Is There Any Hope For Natural Gas Prices?
By Larry Smith
Nov. 23, 2015
A huge increase in natural gas production has driven natural gas prices to rock bottom.
Demand has been increasing steadily, but not enough to overcome the increased production.
Natural gas exports are expected to grow, but will it be enough to offset the production increases.
One of the basic laws of economics is that the balance between supply and demand influences pricing. The natural gas markets provide a clear picture of that balance. Below is a chart of natural gas pricing going back 10-years. As you can plainly see, natural gas prices fell quickly beginning in 2008, which was the beginning of the fracking revolution.
Between 2004 and 2008 the price for natural gas was consistently above $5.00 per thousand cubic feet. Beginning in 2009, the price started to fall as production from fracking increased and the price has continued to fall. The chart below shows the huge increase in natural gas from fracking. According to the Natural Gas Annual, gross withdrawals from shale gas wells increased from 5 Bcf/d in 2007 to 33 Bcf/d in 2013, representing 40 percent of total natural gas production and making shale gas the largest source of natural gas in the U.S.
Below is a chart that shows the total U.S. production numbers for natural gas from 2006 through 2014.
Year Production (NYSEMKT:MCF) 2006 23,535,018 2007 24,663,656 2008 25,636,257 2009 26,056,893 2010 26,816,085 2011 28,479,026 2012 29.543.313 2013 29,522,551 2014 31,345,546
As you can see, natural gas production has been increasing consistently. From 2006 through 2014 natural gas production increased just over 33%
This increase in production has lead to a fall in price and has dwarfed a healthy increase in demand. The chart below shows the demand numbers alongside the production numbers.
Year Production Demand 2006 23,535,018 21,699,071 2007 24,663,656 23,103,793 2008 25,636,257 23,277,008 2009 26,056,893 22,910,078 2010 26,816,085 23,775.388 2011 28,479,026 24,477,425 2012 29,543,313 25.538,486 2013 29,522,551 26,155,071 2014 31,345,546 26,698,069
So while production was growing by 33%, demand was only growing by 23%. Normally, 23% growth would support prices, but not when supply is growing 33%.
In 2006, production exceeded demand by 1.8 mcf. In 2014, supply exceeded demand by 4.6 mcf. The larger buffer between supply and demand explains much of the price decline. Keep in mind you have to have some buffer as there are months, usually winter, where demand exceeds production and you need to pull natural gas from storage. For example, in January 2009, supply was 2,251,958 mcf, but demand was 2,727,773 mcf.
Despite supply exceeding demand, the U.S. still imports natural gas. The chart below shows total U.S. imports of natural gas from 2006 through 2014. The vast majority of these imports are from Canada.
Year Total imports mcf 2006 4,186,281 2007 4,607,582 2008 3,984,101 2009 3.751,360 2010 3,740,757 2011 3,498,693 2012 3.137,789 2013 2,883,355 2014 2,695,378
Imports have fallen almost 2 mcf since their peak in 2007.
The last historical chart I have will put all these figures together on one chart, in an effort to show the excess natural gas we currently have.
Year Production Imports Total supply Demand Excess 2006 23,535,018 4,186,281 27,721,299 21,699,071 6,022,228 2007 24,663,656 4,607,582 29,271,238 23,103,793 6,167,445 2008 25,636,257 3,984,101 29,620,358 23,277,008 6,343,350 2009 26,096,853 3,751,360 29,848,213 22,910,078 6,938,135 2010 26,816,085 3,740,757 30,556,842 23,755,388 6,801,454 2011 28,479,086 3,498,693 31,977,779 24,477,425 7,500,354 2012 29,543,313 3,127,789 32,671,102 25,538,486 7,132,616 2013 29,522,551 2,883,355 32,405,906 26,155,071 6,250,835 2014 31,345,546 2,695,378 34,040,924 26,698,069 7,342,855
With the exception of 2013, excess supply has been steadily growing, which would logically pull down prices.
For the first eight months of 2015, demand, compared to 2014, has increased 782,577 mcf. However, supply continues to increase faster than demand, as 2015 supply for the first eight months has increased 1,331,470 mcf. Surprisingly, imports have risen 46,086 mcf. Clearly, the supply demand imbalance is not getting any better.
One of two things has to happen for natural gas prices to improve. Producers have to reduce production, which is not likely to happen for several reasons, lease requirements and cash flow to service debt being two of them. Or, demand will have to rise fast enough to start making in-roads on excess supply.
