Markets & Economy

As the economy moved into more difficult conditions in the first half of 2020, we’ve seen a significant shift in natural gas pricing. A persistent oversupply has begun to cause pain for gas producers, leading to cuts in capital expenditure, and a need to lower production.

While lower prices are convenient for the average individual, it can make profitability very difficult in the natural gas industry. A proper, balanced supply and demand response is necessary to ensure the long-run success of natural gas companies.

Sources and Uses of Natural Gas

Natural gas in the US comes from three sources. The first is conventional gas, which is produced from traditional drilling, pumping, and compressing. The second is unconventional production, which involves extracting gas that is trapped within shale formations. This has become an increasingly popular form of production in the last few decades. The last source is associated gas, which involves harvesting gas that emerges as a by-product of petroleum oil production.

In the US, natural gas is primarily used for heating and power for home and industry, and as a chemical feedstock in things like fertilizers and plastics.

Source: U.S. Energy Information Administration
Note: Numbers are Estimates

Prices can be volatile for this resource, as supply and demand move over time. Natural gas prices had been falling due to persistent oversupply even before the arrival of the coronavirus, and the companies involved have seen continuously dwindling returns as a result.

The Demand Story

There has been an unsurprising slowdown in domestic natural gas demand, as a result of the economic shutdown. This weakness, coupled with warmer weather in the 2019/20 winter, caused a demand dip.

Similarly, a demand slowdown is starting to also hit the liquid natural gas (LNG) export industry. LNG is the transportable form of natural gas, allowing for long-distance imports and exports. The US has become an exporter of LNG, but we’ve recently seen exports decline.

Global natural gas prices are now very low, causing some international customers to obtain it from their own countries, rather than importing LNG from the US. They’re still paying on their contracts with US LNG companies, but not actually taking the product. Because of this, there has been a scarcity in domestic storage facilities for LNG, further pressuring prices.

Even though much of the country had to pause for the better part of the spring, demand for natural gas is proving to be fairly resilient when compared to other commodities, like crude oil. We expect prices to rise as many of these short-term issues abate in the second half of the year as manufacturing and industrial plants reopen, and the economy at large continues to recover.

The Supply Story

Natural gas prices have been so low for so long that many producers are struggling to break even. This has caused companies to cut their capital expenditures, which in turn is causing a major supply response.

Production has started to significantly decline for primary unconventional gas. This strong supply response has been fueled by an ongoing downturn in the number of rig counts and completions. It’s likely this trend will continue in the next few years, as fewer projects are greenlit due to budgetary concerns. Powered by supply cuts from oil producers, associated gas volumes are falling too.

As a result of shuttered rigs and production facilities, over time, the existing stores of natural gas will slowly shrink, and the rate at which they’re added to will slow. For producers that are best positioned to survive, lower supply will ultimately be a benefit. The drillers that make it through to the other side will stand to profit from higher prices when conditions improve.

Putting it all together

Understanding the supply and demand story is vital to investing in commodities. As demand growth stays strong, and as supply continues to decline, the two forces will combine to create a market deficit. Like with any deficit, we can expect prices to eventually and significantly rise.

We know demand for natural gas isn’t going away, and the stunted supply will create room for substantially improved profitability. At Manning & Napier, we keep our eyes on supply/demand movements like these to find the best long-term opportunities for our clients.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.