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OFOs Growing, Prices Receding and Gas Shut-ins Appear Inevitable

Natural gas production is being curtailed in pockets across North America and some completed wells are not being hooked up, events that energy analysts say are inevitable, given weak prices and a growing list of storage-related operational flow orders (OFO).

According to the Energy Information Administration's storage report on Thursday, working gas in storage as of Sept. 4 stood at 3,392 Bcf. Stocks are 495 Bcf higher than last year at this time and 503 Bcf above the five-year average of 2,889 Bcf.

Price- or OFO-related producer gas shut-ins will average "on the order of 180-200 Bcf between Aug. 28 and mid-November," energy analyst Stephen Smith said last week. Smith based his forecast on total degree days, which he said were four degree days below normal, or in other words, a light cooling load.

"This is unusual storage behavior given that there has been a sustained production excess relative to weather-normalized demand for over a year," Smith said. For the first time in about 10 years, cash Henry Hub prices early last week broke the $2/MMBtu level, he noted. "While it is too early to draw a hard conclusion directly from production data, storage behavior suggests that production shut-ins rose sharply" in the week ending Aug. 28. "With cash gas prices now near $2, a measurable increase in shut-ins would make sense. We expect this phenomenon to continue and perhaps increase in scale possibly until early November."

Smith's base-case outlook through October assumes $60-75/bbl West Texas Intermediate crude, private weather service degree day projections through Sept. 18, 30-year SSEA-weighted averages for cooling degree days and heating degree days, and no substantial hurricane effects.

"These assumptions lead to a projected storage level of about 3,834 Bcf on Oct. 30, which would represent a surplus of 809 Bcf versus 10-year storage norms (as compared with a 385 Bcf surplus one year earlier)," said Smith. "In this environment, with no residual hurricane effects, we estimate a late October 2009 gas-to-residual spread in the range of minus $7/MMBtu to minus $8/MMBtu."

Imbalance restrictions and OFOs at several pipelines have been reported by NGI in the past couple of weeks. And Raymond James & Associates Inc. energy analysts Darren Horowitz and Emily Wang said last Tuesday, "This will not be the last time you hear the acronym OFO."

Imbalance warnings, critical storage days and OFOs are being issued more than two months before injection season ends, which "tells you that we've only seen a small preview of what's to come," wrote the Raymond James duo. "As we head further into injection season and gas storage inches closer to capacity, expect gas-on-gas competition to intensify and create more imbalances in the system. And like a broken record, we continue to say that when the market can no longer shove anymore gas into storage, producers will need to shut in production and natural gas prices will likely fall sub-$2/Mcf."

Several producers confirmed that onshore gas curtailments have begun:

A pipeline may be imbalanced for several reasons, but "the more relevant reason why we believe that pipelines are issuing notices now -- with 10 weeks left in the injection season -- is that the U.S. natural gas storage system is feeling the early effects from being too bloated," said the Raymond James analysts. "Clearly, the slew of imbalance orders and critical alerts issued last week by these Northeast-bound interstate pipelines was a means to stay under this 80% threshold."

In the East Region, the Raymond James analysts noted that storage reached an all-high of 2,041 Bcf on Nov. 13, compared with the Energy Information Administration's maximum storage calculation of 2,178 Bcf. "Today, East storage is currently 1,724 Bcf (84% of the all-time high), while at this same time last year storage was only 1,599 Bcf (78% of the all-time high). Since the Producing Region is essentially already full, a much greater percentage of available gas supply is now flowing into an already oversupplied East Region. That means it is going to get uglier, fast" and "the worst is yet to come."

In an "ideal world," the warnings and OFOs issued last week "should have acted as an emergency brake on flows into storage, and going forward, pipeline operators in the East Region would all ensure that storage fills up on a more steady/even basis," said the duo. "But in reality, as we head further into the tail end of injection season, we believe that the gas-on-gas competition amongst shippers will intensify, thereby creating more imbalances in the system. We could see more warnings or OFOs on other interstate pipelines, or if things get really ugly, we could see higher OFO stages and higher penalties."

Shippers with firm transport capacity or available interruptible transport capacity will benefit the most because they have the ability and incentive to drive spot prices downward, noted the Raymond James analysts. "There is little room for local distribution companies (or LDCs) to 'arb [arbitrage] the market' with their capacity (since most are regulated or governed by prudency schedules). In other words, natural gas falls victim to the marketers, who must find a fair value for the gas in an extremely oversupplied market. And with nearly 50% of the capacity in the Producing Region owned by marketers, this could magnify the problem, leaving cash prices at the Hub looking not-so-pretty."

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