Gas Supply, Demand and Pricing - A Cold Blast in Winter
Over the past week, a much clearer picture has begun to emerge regarding the most likely weather pattern between now and the end of the winter heating season in March.
This developing pattern is likely to bring extremely cold Arctic or even potentially Siberian cold air masses into the eastern U.S. for prolonged stretches during the next 8-10 weeks.
If the emerging pattern unfolds as the meteorologists with whom we have been working most closely believe is likely to occur, it will have far-reaching implications for the natural gas and electricity markets in the U.S. Beginning in mid January, natural gas could be withdrawn from storage at record rates. Before the end of the month, natural gas prices could well be pushed well above $8/MMBTU.
Further, if repeated Arctic incursions occur over the next several weeks, by mid-February many LDC’s may find it increasingly difficult to obtain sufficient supplies to meet their current storage targets for the remainder of the winter heating season. As a result, it may be necessary for LDC’s to bid prices up aggressively in order to drive out of the market a significant fraction of the remaining industrial load and replenish rapidly dwindling reserves.
This in turn could put further upward pressure on the spot market price for natural gas in an increasingly tight market. Prices above $10/MMBTU cannot by any means be ruled out.
Higher-than-expected withdrawals from storage this winter also are likely to have a significant impact on natural gas prices during the summer months – increasing the market clearing-price for electricity this coming summer and setting the stage for continued higher-than-expected natural gas prices in the winter of next year.
Initial Expectations
This year’s winter heating season began with the National Weather Service predicting that temperatures this winter were likely to average significantly above normal in the Midwest and the Northeast (i.e., the two regions of the country with the greatest impact on natural gas consumption during the winter).
This forecast reflected in part the Weather Service’s belief that, by no later than late December or early January, the U.S. was likely to experience El Niño- type conditions strong enough to significantly affect the number of Heating Degree Days during the remainder of the winter.
The validity of this forecast has major implications for the natural gas market – particularly during the first 6-9 months of this year.
As discussed in two earlier EnergyBusinessWatch articles posted on EnergyPulse, the U.S. natural gas market is now in a chronic undersupply condition. (See The Coming Natural Gas Crisis and Is there Sufficient Natural Gas in Storage to Meet this Winter’s Needs?)
As explained in these earlier articles, over the course of the next 12 months, the total natural gas supplies available to the U.S. market are likely to be at least 1.0 –1.5 TCf/year below currently expected levels of consumption.
Over the course of 2003, therefore, steep price increases are inevitable.
The timing of this run-up in prices, however, is likely to be highly dependent upon weather during the winter heating season – and particularly in January and February, when winter weather historically is at its peak.
This is because the winter heating season is by far the most intensive period of natural gas use during the course of the year. Depending upon the severity of the winter, consumption in January and February can reach as much as 30–40 BCf/day (i.e., 60–80%) higher than average daily consumption during the remainder of the year.
Because consumption during the winter months is strongly weather driven, however, fluctuations in consumption during the winter months are far higher than at any other time of the year. It is not unusual, for example, for the daily consumption rate to swing up or down by as much as 20-35 BCf per day over the course of the winter – with variations of this magnitude sometimes occurring during a single week.
Even when averaged out over the course of a month, therefore, the swing in total consumption of natural gas can be very large – with major impacts on the total amount that must be withdrawn from storage to meet winter season demand.
In 2001, for example, the difference in the average consumption rate between the month of January (during which weather was slightly colder than normal) and December (when temperatures were unusually mild) was more than 20 BCf/day (i.e., 88.2 BCf/day in January of 2001 vs. 68.1 BCf/day in December of the same year).
Over a 30-day period, a 20 BCf/day difference in average daily consumption equates to a difference of 600 BCf – a huge swing in consumption, that can – and, in 2001, did – have major impacts on the amount of natural gas withdrawn from storage during these months and the spot market price for natural gas.
This 20 BCF/day differential in mid-winter daily consumption levels experienced during the high and low winter months in 2001 is roughly 5-7X the current annualized undersupply condition in the market of roughly 3.5–4.0 BCf/day.
Despite the chronic undersupply condition that currently exists in the U.S. market, therefore, if the weather for the ’02/’03 winter heating season turns out to be very mild, the potential reduction in consumption due to lower-than-normal winter heating load could temporarily more than offset the underlying longer-term shortfall in supply – masking for several more months the severity of the supply/demand imbalance now facing the U.S. market.
Conversely, colder-than-normal weather could act as a lighted match in a dried-out forest – requiring rapid draw down of the amounts of natural gas in storage and revealing in stark terms the severity of the current supply deficit. This in turn could result in a sudden, severe run-up in prices -- potentially to levels never before experienced in the U.S. market on any sustained basis.
