Vantage Point Advisors’ August Energy Blog

Focus on Natural Gas

U.S. natural gas futures recently hit a 14-year high mark; they gained 35% in July and over 100% year-to-date for 2022, based on the following factors:

  • Forecasts for hotter weather and higher demand;
  • Concerns related to a slowdown in Russian gas flows to Europe; and
  • Record coal prices.

Natural Gas Prices (@NG.1) [1]

 

 

 

 

 

 

Source: CNBC, accessed August 2, 2022, https://www.cnbc.com/quotes/@NG.1

Natural Gas Sources and Uses

Back in 2008, when U.S. natural gas prices were above $10 per MMBtu, there was a business case to be made for drilling for natural gas, even if no oil reserves were present. As prices languished into the $2.00 to $3.00 range for the next twelve years, E&P companies shifted their focus to drilling for oil reserves, and natural gas was produced primarily as a biproduct of these efforts.

Following its production from a well, natural gas is either:

  • Flared (if no economic system exists to move the gas to market);
  • Used to power pumps and compressors in the field;
  • Used for energy-generation to fuel cryptocurrency mining efforts;
  • Cleaned up and sold into a pipeline, and then
    • Used for electric power generation, or
    • Converted to liquified natural gas (“LNG”) and sold overseas

The combination of years of low gas commodity pricing, along with the industry’s focus on oil and its comparative economic benefits, have resulted in lower amounts of natural gas production to cover shortfalls from Russia, stemming from political and mechanical issues with their export pipelines.

U.S. Factors

Extreme heat has already caused U.S. power demand to hit several all-time highs this summer in many states as homes and businesses crank up their air conditioners. To keep those air conditioners humming, electric companies burned more gas than usual due to the retirement of dozens of coal power plants in recent years, and because coal prices were at record highs, making it uneconomical for many generators to switch on at some of the coal plants that remain.[1]

The recent spike in gas prices still came, despite an increase in gas output to near record levels and the ongoing outage at the Freeport Liquefied Natural Gas (LNG) export plant in Texas, which has left more gas in the United States for utilities to inject into low stockpiles.  Freeport, the second-biggest U.S. LNG export plant, was consuming about 2 billion cubic feet per day (bcfd) of gas before it shut down on June 8. The Freeport LNG estimated the facility will return to partial service in October 2022, but some analysts say the outage could last longer.

European Factors

Last week, natural gas was trading around $60 per MMBtu in Europe (700% of U.S. natural gas prices). Cuts in gas flows from Russia, via the Nord Stream 1 Pipeline to 20% of its capacity, drove the spike in European gas prices. Russian gas exports on the three main pipelines into Germany have held near 3.8 Bcf since July 21 when Nord Stream exited a maintenance outage, up from around 1.4 Bcf per day for the 10 days the pipe was shut. Production was close to the 3.7 Bcf per day average during the month before the Nord Stream shutdown, but was still much lower than the 9.4 Bcf per day average in July 2021.[2]

WTI Strip Prices Decrease

Spot prices and futures prices for the WTI contract decreased by approximately $12.00 per barrel in the near term, and by approximately $0.50 per barrel over the longer term.

As shown, the oil price curve remains in a state of “backwardation,” reflecting the market’s expectation of lower future spot prices.

Oil Price Outlook

The price distribution below shows the crude oil spot price on August 1, 2022, as well as the predicted crude oil prices based on options and futures markets. Blue lines are within one standard deviation (σ) of the mean, red lines are within two standard deviations.

Based on these current prices, the markets indicate there is a 68% chance oil prices will range from $70.00 and $120.50 per barrel in mid-November 2022. Likewise, there is roughly a 95% chance that prices will be between $45.50 and $180.00. By mid-January 2023, the one-standard deviation (1σ) price range is $65.00 to $127.00 per barrel, and the two-standard deviation (2σ) range is $37.00 to $202.50 per barrel.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful. The heightened volatility caused by recent events has led to extraordinary futures price ranges. While the mid-December 2022 settlement price is $87.62, the 1σ range has a spread of $62, and the 2σ range has spread of over $165 per barrel!  These factors add up to a challenging price environment for capital allocation decisions.

For more information, contact:

Gregory E. Scheig, CPA/ABV, CFA, CMA
Vantage Point Advisors
Managing Director / Energy Practice Leader
Certified Mineral Appraiser
180 State St., Suite 225, Southlake, TX 76092
214.254.4801
gscheig@vpadvisors.com

 

[1] CNBC Website, https://www.cnbc.com/quotes/@NG.1)

[2] EnergyNow.com, https://energynow.com/2022/07/u-s-natgas-hits-14-year-high-on-hot-forecasts-russia-export-worries/

[3] EnergyNow.com, https://energynow.com/2022/07/u-s-natgas-hits-14-year-high-on-hot-forecasts-russia-export-worries/

Featured Image: Fran Ruchalski/The Enterprise