With storage building and natural gas prices no longer surging, Friedman, Billings, Ramsey & Co. Inc. (FBR) joined a growing chorus of energy analysts in trimming its forecast for U.S. gas prices for the next two years to reflect the "impending flood of shale gas."
FBR's Rehan Rashid, who with his team analyzes exploration and production (E&P) companies, based the reduction in gas prices following a review of five major U.S. shale plays: the Barnett, Haynesville, Fayetteville, Woodford and Marcellus. On those five plays alone, the United States will see a glut of new gas supply, Rashid said.
"We estimate that natural gas supply from these shale plays could increase to about 10 Bcf/d by 2010 and to 16.75 Bcf/d by 2012, with a peak of 38.75 Bcf/d around 2027, from a combined 4.3 Bcf/d today," he said in a note to clients.
Based on its analysis, FBR cut its full-year 2008 natural gas price forecast to $9.75/Mcf, which is below the New York Mercantile Exchange (Nymex) estimate of $10.28. FBR analysts estimate that gas prices will average around $7.25/Mcf in 2009, well below Wall Street's current consensus estimate of $9.44 and the Nymex estimate of $10.02. FBR analysts estimate that 2010 gas prices will average $6.25/Mcf, also well below the current Wall Street consensus of $9.04 and the Nymex estimate of $9.87.
"The analogy to U.S. natural gas supply growth between 1950 and 1970, when U.S. natural gas production quadrupled, makes it very clear to us that when the industry is given a set of assets and provided an economic incentive, it is very efficient in accelerating production, cash flows and associated NPV [net present value]," Rashid noted. "Our analysis indicates that sufficient new rig build capacity is available to achieve this growth rate."
In the near term, bottlenecks from lack of infrastructure "will no doubt be encountered," the FBR team wrote. "Longer term, we have to believe that it is in the economic interest of the collective supply chain to respond to secular needs of equipment and people required to monetize this growth potential and the associated economic value, just as the industry did back in the 1950s."
For the past six months the energy analysts with Raymond James & Associates Inc. have remained bearish on natural gas prices. However, they continue to forecast strong earnings for both oil and gas companies over at least the next five years.
Raymond James' J. Marshall Adkins and Pavel Molchanov noted in last week's Stat of the Week that the three-week sector rotation out of energy and into previously underperforming groups, such as financials and retail, mostly was triggered by the pullback in U.S. gas and oil prices.
"Oil prices have more than quadrupled over the past six years, and energy earnings have followed suit," wrote Adkins and Molchanov. "Despite the good run, investors have yet to fully appreciate the enormous shift of wealth that is flowing (and should continue to flow) into the energy sector. While it may take time, we believe the market will eventually pay for the phenomenally strong earnings and cash flows that this sector should generate over the next five years. This means that investors should look for a return to the long-term sector rotation into energy stocks over the next five to 10 years."
Generally, investors are running away from the outperforming -- and generally "gassy" energy stocks, they noted. "This sector rotation has been more rapid and severe than just about any energy-related correction/rotation we have seen in years..."
The long-term trend in strong earnings "will be achieved by bullish oil fundamentals driving energy earnings upward faster and longer than the average S&P 500 company," wrote Adkins and Molchanov. "Because of this sustainable and significant energy earnings outperformance, we have consistently argued that not only are investors underweight energy stocks, but they are now materially underweight energy stocks. While the stock market was starting to wake up to this reality for the first half of this year, the sector rotation out of energy in July shows there is ample room for energy weightings to continue trending upward over time."
The stock market "doesn't believe that $120+ oil is sustainable," the Raymond James analysts noted. "If oil prices plummet, then obviously future earnings come down and earnings growth would turn negative. Under our commodity price assumptions, however, we think this scenario is extremely unlikely. For 2008, for example, we are projecting record $113/Bbl oil (up 62% year/year), followed by $130 oil (up 15%) in 2009."
Raymond James also is projecting a decline in gas prices to $7.50/Mcf in 2009. "But we would emphasize that energy sector earnings within the S&P are much more oil-levered (given that the mega-cap integrated majors are oil-focused) than the average E&P or oil service stock we cover. Meanwhile, investors should not ignore the double-digit organic production growth from many of the gas-weighted E&Ps."
According to Adkins and Molchanov, "the only fundamental difference we see with regard to 2009 versus the past few years is that energy earnings growth should be driven predominantly by oil rather than gas, at least for North American companies."
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