Heading into the Labor Day weekend with a full tank of gasoline might give holiday-makers a reason to smile, but natural gas bulls staring at the end of summer with storage caverns brimming more than usual have little to cheer.
"In the very near term we believe the combination of cooler temperatures across the eastern half of the U.S. and the upcoming Labor Day holiday will result in increasingly higher weekly storage injections that in turn will keep the pressure on the front of the [New York Mercantile Exchange natural gas futures] curve," Credit Suisse analyst Teri Viswanath wrote in a research note last Monday.
Robust storage levels at this time of year were seen in 2006 and 2007, too; however, those stockpiles were built in anticipation of winter deliverability issues while this time around the build is due to abundant supply and weak demand, Wood Mackenzie's Jen Snyder, a North American gas analyst, told NGI. "In both of those years we ended up with events that took some of the pressure off of the market," she noted. "We had some hurricane shut-ins, and as well in 2007 we ended up with a good bit of early cold weather, so that kind of took the constraints off as well."
However, gas bulls shouldn't pin their hopes on a hurricane-inspired price rally given the abundance of gas in storage and the diminished relevance of offshore natural gas supplies to the North American market, said Washington Research Group analyst Edward V. Garlach. "While hurricanes may cause short-term spikes, we believe natural gas market conditions are unlikely to yield any sustainable price increases." There is enough gas in underground stores to "likely mute any hurricane-related price pressures." Additionally, growing production from Lower 48 unconventional gas plays, such as shales and tight sands, has overshadowed the importance of gas production out of the Gulf of Mexico.
Look for the next few Energy Information Administration (EIA) storage reports "to reflect somewhat significant inventory builds that will likely prompt further selling in the [November-December 2009] part of the curve," wrote Viswanath, who put a pencil to EIA estimates of working storage capacity and additions in an effort to figure out just how big the industry's gas "tank" is.
Citing an EIA estimate from last year that Lower 48 working gas capacity was 4.17 Tcf with about 92%, or 3.79 Tcf, of that usable by the industry, Viswanath added 86.42 Bcf to account for capacity additions to arrive at a working capacity estimate of 4.22 Tcf, of which 3.87 Tcf is the peak. "Based on EIA's capacity utilization assumptions and our estimates of new storage additions over the last year, this would establish a 2.2 Tcf storage ceiling for the East Region, 1.16 Tcf for the Producing Region and 0.5 Tcf for the West Region this year," Viswanath wrote.
The Producing Region, at 92.4% full, has the least amount of room left for more gas during the balance of the injection season, Viswanath noted, an observation that also was made recently by analysts at Barclays Capital. A month ago they wrote that that storage would reach 3,930 Bcf by the end of October and that Producing Region caverns would fill first (see NGI, July 27). "...[F]ull storage in the [Producing] Region could result in very low cash prices for Henry Hub and increased pressure on the Nymex curve," Viswanath wrote. "Furthermore, based upon our supply-demand projections we see very few options for balancing the market outside of forced production curtailments."
Analysts at Raymond James & Associates Inc. recently noted producer shut-ins to come. "Obviously, these shut-ins will skew the supply data even more as we move through the third quarter," they wrote.
More near term, though, the storage build is projected by Stephen Smith of Stephen Smith Energy Associates to decelerate. Smith wrote recently that he expects storage to reach about 4,009 Bcf on Oct. 30, a surplus of 984 Bcf versus 10-year norms and a surplus of 385 Bcf compared with the year-ago period.
As low as gas prices are -- and could get -- they won't be the primary cause of production shut-ins. Instead, as some industry executives have previously predicted, pushback from packed pipelines will force lower-pressure wells out of the gas supply mix, Barclays Capital analysts said last Tuesday.
Calling the gas storage outlook for the next few months "a train wreck," the analysts wrote that "we do not expect low prices to be the primary driver of shut-ins. Rather, infrastructure-related constraints are likely to account for the bulk of the supply reduction, causing involuntary curtailments of production -- producers literally squeezed out of the market."
During second quarter earnings conference calls some producer executives had already predicted as much. EOG Resources Inc. CEO Mark Papa earlier this month said there could be "automatic curtailments pretty much across the board" if pipeline pressures get high enough (see NGI, Aug. 10).
That's not to say prices won't dictate shut-ins, too. By Barclays' estimate, production costs for a group of 48 exploration and production companies, whose output accounts for about 43% of U.S. production, averaged $1.85/Mcfe last year. Of course, actual costs vary from play to play and from producer to producer, but "if cash prices fall below the variable cost of production, price-induced shut-ins could also occur," the Barclays analysts wrote.
"Producers will have to reduce production in order to prevent $2.50 gas prices," Bentek Energy LLC analyst Rocco Canonica told NGI. "We believe the forward market is significantly overvalued, so we're telling buyers not to lock in winter baseload with the current forward strip but wait until it comes off."
Cash prices will bear the brunt of the oversupply situation, according to Barclays. "Although we do expect further downside potential for the [futures] prompt month from the current levels, we would be surprised to see a sustained move below the $2.50/MMBtu mark," the analysts wrote.
Weak prices and storage constraints have prompted some producers to announce production curtailments to come during the second half of the year. Newfield Exploration Co. is one, saying it would voluntarily curtail about 2.5 Bcfe of its 3Q2009 production in response to low prices (see related story). "The cumulative announcements amount to about 61 Bcf for the second half of the year," the Barclays analysts wrote. "We believe private companies are more likely to be disciplined about cutting production when prices are below costs since these companies generally try to maximize earnings an they do not face pressure from public investors to maintain production growth."
To a great extent producers have become the victims of their own success, having unlocked unconventional resource plays only to deliver gas into a recession-addled market.
"The shale gas keeps growing," observed Canonica. "Producers have high-graded their drilling programs, moving rigs out of conventional plays and into the shale plays. They can reduce their active rig counts but still produce the same amount or even more gas. They are going to have to slow down production in the coming months. How much they slow down will help determine the price, but weather, as you know, is the factor that can change the balance the most."
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