The Bottom Is In For Natural Gas

Summary & Key Takeaways:

• The past few months have seen natural gas prices hammered on the back of robust production and a seasonally warm winter in the United States.

• As it stands, following recent production cuts by several major producers in response to lower prices, this headwind looks to have been solved, though the bearish weather problem remains for now.

• On the bullish side, a return of La Niña mid-year in addition to the ongoing build-out of LNG export capacity could see strong demand for much of 2024.

• But, how far prices can rally depends on the supply response to higher prices by producers, in addition to how quickly the excess storage levels are worked though, the latter of which will cap prices in the short-term.

No longer bearish, but not bullish either

After been sold relentlessly throughout almost the entirety of the US winter months, natural gas prices look to have finally found a bottom. The front month futures contract briefly bottomed out around the $1.4-$1.5 MMBtu mark in late February, and has since rallied to around $1.9 MMBtu. US natural gas is now the cheapest primary energy source on the planet.

While we saw a similar rally in late December and early January as the cold freeze swept over the United States, this bullish burst proved only temporary as the seasonally warm weather returned to crush prices by a further 50%. However, we now seem to have an adequate production response from producers that ought to put a floor under prices. I think it is fair to say the bottom is likely in for natural gas.

Alas, that does not automatically mean things are now bullish. Far from it.

Thanks to record levels of production to close out 2023 and seasonally warm weather reducing demand throughout most of the winter months, underground storage of natural gas has seen weekly changes that exceed seasonal norms. That is, although we have been seeing storage being drawn down on an outright basis (which is all but guaranteed during the winter withdrawal season where demand for natural gas is at its highest), storage drawdowns have consistently been below what would usually be the case during the December to February months.

While the market has been in a deficit (hence the outright inventory draws), it has been so to a much lesser extent compared to seasonal norms, hence the sell-off we have seen in recent months.

As such, this has left natural gas storage levels well above where they would usually be this time of year. Storage currently sits around ~500 bcf above the five-year seasonal average, and, according to my rudimentary supply and demand model, inventories are likely to end withdrawal season around at around 2.2 Tcf, or 500-600 bcf above the five-year average.

As is often the case with commodities, higher prices are the antidote for higher prices, and lower prices are the antidote for lower prices. Fortunately, in this regard, US producers have come to the rescue, ensuring this old adage continues to hold true.

Indeed, Antero Resources, EQT Corporation, Chesapeake Energy and Comstock have all announced some form of production cut and/or reduction in drilling rigs in response to lower prices. As a result, dry natural gas production has fallen back from 105 bcf/d to around 100 bcf/d, providing the catalyst for the recent rally and vastly improving the underlying fundamentals.

As such, we should expect to see production trend around the 100-103 bcf/d area for at least the upcoming three to six months, with any dip below 100 bcf/d a welcome sign for the bulls. This drop in production is something rig counts have been signaling for some time now. So, with official production cuts and declining rig counts, it seems reasonable to assume little to no production growth will be seen until at least the summer months.

Demand has underwhelmed

While these trends in production are constructive, it is important to remember they are a function of underwhelming demand. Indeed, as mentioned earlier, the seasonally warm winter has resulted in seasonally weak demand for natural gas, outside of a brief cold blast at the turn of the year.

If it weren’t for strong export demand via pipeline and LNG, one wonders how much lower prices would be (or how much earlier productions cuts would have come).

While seasonally weak demand has left inventories bloated, the ever-increasing build-out of US LNG export capacity throughout 2024 (~3.6 bcf/d) and 2025 will go a long way to churning through these excess supplied.

As such, if production averages around 100-103 bcf/d for the next six months, we could see storage end injection season at levels equal to seasonal averages. But again, such forecasts are path dependent and non-linear as the weather and the production reaction function of producers will obviously play a major role in where inventories end up, given higher prices between now and then could easily be matched by production increases from producers.

Outlook for demand

Importantly, as is nearly always the case with natural gas, the wild card here is the weather. It has been bearish for most of the past few months, and current weather models remain bearish for the forthcoming few weeks, with seasonally warm weather still present.

Much of this warmer than usual winter can be attributed to El Nino. Both the Southern Oscillation Index and Oceanic Nino Index have been confirming the presence of El Nino for some time now, with its presence in US winters historically resulting in warmer than usual weather. This winter has been no exception.

While my previous outlook for natural gas suggested there would be a chance El Nino was shorter and weaker than normal, thus potentially providing seasonally cool weather, this was largely not the case.

Now, El Nino looks to be nearing an end. Prediction models and historical analogs suggest it is likely to be in a neutral state by April.

Source: NOAA

This is something that weather models from the NOAA and other sources are also forecasting.

Source: NOAA

Looking out to the rest of 2024, it also appears La Nina will make its return sometime around July to September. Should this indeed be the case, it is likely a bullish outcome for natural gas prices given it would potentially bring a warmer than usual summer (and thus higher demand for natural gas due to higher electricity consumption). La Nina could also bring with it increased hurricane activity in the Gulf of Mexico, which has the potential to disrupt both production and transport of natural gas. This could be both bullish or bearish depending on whether any disruptions are that of domestic transport/production versus LNG exports internationally.

But, until then, the weather outlook remains bearish to neutral.

Final thoughts

While the overall outlook for natural gas prices in the near term in no longer as bearish as it has been in recent months, the picture is not yet bullish either. How far (if at all) prices can rally over the next three six months depends much on whether La Nina can emerge in time for the northern hemisphere summer and the bullish weather follow suit, in addition to the extent of any production response of producers to potentially higher prices. Should these two factors tilt bullishly while LNG export capacity continues to grow, natural gas prices could well finish 2024 much higher than where they are now, but there is much to get through from now until then.

In the meantime, it’s also worth noting we are through the negative seasonality from a price perspective, with the next three months or so generally bullish for natural gas prices.

And finally, speculative positioning is also nearing its most bearish levels in years, leaving plenty of room for speculators to be squeezed and upside buying pressure emerge, a factor that is likely responsible for much of the recent pop in prices and could provide a significant tailwind should bullish fundamentals emerge as we progress through 2024.

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