Houston, We Have a Storage Problem
The natural gas backdrop remains supportive. But there is nothing in the cupboard!
Near-record low inventories for this time of year have put a bid under the market, keeping the price of natural gas high.
Below is a chart of natural gas inventories from 2007-2022. The thick, light blue line is this year’s inventories over the months.
Storage sits at the low end over the last 15 years, and yet demand holds across the U.S. It’s at the same level as it was in 2014, with 2018 at a lower point over the same time.
We have a bit of a different setup this time around with liquified natural gas (LNG) exports well above previous years.
There is also more US export capacity coming back online between Freeport and new construction- at Golden Pass and Port Arthur.
Freeport LNG, which is a Texas liquefaction facility, has delayed its target for partial restart by about a month as it works to complete repairs following a June explosion and fire that shut it down. That puts its reopening date in early to mid-November.
The liquefaction process takes natural gas and cools it to a liquid state (liquefied), to about -260° Fahrenheit, for shipping and storage. The volume of natural gas in its liquid state is about 600 times smaller than its volume in its gaseous state in a natural gas pipeline.
This has helped tip the U.S. into one of the most bullish setups for natural gas companies and their underlying exploration and production (E&Ps) companies in a very long time.
E&Ps are the companies that extract the crude and gas from the wells.Nord Stream pipeline leaks raise suspicions of sabotage | DW News – YouTube
“Don’t Look at Me! I Didn’t Do It!”
As you’ve read, some state or non-state actor sabotaged Nord Stream 1 and 2.
That rendered line 1 completely inoperable with line 2 still operable at a reduced rate. It’s rather “interesting” that line 1 had a complete breach while line 2 only had an “outer breach,” leaving the inner components of the pipeline operable.
What’s more intriguing is that the explosions occurred just outside of Exclusive Economic Zones (EEZs) of Poland, Germany, and Denmark. This avoided the potential of triggering Article 5 of the NATO treaty. (Sweden isn’t quite in NATO yet.)
How convenient!
Natural gas wasn’t flowing through the Nord Stream pipelines at the time, but they were still filled to maintain pressure and hadn’t been drained yet.
“Freeze! It’s For Your Own Good!”
So, when we look at the below chart, you get an idea how just how low Europe’s imports have been.
We have seen Europe focus on cutting demand to put storage into a “comfortable” position, but even a negotiation now will leave Nord Stream mothballed.
What do we mean by “cutting demand?”
Here are a couple of examples:
“Put an extra sweater on.”
“Take colder showers.”
“Let your grandma freeze for Ukraine!”
Ok, that last one wasn’t explicitly stated. Only implicitly relayed.
The situation is going to keep Europe beholden to the floating (non-pipeline) market, and it has already created one of the largest increases in LNG tanker rates in history.
Pipeline gas is much cheaper than LNG. Europe in general, and Germany in particular, had access to cheap Russian pipeline gas until the US Government – I mean, the Russian invasion of Ukraine – stopped it.
We expect LNG tanker rates to keep shifting higher, but it will also price people out of the market. Pakistan was already unable to secure a cargo of LNG driven by price, which will become a more common theme as we head into peak demand season.
Have a look at this gem of a chart.
You can see the seasonality of it. Starting in November most years, tanker rates spike. Because that’s when it starts getting cold in the Northern Hemisphere.
Except this year, that spike isn’t in November. It happened in September, a full two months early.
This will exert massive upwards pressure on tanker prices this winter. In other words, it’s getting much more expensive, much faster than usual.
Luckily, we know a company that stands to massively benefit from this disruption. But more on that company in a bit.
The chart below helps to highlight how the economics have pivoted over the last 3 years.
The market is pricing in an average of $4-$6 over the next decade given the global backdrop for natural gas.
The white line shows what the market was pricing in October 2019. This is our reference line. The market expected $3.50 by the middle of 2032.
The red, green, and blue lines show July 2022, early September 2002, and late September 2022’s curves going forward.
