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15 November 2018 | 4:51AM EST

Natural Gas: Long term surpluses finally create near-term (financial and physical) shortages

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most on the natural gas forward curve was March 2019 (see Exhibit 3), the contract that was likely the most short.

4.Nonetheless, despite the overshoot in prices, it is important to highlight that the fundamental picture has tightened significantly in the past several weeks. Specifically, we estimate that a record-warm September, 19% hotter than the 10-year average, increased power burns by more than 1.5 Bcf/d in the period, which was further exacerbated by a 5 GW net drop in nuclear generation in the Mid-Atlantic region (worth approximately 1 Bcf/d of gas demand) owing to precautionary shut downs ahead of Hurricane Florence. On the supply side, significant take-away capacity out of the Northeast expected to start this summer was delayed, including sections of the massive Rover pipeline (3.2 Bcf/d) and Atlantic Sunrise (1.7 Bcf/d). This slowed the pace of Northeast production growth relative to what had been expected, contributing to the tighter balance we see currently in the market. Last, but not least, the realized and forecast weather deviation thus far in November, 22% colder than average, will likely remove another 165 Bcf from storage as it lifts heating-related demand (see Exhibit 4).

5.As a result of this tightening and cold start to the winter we are raising our winter 2018/19 natural gas price forecast $3.60/mmBtu from $3/mmBtu, which we believe is consistent with enough of a reduction in C2G substitution (-1.2 Bcf/d) to keep end-March storage at manageable levels around 1.5 Tcf. Interestingly, we estimate it would take a two-standard-deviation (2.5% probability) cold event to move end-March inventories below the 837 Bcf post-polar vortex levels observed in 2014. Should that happen, we believe natural gas prices would quickly move above $6/mmbtu to trigger other adjustment levers, such as lower LNG off-take. High transportation costs have already shrunk the margin on US sales to Europe and Asia, and a further increase in the cost of feed gas would eventually drive the utilization rate of US liquefaction lower.

6.To be clear, LNG exports from Cove Point are already out of the money for January and February (see Exhibit 5). Although the 700 mmcf/d facility is too small to provide meaningful relief, it can be an important case study of the demand response to the shutting of the export arb. Meanwhile, Gulf Coast exports have a significantly higher nominal capacity at 3 Bcf/d, including four trains at Sabine Pass and the first Corpus

Christi train, which is expected to be inaugurated today, November 15th. At current prices LNG exports from the Gulf are still economic to flow (see Exhibit 6), with off-takers incentivized to consider rejecting Sabine cargoes should NYMEX move consistently above $6/mmBtu. We believe the price required for Cheniere’s own spot sales to halt would be higher, however, likely in the $7-$8/mmBtu range, as some of the costs that are of a variable nature to off-takers may be sunk costs for the terminal owner, such as pipeline transport fees. It is important to emphasize that during the polar vortex in 2014, LNG imports were zero, so this new release valve takes a lot of historical upside volatility out of gulf coast pricing locations.

7. Despite the very near-term potential for a tight market, the oversupplied forward balance is still a feature of the market and likely to remain so which is why even the April 2019 contract is still below $3/mmBtu. We maintain our long-dated natural gas price forecast of $2.75/mmBtu as the current market is only dealing with a delivery bottleneck that can be compensated for in a rather short time frame, not a structural shift. While

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we believe that positioning and short covering likely caused prices to overshoot to the upside, given the shape of the forward curve, this current rally would be difficult to fade, as to do so would require shorting this winter against record low stocks and sharp backwardation. And fighting carry is rarely an advisable strategy.

The authors would like to thank Samantha Dart for her contribution to this report.

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Source: Bloomberg