U.S. natural gas stocks are going into winter at the lowest level for fifteen years despite a slightly faster rate of injections into storage over the summer than in 2016 or 2017.
Low inventories have encouraged hedge funds to build their largest position in futures and options for more than eight years and pushed benchmark prices to their highest level for almost nine months.
But pressure on stocks and prices is being tempered by the development of El Niño conditions over the Pacific which should lead to a relatively mild winter for much of the country.
Higher prices will encourage power producers to run gas-fired units for fewer hours in the coming weeks and increase generation from coal, which has been languishing at multi-decade lows.
The resulting switch from gas to coal should help boost gas stocks faster than normal in the remainder of the injection season and limit drawdowns in the early stages of the winter heating season, conserving scarce stocks.
If the winter starts with prolonged cold periods in November and December, however, the gas market could come under severe pressure, with prices spiking.
Working gas stocks in underground storage reached 3,037 billion cubic feet (bcf) on Oct. 12, according to the U.S. Energy Information Administration ("Weekly natural gas storage report", EIA, Oct. 18).
Stocks have risen by 1,688 bcf since the injection season started on April 1, compared with increases of 1,586 bcf in 2017 and 1,325 bcf in 2016.
Even so, gas stocks are the lowest level since 2003, and the market has struggled to eliminate the deficit to the five-year average that developed during the long cold winter of 2017/18.
Until a few weeks ago, most traders appeared unconcerned by low inventories and benchmark futures prices were stuck below $3 until the final week of September.
Since then, hedge funds and other money managers have turned strongly bullish, increasing their net long position in futures and options by nearly 1,500 bcf over the last three weeks.
Portfolio managers' net long position is the highest for 35 weeks, according to position records published by the U.S. Commodity Futures Trading Commission.
Fund managers now hold more than five bullish long positions betting on a further rise in prices for every bearish short position, the most lopsided bullish ratio for more than eight years.
The accompanying jump in gas prices should encourage owners of gas-fired generation units to conserve fuel stocks.
Prices would probably have jumped even further but for the relatively mild winter being forecast for 2018/19 as a result of El Niño conditions developing over the Pacific.
The U.S. government puts the probability of El Niño developing by the end of the year at around 70-75 percent.
El Niño typically brings warmer temperatures into the northern United States but colder, wetter and stormier weather in the south.
In a mild El Niño, which this one seems likely to be, the weather impact can be masked by other developments ("Relationships between climate variability and winter temperature extremes in the United States", Higgins et al, 2002).
Nonetheless, the U.S. government is forecasting average or above-average temperatures across the entire country this winter ("Winter outlook favours warmer temperatures for much of the U.S.", NOAA, Oct. 18).
The U.S. gas market is now delicately poised between low stocks and the likelihood of a winter that it is warmer than average and warmer than either 2016/17 or 2017/18.
Lopsided bullish hedge fund positioning in natural gas poses the main downside price risk if fund managers try to realise some of their profits and close out some of their positions.
On the other hand, the market is relying on a relatively mild winter to eke out the meagre inventories, so any period of prolonged cold could send prices sharply higher.
By John Kemp
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