Despite the rapid withdrawal of natural gas storage supplies due to a brutally cold December and early January, "stubbornly high" U.S. production, more liquefied natural gas imports and the return of coal as a competitor in the power sector "will likely work to contain the upside potential of prices in 2010," according to a new research note from Barclays Capital analysts James Crandell, Biliana Pehlivanova and Michael Zenker.
"That white stuff on the ground is not just snow, it is symbolic of gas demand," the analysts noted. "Cold weather has whittled away a significant amount of the storage surplus, reminding the market that winter always offers the prospect of a reset button. Expected additional cold weather (February, according to some forecasters) offers the possibility of the complete elimination of the y/y storage surplus, a surplus that has plagued the market for over a year and a half. This has helped to revive gas prices -- the first break for producers in some time."
However, the analysts question whether the market is "growing snow blind" by focusing on the storage-slimming weather and ignoring the supply side. Even with the first really cold winter in five years boosting gas demand, the market still faces resilient U.S. production and growing imports.
"Excess production and very weak demand was the underlying cause of the 2008/2009 price pullback," the analysts said. "With the industry able to field far more rigs than needed, plenty of drilling sites on hand and growing evidence that rig productivity grew in 2009, we believe only producer restraint can avoid another supply overshoot in the coming drilling wave. With 2010 hedges in place, and the investor drumbeat for topline growth as loud as ever, producers have the tools in place and the motivation to drill."
As a result, the market could fall prey to the challenges the industry has faced since 2008: too much supply and stagnant trend demand. "Although producers cut drilling, they did not cut enough, by our calculations," the analysts contend. "And higher near-term prices might only push drilling faster in 2010. The market in 2010 remains moderately oversupplied. We expect Henry Hub prompt-month prices to average $5.25, up somewhat from our fall 2009 estimate of $5.05."
The Barclays group added that there are some "unusually large wildcards" that could swing the market this year. In addition to an uncertain weather picture, the analysts cited the wide range of potential U.S. LNG imports and the uncertainty over the displacement of coal by gas in 2010.
"Although we dismissed the concerns that North America would be flooded with LNG in 2009, we do not brush aside the same argument for 2010," they said. "Global LNG supply is almost certain to outpace global LNG demand in 2010, creating an unusually large amount of spot LNG in 2010. The real question is where the surplus LNG lands. Neither the U.S./Canada nor Europe requires spot LNG at this point, so spot trade will head to the market with the most favorable prices. That is, the trans-Atlantic spread, not absolute prices, will drive the destination of spot cargoes, and the trans-Atlantic spread has swung in favor of North America."
On the power demand front, the analysts said that if coal displacement were to end, it would leave a gas demand hole that simply could not be filled by demand growth from other sectors, regardless of the magnitude of the economic recovery. "Even with our above-consensus outlook for power demand growth in 2010 of 3.5%, there is not enough power demand to allow coal to return to trend level output (five-year average) without pushing gas demand in the power sector significantly lower. We expect that coal displacement by gas will continue through 2010, but at reduced levels compared with 2009, as gas and coal continue to fight for marginal megawatt-hours in the key eastern market regions."
The analysts said continued cold weather could push end-of-March gas storage inventories down to 1.6 Tcf, which would support prices going forward. "We had projected at the start of winter that normal winter weather would result in a record end-of-March storage inventory of 2 Tcf," the analysts said. "Now, should the rest of winter feature 10-year normal weather, we project an end-of-March storage level of 1.77 Tcf."
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