After a wild year for gas, how wild will the future be?
After several years of relatively stable natural gas prices, natural gas prices and uncertainty have exploded in 2021.
In fact, very recent (September 21, 2021) futures prices are approximately $5/MMBtu for January 2022, and above $3.55/MMBtu throughout 2022. The current futures market also shows a significant premium in the basis at Algonquin. The futures on September 21, 2021, had basis at Algonquin over $13/MMBtu in January and February 2022.
This leaves us with a bevy of big questions as we look ahead:
- Will prices maintain these levels?
- If the recent runup in gas prices is temporary, how long will it last?
- Why are gas prices at current high levels?
- What will drive gas prices down?
- Will prices return to pre-pandemic levels?
- How do price conditions vary regionally?
- Have we seen some of these conditions before in earlier forecasts?
- Should we expect gas price volatility and uncertainty to continue?
The answers to these questions strongly impact not only all aspects of the natural gas industry, but also the wholesale power sector, the costs of environmental controls, and the budgets of consumers—especially low-income consumers for whom utility bills are a large percentage of total expenditures.
Based on ICF’s market fundamentals forecasting approach, we believe that there is likely to be more volatility ahead. However, we also believe that the futures market is currently significantly overstating likely near-term natural gas prices.
Our full analysis can be found in the Q3 2021 Forecast Report. Read on for a few key highlights.
We see prices coming back down as demand rebounds and producers gain confidence to pick up the pace of drilling activity in 2022, especially in the Haynesville region. The supply and demand dynamics will keep prices elevated above the 2015-2019 average but below current futures, especially in New England where our forecast diverges from where the futures market currently sits under normal weather conditions.
Will prices maintain these levels?
Our team currently believes that the natural gas futures market is significantly overpriced relative to market fundamentals. We, therefore, forecast that current high prices will be very temporary unless the weather is significantly colder than normal this winter. In the near term (i.e., through early 2022), gas futures prices are approximately $0.75/MMBtu above ICF forecasts. Note: Our Q3 2021 forecast was finalized in August 2021 before Hurricane Ida hit the U.S. Gulf Coast. The September 2021 forecast includes updates based on historical data and the effects of Hurricane Ida on gas production.
Gas futures prices are also $0.50/MMBtu above ICF forecasts for the remainder of 2022. The price disparity provides both opportunity and risk to gas market participants.
Why are gas prices at current high levels?
Current high prices reflect several factors:
- Hurricane Ida swept through the Gulf and damaged natural gas and oil production facilities. The storm also shut down power generation, industrial demand, and the storage injections needed to build inventories prior to the winter season. We expect the uptick in prices due to Hurricane Ida to be temporary.
- European market demand for liquefied natural gas (LNG) increased. Much of this was needed to offset the loss of wind power due to an unseasonal calm in the region, while lower-than-expected natural gas imports from Russia drove storage inventories in Europe below the five-year-average level.
- Asian market demand for LNG increased. Countries like China, South Korea, and Japan saw an increase in power generation gas use during the summer.
- Significant concern that winter conditions will be colder than normal, combined with relatively low natural gas storage inventories for this time of year and the market memory of the impact of winter storm Uri.
- A recent legacy of tight investment discipline by producers in reaction to low prices and to concerns about environmental regulation and public perception, leading to expectations of relatively modest oil and gas upstream activity for the rest of 2021.
What will drive gas prices down?
One word: production.
North American drilling activity has been increasing since bottoming out during the height of the COVID pandemic. Drilling activity is expected to continue to ramp up during the rest of 2021 and throughout 2022 in response to higher prices.
We’re already seeing the harbingers of the coming uptick. The number of gas rigs is up from its recent low of 84 in June 2020 to 159 on September 17, 2021. The number of oil rigs is up to 506 from its recent low of 186 in July 2020. The total rig count in the Permian Basin is at 258, more than double the rig count in August 2020, which was 117.
We expect this uptick in drilling activity to lead to increased production before this coming winter and to continue into next year. It is worth noting though that we do not foresee a production boom, but rather a more modest swell as many exploration and production companies are cautiously increasing investment into upstream operations. Overall, we forecast 5.5 billion cubic feet per day (6%) of production increases over the next year, leading to prices that are much closer to $3/MMBtu before the end of 2022.
How do price conditions vary regionally?
Our team’s fundamental forecast diverges from the futures market to an even greater extent in some of the markets in the Northeast U.S. that experience some of the highest winter prices in the country. For example, the current futures market shows a significant premium in the basis at Algonquin for the winter of 2021/22 compared to our Q3 2021 base case. The futures on September 21, 2021, had basis at Algonquin over $13/MMBtu in January and February 2022. Our basis forecast for Algonquin during those months is about half of that.
The futures market prices are based on the expectation that the supply and demand balance will be tight and the marginal supply in New England will be LNG imports. While that is a reasonable assumption for the peak demand days, we believe that basis will not be sustained at those high levels for the whole winter.
We’ve seen that pattern before. Basis at Algonquin reached the heights projected by the current futures market in February 2015 and January 2018, but it wasn’t sustained above $10/MMBtu for multiple months. The current futures market is projecting historically extreme conditions for New England.
Our Q3 2021 Forecast Report provides a deeper dive into these topics as well as answers the questions of if prices will return to pre-pandemic levels and if the futures market is overreacting.
