A price rally this year in the calendar 2010 (Cal10) Nymex gas futures strip is the biggest threat to 2010 spot price recovery as stronger futures would accommodate more hedging and trigger a stronger drilling response among producers, analysts at Barclays Capital said Tuesday.
"Prices for Cal10 close to or above the $6.50/MMBtu level provide a fresh hedging opportunity for key producers, which could spur a recovery in drilling earlier than we expect," the analysts said in a note. "The recent May rally provided just such an opportunity, although in isolation, it was too small to change the supply view for 2010 and has since largely closed."
Economics have improved for shale gas drillers due to declines in service industry costs and increasing well productivity, Barclays noted. Shale activity alone could affect the 2010 price outcome, the analysts said.
"We expect the cut in drilling activity that has already occurred [see related story] will (and we think already has) tip U.S. supply into decline and that despite a glutted market in 2009, Cal10 prices will, at year-end 2009, rally as the market grows increasingly concerned that falling U.S. supply would put the market on a decidedly different path in 2010."
The Barclays analysts wrote that they are focused on the 2010 strip because they think most gas producers have given up on this year. "...[W]e expect that only the bravest company will plan a big drilling program for 2010 without first putting in place a meaningful amount of hedging for 2010 production," they wrote, noting that they referred to independent, largely shale-focused producers and not the super-majors. "We believe that the typical producer in this category is only lightly hedged for 2010."
The improved economics have lowered the 2010 strip price needed for effective hedging from $7/MMBtu to $6/MMBtu and even lower for some producers, the analysts wrote.
"Note that we are not saying the marginal well is now $6/MMBtu. Instead, we believe a $6/MMBtu Cal10 price at the Henry Hub provides a good margin opportunity for a sufficient swath of shale production to meaningfully affect the U.S. supply picture in 2010," the analysts wrote.
That said, the analysts conceded that producers could still be "lightly hedged" at year-end if 2010 strip prices remain below $6/MMBtu for the rest of this year. A rally above $6/MMBtu in the strip, especially above $6.50/MMBtu, would be a signal for a stronger rig count next year, they said.
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