Welcome to the outperforming edition of Natural Gas Daily!
Despite August contracts retesting the lows near $1.70/MMBtu, natural gas producers continue to outperform prompt month contracts. Now if you take a look at today’s price action, you will notice that most of the selling pressure is on the front-end while the back-end is moving up.
So a large part of why natural gas producers have outperformed the prompt months is because of the movement in the curve rather than the movement in the prompt. Another reason why natural gas producers have stopped correlating with near-term price movement is because the fundamental weakness we are observing in natural gas is “temporary.”
What we are seeing in today’s price weakness is the result of 1) bloated storage and 2) weak near-term fundamentals.
Lower 48 production is still stagnating but nowhere near the level required to tame the excess storage.
And LNG exports remain weak and will be weak until the end of August before rebounding to ~7 Bcf/d in September.
So despite much warmer than normal temperatures we are seeing right now, fundamentals are going to stink until the end of August.
The longer-term picture continues to improve
But the longer-term picture continues to improve with very low production as the main driving force for much higher prices in 2021. One of the key drivers for gas production over the last several years has been US shale oil producers via associated gas production. Even though Waha basis pushed absolute prices below $1/MMBtu at times in 2019, Permian producers kept producing because most of the revenue came from liquids.
However, given the macro environment, squeeze on credit lines, and lack of external capital, US shale oil producers will be seeing a downturn like no other until at least the end of 2021.
Source: EIA, HFI Research
By our estimate, US oil production will average mid ~10.5 mb/d range across 2021. For Lower 48 gas production, this puts the implied figure somewhere around ~82 Bcf/d.
And for the natural gas market balance, ~82 Bcf/d is far from sufficient in keeping the market balanced.
According to Rystad’s estimate, if we exclude all LNG exports (assuming it’s zero), the net demand required in 2021 is ~83 Bcf/d.
This means that even if LNG exports remain depressed at ~3.4 Bcf/d in 2021, which it won’t, the natural gas market will be in a severe deficit.
Now a bit of caution is required to extrapolate what this means for 2021 and beyond as we would want to see how natural gas producers respond to higher prices in 2021, but if the debt maturity profile and balance sheet damages are any indications, then fiscal discipline will remain the name of the game for a while.
If so, we do see the visibility of higher prices for both 2021 and 2022.
Near-Term Problem, Long-Term Solution
Lower prices are a near-term problem. Bloated storage, COVID-19 related demand issues, and falling LNG exports all contribute to the near-term weakness in prices.
But lower prices are doing its job by curtailing production, which is set to fall to ~82 to ~83 Bcf/d by 2021 and with it, a market deficit of 3-4 Bcf/d at minimum is born.
So inevitably, the market will correct itself back up via higher prices, and producers will respond either by increasing production or using excess FCF to pay down debt. That’s still up to the producers, but it does give visibility to higher pricing and better earnings.
This is why natural gas producers have outperformed natural gas prices and should continue as the market recognizes the 2021 market deficit.
We remain long EQT.
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Disclosure: I am/we are long EQT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.