Despite the current bearish landscape in natural gas market fundamentals, Raymond James analyst J. Marshall Adkins said he sees a "continued rebound in gas prices" going into 2007 as "the natural gas overhang experienced throughout the injection season will dissipate." As a result the analyst's group is still predicting $10 Henry Hub gas for the entirety of 2007.
In Raymond James' Energy Monthly report, Adkins said that while robust natural gas storage injections in September created a bearish short-term outlook for prices, all eyes are now on winter. "We believe that the market has shifted focus to the potential impact of the upcoming winter on current storage levels," he said in the report. "Since the injection season ended at 3.45 Tcf (which was roughly in-line with our assumption), we believe that gas prices are likely to trend back toward $10/Mcf, assuming a normal winter." He added that widespread investor estimates for full storage were previously at approximately 3.7 Tcf.
Under a normalized weather scenario, the analyst said he still believes that the midpoint of U.S. natural gas will be linked to oil prices with roughly a 6:1 Btu parity price ratio. "Assuming Btu parity of 6:1 and our 2006 oil forecast, fair value for gas in 2006 should be slightly above $10.00/Mcf," he advised. "However, if the gas markets feel temporarily comfortable about the supply/demand balance, gas is likely to trade below this midpoint range."
Adkins noted that the unseasonably warm weather in North America during the 2005-2006 winter has depressed gas prices year-to-date and has had a sluggish effect on natural gas demand, storage and prices. Even with natural gas storage currently at 3.45 Tcf, which is approximately 7% higher year on year, the analyst said he believes winter-ending storage levels will total 1.2-1.3 Tcf, which is closer to historical averages.
In the report, Adkins lowered his team's full-year 2006 gas forecast to $7.04/Mcf from $7.54/Mcf as a result of a major reduction in price expectations for 4Q2006. While First Call is looking for a Henry Hub 4Q2006 price of $6.69/Mcf, Adkins said his team reduced its last quarter of 2006 Henry Hub price estimate from $7.75/Mcf to $5.75/Mcf.
Looking at the full-year 2006 Henry Hub price estimate, Adkins said the forecast implies roughly a 9:1 Btu ratio with the company's oil forecast for the remainder of the year. "Longer term, a return to normalized weather should drive U.S. natural gas prices back toward the 6:1 Btu parity price ratio," he said. "Our forecast for 2006 is conservative compared with both the First Call consensus and the futures market."
He added that as gas storage levels normalize, the longer-term crude oil to natural gas price ratio should average approximately 6:1 and could be as low as 4:1 at times.
"Even at $50/bbl oil prices, a 6:1 ratio would imply $8.50/Mcf natural gas. At $60/bbl oil, the ratio implies gas prices near $10/Mcf," Adkins said. "The bottom line remains simple: the combination of falling domestic gas supply, a healthy U.S. economy, and favorable fuel-switching ratios should eventually result in natural gas prices trading at or near Btu parity with petroleum liquids."
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