What's Going On? - The Natural Gas Rally, Coal-Gas Competition and Power Burn

Over the past 20-some days, U.S. natural gas prices have gone from being the lowest in more than a decade to very close to last year’s levels. The July 2016 CME/NYMEX Henry Hub natural gas futures contract on Thursday (June 23) settled at $2.698/MMBtu, up about 70 cents (36%) from where the June contract expired ($1.963/MMBtu on May 26) and also up nearly 50 cents (23%) from where the July contract started as prompt month on May 27 (at $2.169). Market buying to unwind short positions initially kick-started the rally, but since then hot weather and a boost in power demand has kept the rally going. National average temperatures have averaged nearly 8 degrees (Fahrenheit, or F) higher in June to date versus May, and in the past week they’ve climbed above the peak summer levels normally not seen until mid- to late-July. Gas consumption on a temperature-adjusted basis also soared in the first half of June, led by power burn (gas use for power generation). The combination of hot weather and higher gas usage per degree of demand has been practically made-to-order for the oversupplied gas market, and has led to record power burn in June to date. But higher prices have the potential for bearish consequences—the recent gains have catapulted natural gas prices well above prices for coal on a cost-per-MMBtu basis—making the latter fuel more economically competitive in the power generation sector. That’s welcome news for coal producers, but what will it do to natural gas demand and in turn gas prices? Today, we look at the shift in the coal-gas price relationship and the potential impact to power burn and the gas market.

Last week, in the first episode of “What’s Going On?,” we noted a big fundamental shift that occurred in the U.S. natural gas market starting June 1 (2016), just as baseload contracts for gas purchased in May for expected June demand kicked in. Around that time, the temperature-adjusted demand model used in  NATGAS Billboard (our daily natural gas market report joint venture with  IAF Advisors) showed gas consumption in the power sector jumped well above historical norms for the same observed temperatures (aka temperature-adjusted power burn). Whereas temperature-adjusted power burn had been less than 3.0 Bcf/d above the historical norm in May, it jumped to over 5.0 Bcf/d in the first three days of June, surpassed 6.0 Bcf/d on June 13 (2016) and has now averaged over 4.0 Bcf/d in the first half of June. Absolute power burn has averaged a record 31.5 Bcf/d in June to date; that’s 1.7 Bcf/d higher than the previous record (June 2015) and more than 3.5 Bcf/d higher than the record before that in June 2012 (Figure 1). 

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