Cheniere’s analyst day [LINK] provided another view that the global LNG oversupply is going to be fixed around 2020/2021 and tip into undersupply, whereas the general view coming into 2017 was that it wouldn’t be fixed until 2023 to 2025. These views on when LNG tips to undersupply are directly relevant to Cdn natural gas because global LNG markets now have a major impact on Henry Hub (HH) and AECO gas prices. This winter proved this fact, and it means there is a new way of looking at HH and AECO gas prices. The “structural” changes that started to increase as gas prices dropped in 2014, began to materially (and positively) impact gas prices this winter, and should have an increasing impact thru 2022. US natural gas exports have materially changed the dynamics in a positive way for HH and AECO gas prices, which means global natural gas and LNG markets are now new drivers of HH and AECO prices. And it is why the increasing views (such as Cheniere’s this week) for the potential that the global LNG oversupply gets fixed closer to 2020 should be noted as it could be the major factor that will set the tone and valuations for Cdn natural gas in 2018 and 2019. Plus it is timely to look at this now as we would expect analysts and investors to take a new look at their 2018 and 2019 natural gas thesis in Q3/17, ahead of going into the winter.
The key elements were lining up for gas to be sub $2 in April, just like happened last winter. Historically and certainly prior to this winter, the key dynamics for winter prices have always been storage levels going into the winter, winter temperatures and, to a lesser degree, gas production levels. This winter, the Nov 1 storage levels and winter temperature should have been negative to natural gas prices. Storage going into this winter was a new high of 4.02 tcf (Nov 4, 2016), up slightly YoY from the high of 3.97 tcf (Nov 4, 2015). Winter 2016/2017 was not the warmest on record, but very close to the El Nino winter 2015/2016. Winter weather is the biggest swing factor for gas storage and prices. A warm winter normally causes gas prices to be extremely soft going into the spring shoulder season. The swings in winter demand can be 10 bcf/d between warm and cold winters, an impact that far dwarfs a change in US gas production. The positive for natural gas was that US natural gas production was down over 2 bcf/d YoY this winter. But even with the lower natural gas production, under normal or prior winter dynamics, HH and AECO gas prices probably would have been closer to $2 than $3.
But increasing US natural gas exports changed the gas price equation and led to HH and AECO being $1 higher YoY. The structural change to the normal dynamics of HH and AECO gas prices has led to materially higher US exports of natural gas via LNG and pipeline to Mexico. US LNG exports started in 2016 and are on a strong increase for the next five years. Our March 13, 2017 blog “Under Construction US LNG Export Projects To Add >2 Tcf Of Incremental Demand In 2017 Thru 2019” [LINK] details all the under construction US LNG projects. Pipeline exports to Mexico continued to grow in 2016, averaging 3.6 Bcfd, up 0.7 Bcfd from 2015. This is the sixth year in a row exports to Mexico have increased. Pipeline capacity into Mexico on the U.S. side totaled 7.3 Bcfd by the end of 2016 and will increase by 3.5 Bcfd in 2017, as three new pipelines are scheduled to go into service”. Together, these two factors should add ~0.5 tcf or higher of demand in 2017 vs 2016. And the YoY growth in 2018 vs 2017 will be even higher. Storage ended the winter ~0.425 tcf lower YoY, but the higher YoY natural gas exports in 2017 effectively make a YoY storage ~0.425 tcf decline be more like ~0.925 tcf decline. This is why gas prices are ~$1 higher this year.
AECO benefits from a higher HH even with a wider differential. AECO gas price differentials are to a great extent due to the very strong success in the Montney that is significantly increasing the need for egress. It’s a good problem to have – excellent drilling success means increasing need for egress solutions. But in the near term, AECO is underperforming HH in 2017 and we expect that to continue thru the summer as NGTL’s planned curtailments significantly impact capacity at times in June, July and in Aug. The curtailments are needed as NGTL adds significant egress capacity (+1 bcf/d in NW Alberta by Jan 2018). But even with the wider AECO differential, AECO prices win with the stronger HH gas prices.
