If you’re in charge of purchasing power for your business, you know how important it is to stay on top of energy trends. In this edition of Customer Insights, we’ll look at the specific demand drivers of natural gas and how these may impact natural gas prices this upcoming winter and beyond.
There are several key factors that influence natural gas demand: weather, storage inventories and market demand. We’ll discuss each of these fundamentals and how their outlooks affect forward natural gas prices.
The first, and arguably most important, driver of natural gas prices is weather. Natural gas demand is driven by the need to either heat or cool commercial, industrial or residential structures when temperatures are extreme. Weather, by nature, is the most challenging to forecast. Ironically, weather is also the largest driver of demand and has the most direct, real-time impact on natural gas prices.
Weather forecasts beyond three-to-five days are subject to high degrees of uncertainty. For this reason, many long-term forecasts focus on trends that may influence future temperatures. Recently, the National Oceanic and Atmospheric Administration (NOAA), a division of the U.S. Department of Commerce, provided its long-term outlook for the period of December 2019 through February 2020, which projects a high probability of above normal temperatures for much of the United States. Exceptions to that forecast are seen in the Central and Northern Plains and the Western Great Lakes, as these regions are forecasted to experience an equal chance of above, below or normal temperatures for January through March. The very generic nature of that forecast speaks to the lack of clarity and actionable information provided by long-term weather forecasts.
The map below, published by NOAA, illustrates the three-month outlook of temperature probability throughout the United States, as mentioned in the previous paragraph. To view additional weather maps by NOAA click here.
Another important market fundamental influencing natural gas pricing is storage inventories. Natural gas storage inventories are highly correlated to weather. In winter months, natural gas inventories decrease significantly during periods of extreme cold. Each Thursday morning, the U.S. Energy Information Administration (EIA) reports week-ending storage inventory levels along with comparisons against inventories at the same time in the prior year and the five-year average.
Natural gas prices react real-time to the Thursday storage report as market participants interpret how storage levels may impact demand going forward. For instance, during a week of heavy storage withdrawal, prices tend to go up as less supply is available to get through the peak demand season. Less natural gas available to pull from storage means a greater need for natural gas purchases and deliveries during periods of sustained cold. Below is a recent example of the weekly storage report published by the EIA.
At AEP Energy, we keep you informed about EIA’s weekly storage report through our weekly Energy Market Report. Contact your sales representative today to receive your complimentary copy.
From a historical perspective, natural gas supply outpaces demand in the months of April through October and lags behind demand from November to March. Because of this seasonal supply, storage plays an important role in keeping the natural gas market balanced. As we enter the traditional withdrawal season, it’s expected that natural gas will end the summer injection season with approximately 3,800 billion cubic feet (Bcf) in storage. The current expected inventory of 3,800 Bcf is approximately 560 Bcf higher than levels from early November 2018. This surplus is a product of current natural gas production volumes being significantly higher than levels one year ago. This level also is approximately 70 Bcf higher than average inventory levels for early November over the last five years. Average inventories are depleted by approximately 2,000 Bcf during the traditional withdrawal season, so the market is currently poised to make it through an even colder than normal winter with ample supplies.
Two areas that have had a dramatic impact on natural gas demand over the past several years have been the continued growth of natural gas as an input for power generation and the exporting of liquefied natural gas (LNG) from the Gulf Coast and Mid-Atlantic regions of the U.S. Over the past year alone, 6,000 MW of coal-fired power has been removed from PJM’s portfolio of electric generation. Natural gas-fired generation is expected to replace much of that supply. The anticipated increase in natural gas-fired generation is expected to produce a 2.5 Bcf per day increase in natural gas demand during the next year. In PJM alone, more than 12,000 MW of new natural gas-fired generation has come on line since the beginning of 2018. It is expected that natural gas will fuel 39 percent of electric generation in PJM in 2020, while in 2019 it was only responsible for ten percent. LNG exports have also continued to ramp up over the past year from both increased operations at the Sabine Pass terminal in Louisiana and the commissioning of the Cove Point facility in Southern Maryland in March of 2018. Increased operations at these two facilities are expected to increase demand for natural gas by approximately 2.0 Bcf per day.
So far this year, production volumes in the U.S. have averaged approximately 6 Bcf per day higher than volumes in 2017, so the market should have ample supply despite the increase in demand. However, as the supply and demand factors fluctuate throughout the remainder of 2019 and beyond, forward prices will react accordingly. Those movements in natural gas prices will flow through to impact power prices as natural gas and power prices are more highly correlated than ever.
At AEP Energy we have the resources to keep you informed with conditions affecting your energy prices. Are you on the right path? Contact us today to develop your energy strategy.