Natural Gas Markets to Capitalize on Volatility in 2017
A
ENERGY AND COMMODITIES
NATURAL GAS MARKETS
TO CAPITALIZE ON
VOLATILITY IN 2017
Natural Gas Markets to Capitalize on Volatility in 2017
NATURAL GAS
MARKETS TO
CAPITALIZE ON
VOLATILITY IN 2017
2016 was an “interesting” year for the
U.S. natural gas markets. Though prices
ended on a high note, hitting $3.70/
mmbtu at year’s end, much happened
between Jan 1 and December 31 – gas
storage reached historic highs, prices
hit record lows, producers continued
stacking rigs and production declined
almost 4 BCFD. Now, with the first month
of 2017 in the rearview mirror, gas prices
have fallen back to the low $3 range, the
storage outlook is unclear, producers are
slowing starting to drill again, and the
outlook for prices for the rest of the year
is very uncertain, perhaps more so than
any time in recent memory.
While the U.S. shale gas revolution has brought new resource
wealth and ushered in new opportunities for producers,
pipelines, traders and retailers, the massive shifts from
conventional fields to shale have fundamentally changed this
market. With these still developing shale fields requiring
massive new investments in plants and pipelines, and with the
ability for producers to bring on huge quantities of new supply
in relative short order, regional imbalances are occurring and
prices differences among those regions have been magnified.
More generally, the new and abundant supply of gas has
driven down prices and encouraged increased consumption
for power generation and export to global markets.
These market trends and shifts continue to be ongoing, and the
uncertain interplay of these factors will determine the shape of
prices and the financial health of individual market players for
years to come.
1
Shifting from coal to gas
Cheap gas, combined with intensifying environmental
regulation of coal-fired generation, has increased the use of
natural gas for both peak and baseload power generation.
With this increased reliance on natural gas, the Federal Energy
Regulatory Commission (FERC) has been actively working to
improve the operational coordination between the gas and
power markets, such as with Rule 809, which was issued in 2015.
With this rule, the FERC moved the timely nomination cycle
deadline for scheduling from 11:30 a.m. CT to 1:00 p.m. and
added a third intraday nomination cycle during the gas day –
all so that generators could better manage gas supplies to
meet actual burns. This single rule significantly impacted gas
suppliers, traders and pipelines operators by requiring new
systems and new processes.
Should gas continue to displace coal for power generation,
it can be expected that the FERC will mandate additional
changes. These changes could include shifting the start time
of the gas day to 4:00 a.m. CT to better match the power day,
a move that has been requested by the power markets and
one that would have significant impacts on the gas industry.
In its most recent forecast, the U.S. Energy Information Agency
(EIA) said it believes that natural gas will continue to replace
coal, noting that “the U.S. is expected to increase gas-fired
generation by 11.2 gigawatts (GW) in 2017 and 25.4 GW in
2018 … increasing U.S. gas-fired power capacity by about
8 percent over 2016 levels.” However, these additions, which
could add a BCF or more of generation gas burn on top of the
current full year average of about 25 BCFD, are not a certainty.
If gas prices increase substantially or if the new Trump
administration follows through on its promise to ease the
environmental rules that have led to planned early retirements
of coal-fired plants, these new gas-fired additions could be
delayed or canceled.
Gas exports are growing
The wealth of shale gas reserves being developed in the U.S.
has also attracted a lot of international interest, particularly
from neighboring Mexico. Gas buyers in that country are
moving U.S. gas south in increasing volumes as Mexico’s
domestic production declines and liberalization of the gas
markets advances.
According to the EIA, exports reached 4.2 BCFD in August 2016
(the last month of available data), and those exports will increase
with the completion of additional border crossing capacity in
South Texas. These new capacity additions include the just
completed San Elizario Border Crossing Project, which adds over
1 BCFD of gas flow from San Elizario, Texas, into San Isidro,
Chihuahua, Mexico. With further expansions and additions
coming online throughout 2017, the current capacity of 7.3 BCFD
will increase to nearly 11 BCFD by the end of the year.
2
Export of U.S. gas via LNG is also driving significant new demand.
