Barclays Capital has reduced its outlook for 2016 U.S. natural gas prices, but balances are expected to tighten in the second half of next year as growth slows and demand grows from the largest non-weather related demand increase since 2010.
The domestic gas price forecast for 2016 has been reduced to $2.85/MMBtu from $2.95. Prices in the first quarter are expected to average $2.65/MMBtu, followed by $2.45 in 2Q2016, $3.10 in 3Q2016 and $3.15 in 4Q2016. Goldman Sachs last week also estimated 2016 prices would average $2.85 (see Daily GPI, Nov. 19).
"In the short term, it is hard to argue with the bearish fundamentals as we head into this winter," Barclays analyst Nicholas Potter said in the recent Gas and Power Kaleidoscope. "This forecast makes us bullish relative to the curve for the second half of 2016."
Barclays continue to see an upward trend in prices in the second half of 2016 because of new market demand. The futures market currently is pricing in a warm winter but if it's not as warm as forecasted and production increases disappoint, "the pieces should be in place" for a second- half 2016 rally.
"In our view, another wave of Northeast infrastructure additions is set to boost year-on-year November-March production in the region by around 2.4 Bcf/d," Potter said. "As Northeast production increases are pushed later into the winter, we think total November-March production will average around 73 Bcf/d, largely static with last year's levels."
Parallels can be made between the winter market of 2011-2012 and the current period, Potter said. Currently the futures market is pricing 1Q2016 at $2.52/MMBtu, 5 cents above where 1Q2012 traded, with 2Q2016 priced at $2.54/MMBtu, 27 cents above where 2Q2012 traded.
"The winter of 2011-12 was a tough environment for U.S. natural gas prices," he said. "Relatively high storage levels at the end of October were met with a 5.2 Bcf/d winter-on-winter production increase and a winter that was 14% warmer than normal. The result was one of the lowest storage drawdowns on record, leaving the market with 2,473 Bcf of gas at the end of March 2012. This, of course, had implications for price, with shoulder season getting hit the hardest and April 2012 averaging just $1.94/MMBtu."
Current output and weather aren't as bearish as they were four years ago, but the overall storage level is. The winter of 2011-2012 also shows how quickly a long market may shift into balance, according to Potter. "In 2012 the market was helped by a summer that was 11% warmer than normal. This helped prices to rally from a monthly low of $1.94 in April 2012 to a high of $3.52/MMBtu in November 2012. We think new demand could cause a similar situation this year."
The current April-October strip is priced at $2.61/MMBtu, and given slower supply additions and new demand, the period could be undervalued.
As production growth slows in 2016, demand will begin to pick up through liquefied natural gas (LNG) exports, industrial demand and more pipeline exports to Mexico. The fundamentals will be seen toward the middle of the year and this matters "because as new demand creeps into the market, the cushion that has limited upside price volatility over recent years will start to be a little less cushy."
An estimated 2.3 Bcf/d of new organic demand is expected to enter the market next year, the "largest non-weather related demand increase since 1.8 Bcf/d of incremental industrial demand occurred in 2010," Potter noted. "We think June-August will test the case for how the market is handling this new demand. By that point, both LNG trains at Cheniere's Sabine Pass will be operating (each 650 MMcf/d), infrastructure additions should set new records for pipeline gas exports to Mexico, which historically peak in summer and new U.S. industrial plants will also be ramping up."
Barclays has reduced its year/year production growth forecast for 2016 to 700 MMcf/d from 1.5. Bcf/d.
"According to our supply models, production levels will average 73.8 Bcf/d in 2016 with production largely static or partially declining until a new round of northeast infrastructure additions hits the market in 4Q2016," Potter wrote. "A lower rig count is starting to take hold on production levels in other U.S basins," evidenced by the Energy Information Administration's latest Drilling Production Report (see Shale Daily, Nov. 9).
Weather, as always, could be the X factor in determining if the gas market tightens next year or faces another year of oversupply. The market is doing what it can to rebalance, but El Nino poses a downside risk to the price forecast, which assumes normal weather.
"A 4% warmer than normal winter would cut at least 2 Bcf/d of residential/commercial demand and would leave storage levels in April around 15% higher than our base case estimate of 1.7 Tcf," Potter said. "In this scenario, downside price risk could be around 25-30 cents/MMBtu to our base case forecast of $2.84/MMBtu."