Introduction:
Feb 25, 2003: $18.48; Dec 15, 2005: $15.39; June 19, 2008: $13.09; Aug 17, 2012: $2.70; July 2, 2013: $3.58
Good News: Natural Gas Prices are low!
Bad News: Natural Gas Prices are low!
Confused? You’re not alone; there are enormous, opposing, marketplace agendas at stake on both sides of the current and forecasted US gas price situation. While the industry may tout the benefits of low natural gas prices to the consumers and other stakeholders, they are also worried about the long term impacts of low natural gas prices which has already started to turn away investors and depress normal cycles of exploration and production. Go to any natural gas industry conference and the talk is largely about “unsustainable” low natural gas prices and need to increase demand and thereby prices. Looking back 5 years ago when gas prices spiked at above $12 and now with sub-$4 prices, how the times have changed!
Past bets:
Consider the chart above: In the Pre-2006 scenario, natural gas prices were consistently trending upward (B,E in chart) with abnormal spikes during the winters of 2001, 2003, 2005 and 2008 (C,D,F, I in chart). The spike of 2002-03 made the industry acutely aware of the impending demand-supply gap in natural gas. The industry responded with two different solutions – first was to make big bets on natural gas imports and Liquefied Natural Gas (LNG) terminals. This was the bet the big oil & gas players made. Second was the bet the independents made. They began quietly testing unconventional technology to extract gas from various shale formations. And they struck gold!
With the advent of shale gas and especially the huge supply of Marcellus shale gas, the demand-supply situation in natural gas changed. The floor prices of 2006-2008 suddenly became more of a ceiling post 2009. The euphoria of unconventional gas supply quickly gave way to the concerns about “unsustainable” low natural gas prices. And the need to increase the consumption or demand of natural gas. And the need to manage supplies coming to the market.
Lower Volatility:
One major fallout of low natural gas prices for the past 3 years has been the reduction in volatility of gas. Consider this, between Jan 7, 1997 to July 1, 2010, there were 587 times when the price of natural gas changed more than 5% over a day, averaging about 43.5 such moves in a year. Between July 1, 2010 and July 2, 2013, there were only 56 such moves, averaging about 18.7 a year.
For larger movements of 10% or more change in a day, there were 124 times such movements occurred between the 13 year period (Jan 1997 to Jul 2010) while only one such movement occurred in past 3 year (Jul 2010 to Jul 2013) time period.
Great right? Lower volatility means more stability in prices, yes, but also less opportunity for traders to make money on price movements. Again, two very different perspectives.
Radical Surgery Needed on Hedging Programs:
With low natural gas prices and low volatility, natural gas companies need to rethink their trading and hedging strategies and policies which govern these strategies. Consider this – a 10% move at $4 equals 5% move at $8. We know from the above table getting a 10% change is much rarer than 5% change. Also, the increase in natural gas liquids (NGLs), especially ethane, portfolio has its own implications. Specifically, natural gas companies need to address some key questions:
- How has your hedging program changed over the past 3 years?
- Did you curtain your hedging activity?
- Did you exit the market?
- Are you largely unhedged?
- How has the portfolio of instruments utilized for hedging changed?
- How has your risk management changed over the past 3 years?
- How do you adjust to this era of low volatility?
Less Trading and Fewer Participants:
It is unlikely that the shale gas industry, which is largely focused on the upstream end of the industry, will make huge investments on natural gas trading. Entry of new gas trading participants is expected to decline dramatically compared to previous years and we are already seeing evidence that existing gas market participants are shrinking their trading and hedging programs, their investments in gas trading and risk systems, their staffing and their risk management approach.
Barbarians At The Gate:
If stock prices decline significantly in the gas trading industry group due to low natural gas prices and low volatility, you can expect another round of mergers and acquisitions; perhaps even from some unlikely sources who would like to lock in a supply of low-priced gas capacity for the near future. Asset rich gas companies are especially susceptible to this transaction – especially given the large numbers of planned conversions from oil/fuel oil to natural gas a cheap energy supply as a new driver.
And as in all good trading stories, we do expect the current uncertain environment to continue!
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About the Author
Prashant Shah is a Principal at AXCELERUS, a specialized ETRM/CTRM consulting practice with global client-base and solutions for the full spectrum energy transacting value chain. Prashant focuses on risk management activities, risk reporting, front, middle and back-office processes and energy transacting/risk management (ETRM) systems.
Prashant can be reached at prashant.shah@axcelerus.com.
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These materials and the information contained herein are provided by AXCELERUS, LLC (“AXCELERUS”) and are intended to provide general information on a particular subject or subjects and are not an exhaustive treatment of such subject(s). Your use of these materials and information contained therein is at your own risk, and you assume full responsibility and risk of loss resulting from the use thereof.
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