False Fear Review: US Natural Gas Prices Edition

Here is a twist: Across parts of America’s big shale gas basins, natural gas prices are negative. Yes, producers are paying other businesses to take gas off their hands. That is a far cry from last year, when some worried rising liquified natural gas (LNG) exports would drive up energy costs for Americans, exacerbating inflation. In our view, this is a shining example of a false fear being completely wrong—a helpful way to see reality turning out better than many feared and a driving force for bull markets.

Some recent history: America started shipping LNG in 2016 and became the world’s largest LNG exporter six years later thanks to several capacity additions.^[i] Europe has been an eager customer, given the Continent’s weaning off Russian energy following Ukraine war-related sanctions. However, some worried higher LNG exports would expose American natural gas prices to international developments and volatility. Strong overseas demand relative to homegrown supply could then purportedly spike domestic energy prices—fanning already elevated inflation.

Fast forward to today, though, and that fearful vision hasn’t manifested. Despite the ongoing rise in US LNG exports, domestic natural gas prices haven’t soared … as broader inflation has eased to historically normal rates. (Exhibit 1)

Exhibit 1: US Natural Gas Prices Since 2016

Source: FactSet, as of 8/13/2024. Henry Hub natural gas spot prices (dollars per million British thermal units), 1/1/2016 – 8/12/2024. That huge spike in February 2021 was due to “freeze-offs” (temporary production interruptions due to cold weather) amid huge demand for heating and power.^[ii]

It isn’t as if US demand has plummeted—this year’s scorching summer drove a surge for gas-generated electricity to power air conditioners.^[iii] Nor were exports materially interrupted by the Biden administration’s (now blocked) new export terminal permit ban, considering there is sufficiently permitted capacity to double exports in the next decade. Rather, America’s natural-gas glut has persisted despite record-high LNG exports, with natural gas storage facilities well-above five-year averages.^[iv] Due in part to infrastructure issues—i.e., the lack of pipeline capacity to send the gas to the Gulf Coast or California—drillers in the Permian Basin sometimes run out of storage options and have to pay buyers to take their excess.^[v]

The simple lesson here for investors: Don’t accept projections at face value. Sure, it sounds logical that more US LNG exports would lead to higher prices—and more inflation pain. A development that appears to reduce supply and increase demand should seemingly cause prices to rise, all else equal. But this oversimplification understates the dynamism and complexity of a global market, where global supply and demand are the main influence on prices—even prices for US benchmarks.

Consider this from the supply perspective. It isn’t that US supply is falling when exports ramp up. Rather, it is that global supply is getting a boost, which helps stabilize prices overall. America isn’t the sole actor on the supply front, either. There are other producers, including Qatar—a top LNG exporter with plans to boost expansion over the next couple years.^[vi] That is the funny thing about higher prices: They tend to incentivize more investment and output.

Also, exports are a key lifeline for US producers, who have long had more natural gas than they know what to do with. For US oil and gas firms, natural gas is a byproduct of oil drilling. Some have ended up with so much excess, they were flaring the gas—i.e., burning off the product, which is a huge waste.^[vii] Exports are a way to convert this excess from a sunk cost or wasted resource into a useful product for consumption overseas (e.g., Asia and Europe, where buyers are willing to pay higher prices). This supports producers’ earnings and revenues while helping the gas get burned in productive, not wasteful, ways. It is kind of a win-win-win.

And yes, this does mean we think the Biden administration’s ban of new export terminal permits is rather questionable policy. But again, the order—which a federal court barred last month—doesn’t prevent LNG exports or even stop the construction of export facilities. Rather, it would, if reinstated, pause the review for all requested permits as officials deliberate changes to the current process. For all the hoopla, the order didn’t and wouldn’t materially change supply dynamics in the near or even medium term.

In our view, it is worth keeping this natural gas example in mind when headlines warn a worrisome situation is brewing. By understanding a projection’s underlying components, investors can determine its probability of becoming reality—and the likelihood the issue is a looming problem or a false fear. Separating those two can help instill some discipline when speculation arises.