SMOG - Goehring & Rozencwajg Q1 2024 Natural Resource Market Commentary

2024-06-05 07:45:00 ET

Summary

• Goehring & Rozencwajg Associates, LLC provides financial planning and investment advisory services. The Company offers natural market capitalization resources mutual fund investments for growth in business as well as provides consulting services.
• US natural gas traded at over 50x its oil-equivalent in the first quarter -- a level last seen in 2012. However, today's gas market bears no resemblance to that of 12 years ago.
• Natural gas is one of the most unloved commodities we've ever seen. However, demand is surging and supply is now faltering. Could gas go from unloved to must-own?
• Our newest commentary, On LNG, AI & Shale Supply: We Expect The Turn in US Gas is Here, looks at how natural gas could be nearing an inflection that takes prices much higher.

On LNG, AI, and Shale Supply – We Believe the Turn in North American Natural Gas is Here

We believe the North American Natural Gas market has reached a turning point. Significant shifts now taking place carry profound investment implications for the next twelve months. Our stance, which was cautious for almost a decade, turned bullish in the first quarter of 2020 when Henry Hub was at $1.43 per thousand cubic feet (mcf). In our 1Q20 letter, we penned an essay titled “The Bull Market is Here,” stating: “If production were ever to falter, a massive bull market would result. That moment has arrived.” By summer 2022, Henry Hub gas surged more than six-fold, eventually reaching $9.68 per mcf as Russia’s invasion of Ukraine spread fears of a global natural gas shortage. However, back-to-back warm winters and an ill-timed fire at a US LNG export facility overwhelmed the nascent bull market, and gas retraced its entire move, selling off to within five cents of the June 2020 low. Although it may seem like a strange time to write a bullish lead essay on natural gas, it would have seemed equally strange to make a bullish call in the spring of 2020, immediately before gas rallied 553%. Our research suggests this rally could be even stronger.

Bearish sentiment reached a fevered peak in the first quarter of 2024. The 2023-2024 North American winter was 5% milder than normal – on par with the extremely warm winter of 2011-2012. A lack of heating demand pushed prices sharply lower. Gas for delivery at Henry Hub fell 30%, broke $1.50 per mcf three times, and eventually bottomed at $1.48 per mcf on March 26th. Over the past 25 years, Henry Hub only broke $2.00 five times: in 2002, 2012, 2016, 2020, and earlier this year.

By some measures, natural gas pessimism in March was the worst in history. Gas bottomed amid a broader energy selloff in 2002, 2016, and 2020. This year, natural gas reached $1.48 per mcf, with oil trading at a healthy $81 per barrel. Although a barrel of oil contains six times as much energy as an mcf of natural gas, WTI traded for an incredible 52 times Henry Hub natural gas – a nearly 90% discount on an energy-equivalent basis. Relative to oil, gas has only ever been cheaper once before, following the equally mild 2011-2012 winter.

FIGURE 1: Oil-Gas Ratio & Henry Hub Discount to Energy Equivalent

Although the level of investor pessimism is comparable, today’s North American natural gas market could not be more different than in 2012. For example, although the 2011-2012 winter was also 5% milder than average, North American gas inventories ended the 2012 heating season 900 bcf above average, compared with a surplus of 500 bcf today. In 2012, the shale boom was on the verge of ushering in an unparalleled surge in US gas production. The combination of horizontal drilling and hydrological fracture stimulation allowed independent exploration and production companies to produce gas from previously impermeable source rock. After falling by 35% between 1970 and 2005, production first stabilized in the mid-2000s. In the eight years leading up to 2012, US dry gas supply grew by 14 bcf/d. Over the next eight years, it would increase by over 32 bcf/d or an incredible 50%. Throughout this period, production year-over-year often grew more than five bcf/d. Several times, production growth exceeded ten bcf/d in a single year. The incredible turnaround was entirely driven by the shales: conventional gas production continued to fall by 32% between 2012 and 2020. In total, shale production went from nothing more than a far-fetched dream to a 70 bcf/d behemoth by 2020. The gas shales produced more energy than Saudi Arabia’s prolific oil fields on an energy-equivalent basis.

FIGURE 2: Average Annual Natural Gas Production Growth

The flood of shale gas overwhelmed the US market. Although utilities switched from coal to natural gas wherever possible, power generation could not absorb the excess. Crucially, the US could not export natural gas for most of this period: the first Lower-48 export terminals did not commence operations until 2017. With no outlet for the surplus production, North American natural gas prices decoupled from the rest of the world, and they regularly began trading at a 40% to 60% discount on the world price.

Today’s North American natural gas market could not be more different. Instead of sitting on the verge of a massive production increase, the shale age appears to be entering the early stages of decline. Production is still growing year-on-year, however the growth has slowed from 10 bcf/d per year throughout the 2012 to 2020 period to a mere 3.5 bcf/d presently. Most importantly, on a sequential basis, the dry gas supply likely peaked in December 2023. According to the latest data, February production remained nearly one bcf/d lower than December – the sharpest non-weather-related slowdown outside of COVID since 2008. Instead of lacking LNG infrastructure, the US is now the world’s largest gas exporter, with new terminal capacity to surge over the next twelve months. More recently, analysts predict the promise of data center proliferation, driven by the rapid adoption of large language models, will usher in the most significant increase in domestic gas demand in US history.

The US is set to shift from a prolonged period of acute oversupply to a structural deficit of historic proportions. Although inventories remain high, our models predict they will draw to dangerous levels much sooner than anyone believes possible. Given this backdrop, it is unfathomable to us that US natural gas should trade at a record discount to its energy-equivalent price, even considering two consecutive mild winters. Investors should take note. In many respects, the current natural gas market represents the perfect storm: dry gas production is faltering just as demand is set to surge. We have warned for several years that shale growth would slow. Our neural network models indicated that, although immense, the shale basins were not infinite. The Barnett and Fayetteville were the first two shale gas basins developed in the middle 2000s. Each field ramped sharply before unexpectedly plateauing and declining by over 50%. We concluded that both fields peaked precisely once half their recoverable reserves had been produced – just as Hubbert’s theories would predict. By applying these same principles to the Marcellus, Haynesville, and Permian – collectively 75% of total shale gas production – we warned growth would soon begin to slow before production rolled over entirely in 2025. It appears we were too conservative: US gas supply has likely peaked already....

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