The commodity won't be as volatile as last winter, but short-term costs could be impacted by transportation
Now that winter is fully upon us, a question we often get is: “What is your forward outlook on Natural Gas?”
Term prices for natural gas were very attractive this time last year. Looking farther back, the polar vortex and transportation costs saw natural gas prices skyrocket in February 2014 in many markets. While we don’t expect the same volatility this winter, another season with extended cold periods would definitely have a significant impact on short term costs and forward outlooks.
Many companies have enjoyed very low prices since the economic crisis of 2008. Natural gas inventories rose while demand for the fuel dropped. This created the perfect storm during which companies saved money relative to what they had paid in the past.
Over those six years, many businesses started to forget the importance of managing this cost and became complacent; expecting low prices to continue forever.
The winter of 2013/2014 cut into inventories and throughout 2014, we were unable to replenish our supply to the levels we previously enjoyed. As of October 10, 2014 inventories were 10 per cent below the five-year average of 3,661 Bcf (billions of cubic feet), as reported by the EIA.
A question we often get from those who track natural gas prices and those who are new to the market is “Why are rates not higher now if we’re 10 per cent below the five-year average?” This is a good question based on comparing daily henry hub prices from mid October 2013 and 2014.
The main reason is demand started to drop off after the banking crisis. The five-year average as of October 10, 2014 was 3,661 Bcf, but the five-year average as of December 31, 2008 was 2,416 Bcf. We’re therefore well above the averages of pre-2009 and are in what appears to be a good position. Customers then ask, “Why is the price today not lower”?
We then have to look at withdrawals and demand. To summarize what you’re about the read, natural gas is a “green” alternative; demand is therefore up and continuing to grow.
Both Hillary Clinton and President Obama agree natural gas is a “green” alternative and a “bridge” fuel that can be used to decrease emissions and pollution. Both also agree something needs to be done to reduce emissions and the path of least resistance is to reduce the reliance on coal fired electricity generation. Natural gas is then the best alternative fuel source at this time.
The conclusion we arrive at based on the information above is that we’re once again positioned for volatility. The main area to focus on other than just the commodity price, can include (depending on where you’re located), transportation costs. Many markets are plagued with the issue of pipelines that during cold times, can impact delivered product costs significantly. We feel now is a good time to still consider proactive strategies to manage your costs as your risk versus reward is very positive relative to what you had paid prior to 2009.
As with any good natural gas article, we must now add comments on the shale gas wildcard. Bloomberg reported on October 20, 2014 that “Encana announced plans to buy a company that owns a West Texas prospect for $7.1 billion, or $50,000 an acre.”
Bloomberg then reports that “Tokyo-based Sumitomo Corp. estimated the land was worth a fraction of that price when it took a $1.55 billion write-down on its investment.”
The reasoning for Encana’s interest then moves to the oil on the land. Companies forecast three-billion barrels of oil, mention little to nothing about natural gas and the icing on the cake is only 200,000 barrels of proven reserves were reported to the SEC.
In short, time will tell how much natural gas is available via shale reserves. However, week after week all we’ve been reading and hearing about is natural gas write-downs. This leaves little confidence in shale’s potential to be the answer in terms of lower future prices and may only provide a portion of the demand.
This article is part of the Financial Management Success Centre, which showcases leading strategies for cost control and preservation of working capital in manufacturing.