Citigroup lowered its gas producer stock ratings Tuesday because of high natural gas storage levels, current mild temperatures, growing domestic gas production and expectations for more liquefied natural gas imports (LNG). Citigroup producer analyst Gil Lang also cut his first quarter 2007 and second quarter 2007 Henry Hub price forecasts.
"We believe the U.S. natural gas market is reasonably balanced today, but that a cold winter will be required to avoid an inventory overhang in 2007," said Lang in a research note. He said he was taking "a more cautious stance" on some producer stocks in the near term but expects investor buying opportunities next year.
"While we feel there are many reasons to remain bullish over the long run for U.S natural gas players, we also think that the near-term trading call for the sector is to lighten positions at these levels and look for reentry points in early 2007," he said.
Among the current bearish indicators are LNG imports, which should be greater than levels last winter because of lower prices and warmer weather in Europe. "Early indications are that LNG imports this winter could be 0.5 Bcf/d higher than last year," said Lang. He noted that cold weather in Asia or Europe could quickly change the situation, but Europe has been warm so far this winter.
In winter 2005-2006, cold weather, a storage facility explosion and inadequate pipeline capacity all contributed to higher prices in the United Kingdom despite the impact on the U.S. market of last year's hurricanes in the Gulf of Mexico.
"What is different this winter is that the new Langeled pipeline, the BBL pipeline and the Interconnector expansion should all be online [in Britain] this winter potentially bringing greater supply to the UK," said Lang. "After trading above U.S. price for all of last winter, UK gas prices are now below Henry Hub prices."
Another bearish indicator is U.S. gas production, which finally is responding to higher gas prices. The latest statistics from the Energy Information Administration show onshore production growing 4-5% while total U.S. production is up about 2%, excluding the effect of last year's hurricanes.
"While this production pickup does not appear to have manifested itself in growing inventories, it suggests that the current excess inventory will not be corrected through reduced production and that we will need cold weather to eliminate the excess," said Lang. He also noted that some production still remains offline due to hurricane damage last year. That production also could return, further boosting supply.
To potentially make matters even worse, the Independence Hub deepwater production project in the Gulf of Mexico will begin initial flows in the third quarter of next year, ramping up to about 1 Bcf/d in 2008. "Should inventories remain high through the summer, the [Independence] hub could come online just as the injection/full storage tensions reach their apex as we saw this past September, potentially exacerbating short-term pricing pressure next fall," he said.
While domestic supply is rising and LNG is poised to increase, on the other side of the fundamental equation, Canadian imports are way down. Since the end of September, gas imports from Canada have been running about 750 MMcf/d (12%) lower than the five-year average. Lang said he expects this trend to continue.
"Our initial take, and that of Wall Street as a whole, was that this was a bullish signal that Canadian exports could not be depended on as spending drops in Canada, falling rig activity takes its toll, the weak U.S. dollar hurts costs, ...oilsands demand for natural gas ramps up and as the royalty trust taxation issue creates uncertainty for the trusts," said Lang. "However, we also believe that cold weather in November contributed to weak exports in late November. Exports recovered to a large degree as shown in early December but have been falling again versus the norm." Lang said he doesn't expect Canadian exports to the U.S. to return to historical norms. This could be the major factor that ends up offsetting U.S. production increases in 2007.
Perhaps the biggest player in game currently is January temperatures. If January ends up being colder than normal, that could go a long way toward reducing the storage overhang and bringing the market back in balance, said Lang. For now, however, he's has lowered his first quarter 2007 Henry Hub price forecast to $7.50 from $10, and cut his second quarter forecast to $7.75 from $8.00. Lang raised his third quarter 2007 price forecast to $8.00 from $7.00 and bumped up his fourth quarter projection to $8.75 from $7.
The Energy Information Administration (EIA) in its December Short Term Energy Outlook made the following Henry Hub price projections for the first, second, third and fourth quarters of 2007: $8.58; $7.02; $7.10; and $8.76. EIA said it expects the storage overhang to keep Henry Hub spot prices from spiking above $9 this winter.
EIA also noted that if winter weather ends up being normal, then gas consumption is expected to grow by 1.5% in 2007. Residential and commercial sector consumption is expected to grow by 6.9% and 3.6%, respectively, next year and industrial consumption, which dropped 1% in 2006, is expected to reach its highest level since 2004 with a 1.8% increase. Due to expectations of more moderate summer temperatures in 2007 compared to 2006, power sector consumption is projected to decrease by 3.6%. However, rising total consumption could bolster price levels next year (see Daily GPI, Dec. 13).
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