As we have been writing about for the last couple of weeks, weather forecasts across the United States continue to look hot. On face value, that would seem very bullish for energy prices, especially natural gas which generates a significant amount of electricity in the summer months to power climate control systems. With more cooling demand, one would expect natural gas prices to rise significantly. However, though we did see a significant rally in prices when demand first arrived late in May and early June, over the past two weeks we have seen prices fall off, as seen below.
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We have seen articles blaming this drop in prices on "cooler forecasts," but that does not at all seem to be the case. Below we show the Climate Prediction Center 8-14 Day forecasts from the last 2 days, which is a comparison we do daily in our Afternoon Premium Update.
This indicates that cooling demand should remain significantly above average through the month of July, something we wrote in our blog yesterday. However, over the last clearly two weeks that has clearly not rallied the prompt month August natural gas contract significantly. At Bespoke Weather, we strive to go beyond just the pure weather forecast to develop how it should impact markets directly. An analysis of the natural gas strip over the past few months may provide some answers.
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What we see is that instead of having no impact whatsoever, over the past month the bullish weather forecasts have helped support the prompt month contract while throwing the front-end of the natural gas curve into backwardation. Over the past few months, we observed the entire natural gas curve shift upwards, indicating a fundamental shift in the underlying supply/demand balance that justified higher prices across the strip. However, in the past month, prices have been flat from October virtually through the entire winter 2016/2017 strip while the prompt month contract has still risen about 10 cents. Bullish weather went from tightening the entire market to just supporting the front-end of the curve, with concerns of oversupply and heat fading in August even weighing down the September contract in comparison.
Part of the reason for this more muted impact to a recent round of bullish forecasts seems to be coal-to-gas switching. At these significantly higher price levels, there is far more incentive for utilities to burn coal for power generation as opposed to natural gas. This is exactly what we have seen across the PJM, where for example this morning at 11 AM more power generation in the large demand region came from coal, and natural gas is generating about the same amount of power as nuclear.
Though hotter weather will still increase energy demand and support natural gas demand, each additional CDD will result in a marginally smaller demand addition at these price levels since a decent percentage of that demand will be lost to coal. The result is that hot weather went from being a reason to rally the natural gas market to now being a requirement for price support at these price levels. While hot weather has kept prompt month prices relatively stable over the past month (and with a 25 cent sell-off still coming in the past 2 weeks), any cooling in forecasts could result in relatively rapid declines in price. It doesn't help that late July and August have been seasonally very weak for natural gas prices over the past 5 years as heat begins to wane nationally and traders focus more on expected stockpile size headed into winter.
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Thus, the idea that natural gas prices are declining off of cooler weather forecasts is quite misleading. Forecasts in the long-range are about as hot as they can be in the center of the country (though granted they are only slightly above average in a majority of the South and East). Instead, there is much more at play within the natural gas market keeping this hot weather from rallying prices back towards $3 support.
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