The past 18 months have been a wild ride for natural gas prices, as well as for the bottom line of investors and companies that are subject to their gyrations.
Spot prices in production and demand centers of the US have broken volatility records in recent months, while producers have reversed their course on hedging as gas prices collapsed.
The next few years portend more of the same.
"I think volatility is here to stay for the foreseeable future," Citi analyst Paul Diamond told Argus. "The underlying issues causing that step change in the last 24 months are not going away."
If one measures volatility by the number of days an asset moves by more than 7pc in value, 2022 was the most volatile year for natural gas prices since at least the beginning of the shale era. In 2022, the price for day-ahead delivery at the US benchmark Henry Hub in Louisiana rose or fell by more than 7pc on 65 occasions, the most of any year since at least 2009, according to an Argus analysis.
So far, the Henry Hub has done so 21 times this year. At that rate, 2023 will be more volatile than 2022.
How volatility returned to gas markets
After the shale revolution of the 2000s brought cheap and efficient techniques for increasing domestic gas production, including horizontal drilling and hydraulic fracturing, or "fracking," US gas prices enjoyed a long decade of low volatility. On average, the US benchmark only moved by more than 7pc on 17 days/yr between 2009-2021 — about one-third the 2022 rate.
That period of relative price stability ended sometime around the fourth quarter of 2021 when prices rose on an unexpected increase in power demand and record-high LNG exports. Despite tight supplies and high prices, producers mostly stuck to their promises to investors to maintain capital discipline, declining to increase production at pace with demand.
Producers stuck to their script even when Russia invaded Ukraine in 2022, threatening gas supply to Europe and causing a global energy crisis in which overseas appetite for US gas soared, lifting prices even higher.
The prompt-month price — the price for delivery of gas every day in the following calendar month — for the Henry Hub in December 2021 averaged $3.86/mmBtu. In May 2022, the price was more than twice as high, at $8.16/mmBtu. It averaged over $7/mmBtu in subsequent months, peaking at $9.68/mmBtu on 22 August, the highest since 23 July 2008.
When the 2 Bcf/d (57mn m3/d) Freeport LNG export terminal in Texas went off line in June after a fire, record-high gas consumption kept prices afloat even as domestic supply instantly increased. When the consumption leveled off as cooling demand fell, however, prices began to fall, insulated from the overseas chaos by an absence of LNG export capacity. The price drop accelerated when the US experienced historically low heating demand in January and February, pushing inventories from a deficit to a surplus to the five-year average.
In the two months ended yesterday, the Henry Hub prompt-month price averaged $2.47/mmBtu.
Why volatility could be here to stay
While some of the volatility of recent months has been because of unforeseen events — the war in Ukraine, the fire at Freeport LNG, historically mild weather — much of the volatility to come is expected to arise because of structural uncertainty currently being built into the gas market.
One piece of that uncertainty is what price crude oil and gas will be fetching when LNG export terminals begin coming on line in late 2024 and beyond. For example, if oil prices are low and producers in the Permian respond by pulling back on drilling, that will reduce associated gas production, which could starve LNG terminals. Low gas prices could also reduce production in the Haynesville, which would be hard to make up for in the Marcellus and Utica shales, where pipeline takeaway capacity limits production growth.
If LNG terminals are delayed, prices could plunge as domestic supply races ahead of demand.
"As we add more LNG demand along the Gulf Coast, the timing between LNG facilities, the pipelines to feed them, and the production to meet the new demand all has to be in sync," BTU Analytics analyst Connor McLean told Argus. "If the timing slips for any of those pieces, we are likely to see the market react strongly until the other pieces catch up."
On top of the uncertainty, the steady retirement of coal-fired power plants has reduced the ability of electrical utilities to switch from coal to gas when supplies of one or the other are constrained. And while gas consumption continues to rise, regional opposition to the construction of new pipelines has led to a slowdown in expansions of pipeline capacity.
The increased reliance on gas can make market participants react more strongly to price signals than they would have otherwise.
