The U.S. Natural Gas Market - A Quiet Revolution?

April 26, 2017

BHI recently reported that the U.S. natural gas rig count had increased to 145 rigs, up a total of 24 rigs from the same time last year (see the chart below: blue line on left scale). Unsurprisingly, the gas rig count is also generally well correlated to the natural gas price (with an R-squared value of ~57%), which currently stands at $3.18 per MMBtu (Henry Hub), versus $2.27 a year ago (the blue shaded area on the chart on right scale). Where things start to get interesting is when we look at U.S. gas production (see chart: green trend line – not to scale). As the gas rig count fell from a peak of 370 or so in 2014 to about 88 in early 2016, the average monthly gas production (source: EIA) began to fall after plateauing in the 91-92 Bcf per day range in April of 2015. Since then, gas production has shown a decline to about 87 Bcf per day (about a 5% drop since the peak), where it currently stands. The rig count over this period has since recovered from 88 to the 145 where it stands at today, but this increase in the rig count over the last 6 months has yet to increase the production rate and may only be slowing the decline so far – at least that's what the numbers suggest.

While this rebalancing of the market has been going on, long-awaited LNG exports from the U.S have started to kick in (red trend line on the chart above – definitely not to scale), and reached a recent peak of around 27 Bcf for the month of August 2016. This represents only about an equivalent of 1.5% of one month’s production, but when you add it to the 200 Bcf per month or so that is exported by pipeline to Canada and Mexico, then the numbers are slowly starting to add up.

LNG Exports Starting to Bite

The point here is that LNG exports have started to take a small bite out of total production. The reason for this is the price differential between U.S. natural gas prices and those that can be obtained elsewhere. Gas prices this week currently stand at $3.18 per MMBtu in the U.S., $5.16 per MMBtu in Europe, $6.44 per MMBtu in the UK, and LNG is at $7.15 per MMBtu in Japan. Gas has always struggled to become an efficient global market because it is hard to transport, and creates infrastructure challenges for countries who wish to utilize natural gas imports. Black & Veatch recently reported in their 2016 Natural Gas Industry Report, that survey respondents expect that a proliferation of new LNG facilities will drive down global prices, and help to stabilize the market and increase global production. Reuters also reported this week that traders sending U.S. LNG exports to Asia were able to fetch $10 per MMBtu due to tightening in the market and that LNG traders are currently ‘netting’ US$1 million-plus per U.S. –> Asia cargo. The three biggest importers of LNG in the world today are Japan, South Korea, and China, with India and Taiwan not far behind. Since faster than expected growth in demand is coming from Asia amid delays and outages at new export sites, then the current arbitrage opportunity may continue to exist for some time yet. Again, per Reuters, there is still plenty of LNG capacity available to cater to increasing demand. If U.S. LNG exports gather pace and continue to bite into this capacity then this will tend to help keep domestic gas prices in the firm to a higher range, especially with current gas production levels taking some time to recover.

Looking at the EIA Weekly Natural Gas Storage Report, current storage levels are ticking along at about 20 Bcf below the 5-year average mark, but it should be borne in mind that this is after a period a few years of setting new highs for storage levels. Last week’s storage levels were 11% lower (338 Bcf) than at the same time last year. Nothing significant going on here yet, and everything should be expected to balance out as new production from the increased rig count kicks in and recovers the small decline in production over the past few months.

LNG Infrastructure – Still a Long Way to Go

Some pundits are already claiming that natural gas prices will double in the next year however and this is clearly a possibility, but global LNG infrastructure still has a long way to go to make a real impact on the market. Why will the U.S. play an important role in the growing LNG market? The U.S. currently has one operating LNG export terminal and four more terminals under construction, with another dozen at least in various stages of permitting. Also, a U.S. shipment of LNG heading through the Panama Canal to Japan only takes about 20 days to get there, compared to over 30 days from the Middle east or through the Suez Canal. Now that the expanded Panama Canal can accommodate almost the entire global LNG fleet of tankers that they couldn’t fit before due to their size, then there is a compelling case for a significant increase in U.S. LNG exports.

Overall, it would seem like the U.S. natural gas market may at least be due for a quiet revolution, and let’s hope the rig count keeps rising…