsight tells us now that the market was unable to work off the year-over-year storage overhang since inventories surpassed all time record levels by the end of November.

Of course, the culprit behind that overhang and the ongoing surplus is production. Lower 48 output averaged about 66 Bcf/d in 2013 then ramped up to 72 Bcf/d in 2014.  This year, even in the midst of extremely low spot prices, gas production climbed to a record 74 Bcf/d in the summer before dropping back to 72 Bcf/d recently. So we are still pretty close to record production even though the price in 2015 so far has averaged only $2.70, 40% below 2014 levels.   

But it could have been worse. Two factors helped keep a lid on the surplus this year:  power generation and exports to Mexico. With prices that low, power burn has been up about 4.0 Bcf/d versus last year, with demand posting at record levels in many months. Weather helped a little. Power burn is usually a summer phenomenon (for air conditioning demand) and this summer was slightly hotter than last year. But fuel economics also played a huge role in boosting gas demand outside summer months. With gas prices at historic lows, gas-fired power generators jumped on the bandwagon and utilized their plants at higher utilization rates year round. Structural changes, such as coal plant retirements and the addition of new gas plant capacity helped support power burn growth. And the U.S.’s neighbors south of the border have helped, taking another 0.7 Bcf/d or so out of the market (see The Gas All Went to Mexico).

Together power burn and exports to Mexico created an incremental 5.0 Bcf/d of demand in 2015 versus last year. This helped shave off some of the supply overhang but only just enough to keep inventories from hitting the capacity wall.

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