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Barclays: Oil Prices to Change Trajectory of Gas Supply

U.S. natural gas prices will begin to move higher in "late 2012" once the impact on supply is felt as more gas rigs continue to be diverted to oil plays, a Barclays Capital analyst said Friday.

Through the end of this year and well into 2012 the domestic gas market will remain oversupplied, said analyst Michael Zenker and his team in a note. However, in the coming year Canadian production, reduced liquefied natural gas imports (LNG) and slower growth in U.S. supplies will allow demand to outpace supply.

"We expect that when the gas market realizes supply is no longer growing, it will mark a watershed event, causing gas prices to move higher, most likely for 2013 and beyond," Zenker said. "We forecast this to occur at the very end of 2012."

When the higher returns from oil attract enough of the "finite number of onshore drilling rigs away from gas-directed service," oil prices "matter for North American gas," Zenker said. "To match the return opportunity from unconventional oil drilling, producers would need to receive $12-15/MMBtu for their gas, nearly triple current price levels."

Because of the disparity between oil and gas prices, many might question why exploration and production companies continue to develop natural gas, said the Barclays team. However, there aren't enough North American oil prospects to divert all of the activity away from gas.

"Producers must still deliver the production growth their investors demand, and if that growth comes mainly from gains in gas supply, so be it. But by late 2012 we expect enough rigs to be directed toward oil service -- and away from gas -- to change the trajectory of gas supply. Indeed, this diversion has already begun..."

A bigger move to oil plays will require more opportunities to exploit and of course, continued high oil prices, said Zenker and his colleagues. "Our view is that oil prices move higher than today's level, and that gas prices remain stagnant this year, which should provide the motivation for producers to continue searching for oil in North America."

Barclays is predicting that aggregate North American gas supply should grow 1.7 Bcf/d in 2011, led by 2.9 Bcf/d of growth in the United States, that is offset by declining Canadian output and LNG imports.

"This is hardly a tight market, but [it] does represent a shift to receding oversupply," said Zenker. "Thus, we see a two-part market environment ahead: over-supply and a bearish sentiment in 2011 and for most of 2012, then a change in gas supply trajectory, and mood, toward the end of 2012."

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