The year is already over if you happen to be long U.S. natural gas. At this point, all that matters is whether 2016 offers any chance of clearing the crushing glut weighing on the market.
The short answer: Don't get your hopes up.
Just like the oil market, a gas rally requires supply to diminish, consumption to rise, or a combination of both. With gas, weather can make or break the market: Over the past five years, U.S. gas demand in the first quarter has averaged as low as 81 billion cubic feet a day and as high as 97 billion. This winter has been exceptionally mild in the northeast. Put that together with resilient U.S. gas production and you get today's depressed gas market.
As of December 11, there was roughly 3.85 trillion cubic feet of gas in storage in the U.S., or 322 million above the five-year average, according to the Energy Information Administration. Those inventories should keep declining until March, which for the gas market is when the winter season ends and gas starts flowing back into storage in preparation for the next winter. The key to understanding how prices will fare next year rests largely on how much of that stored gas gets used up in the next three months or so, and then how much heads back into storage between April and November.
In its latest short-term projection, the EIA estimated gas inventories would end the year at 3.38 trillion cubic feet. Mild weather makes that look suspect already: Inventories would need to drop by more than 150 million cubic feet a week through the last three weeks of this month, much higher than the five-year average for late December. If you assume instead that inventories drop at the low end of the range for the past five years -- roughly 105 million cubic feet a week -- then they should end 2015 at 3.53 trillion cubic feet.
Truism or no, 3.53 trillion of anything is a lot. In this case it would be even higher than the level at the end of 2011 -- just a month or so before the price of natural gas made its last nosedive below $2.
The chart below takes that storage figure as the starting point and maps out 2016 using a few different assumptions. The central case takes the EIA's own estimates of gas withdrawals from, and injections into, storage. The high case assumes that weather effects mean withdrawals run about 3 billion cubic feet a day lower than that during the winter and injections run about 2 billion cubic feet a day higher in the summer due to mild weather. The low case assumes the opposite.
A caveat: These scenarios assume all else being equal in terms of the EIA's projections, and obviously supply and demand may well move around as prices respond to movements in inventories. That said, there are three observations to make.
First, the high scenario would not merely represent uncharted territory for gas inventories, it likely simply can't happen. Why? U.S. storage capacity was 4.67 trillion cubic feet as of November 2014, the last time the EIA estimated it. So the high case essentially attempts to force gas into a system that physically couldn't take it. That doesn't mean you should simply dismiss this case -- far from it. The implication is an utter price crash beyond what's been seen so far in order to force gas out of the market by making producers shut in wells.
Second, the central case, while not as apocalyptic, doesn't promise much relief for gas bulls, either. Inventories would end March above 2 trillion cubic feet, which hasn't happened since that bearish spring of 2012. From there, they would start rising again, heading above the 4 trillion level again by next fall, leaving gas producers praying for a harsh winter to deliver them.
Finally, the low case looks better for anyone long gas, but also not the stuff of which big rallies are made. Inventories would still bottom out in March at a higher level than they did both this year and in 2014. That means the weather would have to keep playing ball through the summer in order to get inventories down to below 3.4 trillion cubic feet at the end of October. That would be low and could set up some sort of price recovery into 2017, provided next winter was at least reasonably cold.
All in all, the risk for gas prices still looks skewed to the downside. As you can see below, analysts have been chopping their forecasts for gas prices in 2016. The problem is, at $3, the consensus is still 32 percent higher than where futures are trading -- too sunny for this climate.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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