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'Significant' Natural Gas Basis Differentials to Make Comeback, Says Credit Suisse

Weather in the short term rules, but beyond the first quarter, not much will change for U.S. natural gas markets, the head of global commodity energy research for Credit Suisse said Tuesday.

The investment banker's team of energy gurus discussed the outlook for oil and gas markets during a wide-ranging conference call that offered a less-than-bullish forecast for domestic gas for 2014.

"It is still a story in which supply dominates, and weather in the short-term rules," said research chief Jan Stuart. Credit Suisse raised its 1Q2014 price forecast to average $4.30/Mcf, but the upside for prices is only through March. In the second and third quarters, prices are pegged at about $3.80, falling to $3.75 in the final three months of this year.

"Beyond the first quarter, very, very little changes," he said. Prices in 2015 now are set at $4.20, then would increase 10 cents in 2016 and to $4.50 in 2017. Long term, prices should average $4.50/Mcf. However, "we are still a little bit nervous with the $4.50 price to the downside..."

It's been the story for months on end now: gas inventories quickly replenish themselves. That isn't expected to change on just the latest cold snap, said Stuart.

"We are now expecting the withdrawal season to reach 1.4 Bcf in the ground...There's downside risk to that per the latest weather forecast, which sets us up for a more interesting injection season than in the past…Injections could be something like 2.2 Bcf by the time all is said and done and then again could be as much as 2.4 Bcf...

"It won't be a struggle" for U.S. upstream operators. "Much depends on the pace of the infrastructure buildout in the Northeast, much of which is online. And of course, summer weather could surprise both to the up and the downside. But I think that it's very, very difficult to spin a structurally bullish story on the current weather events."

As Credit Suisse sees it, basis differentials will be the story through at least 2017.

"Long story short, [there is] massive growth potential evidently in the Northeast," Stuart said. Credit Suisse analysts reviewed the Northeast's core dry gas growth, as well as growing supplies from the Marcellus and Utica shales. What they found were "a whole heap of question marks around the cost curve. The question marks basically are telling you that there's an upside to what are already very significant increments in terms of production from these lower-cost basins.

"The downside, in terms of cost per unit, is from prolific basins such as the Haynesville," which gains from its proximity to the Henry Hub. The U.S. Energy Information Administration earlier this month suggested some operators may begin moving back to Gulf Coast production areas from the Northeast because they are closer to the spot price (see Daily GPI, Jan. 7).

"There are plenty of ways to supply what will be coming on demand growth, some 15-20 Bcf/d of demand growth by decade's end," Stuart said. The Northeast operators have to figure out how to move more gas to the South, where all of the demand growth will be, he added.

"There are quite a number of pipes scheduled" in the Northeast, and "a lot that can be done in terms of reversing the pipes. But long story short, by 2016, there will be not enough infrastructure to get all of the supply and growth to flow to the South. That means we need to incentivize the buildout, [add] more infrastructure, which means a big basis risk should widen out further."

A significant basis differential emerged last summer between the Henry Hub and Dominion, "painfully so," said Stuart. "We expect that pain to grow. We expect to see very significant basis differentials emerge again this summer, possibly the summer after.

"The futures market thinks the worst pain will be in '15-'16, and then by 2017, things will begin to narrow again. And as the infrastructure is put into place, we are worried that the futures market is still not wide enough or long enough. "

The Credit Suisse research chief said "it's entirely possible that the East is not yet growing fast enough and that there will be opportunities coming out for drilling the dry Haynesville wells, or for drilling a dry Barnett or Fayetteville well, or Eagle Ford well, i.e., four basins in the South that on the face of it are higher cost." Still, there "might be opportunities to grow a bit if the infrastructure out of the Northeast doesn't get built fast enough."

Natural gas bulls also may be blindsided by the fact that renewables, particularly wind, are becoming economic, Stuart said.

"Wind will continue to get built out," he said. According to one remarkable analysis, Credit Suisse believes that "wind plus solar are likely to take 85% of the incremental power demand going forward.

"That 85% of the incremental power demand routinely is rolled into gas in our forecasts," Stuart said. "We would posit that most every forecast for gas demand for power generation is overestimating what will actually come to gas. In our view...the high water mark is 1.2 Bcf/d in 2016.

"In the other years it's less than a half a Bcf/d. And that difference generates to 2020 a difference between our forecast and that of many others by something like 6 Bcf/d," which he said is about half of the projected liquefied natural gas expected to be exported by that time.

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