Morningstar Inc. has revised its marginal cost estimate for U.S. natural gas down to $5.40/Mcf from a prior projection of $6.50, but analysts said they remain bullish about prices over the long term.
"Despite the lower price forecast and the negative gas demand implications from the warm winter, we're seeing positive data points at the industry, state and company levels that support a more bullish out-year take on natural gas prices," wrote analyst Stephen Ellis.
A "nasty scenario" could ensue for OPEC and oil prices, the analyst team said, because of lower demand combined with a "potentially high oil supply cushion. "For example, the International Energy Agency indicates that global oil demand growth could average around 660,000 bbl/year to 2020 versus average annual demand growth of 1.3 million b/d over 2000-2008.
"While that is a fairly low bar, there are still unresolved oil supply challenges for the industry that have largely remained in the background, given the focus on the oil demand side of the story."
Some of the largest producers, including ExxonMobil Corp., Royal Dutch Shell plc, BP plc, Total SA and Chevron Corp. "plan to lay out a little more than $120 billion in capital spending as a group in 2012, which is roughly triple the amount they spent in 2001," but output for the group is "well below" 2001 levels.
"We're more sanguine about our outlook for natural gas this quarter, thanks to our updated natural gas price deck and recent industry events," said Ellis. Analysts examined production, reserves, assets, capital spending and operating results for the top 25 U.S. gas producers over the past 15 years and divided costs for each firm into "three buckets: production, development, and capital charge."
A statistical "maximum likelihood estimate" was used to isolate costs associated with natural gas from costs associated with oil production. "Moreover, cost estimates (or estimated returns) tend to be presented on a blended oil-gas basis, which fails to isolate the 'true' cost of natural gas production, and, in the case of returns, requires an additional assumption regarding oil or natural gas liquid prices.
"Over the long run, we believe our model is a more reasonable predictor of prices; accordingly, we think natural gas prices will move toward our $5.40/Mcf forecast over the next few years."
Following one of the warmest summers in recent memory, Morningstar's team said the country is setting up for an "unusually warm winter," which might put a damper on improving prices.
"Despite this scenario, natural gas storage levels have continued to fall and are now only 5% above five-year averages versus an 11% difference last quarter." Baker Hughes Inc.'s gas rig count also has continued its "steady decline" and has been almost cut in half since the start of 2012.
"In our view, the natural gas rig count, while not a perfect indicator, is certainly a leading one with regards to U.S. natural gas production, which as of September 2012 is at 73 Bcf/d, up 2.7 Bcf since last September."
On a "more granular level, we're already seeing production declines," with August output down 15% year/year (y/y) in Texas and 19% in Louisiana. Colorado's gas production fell 11%, Ellis said. "Combined, these states make up more than 40% of U.S. natural gas production.
"At a company level, we are also seeing positive data points for natural gas prices. In the third quarter, BP's U.S. gas production declined 15% y/y, Chevron saw a 6% decline, and ExxonMobil's production dropped 5%."
The United States is seeing gas declines "because the majors are seeing poor returns," the Morningstar analyst said. "For example, Shell indicated that it had earned $1.2 billion over the past 12 months from shale gas, whereas its capital employed is around $50 billion, indicating unacceptable levels of returns on capital.
"The industry, state and company data points indicate [that] we are getting closer to an inflection point around natural gas production; we expect natural gas volumes to eventually flatten and decline, leading to higher U.S. natural gas prices and increased levels of drilling activity as gas producers seek to produce more gas to meet stronger U.S. gas demand.
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