Finding the Best Proprietary Forecast Available
Given the critical importance of this winter’s weather to the natural gas markets, EnergyBusinessWatch has been working since early November with some of the top weather scientists in the world, at Foresight Weather in Boulder, Colorado, to examine in depth the impact weather conditions this winter are likely to have on consumption of natural gas.
Based upon the proprietary modeling system developed by its in-house team of experts, the scientists at Foresight Weather have been predicting for several months that any El Nino effect this winter, if it occurs, is likely to be mild.
As a result, these scientists have been predicting since this fall that temperatures in the Midwest and the Northeast this winter are likely to be in the average to below average range -- i.e., significantly lower than the National Weather Service forecast for the same time period.
Thus far, this prediction has been dead on. Through the end of December, winter temperatures are within a few percentage points (i.e., specifically, as of December 28th, 3%) of historical norms. Surface temperatures in the Pacific (one of the major indicators of el Nino- type conditions) already appear to be plateauing, and there is no longer any apparent basis for assuming that temperatures for the winter as a whole are likely to average significantly above average in either the Midwest or the Northeast.
Notably, however, even though weather for the winter season to date has been very close to historical norms (and, in fact, slightly milder than climatologically normal weather), the draw down from storage has been huge – i.e., a total of 755 BCf, since storage peaked in late October. This is more than 50% greater than the 5-year average of 496 BCf for the same period – a clear and unmistakable sign of the severity of the current imbalance between supply and demand in the U.S. market.
It is precisely due to this clear evidence of a chronic deficit that natural gas prices have sky-rocketed since early December, with a particularly dramatic increase (i.e., more than 10%) in the price for the February (i.e., near month) NYMEX forward delivery contract in the first two trading days of the New Year -- to a closing price of $5.34/MMBTU on Friday of last week.
Cross-Polar Flows
The weather scientists with whom we have been working have been predicting since mid-November, however, that by sometime in early January, a new weather pattern might develop, with the potential to bring Arctic or even Siberian air masses into the Midwest and the Northeast for prolonged periods in January, February and potentially even early March.
This pattern results from the combined impact of pressure differentials that have been developing in both the Pacific and the Atlantic, the combined impact of which is to draw very cold air across the Hudson Bay area in Canada down into the eastern two-thirds of the U.S. and cause it to periodically linger in the U.S. for sustained periods.
The first such cold air mass now appears nearly certain to be drawn deeply into the U.S. by the end of this coming week (i.e, January 10th) and to remain ensconced in the U.S. for a period of up to 10 to 14 days. The weather scientists with whom we have been working believe this air mass is likely to bring with it the coldest Arctic outbreak in several years and to usher in a prolonged period of well below average temperatures.
This sustained intrusion of Arctic air, if it occurs, will itself be sufficient to create major further pressure on supplies to the U.S. market and in all likelihood quickly drive prices above the $ 6.00/MMBTU level.
The weather experts with whom we have been working, however, believe that this may be only the first of several such incursions of Arctic air, and that the pattern that began to solidify during this past week could persist for much of February and potentially even into March.
The impact of these intrusions of cold air, if they occur, may take several weeks to play out – in part because the Weekly Storage Reports issued by EIA substantially lag actual withdrawals from storage.
The next report issued by the Agency, for example, EIA’s next Weekly Storage Report, due to be issued January 9th, will report storage for the week ended this past Friday, January 4th (i.e., a period ending a full week before the first cold air intrusion is likely to begin).
Temperatures during the week ended January 4th were among the mildest experienced this winter – i.e., almost 30% milder than normal. Further, as a result of New Year’s Day falling in the middle of the week, non-weather related consumption also is likely to be well below the norm for this time of year.
As a result, even though temperatures already will be starting to plummet when the report is issued, the withdrawal reported on the 9th is likely to be among the lowest of the winter season – i.e., almost certainly less than 100 BCf and quite possibly below the 91 BCf withdrawal that occurred in late November.
Further, even the Weekly Storage Report issued on January 16th will not yet reflect the impact of the extremely cold air likely to be lingering in the eastern U.S. when the report is issued.
The report issued on January 23rd, however, could show a truly stunning withdrawal – i.e., in all likelihood more than 200 BCf in a single week.
Further, while temperatures are likely to continue fluctuating significantly from day to day and week to week during the remainder of the winter heating season, if the pattern continues developing in the manner the experts we have been working with believe is most likely, this may be the first of as many as 6 to 8 weekly reports that, more often than not, may report huge withdrawals from storage.
As the weather patterns continue to evolve over the course of the winter, therefore, the upward pressure on natural gas prices could become intense.
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