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Macquarie Sees Potential for Winter Volatility Despite Production Growth

Growing export demand and an increase in weather sensitivity could drive larger natural gas price swings this winter even as “unrelenting” production growth continues, according to Macquarie Group analyst Vikas Dwivedi.

Macquarie’s 2018/2019 winter price forecast is a base of $2.85/MMBtu, but ranging from a “one touch high” of $6.50 to a “one-touch low” of $1.90, according to Dwivedi, who serves as the firm’s global oil and gas strategist. He was a keynote speaker Tuesday at the LDC Gas Forums in Chicago.

Acknowledging the price swing is a “uselessly wide range,” Dwivedi said it is a product of the gas market’s increasing weather sensitivity.

Looking at models tracking gas demand per degree day, extreme cold weather events in recent years “jumped off of all the curves...and we think it’s because a lot more homes have converted in the Northeast to gas, away from heating oil and away from fuel oil, so there’s a higher sensitivity. The summer is also more sensitive,” Dwivedi said.

Macquarie’s summer 2019 price forecast is $2.65/MMBtu, with a high of $2.80 and a low of $2.00, while long-term the firm’s base forecast is $2.95.

In terms of quantifying the increased weather sensitivity in the market, Dwivedi estimated that an especially cold winter now could be expected to produce an additional 1,000 Bcf of national demand versus a normal winter in years past of around 800 Bcf, while a hot summer now is likely to produce an extra 400 Bcf from 250 Bcf previously.

In the event of significant production freeze-offs, like in the winter of 2017-2018, a lack of salt infrastructure for high-turn storage could “really kick in and create a price path that we’re not really contemplating right now,” he said.

This higher weather sensitivity comes as overall statistical volatility in New York Mercantile Exchange natural gas futures has decreased, according to Dwivedi. Meanwhile, even as end-October storage tracks toward 3.3 Tcf, net length for natural gas futures among “perma-long” managed money traders has been decreasing, a trend that “says people are still a little bit skeptical. Having said that, there are more traders saying, ‘Look, maybe I can get long for the winter, maybe the volatility will give me a bit of a great trade.’

“And I think for consumers it’s the opposite,” Dwivedi said. “Could I end up with very low storage, a runaway price and then having to deal with customers and regulators asking, ‘What happened?’”

For exports, all indications are that Asian demand for U.S. liquefied natural gas (LNG) will continue to grow given the low cost and reliability of domestic supply, along with the potential to break oil linkage.

“What we see in our business in Asia is that gas demand is accelerating to the point where this global LNG market, which is very long, people think it will stay long until 2024-2025, we think it could be balanced way sooner, as early as 2022, maybe even sooner than that,” Dwivedi said.

Production growth is, of course, the key factor fueling the bearish outlook and offsetting otherwise bullish demand growth. A lot of supply growth is tied to associated gas from the Permian Basin and oil economics.

Macquarie is bullish on U.S. oil production, meaning “we think oil production is going to just continually surprise to the upside even with all the constraints that are always a worry,” Dwivedi said. “The only thing we think will slow down oil production is price.”

The market would need to “crush the price of oil,” meaning $40-45/bbl West Texas Intermediate “for not just a few weeks or months, but probably a few quarters” before oil production growth will begin to slow or stop.

In an environment of higher weather sensitivity and greater exports offset by ramping production, LNG-related storage “could be a shock absorber” for volatility, “but it probably won’t be, because so many of the LNG plant owners” lease “a lot of the high-turn storage for their operational needs, so it’s not as available to the market as the nameplate numbers suggest,” Dwivedi said.

“So what should have been a volatility suppressor is probably actually going to be another source of higher volatility.”

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