2023-12-13 07:30:24 ET
Summary
- Natural gas in storage is currently at levels near 5-year highs. This explains the recent plunge in prices as traders face growing concerns that demand for gas may weaken further.
- Our seasonality analysis also suggests that natural gas prices are more likely to head lower than higher in the coming weeks.
- With the supply of natural gas likely to increase given still historically elevated crude oil prices, we see scope for further weakness in natural gas prices in the near term.
- Price spikes driven by geopolitical events are likely to be temporary in our view, and we would consider taking the opportunity to short.
- Accordingly, we maintain our "Hold" rating on BOIL for now, with a view to short natural gas on speculative rebounds.
Natural gas prices have remained relatively subdued this year compared to its meteoric surge to $9.85/MMBtu in 2022, and the equally dramatic collapse back to $2.24/MMBtu in May when we initiated our neutral-to-bearish view on the ProShares Ultra Bloomberg Natural Gas ETF ( BOIL ) with a "Hold" rating.
When we initiated coverage of BOIL in May, we were looking for opportunities to short speculative rebounds in natural gas futures prices on the back of bearish fundamentals. We argued that speculative hopes for a rebound in natural gas prices were building up in the financial media and especially among retail traders, although fundamentals were looking grim.
At one point, natural gas prices were up 59% from when we initiated our view, presenting us with an opportunity to short the commodity on 31 October. However, we decided against taking the trade given that we did not see the typical sharp and speculative spike that we had been looking for. In hindsight, that was of course the wrong decision and a missed opportunity. Natural gas prices and BOIL have since fallen by 36.6% and 64.8%, respectively.
Outlook For Natural Gas Remains Bearish
Looking ahead, we continue to see very few reasons for natural gas prices to move meaningfully higher. And with prices having fallen back to where we started at $2.24/MMBtu in May ($2.27/MMBtu at the time of writing), we view our "Hold" rating on BOIL as adequate for now.
According to the latest available Weekly Natural Gas Storage Report published by the U.S. Energy Information Administration, gas in storage has been running at levels above the 5-year average this year and is currently near 5-year highs. This explains the recent plunge in natural gas prices as traders face growing concerns that demand for gas could continue to weaken as the economy cools.
Our seasonality analysis also suggests that natural gas prices are more likely to head lower than higher in the coming weeks. Below is a chart showing monthly natural gas futures prices stretching back to 1991. Green bars represent periods (December to February) in which prices gained and red bars represent periods in which prices fell.
Since 1991, periods stretching from December to February have historically exhibited a slight bearish bias. Natural gas prices fell in 18 out of 33 (or 55%) of the periods studied. We also note that periods after 2010 were notably more bearish with prices falling in 9 out of 13 (or 69%) of the periods studied. Furthermore, this phenomenon is fundamentally driven rather than the result of mere seasonal effects.
Natural gas prices have been drifting lower for over a decade prior to the Russia-Ukraine war in 2022. This downward drift in natural gas prices was largely driven by the U.S. shale boom which began much earlier in 2008 but only accelerated in 2010. As the chart below shows, shale gas production in the U.S. has exploded from around 15 billion cubic feet per day (Bcf/d) in 2010 to over 80 Bcf/d in 2023.
Shale gas production in the U.S. is predominantly a by-product of shale oil production. This is also commonly referred to as associated gas, which is natural gas produced by oil wells. Because oil prices have remained elevated and are at profitable levels for shale oil producers, production has expanded aggressively in the Permian basin and the Appalachian Marcellus basin. This has resulted in more shale gas being produced and stored despite lower prices.
This dynamic of shale oil production means elevated oil prices are indirectly placing downward pressure on natural gas prices. So long as oil prices remain at levels that are profitable for shale oil producers, the excess production of shale gas is unlikely to cease in our view.
Interestingly, the increase in associated shale gas production has also been driven by a steady increase in the gas-to-oil ratio from oil wells in the Permian basin. Most natural gas analysts do not expect a sustained increase in the oil-to-gas ratio in the Permian basin over the long run. But the damage has already been done if we assume that the ratio will stabilise at these levels.
Enverus, EIA
With the supply of natural gas likely to increase given still historically elevated crude oil prices, we see scope for further weakness in natural gas prices in the near term.
Having said that, should geopolitical tensions reignite in Ukraine or the Middle East, we see the possibility of yet another speculative spike in natural gas prices and BOIL. Ultimately, such price spikes driven by geopolitical events are likely to be temporary in our view, and we would consider taking the opportunity to short.
Accordingly, we are happy to maintain our "Hold" rating on BOIL for now.
For further details see:
BOIL: Natural Gas Prices May Have Further Room To Fall