Some wise guy that goes by the name of Redpill Drifter on Twitter/X stood on a street in Encinitas, California, and asked people at random whether they would take a $20 bill, or a 1-ounce gold coin. He had both in his hand and offered them unconditionally. A remarkable number of people opted for the cash. Of course, he may have edited out people that took the gold (and who knows if he would have honored that offer with the gold coin 100 times more valuable), but regardless, a large number of people went for the cash. Some even accepted $10 over the coin. The experiment did show that the average person is so far removed from commodity markets that they take twenty bucks over an ounce of gold, that they have absolutely no inkling as to such a massive value differential.
Anyone want to take a crack at explaining natural gas markets to these people?
No, I wouldn’t either. There is zero hope. Gold is relatively simple and well known; natural gas markets are possibly the most curious of all markets. The stuff is the bedrock of modern civilization, running in sealed little pipes under virtually every urbanite’s feet, that few know are even there, keeping us unfrozen in winter and powering much of industry, and yet if one grasps the enormity of the value of natural gas and wanders into the market thinking it might be a good investing idea, they will have their limbs blown off before lunch.
There are reasons for these unique market properties and characteristics. Natural gas is unlike many other commodities in that it is very difficult to store, and the amount of storage relative to consumption is miniscule. The entire natural gas world is in a well-balanced flow state whereby production needs to quite closely mirror consumption, because storage injections/withdrawal capability is small relative to demand, and yet demand fluctuates wildly from day to day. Look at this chart from Criterion Research showing ERCOT’s (Electric Reliability Council of Texas, The Texas state grid system) which shows natural gas-fired power generation in Texas soaring from under 15,000 MW one day to 44,000 two days later, due to a cold snap. And if that cold snap had not materialized, demand would have stayed at the lower range, and a vast quantity of natural gas would not have been consumed at all. And this is Texas, multiply that effect in colder regions like Chicago.
Any weather system of significance, whether too hot or too cold, has the ability to throw the whole balance out of whack, sending gas prices soaring or plummeting. A cold winter followed by a hot summer equals pandemonium and high prices, which impact almost everyone in one way or another. The reverse is also true; a mild winter causes a bloat in the system and prices collapse.
All this occurs while everyone is sleeping. Market watchers wake up in the morning to see, usually, a massive red number or a massive green number, depending on how the weather forecast changed overnight. Natural gas traders make enough money to buy a Ferrari every week or two, and producers slowly lose their sanity.
Then layer in the bigger macro forces impacting North America, and the world. Global demand for LNG is soaring, and LNG is a booming industry in North America. Even Canada is getting into the game. But the big action is in the US, where LNG export terminals are being constructed rapidly, adding many BCF per day of new demand that North American producers will have to meet.
As an exclamation point on this chaos, consider that natural gas infrastructure additions necessarily involve a multi-decade horizon, because of the challenge of building that infrastructure. Then also consider this: the US actually was an LNG importer in the 1970s, and four LNG import terminals were built in the US between 1971 and 1980. In the 1990s the US was forecasting a shortage of natural gas. Twenty short years later, the US was in such a natural gas glut that it began exporting it in 2016, and nine years after that momentous occasion the US is now the largest LNG exporter in the world.
And the party’s just beginning. The US, particularly so under the new administration, is expected to accelerate LNG exports with the potential for 10-15 BCF/d of new export capacity coming on stream within the next five years (including Canada, which is part of the North American natural gas system no matter what tariffs get thrown around).
And then on top of that, the AI/data center boom is taking off. Tech companies are used to getting what they want NOW, because they have mountains of money, and their world is so fast paced that they can get left behind in a week. Or a few. Here is how tech companies operate and want everyone to keep pace: Elon Musk set up his xAI data center, with 100,000 Nvidia GPUs, in 19 days (Nvidia CEO said this process normally takes 4 years). Apple just this week announced a staggering $500 billion investment in US tech, including a 250,000 square foot server manufacturing facility that is slated to open in 2026 – next year.
A new interstate gas pipeline (don’t even contemplate interprovincial) would require a year to decipher the regulatory code to comply with a thousand regulations and lawsuits. Tech moves at warp speed, and sort of expects energy to be there by its side.
