NYMEX UPDATE BULLS & BEARS REPORT
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1 June 30, 2016 NYMEX UPDATE BULLS & BEARS REPORT Author MATTHEW MATTINGLY Energy Analyst / Louisville Ph: Author JASON SCARBROUGH VP Risk Management / Houston Ph: INTRODUCTION The NYMEX natural gas market finally saw bullish movement in June trading. Strong heat throughout the United States, increased natural gas generation, potential production declines, and modest storage injections brought upward pressure not only to the July 2016 NYMEX contract, but also to the rest of the forward curve. However, the July contract did see the largest bullish movement. The contract started prompt month trading at $2.169/MMBtu, and finished at $2.917/MMBtu, a 35% increase over the four week trading period. The rest of the forward curve, while seeing some upward movement, is still limited by strong bearish fundamentals that have weighed down the market over the last year. The Bulls have made a strong move in recent weeks, but how much more momentum do they have in them? This Bulls/Bears report will take a closer look into the Bulls momentum by reviewing the market fundamentals impacting the forward natural gas market. Since the Bulls gained so much ground this past month, we will let them tee off first. WEATHER / TEMPERATURES The main driver for the bullish move in the natural gas market is heat. After a cool May, June 2016 brought the heat with above normal temperatures for nearly the entire country. The western half of the United States received the worse end of the heat wave; setting new high temperature records in Las Vegas and Phoenix. Above average temperatures mean more cooling demand, which is in large part fueled by natural gas. Temperature maps are forecasting the above normal heat to continue throughout the summer with both the 30 day and 90 day forecasts showing above average temperatures for nearly the entire country. The bears tried to gain momentum based a short-term temperature forecast of milder temperatures for the beginning weeks of July. However, a revision of the shortterm forecast on settlement day, June 28th, showed above average temperatures for most of the country with extreme heat in Texas and Florida. Texas and Florida are two of the largest consumers of natural gas for power generation. As a result, the NYMEX natural gas rallied strongly on the July contract closing $0.201/MMBtu higher for the day and settling at $2.917/MMBtu.
2 Source: NOAA Prediction Center/Temperature Outlook
3 U.S. POWER GENERATION In March 2016 coal consumption directed for power generation reached its lowest point since This isn t a surprise given the direction of environmental policy over the last 10 plus years. With this Source: U.S. Energy Information Administration Graph: Choice Energy Services historically significant base load fuel source heading faster towards retirement, and until another fuel source is capable of replacing the retired capacity, natural gas will continue to fill in the gap. As a result, power generation will continue to gain ground as major fundamental market driver for natural gas pricing. This increasing input fuel share for natural gas fired generation, paired with the expected warmer than normal summer temperatures, will continue to provide price support for NYMEX natural gas. While most of the price premium associated with above normal cooling demand has already been baked in, unexpected changes in summer weather patterns may further exacerbate upward price pressure and volatility. PRODUCTION DECLINES? The previous Bulls/Bears report discussed the potential of production declines in U.S. shale plays, but EIA s revision of the 2016 data has Choice revisiting the subject. After seeing years of month to month production increases in Marcellus, Utica, and other US Shale plays the EIA has indicated that production has plateaued and even decreased the last couple of months. This could be a result of the sustained low price environment and declining rig counts finally catching up with production. In our last Bulls& Bears report we referenced EIA data that illustrated Marcellus peaked at Bcf/Day with total US Shale peaking at Bcf/Day. However, the latest EIA data (June Report) reveals the Marcellus Shale is currently producing Bcf/Day and that total production peaked even higher at Bcf/Day. Choice will note that June EIA report still illustrates production has peaked and is declining over the last couple of months. The new report shows US Shale production peaked in February 2016, with total production a full 1 Bcf/Day higher than May 2016 data. Will the production declines continue to hold true, or will the EIA make another adjustment to the data showing production gains? Choice Energy Services will be closely monitoring this subject as summer continues.
4 Source: EIA Natural Gas Weekly Graph: Choice Energy Services STORAGE INJECTIONS Without any question, there is a lot of natural gas in storage. With record setting production paired with above normal temperatures from this past winter, we saw a record level of natural gas inventories at the end of withdrawal season. With nearly 2,500 Bcf exiting withdrawal season many analysts were questioning if there would be enough storage capacity available at the end of this injection season. However, the start of injection season has slowed down the record setting pace for the 2016 storage inventory. Recent storage injections have not kept up with the same levels of the past five years and are well behind the injection level highs that were set in 2014 and The recent trend for the weekly EIA storage number is to report an injection that is 60% of the highs that were set in the same weekly period in 2014 & 2015 (see graph below). As mentioned in the Weather/Temperatures section, a cool May led to prolonged heating demand for natural gas. June quickly transitioned to hot temperatures which led to cooling demand for natural gas generation. These factors, coinciding with slight production declines have led to lackluster storage injections in recent weeks. Source: EIA Natural Gas Weekly Graph: Choice Energy Services
5 PRODUCTION The reoccurring bearish fundamental is how much gas is still being produced in the United States today. The EIA Short Term Energy Outlook (STEO) continues to show the combination of production & imports of natural to equal 80 Bcf/Day in the United States. Although production has flattened, and slightly decreased in recent months, 79.5 Bcf/Day is historically considered a high level of production. Natural gas production is 10 Bcf/Day higher than just a few years ago, and the EIA is forecasting production and import growth through the remainder of 2016 and into 2017 reaching Bcf/Day by the end of next year. If the EIA forecasts hold true and we do not see production declines, any bullish movement would be depressed with the amount of gas available to the United States market. Source: EIA-STEO Report, June Chart: Choice Energy Services DRILLING EFFICIENCY Production continues to remain strong, even with declining rig counts, due to improvement in drilling technology and efficiencies. Producers in shale regions are now drilling more wells at one site (pad drilling) and extending the length of horizontal wells to cope with the falling prices of natural gas. Technology improvements have also reduced the drill time of a rig. Three years ago it took about 23 days to drill a well in Marcellus; now it s roughly 14 days. The graph below illustrates drilling efficiency in several of the gas producing shale plays in the United States. Marcellus and Utica specifically have seen a large increase in the average production per rig. The Marcellus production per rig is averaging 10,700.6 Mcf/Day in 2016, equating to a 150% increase since Efficiencies in the Utica shale play have even been more dramatic with production per rig averaging 9,883.7 in 2016, equating to over a 100% increase in just the past 2 years.
