Back At Pre-Pandemic Levels, Natural Gas Finally Looks Like A Buy

By Andrew Prochnow

During the past 16 months, the natural gas market (/NG) has experienced a significant downturn, yet indications suggest that prices have now entered “oversold” territory. When commodity prices reach extremes, they often undergo overcorrection as the market seeks equilibrium.

Following a substantial correction of over 70%, natural gas prices seem poised to stabilize or potentially initiate a reversal. Since August 2022, prices have plummeted from around $9.25/MMBtu to $2.50/MMBtu. During the last 52 weeks, the United States Natural Gas Fund (UNG) has seen a decline of approximately 53%.

The commodities market, including natural gas, witnessed spikes in value due to shortages linked to the COVID-19 pandemic. However, the energy sector’s price action has been particularly tumultuous, driven by the ongoing military conflict in Eastern Europe.

Before the pandemic, natural gas prices were around $2.00/MMBtu at the end of 2019. By the close of 2021, prices had surged above $4.00/MMBtu. Within two months of Russia’s invasion of Ukraine in early 2022, prices skyrocketed above $8.00/MMBtu.

In the past decade, natural gas prices have fluctuated between approximately $1.00/MMBtu and $9.50/MMBtu. With current prices as low as $2.50/MMBtu, natural gas is becoming increasingly intriguing from a long-term perspective, especially amidst the ongoing conflict in Ukraine.

Current Supply and Demand Dynamic

Much like crude oil, natural gas prices are heavily influenced by the prevailing supply and demand dynamics in the market. That means production levels, existing inventories, and the relative strength of demand are the major factors that dictate pricing in the market.

And for some time, those three factors have been pushing prices lower. To wit, natural gas production in the United States is currently thriving.

Moreover, the amount of natural gas in storage is above the 5-year average, while natural gas demand was weaker than expected during the early part of winter.

Considering that bearish setup, it’s no great shock that natural gas prices have trended lower over the last couple of months.

Since the start of November, natural gas prices have fallen by about 33%, from $3.75/MMBtu down to $2.50/MMBtu.

Nevertheless, there is cause for renewed optimism in the market, largely attributed to the recent cold spell enveloping much of the United States. Given that natural gas is a primary source for heating and cooling homes and businesses, extreme temperatures typically trigger an upswing in natural gas demand.

Since the onset of January, a considerable portion of North America has experienced severe cold conditions. Consequently, natural gas production has slowed, and existing inventories have been depleting at an accelerated rate.

In the week of Jan. 12, the U.S. witnessed a drawdown of approximately 154 billion cubic feet (Bcf), contributing to the reduction of existing inventories closer to the 5-year average.

As of mid-January, natural gas inventories stood at around 3,182 Bcf, while the 5-year average hovers around 2,900 Bcf. Should temperatures persist at low levels over the next 4-6 weeks, existing inventories might dip below the 5-year average, presenting a positive outlook for natural gas prices.

Crucially, the intense cold conditions pose challenges for producers, impacting both existing inventories and output rates. Beyond merely depleting inventories, the recent cold spell has also led to a decline in production output.

Evidently, the surge in demand for natural gas is evident through the recent drawdowns in inventories.

All told, that means the supply-demand dynamic in the natural gas market may be shifting, which should help to slow the recent correction in prices, and possibly even trigger a rebound.

Geopolitical Considerations in the Natural Gas Market

In addition to the aforementioned supply and demand dynamics, another key consideration in global energy markets is the ongoing war in Eastern Europe.

Leading up to the war, Russia was one of the world’s top exporters of oil and gas. However, in order to punish Russia for its unprovoked attack on Ukraine’s sovereignty, much of the West has instituted widespread boycotts of Russian energy exports.

At the outset of the war, both crude oil and gas spiked to historically high levels. But as the world has adapted to the new paradigm, prices in both markets have weakened.

At present, oil and natural gas are both trading at the lower end of their 5-year ranges. One reason for that is because the United States has dramatically increased its natural gas exports to Europe, which has helped to alleviate shortages, and push down prices.

For example, in 2022, the U.S. exported on average 6.8 billion cubic feet per day (Bcf/day) of liquified natural gas (LNG) to Europe. That figure was 140% higher than the average amount exported in 2021. As highlighted below, Europe’s increased reliance on U.S. gas exports has eaten into the revenues that Russia collects from its energy sector.

That situation wouldn’t have come to pass if it weren’t for record natural gas production in the States. Case in point, U.S. natural companies averaged around 104 Bcf/day of daily production last year, which represents a new all-time record, and was 4% higher than the average from 2022.

At present, that means the impact from the war in Ukraine – at least from a natural gas perspective – has been minimized. But there’s no guarantee things won’t change in the future.

For example, if the war in Ukraine intensifies – pulling in other countries – that would almost certainly trigger a strong rally in oil and gas prices.

On the other hand, if the war in Ukraine suddenly comes to an end, that would likely be a bearish signal for oil and gas prices – at least temporarily. Under that scenario, one could envision a rollback of the boycotts on the Russian energy sector, which would in turn raise the available supplies of oil and gas in the marketplace.

That means the war in Ukraine remains a significant wild card in the global energy markets.

Going forward, however, the most immediate question for the natural gas market pertains to the weather. If temperatures remain frigid for the next 4-6 weeks, the existing inventory of natural gas in the United States will undoubtedly be drawn down further, which should help to slow, or even reverse, the recent downward trend in prices.

Moreover, one can’t discount the fact that natural gas prices are now trading at the lower end of their 10-year range.

For some investors and traders in the energy sector, that probably makes natural gas-associated investments relatively more attractive. That’s certainly the case here at Luckbox, where we view long investments in natural gas (such as UNG) favorably – especially if frigid conditions remain in the forecast.

To track and trade the natural gas sector, readers can add the following symbols to their watchlists:

• Antero Resources Corporation (AR)
• Cabot Corporation (CBT)
• Cheniere Energy (LNG)
• Chesapeake Energy (CHK)
• Chevron Corporation (CVX)
• Enbridge (ENB)
• EQT Corporation (EQT)
• Kinder Morgan (KMI)
• ProShares Ultra Bloomberg Natural Gas (BOIL)
• Range Resources Corporation (RRC)
• United States 12 Month Natural Gas Fund LP (UNL)
• United States Natural Gas Fund LP (UNG)

Investors and traders looking for energy-focused investments might also consider companies operating in the Permian Basin, which has become one of the country’s most important production zones.