(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2e6Ca1J
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* Chart 4: tmsnrt.rs/2eocEcB
* Chart 5: tmsnrt.rs/2e6ElTa
* Chart 6: tmsnrt.rs/2eo8KAm
By John Kemp
LONDON, Oct 14 U.S. natural gas prices have
surged to the highest level for more than 18 months as stocks
continue to build more slowly than normal despite the warm
The price for gas delivered to Henry Hub in March 2017 has
risen by 11 percent since the end of September and is up by
almost 44 percent since hitting a low back in February (tmsnrt.rs/2e6Ca1J).
The structure of futures prices has also shifted from a big
contango to a small backwardation, with near-term contracts
rising much further than prices for deferred deliveries (tmsnrt.rs/2eo8Rfl).
Futures markets are sending an urgent signal to gas
producers about the need for more drilling and to electric
utilities to run gas-fired plants for fewer hours this winter to
Gas stocks typically rise between April and October and then
draw down between November and March. But stocks have increased
much more slowly than usual this year.
Stocks have risen by less than the five-year average every
week since the start of May, a total of 23 consecutive weeks,
according to data from the U.S. Energy Information
The result is that the gas market has swung from a huge
surplus at the end of the first quarter close to balance by the
end of the third quarter and is on track for a deficit in 2017.
Stocks were 1,014 billion cubic feet above prior-year levels
in late March but by the end of the first week in October the
surplus had shrunk to just 28 billion cubic feet.
Gas production has been falling since April as low prices
forced many gas companies to scale back drilling programmes.
The number of rigs targeting gas-rich formations fell to a
low of just 81 in early August, down from 213 a year earlier,
according to Baker Hughes.
At the same time, gas exports have risen to record levels
this year both by pipeline and through newly built liquefied
natural gas terminals (tmsnrt.rs/2eocEcB).
And domestic consumption has increased sharply as power
producers have burned record quantities of cheap gas.
A big part of the reason for the power burn this summer was
the run of hot weather which saw temperatures consistently above
normal from the end of May boosting demand for air conditioning.
Power producers have also installed an increasingly large
fleet of gas-fired plants and have run them for more hours this
year to take advantage of cheap gas at the expense of coal.
Production down. Exports up. Consumption up. The net result
is gas stocks have increased by less than in 2015 even allowing
for demand driven by the unusually hot weather (tmsnrt.rs/2e6ElTa).
The market has continued to tighten, even as the summer
cooling season ends and the winter heating season begins.
The run of warm weather continued through September and the
first half of October sharply cutting heating demand for gas.
Heating demand, as measured by population-weighted heating
degree days, has been 46 percent lower than in 2015 and 63
percent below the long-term average.
The mild start to the heating season should have caused gas
stocks to rise more than usual. But instead they have continued
to build by less than normal.
In the first week in October, stocks rose by just 79 billion
cubic feet, compared with a five-year seasonal average of 92
billion cubic feet. Stocks are rising by much less than in 2015
even adjusting for the weather (tmsnrt.rs/2eo8KAm).
The continued tightening of the supply-demand balance
despite a mild start to the heating season has sparked concerns
about a potential deficit in 2017 unless production increases
and consumption growth slows.
Futures prices for all maturities have risen sharply but the
rally has been especially sharp for contracts expiring in the
remainder of 2016 and the first half of 2017.
The market will rebalance again through a combination of
more drilling, lower exports and reduced power burn from
combined-cycle gas turbines (CCGTs).
In practice, the biggest short-term shift is likely to come
through a moderation in exports and a reduction in the number of
hours that CCGTs operate during the winter and in summer 2017.
CCGT utilisation rates have been trending upward and reached
record levels during the first half of 2016 as power producers
took advantage of cheap gas and reduced their use of coal-fired
Higher gas prices should reduce the number of hours that
CCGTs generate during the winter months conserving gas.
But because much of the gas is contracted months in advance
and only a relatively small proportion is bought on the spot
market, fairly large price increases are needed to curb
Still, with gas prices up by more than $1 per million
British thermal units since February, there should be a
reduction in generating hours by CCGTs this winter and a
comparable increase in generating hours at coal-fired units.
Hedge funds and other money managers finally began to take
notice of the gas market tightening in mid-August.
Hedge funds' net long position in the two major natural gas
futures and options contracts surged from a low of 622 billion
cubic feet on Aug. 16 to 2,565 billion cubic feet on Sept. 27.
Profit-taking reduced the net long position slightly to
2,364 billion cubic feet during the first week of October but
there were still enough short positions in the market to add
fuel to the subsequent rally.
The physical market is genuinely tightening but with prices
having risen nearly 50 percent in less than 8 months and a large
net long position already established the risks of a short-term
price reversal have increased.
The biggest source of uncertainty is the weather. The
current consensus forecast is for a winter colder than 2015/16
but still warmer than average ("Short-Term Energy and Winter
Fuels Outlook", EIA, Oct 2016).
If the forecast proves accurate, the gas market should
rebalance without too much difficulty. But a period of sustained
cold would boost demand for heating and from CCGTs and could
trigger a much bigger spike in prices.
(Editing by David Clarke)