Expect higher heating costs this winter as natural gas takes a violent price upswing

Natural gas prices have climbed to their highest level for seven years in real terms, as traders anticipate a shortage this winter, with consumption rebounding more quickly than production from the pandemic slump last year.

The global market is experiencing a classic but violent price cycle, with an unprecedented downturn in 2020, caused by the coronavirus epidemic and lockdowns, creating the conditions for a boom in 2021-22.

Last year, volume-weighted global prices fell to their lowest annual level since 1995, after adjusting for inflation, according to the World Bank.

The result was a sharp cutback in drilling and capital investment across the industry, leading to an unprecedented decline in worldwide output, which has remained depressed even as global economic activity has surged.

In an inevitable reaction, monthly prices have now climbed to their highest in real terms since mid-2014, as traders anticipate there will not be enough production to meet all the demand from consumers by the end of the year.

By August, real prices had risen to the 68th percentile for all months since 1980, up from the 1st percentile in June 2020, with further sharp increases so far this month.

Rising prices are sending a strong signal to the industry of the need to boost production and are providing the cash flow to finance a major increase in output, which should support strong growth in 2022 and 2023.

Before the pandemic, both global production and consumption had increased at a compound rate of roughly 3% per year between 2009 to 2019.

But the pandemic caused consumption to drop by 2.1% last year (the largest decline since the financial crisis in 2009), while production plunged even more sharply by 3.1% (the largest decline since at least the 1970s).

As a result of the aggressive supply response, the emerging oversupply of gas had largely been brought under control by the end of 2020.

A colder-than-normal winter, including the big freeze in Texas in February, then eliminated excess inventories, with stocks falling below the five-year average by March and April.

In the next few months, with production largely fixed, high prices will have to choke back consumption through conservation, fuel switching (mostly to coal in power generation) and reduced use (mostly by industrial shutdowns).

But over the next year, higher prices will progressively incentivize more drilling and production, which should return the market to balance by the end of 2022.

John Kemp is a columnist for Reuters.