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Raymond James: Natural Gas 'Disaster' Averted

An "extremely" warm summer, combined with coal-to-gas switching, has created an "unprecedented" Bcf/day swing in the year/year natural gas supply/demand balance, which should lead to higher prices through the second half of the year, according to energy analysts with Raymond James & Associates Inc.

In a note to clients, analysts J. Marshall Adkins and Collin Gerry said the "market is working" and the "gas disaster" appears to be over.

"Throughout this summer, we have seen significantly tighter storage numbers, which has gradually eaten away the record storage surplus from last summer," said the analysts. "For the balance of summer, we forecast that the market must remain 3.75 Bcf/d tighter than last year to clear the current 465 Bcf storage overhang. As a result, we believe U.S. natural gas prices must average in the $2.50 to $3.00 range for the next 100 days."

Raymond James increased full-year 2012 U.S. gas prices to $2.65/Mcf from $2.50. The 3Q2012 forecast was increased to $2.90 from $2.25, while the 4Q2012 forecast was upped to $2.75 from $2.50. The 2013 gas price estimate remains at $3.25, and 2014 gas price estimates still are set at $4.00/Mcf.

"In February of this year our 2012 U.S. gas model suggested that the U.S. would need to either shut-in or switch (coal-to-gas) about 4.5 Bcf/d through the summer to rebalance the U.S. gas market," noted Adkins and Gerry (see NGI, Feb. 13). "At the time, we figured U.S. gas prices would need to average about $2.50 this year to force the rebalancing.

"So far, our assumptions from six months ago have more or less played out. Thanks to the warmest summer on record, we now think 2012 U.S. natural gas prices will average closer to $2.65 and improve gradually over the next two years."

The gas markets "have worked brilliantly this year," wrote the analysts. "With encouragement from sharply lower gas prices, the year/year U.S. gas supply/demand equation has gone from roughly 2 Bcf/day looser (in November 2011) to over 4 Bcf/d (in July 2012)."

With gas prices rebounding to more than $3/Mcf, "the gas market is in better shape than it was six months ago. However, we still have a massive surplus of gas this summer. That means gas prices will likely need to average between $2.50 and $3.00 for the remainder of the summer to avoid over-filling the gas storage system over the next few months."

In 2013 domestic gas prices should improve "but only modestly (to a $3.25 average)" because coal-to-gas switching should reverse "sharply" when gas prices exceed $3.25/Mcf.

Beyond 2013, gas prices will be more closely tied to oil prices "in an inverse relationship," said the duo. "In other words, the lower oil prices go, the higher natural gas prices will go. The simple reason for this is the incredible amount of associated gas supply that is being brought on from these so-called liquids-rich plays."

If West Texas Intermediate oil prices fall to the mid-$60/bbl level, which Raymond James expects in 2013, then U.S. oil drilling should fall and associated gas supplies would taper off as well.

"Bottom line: if oil prices and oil drilling decline as we expect, then U.S. gas prices should move back above $4.00/Mcf in 2014," said Adkins and Gerry.

The analysts also noted that "summer-ending storage" no longer is defined by the Oct. 31 date because injections continue into November.

Last year the weather-adjusted y/y gas supply/demand balance began November with about 2 Bcf/d in the system, noted the analysts. When gas prices fell below $2.00/Mcf, "market forces drove the y/y supply/demand balance down to a whopping 6 Bcf/d gas in the system. As a point of reference, we have never seen that magnitude of change in such a short period of time." To avoid overfilling storage before the end of October, the gas market has to be "much tighter" in the next 100 days.

"We think the gas equation must continue to run about 3.7 Bcf/d tighter (or less gas in the system) to get to the 3.9 Tcf of estimated maximum storage capacity," said the duo. "We currently have 465 Bcf more gas in storage than we did this time last year. Last year, U.S. gas storage peaked at 3.85 in mid-November. If we assume gas storage peaks this year at 3.9 Tcf in mid-November, we must eat up 415 Bcf more gas over the remaining 98 days than we did last year.

"This equates to a 4.2 Bcf/d overhang. However, we can't ignore the fact that last year's weather was particularly mild. Thus, if we normalize for weather demand, the final answer is 3.7 Bcf/d of natural gas excess that must be priced out of the market."

Meanwhile, Fitch Ratings reduced its U.S. natural gas price deck for 2012, with the base case Henry Hub (HH) price at $2.75/Mcf, on weak pricing and the prospects of an ongoing oversupply in the domestic markets.

"While recent heat wave conditions have pushed electric generation usage up sharply this summer, this has been balanced against a very mild winter, which has led to average year-to-date pricing of just $2.43/Mcf as of the end of July," wrote analyst Mark C. Sadeghian and his team.

With a view of a "modest, longer-term decline" in gas prices, Fitch cut the long-term, midcycle gas price to $4.50-5.00/Mcf. "This drop reflects the fact that catalysts for higher natural gas usage are modest, and the economics of shale-based liquids projects continue to drive capital expenditure (capex) decisions, resulting in the treatment of associated gas as a by-product in a number of plays, allowing producers to tolerate lower all-in natural gas prices," said analysts.

The West Texas Intermediate (WTI) base case price deck for 2012 was raised to $92.50/bbl "to reflect near-term market factors," with the 2012 stress case WTI raised to $80/bbl; the long-term stress case price is unchanged at $50/bbl. Fitch's long-term base case price for oil is set at $65/bbl.

"Oil and liquids prices continue to drive the majority of capex decisions in the exploration and production (E&P) space, although some operators have begun to scale back operations in select plays in response to lower natural gas liquids (NGL) pricing and cost inflation," noted Sadeghian. "Current oil prices remain well above Fitch's long-term midcycle levels."

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