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Energy Analysts See Gas Output Falling, Less Optimism on Prices

Demand weakness has forced domestic natural gas producers to lay down rigs at a quick clip, but inventories still may finish the 2009 injection season with 3.9 Tcf in storage, Barclays Capital energy analysts said last week. Meanwhile, Fitch Ratings is no longer optimistic about a rebound in gas prices this year, and late Thursday the credit ratings agency cut its 2009 base case price deck for gas to $4.25/Mcf (Henry Hub) because of the protracted global economic slump.

"Weak demand driven by a sharp global recession is the main driver of the revision to Fitch's price deck," said Fitch credit analysts. "As recently as late 2008, Fitch had anticipated a rebound in natural gas prices late in 2009 driven by a large and relatively quick supply response combined with lower levels of demand destruction than are currently being witnessed. While weather-induced demand stemming from either a hotter-than-normal summer or an active hurricane season could ultimately drive natural gas prices higher in 2009, the underlying fundamentals at this point have driven Fitch to expect weaker near-term prices as natural gas supplies remain high and demand continues to weaken more than anticipated."

Part of Fitch's assumptions about gas prices this year relate to the latest reports from the Energy Information Agency (EIA), which, among other things, found industrial market sector gas demand to be down by 10.1% in December 2008, compared with December 2007 (see related story).

"While there is a possibility that year-end shut-downs and inventory destockings are distorting the data, economic data continues to point to a deep and protracted economic slump in the U.S. with few near-term catalysts to reverse current trends," said Fitch analysts. "Recent commodity price declines are expected to present all end-users with some relief, which could slow demand destruction levels; however, most residential users won't see this relief until the winter 2009-10 due to pricing delays stemming from utility buying and pricing behavior."

Another area of concern for Fitch is EIA's data on the level of gas demand by electric generation users. Fitch pointed to year-end EIA 2008 data, which indicate a 2.8% decline in demand by electric generation users even after a relatively warm 2008 summer. The EIA data also point to higher natural gas production in the United States, and that too is pressuring prices, said the Fitch team.

Production declines following the pullback in drilling "likely" will be distorted compared with previous downturns in the U.S. gas market, said analysts. However, more supply pressures may hit by the second half of the year once an expected surge in liquefied natural gas imports begins to hit U.S. shores, said Fitch. The ratings agency "continues to expect a significant amount of this gas coming to the U.S., particularly during the low demand summer periods, due to a lack of sizable storage capabilities outside the U.S."

Barclays analysts James Crandall, Biliana Pehlivanova and Michael Zenker also see more LNG headed to U.S. shores. Given the uncertainty in global gas markets, the possible outcomes for U.S. LNG imports is "unusually wide," but Barclays is forecasting U.S. imports for full-year 2009 to average around 2.1 Bcf/d, more than double the average 1 Bcf/d expected between April and June this year.

"A global LNG glut is emerging, borne from lowered takes by Asian and European economies, and additions to supply through more liquefaction capacity," said the Barclays team in last week's "Natural Gas Weekly Kaleidoscope." "The U.S. is sure to see at least some of these increased volumes."

The "comfortable" gas storage inventory "will likely be masking deep production declines" by the second half of this year, and without a drilling recovery, the market may see historically low inventories by the second half of 2010, said the Barclays trio.

Gas demand now is lower than it was six months ago, supply has been forced to play catch-up, the Barclays analysts noted. Now both demand and supply "are shifting at an unprecedented pace in a veritable race to the bottom," said Crandall's team. "Overshadowed by the looming uncertainties in demand, supportive supply-side developments are taking place unnoticed, at least as far as prices have been concerned."

For U.S. gas producers, the past few months have sent a "strong signal: stop drilling as soon as you can," said the Barclays analysts. The rig count decline has accelerated since the beginning of the year, "leading to a pullback unprecedented in depth and pace. Given our expectations for continued price weakness through the rest of 2009, the duration of the drilling downturn is likely to be unprecedented as well."

Under current rig count levels, the Barclays analysts think sequential declines, if not already under way, should occur in the "very near future." Assuming the rig count finishes 2009 at 700, which would require another 150 or so rigs to fall, "domestic production could be down as much as 3.8 Bcf/d year/year by December 2009..."

Under Barclays' assumptions, gas storage inventories "are on track to remain in overhang" through early 2010.

"If prices do not rebound and drilling efforts remain depressed, the U.S. market could be heading toward historically low inventory levels" by the second half of 2010," said the Barclays trio. "Thus, we believe the back end of the natural gas forward curve, particularly calendar year 2011, will have to rebound above $7 [per Mcf] to encourage drilling and stem accelerating production declines. The implication should be a steepening contango of the forward curve."

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