Natural gas prices will get support from cold temperatures in the first quarter, and strengthening coal markets will lift the gas-coal switching price floor in Q2 and Q3, but demand will fail to revive gas prices this year, according to analysts at Barclays Capital.
"The drop in 2010 U.S. gas demand is driven by an expected reversal of coal's displacement by gas in 2009, which will push 2010 power-sector demand low enough to offset the gains in the other sectors," Barclays analysts said in a research note published last week. "And the dilemma for the gas industry is that a recovery of gas prices in 2010 would only exacerbate the situation by further trimming gas-coal switching, which would eventually halt the upward movement of gas prices."
On the strength of cold temperatures, Barclays raised its Q1 price estimate to $5.50/MMBtu from $5.20. "Owing to a view that higher coal prices will raise the gas-coal switching floor in Q22010 and Q32010, we have raised our price view for those quarters to $5.00 (from $4.75)." The analysts' fourth quarter price estimate is guided by their October storage level estimate of 3.97 Tcf. "We believe this will hold Q4 2010 prices in check at $5.50 (unchanged). This results in our forecast for 2010 of $5.25."
The positive effects of economic recovery on the demand side will be offset by waning demand for gas among power generators relative to last year due to less displacement of coal by gas. The analysts said the unfolding demand picture could distract market watchers from where the real story is -- on the supply side.
Expectations of a supply pullback due to drilling curtailments are not misplaced, the analysts said. Though producers "have heroically slashed drilling," it won't be enough given that demand will slip this year, the analysts said. Gas supply is expected to continue falling through the first half of this year but then grow modestly at the end of the year.
"The recent snowy, cold weather and price rally could blind producers, prompting an even faster rebound in drilling," the analysts said. "We expect 2010 to register a full 2.1 Bcf/d supply drop from 2009 levels. LNG [liquefied natural gas] import growth of 1.9 Bcf/d over 2009 levels mostly offsets the U.S. decline, but a continued slide in Canadian production and exports causes total U.S. supply to slip 0.9 Bcf/d in 2010."
Although it was not as much as initially expected, global LNG liquefaction capacity grew by a record 5.8 Bcf/d last year, much of it coming online in the second half of the year. "Consequently, global LNG supply rose by roughly 1 Bcf/d year over year -- a substantial increase, yet below what the market was expecting," the analysts said. Europe absorbed the bulk of the excess LNG supply as the continent turned away from supplies of pipeline gas.
This year will see even more LNG supply growth, the analysts said, with a greater likelihood that more of it will come to North America. If all the new liquefaction capacity comes online as people say it will, LNG supply would grow by more than 6 Bcf/d over last year, the analysts said. However, they said a more reasonable assumption is a still-robust 4.5-5.5 Bcf/d increase. Such an increase would leave more than 2 Bcf/d of LNG looking or a home in U.S. and European markets, they said.
"With price differentials favoring U.S. ports, Atlantic Basin spot cargoes are increasingly likely to sail west," they said. "...[S]hort of a major extended cold weather event, the ramp-up of liquefaction plants and the moderation of heating load as the winter wanes should pressure spot LNG prices around the world to again trade closely in 2010."
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