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Natural Gas: Here's Why Prices Could Tumble Below $2 Shortly

Nilanjan Choudhury

Over the past few weeks, natural gas prices have fallen to levels not seen in more than three years, reflecting a steady, albeit slow, descent. Market participants are worried that even a spike in heating demand might not be enough to stop the commodity's collapse below the psychologically important $2 per MMBtu level shortly.

Here are at least three reasons why they think so:

Narrowing Deficit to the 5-Year Average: While inventories are still under the five-year average, rapidly replenishing stocks mean that supplies have climbed swiftly over the past few months. The latest EIA report puts total natural gas stocks at 2.689 trillion cubic feet (Tcf) - 343 Bcf (14.6%) above 2018 levels at this time and just 111 Bcf (4%) under the five-year average. Assuming the current pace of storage build, supply deficit to the five-year average could narrow substantially by the end of August.

Overwhelming Production: The demand for cleaner fuels and the commodity’s relatively lower price has catapulted natural gas' share of domestic electricity generation to 35%, from 25% in 2011. Moreover, new pipelines to Mexico, together with large-scale liquefied gas export facilities have meant that exports out of the U.S. are set for a quantum leap. Finally, higher consumption from industrial projects will likely ensure strong natural gas demand. However, record high production in the United States and expectations for healthy growth through 2020 means that supply will keep pace with demand.

Significant Flaring: While oil production in shale basins like the Permian, Eagle Ford and North Dakota have seen a rapid rise since 2016, it is accompanied by structural challenges like natural gas flaring. Operators are experiencing some growing pains as natural gas output – a largely unwanted derivative that emerges alongside oil production in the region – outpaces gathering and processing capacity, leading to increased flaring. The flaring, leads to greenhouse gas emissions like methane. Therefore, the operators can either ‘self-restrict’ oil production until more natural gas infrastructure is built or pay others with space on existing pipelines to transport the unwanted gas. As companies are reluctant to stop drilling for oil, they continue to ‘flare’ natural gas unabated. Some estimates indicate that operators burn off around 1 billion cubic feet of the commodity each day in the Permian. The huge amount of associated gas production is a prime reason to drag down prices.

Conclusion

Natural gas prices might experience short-lived surge based on positive weather forecasts and potential storm-induced supply disruptions but any powerful turnaround looks unlikely at the moment. 

The bearish natural gas fundamentals and its seasonal nature is responsible for the understandable reluctance on investors’ part to dip their feet into stocks like Gulfport Energy Corporation GPOR, Montage Resources Corporation MR, Cabot Oil & Gas Corporation COG, SilverBow Resources, Inc. SBOW, Southwestern Energy Company SWN, EQT Corporation EQT etc.

Only time will tell whether prices will break below the $2 threshold for the first time since 2016 but as of now it might be prudent for investors to maintain caution — either withdraw for a while or look for fundamentally sound stocks.

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