August 27, 2024
The core takeaway: the fundamental condition of U.S. natural gas is not as bearish as would likely be surmised on NG1 behavior alone. Be aware that the prompt Sep-24 futures contract (NGU24, $1.92 as I type) expires tomorrow (Aug 28) and its open interest has dwindled to 20,000 lots as traders roll risk. The next nearby (Oct-24, NGV24) is priced 17 cents higher ($2.09) with open interest 14X higher (282K lots). Yesterday volume was 121K lots in V4 versus 50K lots in U4. Futures liquidity is at work here.
Physical demand still looks terrific, having recovered from a two-sided demand shock in early July. That’s when Hurricane Beryl (earliest Atlantic Cat 5 of the modern era) temporarily took down the Freeport LNG terminal (export demand) and knocked out power in Houston (domestic demand). That hit to demand backed up “the conveyor belts”, as we call them, and was the largest factor behind the price slump from $2.75 to $2.25 (the first move from $3.00 to $2.50 was normal movement in vol space). Prices below $2.50 violated the previous boundaries of vol space, indicating that Beryl was indeed an unexpected and significant shock. We might think of this as the market was well prepared for hurricanes to hit upstream but not end use.
The incremental slump then to $2 was seepage from the subzero prices in the Permian, as the cash market further cleaned up the local surplus in that producing region. NG1 quickly bounced back to $2.25 (which was also technical resistance in the futures), as both demand growth and producer discipline sustained.
That brings us to this second, current dive to sub $2 NG1 in the past four sessions. It is quite clear the focus of this pricing is (a) clearing of paper length that will not take delivery as NGU24 expires, and (b) instantaneous inventory on USGC rather than expected (or likely) end-of-injection season stocks for whole US (or world). Subzero prices at Waha Hub have occurred with 86 percent frequency this month to date, second only to April 2024 at 91 percent. Current magnitude is steep (price is about minus two dollars per MMBtu) but the relative steadiness in the gas-directed rig counts for New Mexico and Texas (and US overall, down one rig last week to n=97, says Baker Hughes) tell us the involved gas volumes getting cleared by subzero pricing are still relatively small in the grand scheme and producers are continuing to view the subzero prices as an annoyance but more of a cost of doing business in a world that no longer endorses flaring or venting in most instances.
Therefore, think of Permian basis as a lasso tugging down on soon to disappear NGU24 and also NGV24 for now (much like what we have described in the relationship between scrap copper supply and primary copper futures prices), even as we can independently assess the tightening in the broader balance today and for this coming winter in US and certainly in rest of world. We don’t want to overlook that 25 delta calls on U4 rolled off the board last night at 72% implied vol. They expire today. ATM implied vol in V4 is around 64%. The strike for the 25 delta call on that tenor is presently $2.40. The 12-month strip is now priced at $2.85. The next 12-month strip is priced at $3.51. The two-year strip is priced at $3.18.
Bottom line: investors will want to own winter 2024-25 gas risk but, as always with natty, will need to be very careful to size exposure correctly on vol and value parameters. To advance, NG futures do not need Permian basis prices to exit subzero territory. But if/when they do, it will be a strong bullish signal on timing.
Source: Bloomberg, Blacklight Research. Note: the chart at upper left (first slide) shows the contract that will become prompt tomorrow (Aug 28), once NGU4 expires.
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