As the price spiked thanks to the US and EU’s position on Russia, the estimates for natural gas into the next decade have spiked. At one point, we were looking at $6.50, a full 85% higher than the $3.50 priced in 2019.
It’s come down a bit, though. The orange dots – just adjacent to the red line – show the market is pricing in $5.25 for 2034. That’s “only” a 50% increase.
Russia pivots have helped the situation, but global demand was already shifting to consume more natural gas.
What Pivots, You Ask?
Pipelines run east, too. So, the Russians have been sending gas to China and India. They’ve happily taken the discounted gas and sold it back to Europe at the market price.
Everyone makes out:
- Russia can still sell its gas, though at a discount to its strategic partners.
- China and India pay cheaply for desperately needed energy and can still sell the surplus onto Europe.
- Europe’s hairy-armpitted femigreens get to virtue-signal their way to a frozen winter, no industry, and sleeping in their ski suits.
As Charlie Sheen would say, “WINNING!”
With the destruction of Nord Stream, even some sort of ceasefire, treaty, or other “pause” in fighting would leave a major pipeline inoperable.
Russia invading Ukraine has pushed more natural gas by pipe to China and reduced China’s need for LNG cargoes.
At the same time, Europe has reduced their piped natural gas, but increased their imports from LNG.
The above curves help to highlight how different things are from three years ago., Even as the curve gyrates week over week, it’s still holding large parts (roughly 50%) of the gains.
“Honey, the Fridge is Empty…”
There has been a lot of talk about European natural gas storage, and it is being used as a reason to demonstrate how “overblown” the market fear is regarding winter.
There is some truth behind the comments, but it is much more complicated.
There has been a huge hit to demand with shuttered petrochemical and fertilizer facilities as well as other industrial assets.
Refiners have been rolling out economic run cuts and smaller companies are naturally reducing consumption of electricity/natural gas due to prices.
The shift in demand has put more product into storage, but the cuts aren’t sustainable to have a normally functioning economy.
Germany is Closed for Business
The below shows the “successful” transition for Germany to reduce their consumption of natural gas but… at what cost?
Ze Germans have seen a huge drop in industrial capacity including fertilizer, petrochemicals, refining, and other manufacturing industries.
So, while they have “achieved” their goal to increase storage, it came at the cost of crushing their economy.
German capacity utilization is also pushing lower, so what happens the government tries to “restart” the economy?
Even if the industries can afford natural gas, will there be any available?
Germany isn’t the only nation that has looked at rationing natural gas. The below chart shows how many energy-intensive industries have cut runs throughout the European Zone. The U.K., France, and other European nations have highlighted ways they will curb demand through rationing and rolling brownouts.
The shortages within Europe are going to keep them beholden to the floating market, which has been the main outlet for the region to fill the void.
And while that will somewhat relieve the pressure for acquiring gas, it’ll come at a much higher price than it otherwise would have.
How important LNG is to the region?
These next three charts tell an interesting story.
First, on the top chart: since Europe has prohibited itself from importing cheap Russian pipeline gas, its supply has fallen off a cliff. To replenish its stocks, it must rely on LNG to fill the void.
The second and third charts look at LNG, Norway, Russia, and Algeria both in absolute numbers and as a percent of EU total natural gas imports.
First, LNG: at the beginning of 2021, LNG was a mere 20% of EU imports. Now, it’s 40%.
Second, Norway: though not a member of the EU, it’s a member of the European Economic Area. That means it gets a bunch of benefits of working with the EU without contributing to the EU budget. Also members of the EEA are Iceland and Lichenstein. Norway is now roughly 35% of EU natural gas imports, which makes up for much of the Russia shortfall.
Next, Russia: cheap Russian pipeline gas accounts for only 10% of EU imports. It used to be 40%.
And finally, Algeria. Why Algeria?
You may have missed it, but President Macron of France went hat-in-hand to the Algerians to beg them to open their natural gas spigot. As you can see from the charts, the Algerians are still sore about the horrific time they had as a French colony. They haven’t budged on Macron’s request.
What About US Exports?
