Natural gas: A new paradigm emerging

The weather wildcard aside, a tectonic shift took place in the U.S. natural gas market last month. Several large infrastructure expansions came on-stream in November, increasing pipeline as well as processing capacity in the U.S. Northeast – the key heating demand region. Natural gas has traditionally flowed from across the country to this region; however, production growth, particularly from the Marcellus and Utica shale is rapidly outpacing demand growth.

With the expanded infrastructure alleviating bottleneck pressures, production will be able to continue to grow at a brisk pace, and more pipelines and processing plants are due to open in the second half of 2014. By 2015, production in the U.S. Northeast should surpass year-round demand, and at that point it may become necessary to start exporting natural gas to other regions in the United States – or abroad.

This adds further support to our long-held view that technological advances that allow the extraction of natural gas from porous rock formations will continue to result in consistent production growth, keeping natural gas prices low for the foreseeable future. Based on trading at the far end of the forward curve, it would appear that producers share this view. Chart 4 shows the forward curve of the natural gas market six months ago (higher line), as well as the forward curve as it sits presently. The distant delivery months, going out more than a decade, experienced a dramatic selloff – in some cases nearly $2 per mmBtus – which is likely the result of aggressive forward hedging by producers. The lower panel of Chart 4 shows the net change over the six-month period.

We recommend initiating short positions in January or February natural gas, risking to the April highs (4.825 basis January, and 4.77 basis February).

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