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Analysts' Bullish 2010 Stance Leaves Natural Gas a Little Short

A Goldman Sachs analyst team said last week that while it expects an overall rebound in energy commodity prices next year, natural gas values could lag the rest of the complex for at least the next three years.

"Despite our bullish view for 2010 on the back of the expected declines in U.S. production, we believe global natural gas fundamentals remain worse positioned than other commodities due to limited EM [emerging markets] exposure," analyst Samantha Dart and her team said in a Goldman Sachs research note. "Hence, we expect world spot gas prices to prolong their discount to oil-indexed term prices through 2013, even as oil prices rise."

The analysts noted that a combination of a collapse in demand and a surge in supply drove the current global gas glut and that in contrast with oil and other commodities that have experienced a significant rebound in prices since the beginning of the year, world natural gas prices have remained at low levels throughout the period. "Relative to other commodities, natural gas could not be worse positioned, as it has no meaningful exposure to EM, while being highly exposed to DM [developed markets] manufacturing, hit hard during this recession. Further, gas prices have also been under pressure owing to a technological change in supply, namely the development of hydraulic fracturing, better known as unconventional gas, which has driven U.S. natural gas production meaningfully higher in a relatively short amount of time."

Even with the Gulf of Mexico on a steady production decline, the unlocking of unconventional reserves -- i.e., shale plays -- in Alabama, Arkansas, Louisiana, New Mexico, New York, Oklahoma, Pennsylvania, Texas and West Virginia has been billed as a renaissance of sorts for domestic natural gas producers (see NGI, Sept. 7; Aug. 31).

That said, shut-ins brought on by low prices and the rapidly filling storage situation has the analysts believing that declining U.S. production will likely lift the floor to global spot prices in 2010.

"Today, one year after U.S. natural gas drilling peaked, the impact of decline rates on production has become increasingly visible in the weekly inventory builds. In the next 12 months we expect these production declines as well as a rebound in demand to be significant enough that new investment will be required," the analysts concluded.

For the week ending Sept. 12, 2008, rigs searching for natural gas on- and offshore the United States numbered 1,606, according to drilling services firm Baker Hughes. That number dropped by 56% to 705 rigs for the week ending Sept. 18, 2009.

"Accordingly, instead of gas pricing low enough to incentivize demand via coal-to-gas substitution, we argue that prices will need to rise substantially to incentivize supply. This will likely increase the price at which LNG [liquefied natural gas] can be discharged in the U.S., thereby lifting the floor for world spot prices," the analysts said.

Because the rebalancing will also likely be supported by an expected improvement in industrial demand for natural gas, the Goldman Sachs team said it is maintaining its $6/MMBtu and $7.50/MMBtu U.S. natural gas forecasts for winter 2009/2010 and summer 2010, respectively. In addition, the group introduced its U.S. winter 2010/2011 natural gas price forecasts at $7.70/MMBtu, noting that it expects winter 2010/2011 inventories to draw down to 1,492 Bcf, which will lend support to prices.

Despite the expected increase in natural gas prices, the analysts said spot prices will likely remain disconnected from oil-indexed term prices, awaiting EM import capacity growth. "This [disconnect] will be driven, in our view, by a prolonged supply glut in global LNG markets, as new liquefaction capacity will be added to the market. Hence, even as OECD [Organization for Economic Cooperation and Development] manufacturing demand recovers, EM demand growth will be needed to help rebalance the market."

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