The natural gas price is primed for a significant bump a year from now, even if futures traders have yet to acknowledge it, Enverus said in a recent webinar.

The forecast stems from this year’s dramatic reduction in oil and gas production caused by the COVID-19 pandemic’s effect on the global economy. Enverus thinks that sets up a winter inflection point, with gas production still declining in oil plays and little to no increase in pure gas plays, said Amber McCullagh, Enverus senior vice president.

“What that means for the market is you go from historically high storage inventory levels to start this winter to historically low storage inventory levels as soon as the end of this winter,” McCullagh said.

Natural gas futures price chart
(Source: CME Group)

The market is already responding, reaching a two-year high on Oct. 26 on worries of Gulf of Mexico production impacts from Tropical Storm Zeta. What the market is not acknowledging, McCullagh said, is sustained shortfalls in 2021 that derive from three market levers.

US Natural Gas Futures Hit Near Two-year High

Lever No. 1: power generation

Gas-fired power generation was very high during the summer as a result of low gas prices, she said. Enverus calculates that natural gas gains about 1 billion cubic feet per day (Bcf/d) for every 30-cent to 40-cent downward move in price.

However, after the first 2 Bcf/d in 2021, gas will not lose as much market share on its way back up to $3.50 per million British thermal units (MMBtu) as it gained on the way down because of what is happening in the coal market.

Coal stockpiles will be at record lows by August 2021. Even a 16% increase in coal production from September through December, and a 7% to 8% increase in wind and solar generation won’t be enough to offset the shortfall in gas-fired generation.

“Gas-fired generation is going to be down next year, but we would say be skeptical if you see gas-fired generation down 3, 4, 5 Bcf/d because we don’t think there’s going to be enough coal being produced or enough wind and solar generation to accommodate that big a decline in gas-fired generation,” McCullagh said.

Lever No. 2: LNG exports

The vast majority of U.S. LNG is economic in the European market at a spread of 50-70 cents/MMBtu, Enverus says. All U.S. LNG is economic at $1 and up. On Oct. 26, the spread between Henry Hub and the Title Transfer Facility (TTF) in the Netherlands was $2.324.

“We expect 100% utilization, even if Henry Hub continues to rally based on the fact that it’s already October. You’re already making those December lifting decisions,” McCullagh said. “But for the summer of next year that spread is $1.75/MMBtu.”

When U.S. prices rally, that spread will narrow to inside $1/MMBtu, she said. At that point, some U.S. LNG being shut in.

Lever No. 3: gas production

In the second quarter, U.S. natural gas shut-ins peaked, pulling between 5 Bcf/d and 5.5 Bcf/d off the market. Those shut-in wells are almost all producing again, but the falloff masked “a very sharp pace of base declines,” McCullagh said, “particularly since we’ve had very low gas drilling levels since the second half of 2019.”

The production recovery in 2021 will be a modest one, she said, reflecting how low those drilling levels are today and how long it’s likely to take to ramp up, mostly driven by drilled but uncompleted wells.

The difficulty in forecasting gas prices, however, is tied to the difficulty in forecasting winter weather. The five-year average temperatures are milder than the 10-year average, McCullagh said, which is milder than the 20-year average, which is milder than the 30-year average. Enverus works with the 10-year average.

Assuming the 2020-2021 winter is warmer than expected, natural gas inventories could be at a normal level when the season ends, not a very low level as projected in the Enverus base case. That would delay the price recovery in second-quarter 2021, but the lower prices would encourage more gas usage next summer. Subsequently, the lower price would encourage more LNG exports.

“By the second half of 2021, you’re looking at a market that’s, give or take, roughly as strong as you would have had even in a normal weather case,” McCullagh said. “You’re not likely to get the same sort of drilling response without a stronger price signal this winter and in the first half of 2021, which potentially sets up for an even stronger 2022.”

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