This has proven to be a winter of surprises. One of the unexpected developments has been that while higher natural gas demand for heating has driven up spot prices, futures contracts for the commodity have not moved commensurately.
For that matter, the stocks of companies that produce natural gas, or provide oilfield services, haven’t gotten much of a bump from the cold winter either. After years of cheap natural gas, the market appears to expect that producers can simply turn on the taps, and pump out more gas to meet rising demand—making those higher spot prices a short-term phenomenon. But it isn’t that simple.
The number of rigs drilling for natural gas has remained significantly depressed, as drillers favor oil over less-profitable natural gas. Even though natural gas prices are higher than a year ago—peaking at $5.18 in late January, about $2 higher than a year earlier—there just isn’t much equipment left to go after it.
One result is record-high withdrawals from stored natural gas inventories, as production lags behind elevated consumption. Storage levels max out at approximately 3.9 trillion cubic feet (Tcf). Over the course of a typical winter, that might be drawn down to 1.6 to 1.7 Tcf. This year, though, there are signs that by winter’s end, storage could fall below 1.0 Tcf. That would mark a longtime low.
It isn’t a given that natural gas supplies will be easily replenished come summertime. An unusually warm season could still drive heavy consumption—thanks to the commodity’s use in power generation—making it tough to produce a surplus. With inventories starting near historic lows, even robust production levels might not be enough to bring storage levels back up to normal levels. That could mean next winter’s heating season could start in a climate of scarcity, exerting upward pressure on prices.
One result could be that the production and oilfield service companies would see revenues increase as well—and in turn drive the price appreciation we have been anticipating.
Past performance does not guarantee future results.
Economic predictions are based on estimates and are subject to change.
The statements and opinions expressed in this article are those of the author. Any discussion of investments and investment strategies represents the portfolio manager’s views when presented, and are subject to change without notice. There is no guarantee that any particular investment strategy will be successful.
Spot Price: is the current price at which a particular security can be bought or sold at a specified time and place. A security's spot price is regarded as the explicit value of the security at any given time in the marketplace. In contrast, Futures Price: is the expected value of the security, in relation to its current spot price and contract time frame in question.
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