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Analysts Look to Second Half for Price Strength

Looking ahead to the second half of next year, analysts at Bank of America Merrill Lynch see the potential for some gas price recovery. However, the cash market will remain weak for the near term and volatility will be high, they wrote in a recent research note.

"In our view, there is some value opening up in the second half of 2010," they wrote. "We stick to our average 2010 forecast of $6/MMBtu, relative to the forward of $5.40/MMBtu. In our view, gas prices could rise to an average of $7.60/MMBtu in the fourth quarter next year to reflect a tighter market, relative to the current forward of $6.00. Overall, we expect the forward curve to continue to flatten going forward."

Demand destruction, robust production from unconventional plays and rising volumes of liquefied natural gas are keeping a lid on gas prices, the analysts noted. "...[W]e expect bearish market fundamentals to limit the upside of U.S. natural gas prices this winter," they wrote. "In the absence of storage capacity or fuel switching, U.S. natural gas prices will have to gyrate daily to balance supply and demand."

While gas benefited earlier this year from fuel switching from coal to gas by power generators, it's now payback time as generators work through coal stockpiles in an environment of weak baseload generation demand, the analysts noted.

For the gas market to rebalance itself, prices will need to remain "low" at least through February, according to the analysts. "...[W]e believe most of the rebalancing in the U.S. natural gas market will have to come from the supply side," they wrote. "To date, the impact of the sharp rig count reductions is still concealed by rising shale gas production."

Production declines from rig count reductions and field declines should manifest themselves in the third quarter. "Dry [gas] production should decline from a peak of 58 Bcf/d down to 53 Bcf/d by mid-next year," the analysts wrote.

Regardless of what happens with weather and the economy, gas prices will have to rise by the middle of next year to entice producers to bring rigs back into production, the analysts wrote.

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