U.S. natural gas futures have retreated over the last two days but still managed to finish the week higher. The cause of the recent rout? Weather forecasts for the rest of May have taken a bearish turn, cooling in the wrong places, which has reduced the need for the fuel for power generation.
Through the first three weeks of May, the weather has been nearly perfect for gas demand. In fact, according to CWG, the total gas-weighted cooling degree days for May 2022 would be the second-most bullish, in terms of gas demand, in the last 22 years, behind only 2018. This warm weather has directly translated to robust demand for power generation and, therefore, natural gas as fuel.
We explained a few weeks ago that we believed the market was pricing in a hot summer. Analysts now expect hot weather; summer temperatures have fallen on the warmer end of the historical average over the last ten years, a phenomenon often called “climate drift.” Thus far, it seems the market has gotten it right. But summer is still in its early innings.
We have been warning against production growth as a bearish factor. The primary limiters of production growth across the U.S. have been pipeline capacity, a lack of raw materials, and labor constraints. The South-Central region has boasted the most available takeaway capacity over the last two years, helping the region lead lower-48 gas production growth. As a result, Permian and Hayneville basin production is up by 1.6 & 1.2 Bcf/d year-over-year. In contrast, Appalachian (Marcellus & Utica) production growth has stalled at 0.2 Bcf/d year-over-year because of egress capacity constraints and no new pipelines. Look at the repeated delays of the Mountain Valley Pipeline (MVP), the only pending large-scale pipeline project in the region, as a prime example of how difficult it is to build a pipeline in the Northeastern U.S..
Three separate pipeline expansion projects have been announced that would enhance takeaway capacity on three separate existing pipelines for the Permian Basin. The cumulative total takeaway capacity from the expansion projects is around 1.7 Bcf/d. Then yesterday, Whitewater Midstream announced a final investment decision for its mega-2.5-Bcf/d Matterhorn pipeline that would transport gas from the Waha region to the Katy, TX area. Between the pipeline expansions and now this new pipeline announcement, that’s enough capacity to support around 4.2 Bcf/d of growth by mid-2024, not including a possible 1 Bcf/d of current spare capacity out of the basin. So in total, that’s 5.2 Bcf/d of potential takeaway capacity, more than enough to support production growth for a few years and loosen a tight U.S. lower-48 supply-demand balance.
AEGIS hedging recommendations continue to be costless collars throughout the curve. However, at the first sign of production growth, we could see near-term tenors back off by quite a bit, so swaps should not be disregarded, especially with prices near thirteen-year highs. We are in a market where the pace of production additions could be the difference between a $4 and $7 gas price next year. We remain tactically cautious about longer-dated tenors, primarily because of the recent rally.