The low level of residual fuel and distillate inventories this winter means there will be less fuel available for switching and a higher natural gas price threshold for consumers to begin switching, according to bullish analysts at Raymond James & Associates.

The inventory situation should provide some upward pressure on oil and gas prices, said Raymond James analyst James M. Rollyson, who believes natural gas prices will rise to more than $5.67/MMBtu before forcing gas consumers to switch to alternatives.

“This winter appears to be setting up for a replay of the 2000/2001 natural gas debacle that sent natural gas prices to double digits,” said Rollyson. “Just like last time, we expect that natural gas supply/demand imbalance to be corrected by incentivizing certain natural gas consumers to switch to lower priced alternative fuel sources such as residual fuel and heating oil.

“Accordingly we expect fuel switching to once again drive a material up-tick in demand for oil-related products, driving up both residual fuel and heating oil prices and at the same time, natural gas prices,” he said. “At current levels, natural gas price levels will have to increase meaningfully above the $5.67/MMBtu level to encourage adequate fuel switching. Ultimately the switching price point is likely to move much higher.”

In winter 2000-01, about 500,000 b/d of oil product demand was caused by fuel switching from natural gas, which eventually led to the current low inventory situation.

Rollyson believes the low level of storage oil — currently distillate is 8% below levels last year and residual fuel inventories are 12.7% below levels last year, according to the Energy Information Administration — will limit fuel switching capability and drive up prices this winter. Because resid inventories are insufficient to allow 1.5-2 Bcf/d of gas demand to switch over, said Rollyson, it seems evident that gas prices will rise “substantially above $5.67…”

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