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$10-Plus Gas Prices Through 2008 Appear Justified, Says Analyst

Natural gas prices of $10/MMBtu or higher in the last half of 2008 appear justified, given the colder-than-normal weather last winter, a hotter-than-normal early summer and significantly weaker imports of liquefied natural gas (LNG) and Canadian gas, an energy analyst said last week.

And that's even taking into account exceptional growth in U.S. onshore gas production and solid contributions from the deepwater Independence Hub, said energy analyst John Gerdes of SunTrust Robinson Humphrey/the Gerdes Group (STRH), According to STRH calculations, gas in storage entering the heating season Nov. 1 should only "modestly" exceed 3,300 Bcf, Gerdes said.

Even though the 3,300 Bcf storage level would be 200 Bcf below "normal" levels, "in a historical context, this is a comfortable level of gas in storage," said Gerdes.

There are a lot of factors that are feeding into slightly lower storage levels this winter and higher prices, said the STRH analyst.

For LNG, "intense global competition" will cause U.S. imports to only "slightly" top 1 Bcf/d this year, Gerdes said. U.S. deliveries are "largely impeded by intensifying growth in Far Eastern LNG demand due to the increasing regional importance of gas-fired power generation, the relative attractiveness of LNG versus fuel oil and the emergence of significant Indian/Chinese LNG demand."

In addition, European LNG demand is up because of a move to more gas-fired power generation, concerns about the Russian gas supply and the "likely irreversible decline" in the United Kingdom's North Sea production.

"Notably, oil-indexed Russian gas exports to Europe are currently priced at plus-$12/MMBtu," said Gerdes. "A $10-plus gas price [in] the second half of '08 appears necessary to rationalize enough industrial gas demand to modestly exceed the 3,300 Bcf lower threshold of sufficient gas in storage entering the heating season."

U.S. gas storage levels are gaining from the growth in U.S. onshore gas production, which is showing no sign of slowing down, Gerdes noted. Since early 2007, even with the modest decline in U.S. gas-directed drilling activity and a sub-$8/MMBtu environment, U.S. onshore output continues to surge.

"The relationship between onshore drilling activity and production equated to a 2% increase in well/rig productivity last year, which was a marked improvement over the long-term trend of 5-8% per annum deterioration in U.S. onshore well/rig productivity," said Gerdes. "The improved '07 onshore well productivity was likely the result of greater resource play capital efficiency (industry learning curve), most notably in the Fort Worth Basin Barnett Shale, and increased onshore drilling rig efficiency given the ongoing replacement of roughly 50% of the older rig fleet with new or refurbished units."

The Barnett Shale's output helped Texas contribute more than half of the net growth in U.S. gas production last year, according to STRH research.

"Strong growth in 'Other States' production, driven primarily by development in the Northern Arkansas Fayetteville Shale play, constitutes a further 30%-plus of the net growth in U.S. gas production," Gerdes noted. U.S. onshore well/rig productivity is on track to improve "an astonishing 12% in '08," driven by shale resource plays.

"Next year, assuming a similar increase in gas-directed drilling activity, the 1H08 [first half of 2008] assimilation of new/refurbished onshore drilling equipment and a flattening industry resource play learning curve, we conservatively expect onshore well productivity to revert to the long-term trend of 5% per annum deterioration," he said.

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