The widely held belief of the last few years that natural gas would be transitioning to a crude oil-like global market in the near future appears to be overstated, if a new report from Goldman Sachs analysts holds up. Higher than expected U.S. production levels will likely prolong the "winter disconnect" between U.S. and international natural gas prices through, and possibly beyond 2009, according to Goldman Sachs analysts Samantha Dart and Jefferey Curry.
"While North America will have to find an outlet for its excess gas supplies, the rest of the world is likely to remain tight," particularly in the first half of 2009, Dart and Curry said. "As a result, we expect average 2009 U.S. natural gas prices to continue well below international levels, at $8.30/MMBtu, significantly lower than our UK NBP [National Balancing Point] of $14.80/MMBtu."
With the current financial turmoil, some market experts note that the credit crunch will likely reduce production in 2009. A group of Barclays Capital energy analysts said Tuesday that the tight credit environment could prove to be the bigger concern for natural gas drilling in 2009 than the sharp fall-off of gas prices over the past few months (see related story).
Some producers are already reducing drilling targets and capital expenditure budgets. The latest to trim capex budgets are Quicksilver Resources, Equitable Resources, Denbury Resources and ATP Oil & Gas Corp., Devon Energy Corp. and PetroQuest Energy Inc. Chesapeake Energy Corp., Petrohawk Energy Corp., Penn Virginia Corp. and SandRidge Energy have all made similar reductions to deal with the current economic environment.
Even as U.S. natural gas prices continue to sink, the Goldman analysts said they find the commodity undervalued, noting that winter cold could change things in a hurry. They added that they expect excess supplies in 2009, but the market first has to get through the winter.
After peaking at $13.694/MMBtu on July 2, 2008, front-month natural gas futures prices have plummeted, closing at a $7.159 (52%) discount from the summer's peak to Friday's (Oct. 10) finish at $6.535/MMBtu.
Despite the production growth, the analysts maintain that current prices are undervalued because the economic crisis of the past few weeks, which has triggered a sell-off across all commodities, has exacerbated the downward price pressure on natural gas. "With hurricanes Gustav and Ike likely removing an estimated net 231 Bcf from the market, inventories are now expected to start the winter at 3,361 Bcf and end the winter at 1,417 Bcf, assuming normal weather, leaving substantial upside vulnerability to cold weather shocks," Dart and Curry said. "On net, we now expect 2008/2009 winter prices to average $9.50/MMBtu, well above the current forward curve but a downward revision from our prior forecast."
The analysts added that U.S. natural gas prices are approaching Appalachian coal prices, providing incentive for fuel substitution to combined-cycle natural gas plants from the least efficient coal plants. "The leftover coal can then be exported to Europe," the analysts said. "Given that we believe natural gas prices will move so as to motivate such fuel switching and rebalance the market, we are introducing our summer 2009 Nymex [New York Mercantile Exchange] natural gas forecast at expected parity with coal, at $7.80/MMBtu." Because the coal-to-gas fuel substitution would likely tighten the U.S. balance by 240 Bcf, the analysts said there is an upside risk to their 2009 U.S. natural gas price forecast.
Dart and Curry said that while U.S. natural gas prices headed lower during summer 2008, global prices for the commodity rallied. The analysts said U.S. production growth has led to a surplus, which is "decoupling" the U.S. market from the rest of the world.
"Importantly, this strong production growth has raised the prospect that North America may be shifting into a 'trapped' basin, where a lack of export capacity amid ample supply will lead to a prolonged period of much weaker U.S. natural gas prices relative to the rest of the world," they said. "Specifically, the higher-than-expected U.S. natural gas production increases that became apparent in July and that led us to lower our Nymex natural gas price forecast in August were confirmed by the 9% year-over-year production growth just reported by the Department of Energy (DOE) for July. We believe these production increases will likely prove persistent in the next year, prolonging and deepening the winter disconnect that we expect between U.S. and international natural gas prices through, and possibly beyond, 2009."
As a trapped basin with excess supply, Dart and Curry identified five adjustments that could absorb the excess gas over time:
On the international front, the analysts said they believe the rest of the world will likely continue to fight for imports, particularly in the first half of 2009. As a result, they believe that both UK NBP and spot LNG prices will maintain a close link to oil-indexed natural gas prices during that period. However, with the arrival of the second half of 2009, support to European exchange-traded natural gas prices may weaken as new global liquefaction capacity ramps up and Japanese nuclear power capacity is restored. "We are therefore introducing our summer 2009 and 2009/2010 winter UK NBP price forecasts at $13.50/MMBtu and $17.20/MMBtu, respectively."
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