6 Source: EIA-DPR Report, June Chart: Choice Energy Services RIG COUNT Choice Energy Services has consistently talked about the declining rig counts that have occurred over the past 18 months. That is because since 2014 rig counts have decreased by over 1,500. While it has been noted already that drilling technology and efficiencies have improved, rig counts can t continue to fall week over week. At some point exploratory rigs need to be in the ground to bring new production on line. The rig count breaking point could have finally hit in recent weeks. On May 20, 2016 the total US Rig Count dropped to 404 total rigs, which was the lowest total number in over 65 years. But since that time we have finally started to see an uptick. The recent weekly rig increase was recently discussed by Choice Energy Services in a blog post published in The Burn. Below is an excerpt from that blog entry discussing the rig counts: As predicted, rig counts have started to rise with the increase in oil prices. After bottoming at 404 rigs on 05/20/2016, the rig count report has risen to 424 total rigs as of 06/17/2016. While this is just a small move, it is at least a move in the opposite direction. Furthermore, producers now have additional motives to put rigs in the ground due to the recent bullish momentum in natural gas prices. The July 2016 NYMEX contract has increased by 27% over the last few weeks, trading currently at $2.747/MMBtu. During the same time Calendar 2017 NYMEX strip pricing has increased by $0.12/MMBtu, now trading at $3.106/MMBtu. Therefore, the increase we are seeing in rig counts for oil could start seeing could seeing its way to natural gas rig counts as well. Source: Baker Hughes Chart: Choice Energy Services
7 It would be very premature to say that rig counts will continue this weekly climb, the increases have only occurred over the past three weeks. Thanks to bullish movements in the energy commodities market over the last month there is finally a reason to add exploratory rigs in the ground. But don t call it a comeback just yet, rig counts still have a long way to go to match the levels of previous years, but at least it s a change in direction for the weekly rig count. STORAGE The latest EIA storage injections have not reached the same levels of the past couple of years. As discussed in the Bull sections, the recent trend for the weekly EIA storage number is to report an injection that is 60% of the highs that Source: EIA Weekly Natural Gas Storage Report Chart: Choice Energy Services were set in the same weekly period in 2014 & But even with the recent trend of lackluster injections, storage levels are still at records highs. The current EIA storage report, as 6/23/2016, shows inventories at 3,103 Bcf which is the highest recorded storage number for week 25. This figure is well above inventories of a year ago (2,506 Bcf) and the five-year average (2,457 Bcf). Earlier in the year there was discussion that the United States could run out of storage capacity, but that has levitated some with recent storage injections and hot summer projections. Nevertheless, the U.S. will still leave injection season with a lot of natural gas in the ground. If injections can keep pace with the average injections over the last five years, the U.S. would max out injection season at 4,480 Bcf. Another scenario is if injections continue the same pattern of recent weeks, and inject 60% of the highs that were set in the same weekly period in 2014 & Under that scenario, the U.S. would max out storage at 4,224 Bcf. Under either option, the U.S. is setting up for another record breaking year for natural gas storage.
8 SUMMARY After months and months of deflated natural gas prices, the bulls finally broke through and brought upward momentum to the market. The bulls have been led by weather as the summer heat has limited the storage injections reported by the EIA. The heat is not expected to stop in June as both the short-term and long-term forecast are showing above-average temperatures for the vast majority of the country. Conjointly, there are reasons to believe that production has reached its peak and is in decline after months of deflated prices have taken its toll on producers. Add it all together, and one finally gets a rally in natural gas. On the other hand, how much more momentum do the Bulls have in the natural gas market? The movement seems limited due to the strong bearish fundamentals that counter the bullish momentum. While the recent lackluster storage injections are concerning, storage is still well on pace for the record breaking year for storage capacity. The same can be said for production, while production could have recently peaked, the United States is still expected to produce and import nearly 80 Bcf/Day of natural gas. Historically, that is a lot of natural gas. Furthermore, the rally in natural gas prices will give producers additional incentive to bring production back on line that was previously shut in due to below $2.00/MMBtu pricing; leaving producers in a catch 22 proposition. On one hand, higher pricing is needed to maximize profit on their wells. On the other, large increases in production will only weigh on pricing in this oversupply market making it difficult for the Bulls to gather too much momentum into the future.
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