Even with the recent plunge in temperatures, three energy consultants in separate reports Tuesday said working gas levels in storage will likely finish the season at 1.7 Tcf or more. Barring production shut-ins from hurricanes and assuming normal weather patterns, one analyst said the storage glut could put downward pressure on gas prices through the rest of 2007.
In his monthly report, Natchez, MS-based consultant Stephen Smith said projections of continued high storage levels have led to a revision to his gas price forecast for the rest of 2007.
"We are projecting a 1,715 Bcf storage level for the end of March, which is 828 Bcf over 10-year norms and 19 Bcf higher than last year," Smith wrote in a research note. His projections are based on 10-year heating-degree-day (HDD) norms from Friday (Feb. 2) through the end of March. "If HDDs were to be 10% lower than normal, then the projected end of March storage level would be 1,918 Bcf."
Smith's "base-case" gas price outlook assumes oil prices ranging between $50 and $65/bbl for West Texas Intermediate (WTI) through 2007, minimal production shut-ins from hurricanes, and 10-year weather norms for the rest of the year (after using specific HDD/cooling-degree-day forecasts for the two weeks ending Feb. 2).
"The price outlook envisions a significant storage surplus for the rest of 2007," Smith said. "As a result, Henry Hub is likely to sell at a discount to 1% sulfur New York Heating residual fuel oil from March through October."
Smith expects gas prices will now average $6.15/MMBtu (Henry Hub) in 2007, down 25 cents from a previous forecast of $6.40/MMBtu. Prices were revised to $5.35 from $5.65 in 2Q2007; to $6.15 from $6.60 in 3Q2007; and to $6.80 from $7.05 in 4Q2007. In 2008, Smith now expects prices to average $6.35/MMBtu, down from a previous estimate of $6.60. The 2009 gas price was revised to $6.40 from $6.55, and in 2010 the price was revised to $6.40 from $6.45.
"While winter finally arrived, 10 short weeks is all that remains of the natural gas withdrawal season," wrote C.K. Cooper & Co.'s Philip J. McPherson, director of research. In a note to clients, McPherson said that even with the rise in gas futures to more than $7.50/Mcf following the latest two-week cold snap, the contract "quickly reversed to the $7.00/Mcf level. We continue to believe that natural gas is heading back to the December lows of approximately $6.00/Mcf. Simply stated, there is just too much gas in storage."
McPherson said if winter continues to remain cold and the average weekly withdrawals are met, storage would still finish this season at April 2002 levels (1,492 Bcf), when gas prices were below $4/Mcfe. He advised investors to use the recent strength in gas-weighted issues to reposition toward "a more oil-weighted energy portfolio," or companies with "zero correlation to U.S. natural gas prices."
John Gerdes of SunTrust Robinson Humphrey/the Gerdes Group also expects storage levels to be high at the end of the season, but he was more optimistic in his outlook for prices. Gerdes said current weather forecasts "continue to paint a bullish near-term picture, and the lack of a strong gas price response is likely attributable to traders looking past the current weather cycle toward an expectation of mild conditions in mid February." He noted that for the current week the National Oceanic Atmospheric Administration is forecasting 221 total degree days (TDD), which is 5% higher sequentially and 14% above the long-term average.
With a minimum of two to three greater-than-average storage withdrawals in upcoming weeks, "inventories exiting the heating season should approximate 1,700 Bcf, roughly the same as last year," Gerdes noted. However, "even exiting the heating season with +1,700 Bcf in storage, supply-side adjustments appear likely to support stronger gas prices over the next 12-18 months."
Gerdes' forecast puts average oil prices through 2007 at $61/bbl WTI and gas at $7.44/Mcf Henry Hub. Those prices, he said, "should result in the unwinding of the fuel switching evidenced last year favoring burning natural gas over residual fuel oil. Consequently, we expect fuel switching to residual oil to arrest overall growth in gas-fired power generation this year."
Oil prices below $60/bbl would "provide a significant price advantage to burning residual fuel oil over natural gas," Gerdes wrote. "Notably, over the past six months in a +$7 price environment, our analysis suggests industrial demand recovered 1+ Bcf/d year-over-year. The recovery in industrial gas demand is a blend of high-gas-price comparisons associated with hurricane-disrupted supply and genuinely stronger industrial demand in a lower gas price environment."
If gas prices for 2007 average around $7.44/Mcf, "U.S. gas drilling activity should remain stable to decline modestly. Given that Canadian gas producer cash margins are about 20% weaker, we expect Canadian gas well completions to be at least 10% below last year." Last week's Baker Hughes report indicated a 26-rig decline in the U.S. gas rig count to 1,440, which "appears to suggest that recent upward momentum in the survey may not be indicative of acceleration in drilling activity. Given that E&P companies are 10% free cash flow negative in a $7.50 gas price environment, one possible explanation for recent drilling activity strength may be mild weather conditions."
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