(Thomas Mak, Farzan Faizeen)
Impact of COVID 19 on Natural Gas
Natural gas has become increasingly important as nations shift towards eco-friendly alternatives due to it releasing low levels of emissions. When processed and converted into cleaner fuels, it can be used for heating and generating electricity.
The natural gas market has not been immune to the effects of the pandemic. However, the impact has been less severe in comparison to coal and oil. Nevertheless, it is estimated that demand has declined approximately by 4.5% year over year in Q1 2020. To put this into context, this is double the amount of demand lost after the 2008 financial crisis.
The reasoning behind this can be explained when evaluating the changes in commercial and industrial usage. Firstly, lockdown measures have meant reduced economic activity and by extension, a change in the pattern of electricity consumption. The uncertainty coupled with worldwide business closures has resulted in a significant decline in overall electricity demand. Secondly, even before the pandemic, a mild winter in the northern hemisphere had meant demand for home heating was reduced. Thus, it has resulted in the natural gas market to go through a strong supply, a period of high volatility and to reach historically low spot prices.
US natural gas prices fell to the lowest level since 2016 on Q1 2020 as natural gas fell below $2 per million British thermal units (mmbtu) due to a marked deterioration throughout the quarter. Such deterioration can be attributed to the severity of COVID-19, ample supplies, and warm winter.
(Source: World Bank)
As we can see from the percentage bar chart above, electricity and industrial applications dominates the global usage of natural gas – 40% of natural gas is used for electricity and a total of 15% for industrial uses. Due to the unseasonable mild temperatures from Q4 2019 to Q1 2020 – whereby the second warmest winter on record – the weakened demand for heating has triggered a substantial decrease in electricity demands. With warmer temperatures in South Asia and West Europe playing a pivotal role in reducing natural gas demands, this in turn caused the US natural gas price to fall from $2 to $1.83 per mmbtu in Q1 2020 given the US’ position as the biggest natural gas exporter in the world.
In respect of industrial uses, natural gas is a vital feedstock for the manufacturing sector, non-renewable resources like oil and natural gas provide the necessary energy source to make a wide range of petroleum products (e.g. clothing, lipstick, contact lenses). However, mitigation measures taken to contain the spread of COVID-19 have resulted in a rapid decline in industrial activities, which resulted in a 12% decline in US natural gas prices and a further 25% decline in European prices during Q2 2020.
Apart from weakened demand for electricity and industrial applications, ample supplies is another key factor that triggered the sizeable declines of natural gas. In Q1 2020, the US Energy Information Administration announced its prediction on the output of natural gas production in 2020, whereby the principal agency forecast that output would increase by 3% this year to a historic high of 94.7bn cubic feet per day. This cast huge doubt on the growth potential of natural gas prices because if natural gas producers don’t act swiftly to reduce production before the market bottoms out, supply is going to outpace demand by a huge margin.
Despite natural gas prices is showing signs of recovery following a rebound to $2.45 per mmbtu in Q3 2020, it is our provocation that this rebound will be short-lived. Our outlook on natural gas remain bearish not only because of the emergence of the ‘high supply – low demand’ dynamic, investors must also take into account of how the increasing global efforts to reduce natural gas consumptions and emissions would create a demand vacuum.
(Source: Financial Times)
The record-breaking volume of natural gas being burnt off in flares by oil companies represents a huge set back in global efforts to reduce greenhouse gas emissions – more than 400 million tonnes of carbon dioxide was released into the atmosphere due to the generation of unwanted natural gas from the oil extraction process. Instead of burning it off, natural gas can actually be captured and used as a fuel supply for heat and electricity. However, given that natural gas prices have been consistently low since Q4 2019, oil companies have little incentive to capture natural gas and prevent it from reaching the atmosphere.
Take BHP as an example, BHP is currently considering selling natural gas assets to prepare for a low carbon future. After major shareholders express concern on BHP’s ESG credentials, BHP has created a concrete action plan to sell its mature gas fields at Bass Strait. Despite the fact that the profit generated by BHP’s oil and gas division accounted for over 30% of the total earnings generated by BHP last year, BHP remains committed to improve its ESG credentials by investing in commodities that are commonly used for low carbon power generation (e.g. copper and nickel). In sum, the strategic shift of BHP casts another huge shadow of doubt over future demands of natural gas, as oil and gas companies begin to prepare for a greener, low-carbon future.
COVID-19 halting industrial productions, supply rapidly outpacing demand, and warmer-than-expected winter all contributed to the demise of natural gas. A wider implication that can be drawn here is that the outcome of the 2020 U.S. Presidential Election will have a huge impact on not only the future of natural gas, but also the future of the oil and gas sector.
During Trump’s first term as U.S. President, he oversaw a substantial increase in crude oil production as the U.S. became the top crude oil producer in 2019, which reflects the boarder trend of the Trump administration favouring non-renewable sources. In contrast, Biden vows to place climate change at the heart of U.S. energy policy and promise to spend $2tn in green energy development to support the national ambition of going 90% carbon-free in power generation by 2035.
Thus, if Biden is elected, demands for non-renewable sources like crude oil and natural gases would continue to be subjected to rapid decline. And due to the Trump administration’s poor response to the COVID-19 pandemic, one can certainly argue that voter sentiment may swing to Biden’s favour.
Industry jargons .
Bearish: A pessimistic outlook, represent a general decline of a financial market. It typically includes a transition from high market confidence to widespread fear and panic.
ESG: Environmental, Social, and Corporate Governance. The three central elements in measuring the sustainability of an investment in companies, which seeks to help investors to determine the long term growth potential of the target company.
Demand vacuum: A rapid decline in demand caused by recession, economic stagnation, and/or low market confidence.
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