Everyone agrees demand for natural gas is going to grow in the future, the question is, will it grow enough to offset all the supply.
First, let’s see where demand is coming from today. The demand chart shown above, showed natural gas demand for 2014 was 26,698,069 mcf. Broken out by end user, demand per category looks like this. I also included a column that shows the increase since 2009.
Use Amount % Increase Since 2009 Electric Power 8,149,111 18.5% Industrial (feedstock for chemical plants etc.) 7,623,826 14.5% Residential 5,087,314 6.5% Commercial 3,466,600 11.1% Lease Fuel (fuel used in drilling operations) 1,074,943 17.7% Pipeline & Distribution Use (pipeline operations) 835,757 24.7% Plant Fuel (fuel used in natural gas processing plants) 425,238 17.4% Vehicle Fuel 35,280 29.4%
The top four categories, electric power, industrial use, residential, and commercial use is where the bulk of demand is. All of the categories saw an increase since 2009 and all of them should continue to see slow steady growth. Electric power demand saw a nice increase and that is likely to continue, especially if the EPA Clean Air Regulations are upheld in court. Platts, forecasts natural gas demand would increase by 3 Bcf/d, if the clean air regulations are upheld. Although some of the smaller categories saw nice percentage increases, none of those categories are large enough to offset production increases, something else will be needed.
It is a given, that LNG exports are going to begin soon and exports to Mexico are going to expand rapidly. The question is, will these two new end users increase demand enough to force prices higher.
Mexico’s 2014 gas demand averaged 7.2 Bcf/d while domestic production was just 4.4 Bcf/d. To meet their gas demand, Mexico has been importing growing amounts of natural gas from the United States. The economy in Mexico had been doing well and there is rising demand for natural gas to support gas-powered electricity generation. Gas exports to Mexico have more than doubled from 2010′s 900 MMCf/d to 2014′s 2 Bcf/d. In 2015 exports have continued to grow rapidly, in August, natural gas exports to Mexico averaged 3.2 Bcf/d
That is a large increase in natural gas export over a short period of time, but it has obviously not resulted in higher prices. However, the rise in natural gas exports to Mexico is not done. Mexico still imports some natural gas through LNG terminals, which is more expensive than product piped in from the U.S. The chart below shows Mexico’s natural gas imports for LNG and pipeline.
Enough pipeline capacity will be online, with contacted supply, by 2017 to increase exports to 8.5 Bcf/d. U.S natural gas demand in 2015 is expected to average 76 Bcf/d, of which, approximately 3 Bcf/d is exports to Mexico. If Mexican exports do grow to 8.5 Bcf/d, or more,by 2017, that alone would increase demand to approximately 81 Bcf/d.
LNG exports from the U.S. will begin within the next few weeks with the start-up of the Sabine Pass facility In total, five LNG export facilities are in various stages of start-up. Below is a summary of the five facilities.
- Cheniere Energy’s (NYSEMKT:LNG) six-train Sabine Pass plant in Cameron Parish, La., is the most advanced project. Cheniere is developing up to six natural gas liquefaction trains, each with an expected nominal production capacity of approximately 4.5 mtpa (million tonnes per annum) of LNG, at the Sabine Pass LNG terminal adjacent to the existing regasification facilities. As of a few weeks ago, trains 1 and 2 were 95% complete, trains 3 and 4 were 74% done, train 5 began construction in June, and train 6 was still waiting for contracts to take product.
- Cheniere Energy Corpus Christie – Plans are in place for five trains, construction began in May on train 1 and 2, a final investment decision will be made soon for train 3. Train four and five are still under consideration.
- Cameron LNG, in Louisiana, is slated to be a three-train LNG export terminal capable of exporting 1.7 Bcf/d of LNG, much of which is contracted to its partners. Construction began in October 2014 with commercial operation expected to begin in 2018. Cameron LNG is a subsidiary of Sempra Energy (NYSE:SRE).
- Freeport LNG’s and Corpus Christi LNG terminals in Texas have capacities of 1.8 Bcf/d and 2.14 Bcf/d, respectively. Construction on the Freeport LNG terminal began in November, 2014, with commercial operations expected to begin in 2018.
- Dominion’s (NYSE:D) single-train Cove Point project at Lusby, Md., began construction in October 2014 and operations are expected to begin in 2017.
In total, those facilities will create demand for approximately 9 Bcf/d of supply by 2020. Several other LNG facilities could be added, most likely Kinder Morgan’s (NYSE:KMI) Elba Island, Exxon Mobil’s (NYSE:XOM) Golden Pass and Energy Transfer Equity’s (NYSE:ETE) Lake Charles facility.