Even with Freeport sidelined (due to what, again?), we are still exporting about 6 million tons.,
And when Freeport comes back in November,- the U.S. will be back to about 7 million tons.
This is going to keep a steady flow of product moving offshore and helping support U.S. prices.
French President Macron has complained about “price gauging” in the U.S., but Henry Hub is the most liquid trading hub in the world for natural gas.
From Wikipedia:
The Henry Hub is a distribution hub on the natural gas pipeline system in Erath, Louisiana, owned by Sabine Pipe Line LLC, a subsidiary of EnLink Midstream Partners LP who purchased the asset from Chevron Corporation in 2014. Due to its importance, it lends its name to the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX) and the OTC swaps traded on Intercontinental Exchange (ICE).
The upshot is this: natural gas is a globally traded commodity whose price is discovered by the market. It’s practically impossible to set a price cap on it. Present day French economists and their presidents find this hard to understand.
Instead, we are seeing a rise in global demand for natural gas and a concern about availability leading to countries and companies trying to secure as much volume as possible.
U.S. natural gas production has been pushing higher, but because of shortages in pipeline capacity some product is “stranded.”
This creates broad price differentials with some of the biggest occurring between Waha and Henry Hub.
What’s Waha? From Aegis Hedging:
Waha is a locational (basis) gas market within the Permian basin of western Texas. Waha is a popular origin price for gas sold in the basin for transport to other markets. It is also a common part of producers’ price formula for their natural gas and, sometimes, NGLs, especially ethane.
Waha is located within the Permian basin and is connected to interstate and intrastate pipelines.
When Texas demand is high, Waha gas is consumed locally or nearby, but long-haul pipelines are always necessary to dispose of all supply.
Gas can be exported to Mexico directly from Waha without first leaving the basin for another intermediate market.
Westbound pipes include El Paso and Transwestern, which take gas toward Arizona and southern California (SoCal basis market).
While production has moved higher, we have also seen a rise in U.S. domestic demand for natural gas.
The below demand figures also carry a slowdown in LNG gas flows as Cove Point (an LNG terminal in Maryland) conducts maintenance ahead of the winter push.
It’s important to appreciate that not all volume is the same. Henry Hub versus Waha is the perfect example of this.
Even as natural gas supply pushes higher, a lot of that is originating from the Permian by way of associated gas.
This is going to trap natural gas at Waha where it has no easy route to domestic or international markets.
It’s a key reason why the CEO of Kinder Morgan stated that the U.S. is going to need another 20bcf/d of natural gas pipeline capacity built over the next decade.
This is needed to help debottleneck the market and get natural gas to the market.
But in the meantime, we are going to have some product stuck in the market.
Here is a map that helps you visualize where the biggest bottlenecks exist:
As we look forward, natural gas producers aren’t as hedged as they have been in previous years. They have been able to lock-in some healthy pricing when we look at 2023 and beyond.
We are looking at companies that are in a good position to capture upside to spot prices as well as locked in healthy gains by way of hedges.
Here is a table with numbers that demonstrate the hedging positions of natural gas companies.
Not only is the domestic situation improving, but the geopolitical backdrop remains supportive for U.S. molecules.
The news of the Nord Stream “leak” followed closely to the G7 agreement to issue price caps on Russian crude.
Yes, you read that correctly. Price caps. You know, those things that earned Trickie Dickie Nixon utter derision?
The G-7 plan, which is part of broader efforts to punish Russia for its military invasion of Ukraine, would allow buyers of Russian oil under a capped price to continue getting crucial services like financing and insurance for tankers.
This would keep insurance available as well as tankers but attempt to reduce the revenue Russia can possibly earned. This faces several problems:
- All 27 EU nations must sign off on it to be adopted. (Unanimity – an EU rule – is an almost insurmountable hurdle.)
- Russia’s major buyers (India/China) haven’t signed up – and will not sign up – for the deal. They’re simply making too much money buying discounted Russian crude and natural gas and selling it back to Europe at full market price.
