The Week gone by

Natural gas prices paused last week after a sharp 30% decline since the beginning of the year. US natural gas futures dropped to $1.522 per million British thermal units (MMBtu), the lowest level since June 2020, driven by an unusually mild winter and increased US production. Similarly, on MCX, prices reached Rs 128.5 per MMBtu. However, there was a rebound from these lows following an announcement from major shale driller Chesapeake Energy, stating plans for reduced production in 2024. In response to the recent price decline, Chesapeake announced a 20% reduction in 2024 spending compared to previous plans, along with a corresponding decrease in output by roughly 20% compared to last year. Before assessing whether this relief rally will continue, let’s briefly review the reasons behind the steep fall in natural gas prices.

Supply Glut: Natural gas is facing an oversupply issue, driven by near-record production levels in the US and projected increases for 2024 and 2025. February saw a slight uptick in gas output in the US Lower 48 states, reaching 105.8 billion cubic feet per day (bcfd), up from January’s 102.1 bcfd. However, production levels remain below the monthly record set in December at 106.3 bcfd.

Warm Winter Weather: For the second consecutive year, 2024 has experienced warmer-than-usual winter temperatures. This has significantly impacted heating demand for natural gas, particularly in the residential and commercial sectors. Subdued demand has resulted in lower withdrawals from storage facilities during the peak demand period.

Elevated Stock Levels: Due to reduced withdrawals from storage facilities, US natural gas inventories are currently well above average for this time of year. According to data from the EIA, natural gas inventories stood at 2.47 trillion cubic feet (tcf) during the week ending February 16th, representing a 22% increase compared to the five-year average and a 12% increase compared to the same period last year.

Will the relief rally in Natural Gas continue or do the bulls need more patience?

Following a significant 24% price decline in February, natural gas producers are considering spending cuts and reductions in drilling activities. However, the impact of these production cuts will take time to materialize, especially with the rising Gas/Oil ratios. When the ratio increases, more natural gas is produced relative to crude oil. Therefore, last week’s gains in natural gas were primarily driven by short coverings resulting from drillers’ knee-jerk response, while the current dynamics, including warmer-than-expected winters, low heating demand, and elevated storage levels, persist.

Notably, considering the seasonal price pattern of natural gas, prices typically remain under pressure in January/February, reaching a bottom by late February or early March. From March onwards, prices usually begin to recover as winter-season heating demand leads to significant withdrawals from storage facilities while cooling demand emerges in the summer.

This time, due to elevated inventory levels and warmer winters, it will take time for the prices to form a strong bottom.  But, no major fall is likely considering strong demand side fundamentals in the quarter to come. In the second quarter of 2024, the US supply-demand balance sheet is expected to gradually tighten. Increased global demand for LNG, particularly from Mexico, along with steady demand for US LNG exports to Europe and Asia, presents significant growth potential.  From a short-term perspective, MCX natural gas prices may find strong support at the Rs 137/121 level, while resistance is anticipated between the Rs 165/180 levels (CMP: Rs 148).