If the future price of natural gas remains higher than the spot price, would producers be incentivized to tighten production? Market participants discussed the possibility that the contango in natural gas would keep some producers from reining in supply.
NGI spot price data show that the Henry Hub natural gas price rose 16.5 cents Monday to average $1.535/MMBtu. Along the forward curve, May 2024 Henry Hub basis was $1.842, with prices higher further out on the forward curve, according to NGI’s Forward Look.
The price situation, a contango, is usually a sign that the cash market has too much supply, analysts said.
Price Futures Group senior analyst Phil Flynn told NGI that premiums to near-term contracts are typical this time of year when prices are pressured by ample supply and weak demand.
A mild winter and robust production have disrupted the supply/demand balance and resulted in storage building to 2,325 Bcf as of March 8. A modest 9 Bcf withdrawal for the week widened the surplus to the five-year average to 629 Bcf, according to U.S. Energy Information Administration storage data.
When in a contango, “The futures price curve incentivizes those with supply to keep holding it and deliver at a later and higher priced date, as long as the basis (storage cost, insurance, etc.) doesn’t exceed the higher price in the spread,” a market observer told NGI.
“That is likely why major exploration and production companies (E&P), including Chesapeake Energy Corp. and EQT Corp., announced they would slow their production,” the observer said.
As top North American E&Ps move to slow output in an effort to balance the market, Lower 48 production estimates averaged 101.6 Bcf/d over the recent seven days, according to Wood Mackenzie data, a far cry from the record levels of around 107 Bcf/d early this year.
The Opposite Effect
However, participants in a discussion on energy platform Enelyst appeared concerned that the contango would have the opposite effect on some producers, encouraging them to keep up production by offering them the opportunity to hedge at higher prices.
The Enelyst participant said that while cash is telling the market “we have too much gas,” the contango is incentivizing producers, signaling the issues are short term.
David Dutch, a former trader and NGI’s vice president of Business Development and Client Support, explained, “A contango market is a ‘normal’ market in commodity trading as it allows storage players to buy cheap spot gas, inject it, and sell in the winter for a nice spread (profit).
“If you can get $4 bucks in the winter, and LNG imports are set to increase, then if you are a producer, you like the math. Plus, getting gas out of the ground is getting cheaper.”
Dutch added, “If a producer can get their gas out of the ground for under winter pricing, they will keep producing and simply sell the winter to lock in profit.”
Support For Contango
There is ample support for the contango, according to Dutch. He cited factors including the fear of producers shutting in and additional liquefied natural gas coming into the market in the future, “which is bullish for producers.
“With LNG exports at 14 Bcf and climbing in the future from the United States, natural gas has become a global market, and the steep contango is reflective of this,” Dutch said.
But, by using the long-dated prices as a prediction, the market is “giving producers hope” and “keeping too much hope in the back half of the curve is not fixing the problem,” the Enelyst participant said.
Confirming their fears, many E&Ps appear hesitant to pull back too much, given expectations for a surge in demand for LNG next year. That’s when new LNG facilities are set to demand substantially more fuel for export to Europe, Asia and elsewhere.
Flynn echoed the concerns. For right now, the market “has it backward” and is sending false signals because “there is no place for production to go.”
With natural gas inventory surpluses widening heading into the storage injection season beginning April 1, alarms have sounded about a natural gas supply that could build to near 4 Tcf by the end of the injection season on Oct. 31 and exceed the limits of current storage capacity.
“The industry is in bad shape,” Flynn said. To stem the tides, producers should have begun to institute cuts in the winter, he said. “I have spoken with traders who are actually astounded that producers are not reacting quicker.”
