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Energy Analysts Bullish -- and Bearish -- about Winter Price Outlook

Following last week's bullish storage injection, energy analysts remained perplexed about this winter's outlook for natural gas storage and its effect on winter prices. Raymond James analysts, running with the bulls, said the "big surprise" next winter will be a "resurgence" in industrial demand and a price return to 6:1 parity with oil. But energy analyst John Gerdes, still in a bearish mood Monday, noted that prices have hovered around $6-$7/MMBtu with no "noticeable" increase in industrial demand, and he remains convinced that gas prices will have to remain below $6 for at least a few months before there is significant upward movement.

Raymond James analysts J. Marshall Adkins and Darren Horowitz continued their bullish theme in this week's Stat of the Week. They noted their forecast is at odds with most analysts, but said the "sharply increased" forward gas curve is sending another signal, that the "gas equation will reset in November, with next winter's gas model reverting back to a more normalized winter ending storage level of 1.3 Tcf."

Assuming there is a "normal" winter, Adkins and Horowitz cited three gas drivers that "should lead to a winter 2006/2007 ending storage reality that is far more bullish than the current stock market consensus": 1) a net 0.25 Bcf/d of decreased year-over-year natural gas supply; 2) substantially higher (net 4.5 Bcf/d) winter-over-winter gas demand because of economic/industrial demand, price-induced fuel switching, etc.; and 3) a modest 0.3 Bcf/d net increase in weather-related gas demand, with warm weather comparisons offset by a resumption of hurricane-related production.

The tight market assumes a 30-year normal winter, said the Raymond James duo. "If it proves to be colder versus normal, then the probability increases for winter-ending storage levels to trend closer toward the 1.0 to 1.2 Tcf range." If their assumptions are correct, "it also implies natural gas prices should migrate back toward a more normalized 6:1 parity with crude oil in the winter of 2006/07. Should this thesis come to fruition, it may be a costly mistake to write off the natural gas-levered stocks without doing the math."

They noted that in actuality, "gas demand destruction actually outpaced supply destruction following the hurricanes last year," and "year-over-year gas demand (adjusted for weather differences) was running 1 Bcf/d higher in August than in the previous year." When combined with the warmer-than-normal weather, "this demand destruction resulted in substantially smaller gas storage withdrawals than would be expected during a normal winter season. Of course, we expect that to reverse itself this winter.

"From a demand perspective, the gas market should look significantly better this winter. The lost demand from last year appears to have already returned to the market. Over the past four weeks, the year-over-year weather adjusted, supply/demand equation is 1.5 Bcf/d tighter than last year. If this trend holds up, this winter should see weather-adjusted demand up by about 5.5 Bcf/d over last winter. In an attempt to err on the side of conservatism, we are only modeling a 4.5 Bcf/d improvement in nonweather related winter over winter gas demand."

Gerdes of SunTrust Robinson Humphrey/The Gerdes Group doesn't read the numbers the same way. The "bull case" for gas, he said, requires "substantial recovery" in year-over-year industrial gas demand," but the "continued flat year-over-year industrial gas demand poses a far greater threat to the bull case for natural gas than the recent strength in gas-fired power, as the magnitude of lower industrial demand (2.1 Bcf/d) last year is materially greater than the projected growth in gas-fired power demand (0.7 Bcf/d) this year."

Gas storage injections year-to-date "do not reconcile with a noticeable, sustained year-over-year increase in industrial gas demand," said Gerdes. "Moreover, given the surge in gas-fired power output last summer, unless natural gas prices decline to $4-$4.50/MMBtu and allow gas-fired generation to compete with coal-fired power on the basis of relative fuel costs, the upside to our year-over-year projection for growth in gas-fired generation is limited."

The analyst expects coal and nuclear energy to contribute "meaningfully" to this year's growth in power supply. Along with "solid" gas-fired generation, "nuclear power output is expected to cycle 20 billion kWh higher this year, while coal generation should conservatively increase at about half the rate of last year."

If industrial demand does not recover from last year's losses, "then either storage is likely to exceed even our elevated projection or the line pressure of the U.S. pipeline/gathering infrastructure is likely to increase and act as pseudo storage," said Gerdes. "More probably, a combination of these two phenomena would occur. Moreover, elevated line pressure would also act as a governor on U.S. gas production."

Under any of Gerdes' assumptions, 500-plus Bcf of excess gas supply could remain entering the heating-season, with 200-300-plus Bcf related to storage and 200-300-plus Bcf of pseudo storage related to line pack. "Needless to say, none of these scenarios are positive for natural gas prices or E&P [exploration and production] company operating performance. Our energy investment outlook remains negative."

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