Natural Gas Prices: Production Cut Hopes Fail to Materialize

Weak inventory build and the arbitrage window is also widening, with premiums in the European and Asian markets increasing

• U.S. natural gas prices fall below $2 per million British thermal units (mmBtu).

• Price decline occurred despite a smaller-than-expected U.S. inventory build.

• Arbitrage window to Europe and Asia may accelerate demand for U.S. cargoes.

U.S. natural gas prices (/NGU4) fell 3% in afternoon trading on Thursday, bringing the September contract to the lowest point since trading started.

Accounting for today’s move, the commodity is on track to record its eighth weekly loss and comes after prices fell by 22% in July.

Production cuts haven’t helped natural gas prices

Earlier today, the Energy Information Administration (EIA) reported an 18 billion cubic feet (Bcf) build in stocks for the week ending July 26. That was below the +31 Bcf consensus estimate.

Normally, a smaller-than-expected build would provide a tailwind for natural gas prices, as it signals that supply decreased or demand increased or both.

However, U.S. stocks are trending 8.4% higher than a year ago and 15.7% above the five-year average, according to EIA data. A warm winter in 2023 left inventory levels at better-than-seasonal levels, helping to bolster stocks through the summer.

The recent selloff prompted a belief that producers would cut production, like what we saw during the first quarter of the year when prices rapidly declined. However, as prices rose from April to May, producers increased production.

Currently, U.S. output is slightly above 102 billion cubic feet per day (Bcf/d).

Now, with the withdrawal season only months away, shutting down production doesn’t make as much sense from a producer’s standpoint.

The contango in the natural gas futures market is rather steep recently, with the January contract (/NGF5) trading at a $0.46 per mmBtu premium versus the September contract. That further desensitizes producers to materially cut production, as they could hedge against price declines while keeping production high by selling those further-dated contracts.

Arbitrage window to Asia to support U.S. production

The arbitrage window is also widening, with premiums in the European and Asian markets increasing. The premium for Dutch TTF natural gas futures prices versus U.S. prices rose to the highest level since December 2023 at 9.705, and the premium for Japan/Korea Marker liquefied natural gas futures (/JKM) is also at the highest since December.

The premium in Asia is outpacing Europe’s premium versus the U.S., which has resulted in cargoes being diverted to the East through July. Asia’s premium has shrunk against Europe’s over the last two weeks, but the net impact remains positive for LNG competition for U.S. product.

The regional price differences will likely support continued U.S. production figures.

Where are natural gas prices headed in August?

I’m maintaining my bearish stance on U.S. natural gas prices as a steep contango going into the winter, along with arbitrage opportunities to the East and higher-than-average U.S. stocks, should prevent a material reduction in gas flows.

The market should offer opportunities to sell into strength, given the fundamental backdrop.

The risk to trading the long side is that the current price is at heavily oversold levels. Based on various technical indicators, we could see large retracements to the upside.

Using defined risk strategies in the options market helps to counter some of that risk, and the elevated volatility offers attractive premium selling strategies to utilize, such as a short vertical call spread.

An example trade would be waiting until natural gas rallies and then selling a call spread with the short strike near the prior swing high at 2.3, betting that prices fail to breach higher and put in a lower high.

Thomas Westwater, a tastylive financial writer and analyst, has eight years of markets and trading experience. @fxwestwater

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