The global natural gas market is oversupplied, but the US is best positioned to keep growing its natural gas exports being the low cost producer. Cheniere’s analyst day outlook is in line with all other global LNG outlooks – there is a current oversupply. The near term LNG oversupply has put an increasing need to be the low cost LNG provider. The other point that there is without dispute is the US Gulf of Mexico LNG projects (ie. Cheniere’s Sabine Pass and Corpus Christi) are the low cost LNG projects and therefore the LNG projects that are going to keep going ahead. Below is Cheniere’s graph from this week. The US GoM LNG projects are going ahead for this very reason whereas we continue to see delays to FIDs for other global LNG projects, especially greenfield LNG projects. For Mexico, US continues to capture almost all of the market share for Mexico’s gas imports due to its cost advantage from pipelines and/or short LNG distances. The most recent available splits showed US had 82% of that market share in 2015 and that percentage is going higher with increasing pipeline capacity between the two countries.
Cheniere sees the global LNG oversupply getting fixed in 2020, two to three years earlier than most expectations. Our April 6 blog “Tokyo Gastech: Changed/New Views On Timing Of LNG Correction, Impact Of FSRUs, and LNG For Fueling Ships” [LINK] noted views from Woodside and Qatar for the LNG oversupply to be fixed quicker than expected. Arguably, they are speaking to their book as LNG is how they monetize their large natural gas reserves. Cheniere is less of a natural gas reserves owner and more of a midstream/marketing/delivery LNG player, but it has a similar LNG supply/demand outlook ie. one of a “tightening LNG market”. Cheniere sees the LNG oversupply gone in 2020 and the market moving to undersupply in 2021. The analyst day presentation notes a range of factors, but highlights emerging and new markets and how “floating regasification continues to unlock new markets’. Cheniere notes that “of the 24 new LNG markets since 2005 (first FSRU), 14 were enabled by FSRUs”. This is the concept of smaller new markets. Plus Cheniere highlights that FSRUs currently have ~95 MTPA capacity (12.5 bcf/d), and that there are 9 more ordered that have ~38 MTPA capacity (5.0 bcf/d), and there are 40 more proposed that have ~100 MTPA capacity (13.2 bcf/d). If the call on the oversupply being fixed in 2020/2021, the visibility to this happening will be long before 2020
When the market tips to undersupply, it could tip hard. Cheniere made an interesting point to keep in mind, when they said “long lead time to new supply means once the market is tight it will take 4+ years for supply to adjust”. Cheniere warns that the lack of liquefaction FIDs in the past 18 months means that when the market flips to undersupply, it is so for 4+ years. This was an interesting point to keep in mind as it infers, when the market tips, it tips hard and LNG prices should be up strongly in this shortfall period. It makes us wonder how much LNG prices go up in a period of undersupply.
Its why we continue to believe HH prices are likely to outperform the 2019 thru 2022 strips, and AECO will benefit from HH strength. The HH strips are below $3 in the 2019 thru 2022 period at $2.92 for 2019, $2.93 for 2020, $2.95 for 2021, and $2.98 for 2022. The more that US natural gas exports increase, it means that the remaining North American market will be stronger and with less downside risk from warm winters. It is why we continue to believe HH will outperform the strips in 2019 thru 2022 and is more likely a $3.25 to $3.50 than below $3. For AECO, we continue to expect to see AECO differentials remain wide for the next few years as we see a ongoing race to increase egress to move natural gas thru Alberta as we continue to be in the camp that doesn’t expect to see BC LNG FID in 2017 or 2018, which means that any BC LNG physical demand relief is post 2022 at the earliest. However, as seen this winter, AECO will still go up with a stronger HH even with a wider differential.
Most of all, if the LNG oversupply is fixed in 2020, the tone and valuations in 2018 and 2019 should improve for Cdn natural gas. This winter proved that global natural gas and LNG markets can materially impact HH and AECO gas prices. Cheniere is the latest to come out with the LNG outlook support for its call that LNG oversupply will be fixed in 2020 and 2021. We are highlighting this 2020 view as it will impact the tone and valuations for natural gas (US and Canada) before 2020. LNG oversupply being fixed closer to 2020 than 2023 to 2025 (the views coming into 2017) may not impact spot HH and AECO gas prices, but should lead to an increase in the out years (2019 thru 2022) of HH strips. And a move up in the 2019 thru 2022 strips should lead to a stronger investor tone and ultimately valuations for natural gas, including Cdn natural gas. Lastly, we believe it is timely to look at this now as we would expect analysts and investors to take a new look at their 2018 and 2019 natural gas thesis in Q3/17, ahead of going into the winter.