There have been many calls for a bull market in natural gas over the past five years or so, but the combination of “free money” from the Fed combined with the lack of capital discipline in the industry have prolonged the pain for producers — similar to the way Garet Garret described wheat farming in his 1924 book Satan’s Bushel. (For further discussion of Satan’s Bushel, see WILTW July 30, 2009.)

However, a record draw from natural gas storage during early-January’s cold snap helped bring natural gas inventories to the low-end of their five- year average range (see charts below). Could this mark an important turning point for natural gas? With the market beginning to look beyond this winter’s inventory draws, what are the chances that natural-gas inventory refills will underperform expectations? The answers will be revealed in due course, but the following data-points could provide important clues.

Shale gas production growth continues to be concentrated in two regions: the Appalachian (consisting of the Marcellus and Utica shales) and Permian. Although these two regions account for less than 40% of U.S. dry natural gas output, they have generated 100% of the growth in shale gas output since early 2012, as the following chart on the left demonstrates.

Sooner or later, the dangers associated with this high level of concentration will emerge, and the result could be higher gas prices if other regions do not yield sufficient incremental growth opportunities. For example, conventional U.S. dry natural gas output has fallen by over 25% since early 2012, while the combined output of the Haynesville, Fayetteville, Barnett, Woodford, Eagle Ford and other smaller shale plays has been effectively capped for six years.

As the chart on the right shows, the growth rate of shale gas has been in a downtrend since the initial wave appeared earlier this decade — as the production base gets ever larger, the ability to raise growth rates becomes harder to achieve.

The sharp efficiency gains that helped drive the production growth in the Appalachian and Permian regions since 2012 appear to have run their course. The new-well gas production per rig in these regions peaked in 2016 and both have begun to recede, as the blue lines in the following charts attest. Even though the rig count has been rising over the past 18-to-24 months in both regions, the fact that new-well productivity has stopped growing could be signaling that the best drilling prospects have already been used up, and that higher prices — on a sustained basis — will be needed to generate faster production growth.

Increases in recurring, structural demand will underpin future consumption growth in the U.S. As we have long predicted, natural gas has displaced coal in the production of electric power, and now accounts for the largest share of all energy sources for power generation, as shown in the following chart.

Global increases in structural demand will also contribute to rising prices, especially if future U.S. LNG exports meet expectations. Although LNG exports currently absorb less than 5% of U.S. production, if the expected capacity comes online by the end of this decade as presently forecast (see chart on the left), and the U.S. dollar continues to weaken (supporting emerging- market economies), then Asian LNG prices may continue rising (see following chart on the right).

Meanwhile, China’s share of global LNG consumption is expected to increase from 4% in 2015 to 16% in 2030. Although the Platts JKM LNG benchmark has more than doubled from a low of $5 per MMBtu last year to more than $11 last December, there is plenty of upside before reaching the prior high of $20 registered in 2013–2014.

The possibility of an LNG supply disruption in the Middle East also cannot be dismissed. Consider Qatar, which is the world’s largest exporter of LNG, accounting for 30% of the total. Although its regional neighbors account for only 10% of its LNG exports, the political strains between Qatar and Saudi Arabia came into full view last summer, because of the former’s implicit support for the regime in Iran, with which it shares the South Pars/North Dome gas field in the Persian Gulf. Recall there is evidence that Secretary of State Rex Tillerson had to keep Saudi Prince MbS from invading Qatar.

A rising tide will lift all boats: if the weakness in the U.S. dollar persists for another six to seven years, then sooner or later, all commodities will participate in the bull market. The shale gas production boom took off after 2010, when the U.S. dollar embarked on a multi-year uptrend that was supported by an exodus from the euro during the sovereign debt crisis and a marked slowdown of capital flows to emerging markets. Moreover, shale gas output was supported by the relentless flow of “free money” from the Fed, the lowest interest rates in 5,000 years and a complete lack of capital discipline among industry participants.

If these trends continue their reversal, could they trigger a new bull market in natural gas? Supply growth appears to be less robust than pre- 2014 and inventory draws are exceeding expectations just as the weaker dollar is boosting emerging market economies (and structural gas demand globally). Moreover, interest rates are rising in the U.S. and globally, which will raise the ROIC hurdle for new drilling projects, just as shareholders demand that managements pay more attention to capital discipline. Finally, a rising price for oil is going to help pull up the price of gas that is traded globally, now that U.S. producers have more access to international markets.

The greatest wild-card in natural gas prices is weather. We have been writing about extreme weather events since 2002. (For those who want the list, click here.) Given the record droughts in California, last December’s fires in Santa Barbara (CA), flooding in Paris after the heaviest rains in 50 years, earthquakes and volcanoes, and the unprecedented violence of hurricanes, who wants to bet on the status quo and benign weather in the gas-consuming (and producing) parts of America? Not us!

Wouldn’t it be ironic if, after several years of mild weather and $3 gas, the patterns shifted toward more violent extremes in both the winter and summer months, as occurred with last year’s destructive hurricanes and the recent extreme cold? And, to compound the bullish surprises, what if these weather extremes occurred just as production growth in Appalachia and the Permian began to slow from their trends of recent years?

A January 26th Bloomberg article headlined “The U.S. is About to Get Real Cold Again. Blame it on Global Warming,” said the following: “The North Atlantic jet stream has been moving exceptionally far north or south more frequently since the 1960s than at any time in the last 300 years...The amount of summer sea ice in the Arctic has declined by more than 30 percent in the past few decades. This has exposed more open water and land, which absorb heat and accelerate warming [meaning colder winters]. The shift has been happening more quickly than computer models projected; summer seasons that are completely ice-free around the pole are considered likely sometime in the next few decades.”

Natural gas equity relative strength (R/S) has fallen over 90% from its high, triggering our 90% rule. In WILTW April 19, 2012, we demonstrated numerous instances in history when an 80% to 90% decline in a market or commodity has marked a turning point—beginning with the 89% decline in the DJIA between the summers of 1929 and 1932.

The following chart shows that the relative strength of the First Trust Natural Gas ETF (FCG, $22.76) has fallen over 90% over the past seven years, but appears to have stabilized since mid-2017. Although it may still be too early to call natural gas stocks a buy, this chart may signal that natural gas stocks could outperform the S&P 500 in a bear market, because they have disappointed expectations for so long.

This article was originally published in “What I Learned This Week” on February 1, 2018. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.