For years now investors and traders have tried again and again to call the bottom in the U.S. Henry Hub Natural Gas market but after every squeeze we have seen it fall back down to its lows. It has been in a perennial bear market for years due to the development of U.S. shale oil and fracking technology. U.S. Natgas has rallied 50% since July when it was trading around $1.6/MMBtu to around $2.4/MMBtu earlier this month. Today, judging by how cheap these gas focused entities are, the question on everyone's mind is, is this the start of a new bull market or just another bear market squeeze?
Following the coronavirus lockdown, the reopening euphoria helped all asset classes to bounce off of their March lows as the U.S. central bank pumped in about $1.4 trillion of money in just six weeks in March and April. As the summer progressed, the warmer than expected forecasts for July, with higher degree days, helped natgas rally from its lows as we started drawing down and injecting less into storage week on week given the higher power burn and cooling demand. As of now the end of season October storage is forecasted to be 3.99 tcf. The cooler than normal weather has helped reduce the deficit a bit, even though the deficit is still expected to be 1 bcf/day. Now that oil prices have rallied, some of the U.S. shale companies that closed wells back in May are now restarting which has helped production pick up at a time we are past peak power demand. LNG economics are not the best and given excess cargos, it may cap any upside in the near term as well.
The U.S. gas market is not like the oil market when wells are shut, and there's a dramatic decrease in production. When one drills for shale oil, we get gas as well. So, the gas market always sees extra supply over and above their pricing dynamics. This is why the market is in such excess as it is cheap to get it out of the ground and there is a lot of it. When gas prices get too low, there is a case to be made to substitute coal demand for gas demand, but this is easily offset by rising gas production and not enough to make a dent in storage availability. We are nearing the end of summer as we approach Labor day, officially the end of summer. We have fewer heating degree days and a last-minute surge in demand to use up the gas in storage. After September, we head into the shoulder period, before the northern hemisphere winter starts. Judging by the levels of gas in storage, it is very comfortable going into winter.
Should oil prices fall substantially causing the U.S. shale drillers to close the oil wells again, this could lead to lower 48 states production. Of course, at this time of year, we can also see hurricanes develop that could potentially take some production out. But it all depends on where the hurricanes make landfall and how much infrastructure is lost or damaged causing inventories to tighten.
It is tempting to buy gas focused E&P's but one needs to understand the pricing dynamics of the U.S. gas market and what the cash flow dynamics are for these companies. They have been overproducing and overspending for years, stressing their cash flows. Capital markets are now closed to them as investors have gotten burnt lending them money in hopes of a revival at some point. It can be a tactical buy from time to time, but cheap can always get cheaper if the commodity momentum is not on your side.