Some traders in the natural gas market are expecting very dramatic downside because 5 cent strike Oct-23 puts on the ICE NYMEX look-alike futures contracts recently traded in the options market. The buyer of the 5-cent strike put is expecting negative or zero pricing at the Henry Hub for an entire contract month. The June-23 $1.00 strike puts recently traded at 2.2 cents per MMBtu. Those are expensive deep out-of-the-money puts with an underlying at $3.47 per MMBtu for June-23. The natural gas market is now putting an additional premium on dramatic downside. Extremely warm weather in January-2023, rising production, and the loss of 2 Bcf/d of demand from the Freeport explosion since June 8, 2022, have led to additional premium being placed to the downside. The next thing on our minds is if the natural gas market does need to have production shut-ins to avoid overfilling in storage by the end of summer 2023, at what price level would they occur in the major natural gas producing basins and how much volume would be shut-in at each price level.
Production Shut-In Price & Volume
In April 2020 through June 2020, roughly 3 bcf/d of natural gas production was shut-in when the NYMEX futures contracts hit the $1.50 per MMbtu price level. Natural gas production fell by around 9 Bcf/d from Apr-20 until May-20, but most of the lower natural gas production was due to lost associated production from the massive amounts of oil production that was shut-in when oil prices went negative. In isolation to natural gas production itself, it is estimated that 3 Bcf/d was shut-in during the heavy Covid lockdown period of Apr-20 through Jun-20. Although, producers are significantly more efficient since that time period, runaway cost inflation has offset much of those efficiency gains over the last 3 years. Therefore, the $1.50 per MMBtu price level still seems to be a reasonable level where shut-ins begin at around 3 bcf/d.Another way of estimating the price levels where production shut-ins will occur is to look at the variable production costs of the publicly traded pure natural gas producers.
The assumption is that once the price of natural gas goes below its variable production cost in the region, there should be producers who temporarily shut-in their production. The other factor to consider is the cost of shutting in production and bringing production back online once prices go back above variable production costs. Production shut-in costs are not reflected in current quarterly reports, but they are still significant. The average variable cost of all of the pure natural gas producers in the bar graph is $1.39 per Mcf. This number is close to the $1.50 per MMBtu production shut-in level that was witnessed during the heavy Covid lockdown period from Apr-20 until Jun-20. This sample is more heavily weighted towards Northeast Marcellus and Utica producers. Antero Resources and Range Resources have variable costs at $2.84 and $1.80 per Mcf, respectively. SilverBow Resources, an Eagle Ford natural gas producer, has variable costs at $1.15 per Mcf. Comstock Resources, a Haynesville producer, has variable costs at $0.76 per Mcf.
There is a lot of production volume that can be shut-in once prices go below $1.50 per MMBtu. Production shut-ins can be as high as 4.5 Bcf/d once prices go below $1.35 per MMBtu in the Northeast based on current variable production costs. However, as prices go lower, variable operating costs will likely come down, making it a moving target lower.
The general price level where production shut-ins begin is a NYMEX price of $1.50 per MMBtu. Some producers in the Northeast may shut-in some production at higher price levels of around $2 per MMBtu. Prices below $1.35 per MMBtu in the Northeast could lead to a large amount of production shut-ins of around 4.5 Bcf/d.