While the natural gas market pauses to consider whether this winter is effectively over, and awaiting what is setting up to be an exciting injection season, we thought it would be helpful to discuss a facet of natural gas supply and demand which may not be fully appreciated by the at-large producing or consuming community. Renewable power generation is frequently hailed as the eventual and ultimate destroyer of domestic natural gas demand, yet this component of the U.S. power stack carries significant complexities that need to be better understood before concluding if, or when, the annual consumption of natural gas will be materially impacted. Rather than diving straight into the details of hydro, solar, or wind generation, we thought it would be advisable to first provide a brief historical overview of natural gas consumption in the power sector. This historical overview will provide context for what will eventually be a series of four Friday Focus notes on the interplay between renewables and natural gas in the U.S. power stack.
In late 2011, early 2012, the juggernaut of natural gas production growth from horizontal drilling of shale wells in the United States collided with, what was at the time, the warmest winter in more than 50 years. This created an enormous inventory glut, with end of March 2012 storage peaking at almost 2.5 Tcf. As consumers and producers of natural gas (both direct and indirect) recall, this led to a precipitous decline in natural gas prices which lasted for approximately 5 months before the market was able to absorb excess supply. For reference, the summer of 2011 posted an average NYMEX price of $4.19/MMBtu, while the aforementioned 5-month period (Feb-June 2012) collapsed to an average of $2.35/MMBtu. At the time market participants questioned price elasticity in the power stack, and whether it would be sufficient to soak up such a monumental inventory overhang. Those questions, or concerns, were swiftly met with the stark reality that the overbuilt natural gas generation fleet, which had been under utilized since the early 1990s, was easily up to the task.
Fast forward to late 2015, early 2016, and the natural gas market faced precisely the same dynamic. Fueled first by prolific production growth, which resumed as soon as prices recovered in late 2012 and further accelerated following the 2014 rally driven by the highest multi-year strip pricing environment in the shale era. An oppressive and record setting warm winter (Nov 2015 – Mar 2016) forced the market once again to search for a balancing mechanism. This time around the forward curve was hammered by a barrage of producer selling which all but guaranteed stalled production growth, as sub full-cycle production economics were locked-in. At the same time production growth was being halted, once again the power sector rose to the occasion. The annual average daily consumption of natural gas from the power sector in 2016 climbed to 27.3 Bcf/d or 2.4 Bcf/d more than the 2012 average.
In late 2012, following the eye-opening increase in power consumption of natural gas, the narrative shifted to one where the acceptance of drastically increased baseload consumption was acknowledged, but footnoted by the belief that incremental gains would be minimal or non-existent without significantly greater capacity additions of natural gas fired power plants. In addition, it was argued that the prolific growth in renewable generation capacity was going to chip away at total fossil generation, and thus put an end to the growth in natural gas consumption in the power stack. Looking back on 2016 it is clear the assumption of limited incremental demand gains from the power sector was in error, and at the same time there was a second building frenzy of natural gas fired power plants, although modest compared to what was seen in the 1990s. Now moving forward through the following 4 years (2017-2020) the narrative re: prospects for natural gas power consumption became increasingly dominated by the onslaught of renewable generation adds which were undoubtedly reaching critical mass. The seemingly blank expiration date on governmental subsidies for renewal generation allowed for a remarkable buildout of wind and solar generation.
Now that most of 2020 is in the books, from an official data standpoint (EIA data goes through October 2020 at present), it is worth revisiting natural gas power consumption in the age of prolific renewable generation expansion. First 2017, when once again a new record setting warm winter was endured, gas consumption averaged 25.3 Bcf/d, which was a notable year-over-year decrease, yet rationale with an average Henry Hub price $0.65/MMBtu higher than the prior year. Moving on to 2018, history shows that despite a flat year-over-year pricing environment there was an incremental 3.6 Bcf/d of natural gas consumed by the power sector. The subsequent year (2019) proved yet again that the thirst for natural gas in the power sector had not been quenched. That year power consumption of natural gas moved up another 2 Bcf/d to a jarring annual average of 31 Bcf/d. A $0.46/MMBtu retreat in annual average prices at the Hub certainly helped the cause in 2019, and the first 10 months of 2020 have posted yet another increase in consumption (+1.2 Bcf/d for Jan-Oct), supported by low $2.00 pricing. Please note that winter 2019/2020 was exceptionally mild in all three Northern Hemispheric consuming regions, even before the onset of pandemic related demand losses.
Clearly there were some noteworthy variances in Henry Hub pricing from 2017-2020, with the just ended year being the worst of the bunch at $2.08. Weak 2020 Henry Hub pricing unquestionably helped support the 3rd consecutive annual increase in natural gas consumption from the power sector, however, lets now turn to the renewable stack to see how well that group of generation assets fared over the period from 2012-2020.
From here our focus will shift to de-mystifying the effect of renewables on the natural gas market. Please note that we are including hydro-electric generation as a renewable generation source, although the state of California and some others do not. From our perspective, any source of power generation that has effectively zero fuel costs should be deemed renewable.
In 2012, aggregate generation from all renewable sources in the lower 48 totaled 49.6 GWh, or the natural gas equivalent of 8.9 Bcf/d assuming a 7.5 heat rate. In 2013 this total jumped 6% higher, followed by more modest gains of +3% and +1% in 2014 and 2015. At the height of the renewable bonanza, and supported by transmission system upgrades, 2016 and 2017 posted consecutive annual increases of +14%. The next two years (2018 and 2019) showed the 2017 narrative of ‘gas generation destroying renewable growth’ to be a bit of overshoot. Those two years posted modest annual increases of +4% and +2%. With the 2020 data made available thus far (through October), the annual increase appears to have jumped once again by double digits (+10%). With renewable generation in 2020 almost double what it was in 2012, there is no denying there has been a shift in the U.S. power stack. However, as noted in the provided history of natural gas power consumption from 2012 through 2020, this has not equated to a headwind for the natural gas market.
In our daily reports, and in discussions with clients, we have often pointed out that the wind doesn’t always blow, the sun doesn’t always shine, and some years are drier than others. These unequivocal statements are applicable not only in annual impacts to the power stack, but also seasonal, monthly, weekly, and even daily. From a forward-looking perspective we do at some point, in the next 5-10 years, expect to see renewable generation erode natural gas’ share of overall U.S. power load. However, the past 9 years have seen natural gas’ share of total U.S. power load increase from 30% to 41%, despite a 2x increase in renewable generation. As a result, the contemplation of eroding market share should be carefully dissected with an understanding of how each renewable source (wind / solar / hydro) is impacted by annual and seasonal weather patterns, as well as regional dynamics which are quickly evolving. Factors such as one states’ renewable generation goals, or zero emission targets, must be factored with that of the neighboring states, as the transmission of power often crosses state lines. In addition, the necessity for utility scale energy storage will be a requirement for renewable generation to sustainably curb the call on natural gas for power generation, and thus that must be addressed and implemented in advance.
As noted in the opening of this Friday Focus, we plan to take a deeper dive in to each of the 3 main sources of renewable generation in subsequent Friday Focus pieces, with of course an emphasis on what it means for producers and consumers of natural gas. We will endeavor to make these timely with one in the spring focusing on hydro-electric generation, as that part of the power stack peaks from May to June. A mid-summer update will focus on solar generation, and how it has begun to proliferate in regions outside of the Southwestern U.S., and in early Fall we will dive into the wind generation stack and its inherent volatility.