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North American natural gas prices have surged to decade-highs, yet headline inventories appear reasonably full at face value.
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However, adjusted for steeply higher exports to global markets roiled by energy crises, inventories are actually at the bottom of their 5-year range, which better explains current market pricing.
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Exports are likely to remain strong and Henry Hub price insensitive over the coming winter, which will create additional competition for scarce inventories even in an especially cold/tight market.
The price of Henry Hub natural gas, the primary North American benchmark, reached its highest level since 2008 at over $6 per Million Btu (MMBtu) earlier this month and, while easing back slightly, have remained heady at around $5/MMBtu. That’s still a decade-high for gas prices, save a short-lived blowout during the 2014 polar vortex that—and this part is important—happened during the dead of an especially cold winter. Henry Hub prices are already at that winter-crisis level, and we haven’t yet even hit Halloween. Even more bizarre, US headline natural gas inventories look positively unremarkable at roughly 3300 billion cubic feet (Bcf), or pretty much back at their 5-year average level for this time of year.
So, what’s going on with prices? Very simply: US natural gas exports have exploded and those export markets are experiencing an acute energy crisis, which has pushed global LNG prices to all-time highs and made US exports less sensitive to changes in North American feedstock prices. Inventories haven’t been able to keep pace with the now-higher level of total system demand.
(Shoutout: I don’t always adjust for export demand for reasons discussed below; the initial idea for this adjustment came after a discussion with and post by natural gas Twitter bull NachoTrust.)
US Gas Export Boom Built Bridge to Global Energy Crisis
Domestic US natural gas production has risen by nearly a quarter over the past half-decade, helping keep prices low and reasonably stable. Yet only some of that new supply was used by the US economy, while the lion’s share fed surging natural gas exports with cheap feedstock and facilitated the birth of the US LNG industry. (I first discussed these booming exports in my last natural gas piece.) LNG exports have risen from nothing at the beginning of 2016 to more than 10 Bcfd today, while more traditional natural gas pipeline exports to Mexico have more than doubled to around 6.6 Bcfd. The turnaround in the US natural gas trade balance has been staggering: from net imports accounting for roughly 10% of available supply in 2011 to net exports exceeding 10% today.
This export demand is both less seasonal (relative to domestic demand) and operates on an entirely different economic calculus. For example, unlike in power generation where the relative cost of alternative fuels like coal will affect demand for natural gas, LNG exports are effectively a geographic arbitrage between domestic and foreign prices. This feature of LNG economics means that these exports act as a kind of natural pressure relief valve for the North American natural gas market. Price spikes put LNG exports out of the money and prompt shipments to fall, reducing demand and easing market strain. The extent and volume of that buffer is debatable: most of a facility’s capacity is theoretically locked up in long-term contracts; but, somewhere around one-quarter of LNG exports are more flexible spot cargoes. (Even then, LNG exports fell by more than half in Summer 2020, so we certainly have some demonstrated flex.)
However, the global energy crisis has clogged this pressure value with $30+/MMBtu LNG prices in Europe and Asia. This extremely high global gas price environment means that Henry Hub prices could rise 5-fold before compromising LNG economics, so all bets are off if winter is cold and inventories get tight. If you assume that those exports aren’t budging even if prices rise, it’s useful to adjust inventory sufficiency calculations to understand the true extent of our winter stores. And that’s where we start to run into problems, with that adjusted inventory figure sitting at the very bottom of its 5-year average heading into this winter.
Effective Inventories Deflated by Export Demand
Adjusting for both higher domestic demand and steeply higher exports, we are currently at the bottom of the 5-year range for this time of year (right chart vs demand-only chart on left). Looking back over the longer history of this series (first chart at top), you can see that there was a wide deviation of this series below its 5-year average in 2018. While this deviation did prompt a price rally, it is important to note that the differential between domestic and foreign gas prices wasn’t high enough for the market to view a complete blowout as a possibility. And that’s where things start looking starkly different today.
With that wider Henry Hub-Global LNG pricing spread, it’s possible that adjusted inventories are even lower than they appear on the above chart. I didn’t want to get too clever with the adjustment calculation, but just know that export demand is even less relenting today than it was when we last dropped below the bottom of the 5-year range in 2018.
Smaller Propane Market in Even Tighter Bind
North American propane markets—which closely track natural gas seasonal demand cycles but are typically used for off-grid/rural heating—are facing similarly low inventories and gangbusters export growth. In fact, even before adjusting for demand, let alone exports, inventory volumes are below their 5-year range. Save the short-lived spike during the 2014 polar vortex, North American benchmark Mont Belvieu propane prices have risen to their highest level since 2011. Like natural gas, exports have been rising on the back of growth in US shale gas production, but are an even larger share at more than half of total available supply.
Heating fuels like natural gas and propane are heading into winter with weak inventory positions as well as large and price-insensitive export demand. The pace of recent export growth necessitates adjusting nominal inventory levels for this rising demand sink, which facilitates a better understanding of price moves despite apparent headline inventory sufficiency. While propane inventories are already in critical territory, natural gas inventories may prove enough absent an especially cold winter (a subject for another newsletter). Still, the low inventory position mixed with the unknowability about ultimate winter conditions pushes the market to price in winter tail risk.