Hitting a $6/Mcf natural gas price after 2016 is “achievable,” but in four years a $5 gas price now appears more realistic, according to energy analysts with Tudor, Pickering, Holt & Co. (TPH).
The TPH analysts said they were taking the time to “true up long-term price with our current thinking,” which resulted in trimming the long-term gas price forecast by $1/Mcf.
TPH used New York Mercantile Exchange futures prices to set second-half 2012 price estimates at $3.06/Mcf and 2013 prices at $3.65. Mid-term gas price forecasts remain at $4.25-4.50. The gas price revisions followed changes to TPH’s long-term commodity price assumptions for West Texas Intermediate (WTI) crude oil to $89/bbl and Brent crude at $104.
The $6/Mcf long-term gas price “was predicated on assumption that cheap gas prices (versus crude) sufficiently stimulated industrial and transportation demand, which combined with liquefied natural gas (LNG) exports, resulted in a higher natural gas price,” said analysts. That scenario still is achievable, they said “as efficient markets drive consumers toward cheap/clean Btus…eventually.”
It’s really a question of timing and the “magnitude of the demand response/LNG exports,” said the TPH analysts. “A significant variable was the magnitude of the supply growth in less than $5/Mcf gas tape.” The U.S. onshore plays are expected to produce more than 6.7 Bcf/d this year, which would be about 11% higher than in 2011, they added.
“Some was due to drilling to hold acreage, but a meaningful portion was from basins economic at $5/Mcf or lower. High case assumptions of normalized annual demand growth are 4 Bcf/d (1 Bcf/d from power and 1 Bcf/d each from industrial/transportation/LNG exports ) and are still below the supply growth experienced over the past two years.” Analysts said they needed “more visibility around timing and magnitude of incremental ‘demand’ before dialing in $6/Mcf longer term.”
Oil prices were cut because “North American supply growth with declining U.S. demand means a discount to global crude prices [will] persist.” The new oil outlook “assumes $87/bbl as long-term WTI,” which may appear “bad on the surface (obviously lower than previous $100),” but the Bakken Shale and Western Canadian oil supplies are among the crudes that will see “narrower differentials versus WTI from most recent time periods…For example, using long-term Bakken differential as $5, Western Canada as $14/bbl.”
Lower commodity assumptions no doubt are “punitive” to the net asset values (NAV) of exploration and production companies, said TPH. Analysts said the “overall valuations” would drop 16% with large caps less impacted (minus 17%) than small caps (minus 26%). And gas stocks would drop about 25%, while oil stocks would fall about 17%.
“Lower crude/gas prices are offset somewhat by lower expected long-term differentials,” the analysts noted. “That said, we continue to use multiple valuation metrics (NAVs, multiples, returns, liquidity, etc.) to assess reinvestment opportunities/changes to asset quality.” The impact to the NAVs would be more than the impact to ratings, they added.
Separately, Standard & Poor’s Ratings Services (S&P) said the credit quality for the U.S. oil sector “should remain relatively stable” for the rest of this year, but there’s more caution about the outlook for gas-weighted producers.
“We believe oil-focused exploration and production (E&P), integrated oil and diversified companies will continue to generate strong returns, despite the recent oil price decreases due to global economic jitters and moderating demand,” said S&P credit analyst Carin Dehne-Kiley. “Thus, we maintain our stable outlooks on most producers.”
At the same time the spot price for natural gas remains below S&P’s $4/Mcf estimate of the all-in average finding, development and production cost of natural gas, which would make “many” gas projects uneconomic currently. “As a result, we are more wary regarding the outlook for natural gas-weighted producers,” she wrote.
S&P’s base case price deck assumptions factor in WTI oil prices of $85/bbl for the remainder of 2012 and $80/bbl in 2013; Henry Hub natural gas prices of $2.00/MMBtu for the remainder of 2012 and $2.75/MMBtu in 2013; and average natural gas liquids (NGL) basket prices equating to 42% of WTI in 2012 and 50% in 2013.
“At these price decks, we estimate oil-focused producers will continue to generate strong returns and that many natural gas-focused producers are not covering their all-in costs with unhedged revenues,” said Dehne-Kiley. “NGL-rich natural gas projects are economic at our price deck given the premium of NGLs relative to natural gas.”
However, cash flows from low gas prices “are in many cases insufficient to fund the high levels of capital expenditures companies need to acquire acreage and ramp up production,” said the S&P analyst. Gas-weighted operators are increasing leveraged as they burn through cash and tap their credit lines. “Although many companies have above-market hedges on the majority of their natural gas production through 2012, these hedges generally roll off in 2013, leaving the companies exposed to natural gas price volatility.”
Since January S&P has downgraded 11 E&P, integrated or diversified energy companies; it also has upgraded eight companies. “The downgrades primarily affected companies focused on natural gas that are switching to crude oil and natural gas liquids production,” according to S&P. Upgrades “primarily affected companies that already produce meaningful volumes of oil and are growing their oil production.”
Meanwhile, another hot summer, combined with a continued move by power generators to switch to natural gas, has reduced the big storage overhang and should send natural gas prices higher, according to Goldman Sachs. Goldman’s updated 3Q2012 New York Mercantile Exchange (Nymex) natural gas price forecast is set at $2.90/MMBtu from $2.10. The average price forecast for full-year 2013 is $4.00/MMBtu.
“Our revised near-term forecast is slightly below current prices as the market is pricing in too much support from weather, in our view, and we expect prices will come under renewed downward pressure later this quarter as the heat subsides and injections pick up,” wrote analysts David Greeley, Jeffrey Currie and Johan Spetz. However, the trio remains “bullish on U.S. natural gas prices in 2013.” Analysts expect to see “ongoing producer response” to lower gas prices, combined with a normal winter, which would reduce fuel switching next year “allowing prices to move sustainably higher.”
Nymex natural gas prices have rallied 92 cents/MMBtu, or 42%, from their lows in mid-June on “strong demand” from the power generation sector.
Slower production growth and a return to normal winter weather next year would “reduce the amount of price-induced coal-to-gas substitution required,” said the analysts. “The shape of the U.S. coal-to-gas switching stack implies that prices can move back to $4.00/MMBtu relatively quickly as the amount of switching is reduced to around 2.5 Bcf/d.” However, the “upside is likely to be modest as the long-term potential of shale gas remains very impressive and the structural demand shifts on the horizon are all associated with high levels of policy risk.”
The heatwave this summer has cut into the “reliance” on coal-to-gas switching in 3Q2012, and that should allow gas prices to escalate, said the analysts. Switching levels “proved resilient” when gas prices moved higher in 2Q2012, indicating that switching “can be sustained at a higher price than we previously expected.”
Hedging opportunities for U.S. producers remain “limited, given current low prices,” but for consumers “there are good opportunities…to hedge longer-dated natural gas,” said the Goldman analysts.
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