European Storage and U.S. LNG: cautious optimism

U.S. LNG’s summer from hell is almost over, as netbacks show an increasingly favorable environment. While U.S. LNG exporters can breathe a sigh of relief, it’s too soon to reach for the champagne: European storage injections are slowing but remain above last year’s highs, and many European countries are experiencing their highest post-lockdown COVID case counts. Rising Henry Hub prices could also weigh on LNG shipments. While we think the worst is over for LNG exporters, risks remain on both sides of the Atlantic.

Why is Henry Hub rising?

We’re frankly surprised that Henry Hub prices are rising, since the fundamentals do not seem to align with the price enthusiasm in recent weeks. To wit: August temperatures are expected to be cooler than previously expected; U.S. natural gas storage levels are rising; U.S. COVID cases have declined in recent weeks but are expected to rise amid school re-openings, flu season, and more time spent indoors; and COVID cases are rising in key export markets, especially Europe. On the other hand, there has been more optimism on vaccine development and deployment – but most experts believe that most Americans will receive a vaccine only by 2Q2021 at the earliest. It’s possible that the market is also betting on lower future production from oil (and therefore associated gas). There’s some evidence that HH prices are rising on technical (i.e. traders covering short positions) rather than fundamentals. Nevertheless, rising Henry Hub prices raise feed gas input costs for U.S. LNG exporters and, all things being equal, limits export cargoes.

Rising Henry Hub prices don’t seem to align with fundamentals because of storage dynamics. In recent weeks, storage levels across the U.S. South Central region (where Henry Hub and LNG projects are located) started ticking up again, raising the possibility of a storage max-out later in the year. National-level storage data rose above 5-year averages last week on greater storage injections in the South Central and Midwest regions.

As we mentioned above, it’s possible that market participants are wagering that 1) domestic oil production will remain constrained and 2) associated gas supply from oil production will also stagnate or even decline. We see some evidence for this view: WTI prices have risen slightly from $40/bbl in early August to about $42/bbl as of this writing, and rig counts are under pressure, despite an uptick in Permian rigs last week. The most recent EIA data shows a decline in domestic crude production, we’ve heard anecdotal reports of producers reluctant to restart shut-in wells, and many producers have reduced their output projections in recent SEC filings. If high prices are sustained, then producers in the Haynesville or Appalachia might turn on production. We’ll circle back to this topic in a future article.

European LNG demand: Will it hold?

There are some faint warnings that European demand could soften, but no bright red warning lights as of yet. Seven-day averages of European COVID cases are up 23% week-over-week (conversely, U.S. cases are down 7%). Several European countries have suggested that additional containment measures may be needed to slow the spread of the virus.

The European storage situation is improving for now, as the pace of injections has slowed considerably over the summer. European storage levels are only barely above their 2019 highs, and we have read of European coal-to-gas switching gathering pace.

Much will depend on Europe’s winter. If the continent experiences another unseasonably warm winter, heating demand will suffer. U.S. LNG could repeat its “summer from hell” again next year if European natural gas inventories remain elevated on weaker winter demand.

On a happier note, futures markets are predicting a sunnier outlook for European netbacks. Our analysis shows that U.S. LNG exports will be “in the money” for October shipments to Europe, suggesting that fewer cargoes will be cancelled. Cargoes to Asia are in a more favorable position, suggesting that we have likely already seen the worst of the cancellations this summer.

Cautious optimism

Despite rising Henry Hub prices, a possible resurgence of COVID cases in Europe, and elevated natural gas storage levels on the continent, we believe we may be over the worst of the cancellations. Every day brings us closer to a vaccine and (hopefully) a return to more “normal” market conditions. Although risks remain and additional COVID outbreaks are likely, the worst may be over for U.S. LNG exporters.