Natural Gas: 2017 Takeaways, 2018 Outlook

What were the key trends in the natural gas market in 2017?

1.Transitioning into a Net Exporter

The biggest news was probably that the US is transitioning into a net exporter as a direct result of the new market reality reflected in the abundance of natural gas and the emergence of new global demand sources. US LNG export projects are economically favorable and more competitive compared to projects in the rest of the world. Cheniere Energy’s Sabine Pass LNG export facility was a major demand driver for the domestic natural gas market in 2017 with feedstock gas over 3 bc/d. The export facility delivered 210[1] LNG cargoes, equivalent to approximately 750 Tbtu, to 25 countries across the globe.

Pipeline exports to Mexico also experienced a remarkable surge and reached a near record above 4 Bcf/d in 2017 as the Mexican energy landscape is undergoing fundamental changes in terms of new reforms and expanded infrastructure.

[1] Cheniere Energy as of October 2017

2. Robust Production

Based on EIA data, natural gas domestic production experienced slower growth in early 2017 due to the decline of capital investments and bearish drilling economics. Output levels reached an inflection point in July as production gained strength and set records starting from October throughout December. The v-shaped recovery was attributed mainly to the continued growth within the Marcellus and Utica Shales along with support from the other supply basins including Permian, and Haynesville. The development of these unconventional sources of natural gas and technological advances such as horizontal drilling have enabled the US to shift from an importer to a self-sufficient gas exporter. Improvements in upstream technology have increased rig efficiency and the estimated ultimate recovery (EUR) per well is making well drilling cheaper and faster. This has led to lower costs and positioned US as the world’s largest gas producer, representing approximately 40% of global output growth.

3. Weak Prices

The significant growth of natural gas production and storage levels has outpaced demand. This imbalance has exerted downward pressure on natural gas prices. As shown in Figure 1, throughout 2017, Henry Hub Natural Gas prompt month.  Prices plunged in February and March amid mild weather conditions and the curtailment of consumption in the power generation sector. However, due to higher price elasticity in the Midwest and Southeast where coal has historically been a major fuel source in the generation mix, coal prices became more competitive and gained ground compared with natural gas. Afterwards, Henry Hub Natural gas prompt month futures prices recovered slightly on higher residential and industrial demand.

One of the most important trends in 2017 is the rise in influence of Henry Hub on the global gas market due to its competitiveness. This competitiveness is measured through the price spread between Henry Hub and the spot price of Asian and European import destinations. Netback margins reached a three-year high in 2017. In December, the netback from the UK NBP and Asian markets hovered at a high of $8.83/MMBtu and $8.11 consecutively. The increased arbitrage opportunities between these regional markets spurred offtakers’ interest to lift LNG under long-term Sale & Purchase Agreements (SPAs) and to redirect cargoes where economically favorable.

4. Pipeline Expansions

There are currently more than 10 projects planned in the Marcellus/Utica region. But three project developments to expand major pipelines systems made great progress in 2017. These projects are designed to allow the constrained gas market to serve downstream end-users and LNG export terminals. Among the largest projects are Energy Transfer Partners LP’s (ETP) Rover; Williams Cos Inc’s Atlantic Sunrise; and TransCanada Corp’s Leach Xpress.

Rover pipeline Phase 1 came online in late 2017 and Phase 2 is expected to be in service by the end of Q1 2018.  Since the start up of Rover, gas production in Southern PA and Eastern Ohio reached record highs. Phase 2 of the project is designed to move gas from West Virginia, Pennsylvania and Ohio to markets in the Midwest and Canada. Once completed by the end of 1Q18, the Rover pipeline project will be able to transport up to 3.25 bc/d from the Marcellus and Utica Shale production areas to markets in the Midwest and Canada. This expansion has impacted prices, specifically in Dominion South. From January 2017 to July 2017, the average spread against Henry Hub decreased from $0.76 MMbtu to $0.53 compared to the same period in 2016.

Atlantic Sunrise is a major Transco project that is aimed at moving Marcellus gas to the Southeast and the Gulf, including the Sabine Pass LNG export terminal and Cove Point in Maryland. The last phase is expected to be in service by mid-2018, adding takeaway capacity of 850 MMcf/d.

TransCanada Corp’s Leach Xpress is projected to move 1.5 Bcf/d of gas capacity from Pennsylvania to West Virgina, where it is connected to TCO system that displaced gas to the Gulf through interconnection with long-haul pipelines including Trunkline and Texas Eastern. This expansion is likely to decrease the spread basis between Henry Hub and TCO and TETCO M-2.

Were there any unexpected surprises that affected the natural gas market?

Summer 2017 was a very active hurricane season. Hurricanes Harvey and Irma were very powerful and made landfall on Florida and the Gulf Coast consecutively. In contrast to Katrina, their impact on the natural gas market were more weighted towards the demand than the supply side. Natural gas output decreased by 3.6 bcf/d due to shut-ins. However, overall production recovered rapidly as Gulf of Mexico production has become less important and Marcellus gas volumes have continued to increase. On the demand side, the impact was more significant on power generation, transmission lines, pipeline exports to Mexico, and  chemical plants’  ethane crackers.

What was the level of activity of the derivatives market in 2017?

As illustrated in Figures 2 and 3, the trading activity of Henry Hub futures and options increased considerably in 2017. Henry Hub Natural Gas futures volume reached a record of 893,256 contracts on December 7 with a daily average volume of 425,000 contracts compared to 374,000 contracts in 2016. Henry Hub Financial options (LN) also set a new single-day electronic volume record of 129,987 lots on-screen. The strong performance was driven by the need to hedge and manage market risk by increasingly diversified particpants.

What is the outlook for 2018?

Based on analysts' projection, US natural gas demand is expected to increase in 2018 due to incremental growth mainly in the LNG export and residential-commercial sectors.

US liquefaction capacity is projected to increase as the first Northeast LNG project-Cove Point goes online early January 2018 and as Sabine Pass’s fourth train has completed commissioning and started the commercialization phase. Collectively, the two projects will be an important outlet to displace over-supplied natural gas.

According to industry analysts, the second wave of US LNG export projects, specifically greenfield ones, are likely to face challenges to demonstrate commercial viability and obtain final investment decisions because the window of competitiveness of US prices may narrow as spot prices in destination markets decrease.

The residential-commercial sector could drive significant growth in heating demand due NOAA's expectation of  colder than average temperatures in the Midwest and the Northeast regions, which represent approximately 65% of total hearing demand. This would have an effect on storage withdrawals, which are likely to pull back inventories to low levels. Industrial demand is, however, forecast to stay stable with some incremental gains tied to the completion of fertilizer plants and the start up of gas-to-liquids projects.

On the supply side, natural gas production is expected to continue to grow to meet rising demand. Growth would be driven by a surge in Marcellus/Utica output in addition to increasing volumes of associated gas from the Rockies and Texas.

Looking ahead to the reminder of winter and based on the NOAA weather forecast, temperatures are likely to be below average in major consumption markets like the Northeast and the Midwest, and colder than normal in the South and the West. The weather risk premium should be offset by strong production. This could exert a downward pressure and a bearish sentiment  on prices, which are anticipated to stay weak but to gain momentum with cold snaps and as LNG exports ramp up. Timespreads are expected to weaken as a result of added takeaway capacity from pipeline expansions, especially in the Northeast.

 

 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.