The CME/NYMEX Henry Hub January contract settled yesterday at $3.54/MMBtu, about 30.8 cents (~10%) above where the December contract expired ($3.232) and 77.6 cents (28%) higher than where November settled ($2.764). The natural gas winter withdrawal season is officially underway—it’s a lot colder and gas demand has spiked. But this week also marks another key bullish threshold: as today’s Energy Information Administration (EIA) storage report will likely show, the U.S. natural gas inventory has fallen below the prior year’s levels for the first time in two years (since early December 2014). That’s in sharp contrast to where the inventory started the injection season in April—more than 1,000 Bcf higher compared to April 2015. Moreover, we expect the emerging deficit to grow substantially over the next several weeks. Today we look at the supply-demand fundamentals driving this shift and what it means for the winter gas market.
Our NATGAS Billboard outlook projects that EIA will report a (139)-Bcf withdrawal for last week, which would put the overall U.S. inventory at 3,814 Bcf as of December 9 (2016). That is 32 Bcf below the inventory level in the same week last year, but still 172 Bcf higher than the five-year average for the same week. This marks the first year-on-year deficit in storage since the week of December 5, 2014. By late December, we also expect the inventory to dip below the five-year average, based on the latest weather forecasts—that hasn’t happened since late-May 2015.
As we’ve noted previously here in the RBN blogosphere, the U.S. natural gas inventory—as reported by the EIA each week—is regarded as an ever-present bellwether for price direction in the natural gas market. Gas market participants and analysts train their eyes on weather forecasts—and the constant daily, or even intraday, revisions to the forecasts—along with natural gas flow data (see Sooner or Later for more on flow data analysis) and other fundamental factors to see how they might change the storage picture. Market trackers then await the weekly release of the EIA storage report (a benchmark for storage activity in the prior week) for what it says about the cumulative impact of the supply/demand balance on market economics. In the minutes and hours immediately following the EIA release each Thursday at 9:30 a.m. Central Time, the market frequently reacts to the reported withdrawal/injection volume, especially if it differs significantly from industry expectations.
But in a more fundamental sense, one of the main factors influencing the market is where the inventory level stands relative to history—in other words, the surplus or deficit in storage relative to a historical period, most often last year or a recent average, such as a three- or five-year average. This is a valuable way to anchor price and price direction in the context of historical pricing and fundamentals. For example, if it’s gotten colder and demand has spiked while supply is relatively flat (as is usually the case in the winter months), more gas will be coming out of storage than going in. That seasonality is expected and generally priced into the market. But if outright storage levels are lower than previous years or withdrawals from storage are happening at a much faster pace than it was in prior years due to weather being even colder than expected, the market is likely to add a premium to prices. In fact, as it turns out, there is a high degree of correlation between prices and the relative storage inventory, as shown in Figure 1 below, which is taken from our NATGAS Billboard report, a joint venture with veteran forecaster Kyle Cooper of IAF Advisors. (For daily, detailed updates on North American natural gas markets, you can subscribe to our daily Billboard email and pdf report. And by popular demand, we now also have a separate Billboard Excel data file with historical daily gas production, imports/exports and demand volumes going back to 2010, as well as our near-term weather and demand forecast.)