With Chenier’s Sabine Pass LNG Terminal now running two
process trains (with Train 2 having come online in October 2016),
the plant is currently consuming about 1.5 BFCD. Construction
of Train 3 is substantially complete, and it’s expected to start full
production in the next month or two, increasing gas consumption
to more than 2 BCFD. With the start-up of Train 4 expected in late
2017, total gas demand at Sabine could exceed 2.5 BCFD by the
end of the year. Taken together, incremental exports of U.S.
natural gas via pipe and ship is forecast to add as much as 4-5
BCFD of demand by the end of 2017.
Marcellus and Utica development continues
Infrastructure development to move Marcellus and Utica gas
to the north and west is continuing, reshaping the markets in the
Northeast and beyond. With the massive increases in production
from the Marcellus over the last several years and with the Utica
field continuing to ramp up production, pipeline capacity in the
region has been overwhelmed, creating huge bottlenecks and
limiting transport out of the region. With gas often trading below
$1 at the Marcellus regional hubs, lack of capacity was forcing
many producers to delay new investments, including deferring
completions of previously drilled wells.
However, with several new pipelines and expansion projects
coming online in early 2016 and others beginning operations in
late 2016 (such as the Algonquin AIM expansion and the
Constitution Pipeline), the first full year impact of this new
capacity will be felt in 2017. With more gas moving south and west,
and with new capacity easing constraints into New England, the
basis number is certainly going to be rewritten, and improving
wellhead prices in the Marcellus region will incentivize producers
to increase drilling and production.
Regulatory changes are already happening
Beyond the many operational developments, regulatory changes
may also hit hard this year. The new Trump administration and
Congress have already started following through on their various
campaign promises to reduce regulatory burdens for U.S.
businesses, including the energy industry.
In January, Congress acted to roll-back Obama-era regulations
limiting methane gas emission by producers and pipelines, and,
in only the second week of his administration, President Trump
issued executive orders that signaled the beginning of the revision
or elimination of most, if not all, Dodd-Frank regulations. Though
his initial targets for revision are primarily aimed at bank
fiduciary rules, Mr. Trump’s directive ordered the Treasury
secretary to restructure or eliminate other provisions of the
regulations to ensure they are in-line with his administration’s goal
to improve the competitiveness of U.S. businesses in the global
markets. Still, there is no clear indication yet as to whether the
regulations most impacting energy traders – which include trade
reporting and swaps rules – will ultimately be affected.
Natural Gas Markets to Capitalize on Volatility in 2017
Where is all this heading?
While seasonality and weather are the primary determinants
of short-term natural gas prices, the increasing complex array of
factors at play in today’s market could exacerbate volatility. With
large increases in demand for U.S. natural gas focused on a few
specific markets or segments (power generation, Mexican exports
and LNG), upsets in these markets, significant regulatory or
political changes, or even market rumor related to these factors
will undoubtedly add downside pressure to prices. And should
demand unexpectedly decline or producers return en masse to
drilling, the market will again become largely oversupplied, and
prices could rapidly fall back to the low levels of early 2016.
Dealing with uncertainty
While many of the changes in the market are obvious, such as
increasing exports, the magnitude and the impact on prices
of those individual changes is uncertain, and the effects brought
about by the interplay among them is even more unclear.
Companies operating in this market need to continue to be
acutely aware of their surroundings and leverage technologies
that can improve their vision of market conditions and
commercial exposures as well as tools to help limit risks and
improve financial performance.
Unfortunately, many companies, facing declining margins due
to low prices, have cut back on technology spending, and their
current systems are not up to the task of effectively managing the
risks of a volatile market. In particular, gas retailers, who operate
amid fierce competition and with thin margins, can be especially
vulnerable to the price shocks of high volatility, as a year’s profit
can be lost almost overnight. For those retail gas providers that
don’t have the appropriate systems in place to manage volatility
in their supply portfolio, 2017 could be a very difficult year.
Obviously, nobody can accurately predict what natural gas
prices will do a year out – or even a month out. Still, it does
appear that this market is going to be substantially more difficult
to forecast than in previous years. The supply and demand
balance is clearly transitioning, with both sides becoming more
concentrated by geography and/or market. And with this
increased concentration, events on either side of that balance
will have a larger impact than in the past, and the result is going
to be increased price volatility.
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