Big tech also wants clean power, and are even pursuing nuclear as the ultimate option, particularly SMRs – small modular reactors – but those won’t be here for a decade. So natural gas is going to bear the brunt of the AI demand load for the next while, with forecasts of anywhere from 3-10 BCF/d of new demand being added by 2030.
Glory days for natural gas producers, right? Well, you’d think so. And maybe it will be thus, prices have risen substantially in the past twelve months (a real winter is the cause of that, but still). But it’s not going to be a smooth ride. It never is with natural gas.
To add a lot of new production in order to meet this new demand requires a lot of things to happen. There has to be a lot of drilling, and there has to be a way to get all that gas to market. If we’d had a normal winter, and the gas storage situation had stayed close to balanced, we might have had more time to orchestrate the needed buildout of new supplies. But like discussed above, the natural gas system is like the human blood system – the pressure and volumes have to be juuuusssstttttt right. And the balancing act gets ever harder. Those huge new LNG terminals have the ability to turbocharge volatility; a few years ago the Freeport LNG export terminal went out of service for 8 months after an explosion, and that single event impacted North American natural gas prices materially and negatively for almost a year.
Add to that the battle scars that producers earned in the past decade, when they joyously flooded the market with gas upon discovering they could drill wells for 4 miles horizontally and frack the crap out of them, producing prodigious amounts of gas with ease. The markets beat them up for that, for blowing capital with little to show for it, and now they are a subdued lot. Consider this S&P Global article’s take: “A number of the public gas-focused E&Ps that have reported year-ahead capital plans to date have said they don’t intend to increase activity and grow production meaningfully in 2025. This trend could result in a situation where supply lags the ramp-up in demand..”
If producers stick to their guns, that is, show discipline in production growth, we will see higher natural gas prices, which is the correct market cue to increase activity. But higher prices are precisely what Trump seeks to avoid, by talking of “drill baby drill”. How does that get resolved? No one knows, and by the time the question could ever settle in the ears of the White House, they would already have initiated three new earth-shaking proposals across the socioeconomic spectrum in that interval.
It is a very complex equation. Natural gas volumes can keep rising regardless of natural gas prices in fields like the Permian or Canada’s Montney/Duvernay if the price of oil remains healthy. This is the solution gas part of the equation, and it is quite large. But it is not all, not by a long shot.
The more pure gassy plays, the Haynesville and Marcellus, account for nearly half of US production, and they will ramp up when prices warrant – if infrastructure can be built to move the gas to market. Which is not a given by any stretch either; new pipelines need long term commitments, and producers have become gunshy about the future, they’ve been rug-pulled too many times, and investors simply want to see a shareholder return.
The natural gas market can drive one crazy, and it is definitely not for the faint of heart. It is therefore even harder to make any sort of prediction when so many variables – such as a prolonged cold snap, or a warm one – can cause the commodity to double or triple in price within months. Imagine if oil was like that, going from $30/barrel to $120 because of a bad month of weather. And yet that is the environment natural gas producers live in, one that is hidden behind the public face of natural gas, which on a good day will elicit not much more than a “Huh?” from the average citizen.
Having said all that, a few facts seem to stand out. The US producers about 105 bcf/d, Canada about 19, for a total NA supply of roughly 124 bcf/d. Within the next five years, demand growth will likely range from a low of about 20 bcf/d to a high of maybe 30. Consider also that the best wells in the heart of the best field, the Marcellus, now routinely have first year decline rates of 75 percent – they may come on at 40 mmcf/d, but within a year they can be a tenth of that. In other words, the treadmill is running fast.
Given that the producing community may be asked to come up with the equivalent of another entire Canada to satisfy growth in demand, or if things go well another Marcellus, there seems to be a case building that natural gas prices will no stay in the toilet as they have the past few years.
That is potentially good news for producers, but will light fireworks in a new US administration that recognizes the fundamental importance of cheap, reliable energy, and that natural gas is a cornerstone of the economy. There are very strong forces that will pull in opposite directions, and the result will be unpredictable and wild. But what else would one expect from natural gas markets?
Turns out an energy transition isn’t quite so simple. Read why in The End of Fossil Fuel Insanity – the energy story for those that don’t live it, and want to find out. And laugh. Available at Amazon.ca, Indigo.ca, or Amazon.com.
Read more insightful analysis from Terry Etam here, or email Terry here.