I believe the above facilities will get built as they have take-away contracts in place for the LNG. Therefore, I think it is reasonable to add a conservative 3 Bcf/d to the 9 Bcf/d total shown above for a total of 12 Bcf/d from LNG exports by 2020.
Adding It Up
As previously mentioned, the EIA forecasts 2015 U.S. natural gas demand to average 76 Bcf/d. We know natural gas power burn will increase, as will industrial and commercial use. Using a conservative 1% a year increase for the current end use sectors through 2020, demand would grow to approximately 80 Bcf/d
Add in, an additional 5 Bcf/d in exports to Mexico and 12 Bcf/d for LNG export and you have potential demand of 97 Bcf/d by 2020. The 97 Bcf/d should be looked as a potential, quite frankly, I think arguments could be made that the number should be higher and arguments could be made it should be lower.
The 97 Bcf/d would be a 28% increase from the 76 Bcf/d we use now and would be substantially higher than current production. However, before natural gas longs celebrate, we need to see where natural gas production will be in 2020.
The forecast production number for 2020 I see most frequently is 90 Bcf/d, which would be less than demand. The EIA’s latest Annual Energy Outlook reference case calls for US natural gas production to grow at a rate of 1.4% a year over the next 25 years, reaching 97.1 Bcf/d in 2040. This report from CoBank calls for production growth of 29% over the next five-years, which would parallel demand growth.
It was clear to me during my research that there is no consensus on where production will be in 2020. The only consensus is that production will be higher. It is my opinion, that U.S. production along with imports from Canada, could be increased enough to meet demand. However, I do believe the natural gas market will be much more in balance and prices will move higher. How much higher depends on several variables.
- Will continued advancements in drilling efficiency bring even more production out of the ground?
- Will world LNG prices support continued growth in LNG exports, beyond the few facilities currently scheduled to get built?
- Will utilities accelerate the switch from coal to natural gas for power burn?
- Will exports to Mexico continue to grow?
- Will the growth in natural gas industrial use continue to grow?
- Will the U.S. economy slowdown or expand?
- Will natural gas demand for vehicles increase to any great degree?
All these variables, and more, could affect natural gas prices. One important point to consider, is that the increase in demand is caused in large part by low prices, any large increase in price would likely slow natural gas demand growth.
Conclusion and Investment Ideas
I believe it is clear that natural gas demand is about to see some significant growth, mostly related to export opportunities, but also increased power generation and industrial use. The demand growth will start slow, but pick up momentum starting in 2017. Short-term I see no catalyst for higher prices, but I do believe prices will move higher starting in 2017, as the demand growth starts to catch up to the production.
An increase in natural gas prices would be beneficial for the producers, but I believe the biggest beneficiaries will be the pipeline companies. There is little doubt demand for natural gas will grow, what the price will be for the natural gas in unclear. Therefore, pipeline companies are a more sure winner in a growing demand environment.
In my opinion, the two biggest winners will be Kinder Morgan and Energy Transfer Equity.
Kinder Morgan has approximately 68,000 miles of pipelines, which is the largest natural gas network in North America. KMI serves all the major consuming markets of the United States, and transports approximately one-third of the natural gas consumed daily in the U.S. Kinder Morgan has pipelines that are connected to every important natural gas resource play and supply area, including the Eagle Ford, Marcellus, Bakken, Utica, Uinta, Haynesville, Fayetteville and Barnett. In addition, Kinder Morgan has several agreements in-place to provide pipeline service to both of Cheniere’s LNG facilities and also has pipeline export capacity to Mexico. Any expansion of natural gas is a huge benefit to KMI.
A potential winner could be Energy Transfer Equity once they complete their merger with Williams Companies (NYSE:WMB). The merger, once completed, will create. among other things, the largest natural gas transportation network in the country. However, regulators have not approved the merger yet and there is some thought that ETE will have to sell some of the pipeline network to appease regulators.
Even if ETE has to sell some lines, they along with KMI, will be the largest transporters of natural gas in the country. It seems reasonable to expect an increase in natural gas flow through KMI and ETE pipes.
Natural gas demand is growing and it may grow enough to bring the supply demand equation more in to balance. If that happens, I believe natural gas prices will rise. Unfortunately, I think it will be 2017 before demand starts to really increase and it may 2020 before demand will be high enough to create a tight market. So, an investor looking to benefit from the rising demand over the next five years, should look to the pipelines for the more likely positive benefit.