But it remains unclear how effective a price-cap regime would be, particularly since some of Russia’s biggest buyers haven’t agreed to join. India is reluctant to formally join a price-cap scheme, since its industry worries it could lose out to other buyers on the chance to buy discounted Russian crude, according to people familiar with the views of Indian firms.
There are a lot of ways around these initiatives. So even if it’s adopted, I don’t see this having any impact.
Russia has also said that they won’t sell crude to countries that participate in it, but the work arounds regarding insurance and STS (ship-to-ship transfers) will keep things flowing.
Europe’s natural gas demand over this coming winter is seen 7% down from the past five-year average because of high prices. That’s still “notably below” the European
Commission’s target, according to Kateryna Filippenko, an analyst at Wood Mackenzie.
- “There’s potential for even more demand destruction,” Filippenko said in a Bloomberg TV interview.
- Further disruptions in Russian gas supplies to Europe are likely, with Moscow set to keep putting pressure on the bloc.
- A potential slowdown in China due to Covid woes and comfortable storage levels in Japan may limit their appetite for gas, which is “good news for Europe.”
It’s also important to consider that we are also coming into shoulder season when demand naturally diminishes mixed with the broad shutdown of the industrial sector.
Shoulder months are those in which temperatures outside sit comfortably between 45- and 65-degrees Fahrenheit. This means that the air outside is close enough to buildings’ ideal internal temperatures that engineers can open economizers and use all or mostly outside air. As a result, tenants get to breath fresh, comfortable air and well-run buildings can cut energy costs significantly.
Electricity prices hit insane levels. But even as it falls, it will level off at prices that are still insanely expensive.
So, is above seasonally normal storage good?
Absolutely!
But you need to look at the total picture.
The next question is this: What does mother nature bring for winter?
If there is a polar vortex, it will pull a significant amount of natural gas out of storage. And Europe can’t just buy more by pipe.
Instead, they will have to rely on the LNG market. That market will be very expensive, as well as much tighter, given the time of year.
I agree with the view that some of the prices became absurd.
But to ignore the prevailing problems heading into winter just because they have natural gas in storage is crazy.
The chart below puts into perspective the sheer number of cuts that have occurred throughout Europe.
Can the continent’s economy really survive with this much capacity offline?
If all these facilities were to run “normal,” the natural gas in storage would drop quickly, with little ability to refill it quickly.
In short, the problems are far from over. And we will take advantage of that.
So What Company Demands Our Attention?
Southwestern Energy (SWN) was trading at over $20 when the natural gas curve was about $4 lower than it is today.
The company had a balance sheet problem due to their massive debt issue.
The hedge fund I was working for in 2015 had a large short position (at my recommendation) given the debt position, leverage to natural gas liquids (NGLs), and weakening natural gas prices.
The company is very different from those years, and the market has changed considerably in that time as well.
Natural gas liquids and natural gas have seen their prices rally and remain more robust today since the shale revolution kicked off in 2011.
The company sold its Fayetteville assets for about $1.865 billion, which helped to clean up their balance sheet and set SWN on a better foundation.
The sale was completed in 2018 and allowed the company to begin an aggressive balance sheet repair.
Once they got to a good footing, they went out and did a very accretive deal in the Haynesville buying GEP Haynesville LLC for about $1.85 billion.
This provided a significant uplift to their natural gas portfolio, and it moved them closer to Henry Hub and away from the bottlenecks that still plague the Northeast.
SWN has been able to increase their production of natural gas at the best possible time to capture strong pricing and send estimated revenue growth higher.
Southwestern is positioned in two of the largest natural gas basins in the world with more running room, as the U.S. is called upon to export a growing amount of LNG and NGLs into the global markets.
The growing revenue and controlled cost are driving EBITDA higher while the “balance sheet repair” story only continues to rill forward. The company is in a fantastic position to keep driving forward and sending the stock price back over $20 in the coming few quarters.
RECOMMENDATION: BUY SWN up to $7.00. Thanks to its strategic positioning and ability to ramp up production at the perfect time, Southwestern Energy is a peach of a pick.
Take care,
Freedom Financial News
