The 2021 Henry Hub natural gas strip has been volatile in December of 2020. Expectations for strong pricing this winter evaporated as weather models turned warmer. Forward curves can implicitly show us what supply and demand expectations the market is baking into future prices. As power burn is particularly sensitive to gas pricing, especially in the summer, a falling or rising natural gas strip has implications for expected natural gas power burn. Lower natural gas prices, all else equal, should push power burn higher due to more attractive marginal power pricing from natural gas generation as compared to coal. Today’s Energy Market Insight analyzes estimated natural gas power burn given the 2021 strip as of December 1, December 7, and December 11 to analyze implicit assumptions of the volatile 2021 strip.
On December 1, the 2021 Henry Hub strip averaged $2.83/MMBtu on expectations that higher pricing was coming as normal winter weather in tandem with high feedgas deliveries to LNG export facilities were expected to draw down storage. As the week progressed, winter weather models showed that Winter 2021 could be much warmer than normal. By December 7, the Henry Hub strip had fallen $0.31 to $2.52/MMBtu. Then last week, the EIA reported a higher-than-expected storage withdrawal, and weather models moved slightly colder. On December 11, the Henry Hub strip climbed back to $2.70/MMBtu.
Power burn is particularly sensitive to gas pricing as gas price compared to the price of other fuels determines where natural gas generation will land in the power supply stack. Low gas pricing incentivizes coal to gas switching in power markets. Switching bolsters gas demand at the expense of coal demand. Coal to gas switching was in full swing in the summer of 2020 due to weak natural gas prices across the US. As a result, summer power burn exceeded 45 Bcf/d for the first time even as total power consumption was down year over year due to pandemic driven declines. The summer relationship between Henry Hub natural gas prices and monthly US natural gas power burn for each summer is shown in the chart below. In general, at lower gas prices, summer power burn climbed compared to previous years.
This relationship means that big downward moves in expected natural gas pricing can add upside for gas power burn, especially in summer when power burn is highest. At the December 1 strip ($2.83/MMBtu), modeled summer power burn is 33.1 Bcf/d, just above the 2018 average. At this price, coal to gas switching is minimal as coal is still the economic fuel choice in many regions in the US. Even at the December 11 strip ($2.70/MMBtu), coal to gas switching is immaterial. Modeled summer power burn at $2.70/MMBtu comes in only 0.4 Bcf/d higher than at $2.83/MMBtu, which is an immaterial change. However, at $2.52/MMBtu, modeled coal to gas switching becomes material as coal is pushed out of the supply stack by cheap gas in most regions in the US. The $0.31 fall in the strip by December 7 ($2.52/MMBtu) relative to December 1 ($2.83/MMBtu) raises modeled summer power burn by 1.1 Bcf/d to 34.2 Bcf/d. Since gains in natural gas generation can be driven by its price relative to the price of coal, which is relatively cheap in most of the US, the fall to $2.50/MMBtu for 2021 has a disproportionate effect on summer power burn compared to the fall to $2.70/MMBtu.
While the market is now signaling in the 2021 strip that it expects 2021 pricing to be above $2.50/MMBtu, if gas pricing comes in at this level, there could be material coal to gas switching to bolster summer power burn. Exacerbating this dynamic in 2021 is the retirement of 3.5 GW of coal capacity in November and December of this year, and an additional 2.6 GW of coal retirements from January to October 2021. As more coal capacity is removed from the market, natural gas will step in to fill the gap left by retirements. As 2020 has shown us, market dynamics can quickly change, but a view on the range of outcomes for 2021 is key to planning for the year ahead. Request a sample of BTU’s Henry Hub Outlook to get more information on BTU’s expectations for 2021 and beyond.