The US natural gas market’s fundamental dynamics have evolved into effective circuit breakers that limit upward and downward price pressure. And there is little evidence to suggest the commodity can escape these price-constraining handcuffs anytime soon.
The astonishing production volumes unleashed from shale and other tight resource plays starting in the mid 2000’s turned the market upside down and flipped the country from relative scarcity to exporting gas via both pipelines and LNG. The new reality is one where the battle between sources of supply and demand are so evenly matched that imbalances naturally adjust before prices can break the $5/MMBtu threshold for extended periods. Gone are the days of annual average benchmark prices north of $8.00 per MMBtu.
The main sources of US gas demand are power generation, industrial applications like petrochemical production, commercial/residential consumption for space heating, and now exports (pipes to Mexico and LNG). Supply is made up of onshore and offshore development, along with some pipeline imports from Canada. Demand has recently been mostly driven by the power sector and exports. Industrial demand is expected to increase from petrochemical facilities coming online over the next three to five years.
Supply is more sensitive than it’s been for decades due to to fracking and horizontal drilling techniques that have unlocked an enormous reserve base. Supply can be dialed up and down more quickly than ever before – think months as opposed to years.
Prices are now caught between these opposing forces. LNG exports emerged because US natural gas prices dropped considerably below levels being paid in other countries, particularly in Asia where gas prices remain tied to oil prices. Entrepreneurs clamored to access this arbitrage window and began applying to build export plants or retrofit import terminals to process exports. The first export plant in the lower 48 opened for business last year. Although the arbitrage opportunity has narrowed, there are still opportunities for companies to make money liquefying cheap US gas for sale into higher-priced markets around the world. That opportunity, however, is highly price sensitive and if domestic US prices rise too much, that disincentivizes shipping LNG overseas where it’s no longer competitive with local prices or other import sources.
In that scenario, gas that would have left the market as LNG remains in US inventories, thus increasing supply. At the same time, the higher prices that discouraged LNG sendout simultaneously stimulate more US gas drilling as rigs that were laid down during the weak price environment are put back to work. This increased production can only continue until supply once again dominates demand to the point where prices are beaten back down – perhaps to a level that again incentives LNG shipments overseas – you see the point.
In the current market environment, it’s difficult to see how US gas supply returns to a situation of scarcity, barring a major natural disaster. Supply losses from Hurricanes Katrina and Rita drove benchmark spot prices above $13/MMBtu in 2005. Regulations that ban or decrease fracking had been another potential obstacle for US gas supply up until the recent election. However, the Trump administration appears to have little appetite for that kind of thing and have in fact vowed to decrease regulatory burdens for US oil and gas producers.
Over the longer term, US natural gas prices will probably strengthen due to circumstances we can’t envision today, but until these new unknown dynamics surface, market fundamentals will enforce range-bound natural gas prices.
