Fundamentals are in place for U.S. natural gas prices to recover to “at least” $4.00/MMBtu in 2013, with prices through December averaging $3.50, Canaccord Genuity said Monday.
Since the beginning of the injection season, the year/year (y/y) storage overhang has eroded to 200 Bcf from 900 Bcf “largely on the back of 5 Bcf/d plus stronger year-to-date gas-fired power demand, noted energy analyst John Gerdes. “In a sub-$3.00 gas price environment, gas-fired power generation served as the corrective mechanism to reduce the storage surplus.”
However, the “necessity” for low gas prices and the strength in gas-fired power demand has receded, he said. Gas-fired power demand “should wane late this year with a rise in gas prices.”
Last week Barclays Capital raised its estimate for average 4Q2013 gas prices to $3.35/MMBtu from $3.00, while Bank of America Merrill Lynch lifted its 2013 average gas price by 25 cents to $3.75 (see Daily GPI, Oct. 11; Oct. 9).
The exploration and production (E&P) industry responded to the earlier gas storage overhang by reducing onshore dry gas-directed activity to about 430 rigs, “which is markedly below the 600-700 gas rigs necessary to maintain market equilibrium long-term,” Gerdes said. “Specifically, the gas market is currently 2 Bcf/d plus undersupplied on a weather-normalized 13-week moving average basis. Consequently, gas storage should be meaningfully lower y/y exiting the ’12/’13 heating season.”
Assuming 15-year average winter weather, the Canaccord Genuity analyst expects gas in storage to approximate year-ago levels before the end of this year, which would mean the heating season would end with storage about 600 Bcf below year-end 2011. “If the storage dynamics materialize…our $4 gas price forecast next year clearly has upside bias.”
U.S. gas supplies should exhibit “modest growth” early next year as gas wells that were deferred this year are completed.
“Our expectation for the gas rig count to average almost 600 rigs next year is highly optimistic, though still results in November ’13 gas storage of only 3,300 Bcf,” said Gerdes. “Further, without at least a $4.00 gas price signal and corresponding increase in gas-directed drilling activity, our November ’13 storage projection is also overly optimistic.”
Canaccord Genuity’s domestic gas supply projection for 2012/2013 includes 2 Bcf/d per year of gas output growth associated with oil-directed drilling activity, assuming the oil rig count remains slightly above 1,400 rigs through next year.
In the coming year U.S. gas prices should return to the 2011 gas price level of $4.00/Mcf, which would “induce a reversion in this year’s fuel switching gains, leading to a 1 Bcf/d decline in gas-fired power demand,” said Gerdes. He also expects 2 Bcf/d of gas supply growth associated with oil-directed drilling.
For the long-term, Canaccord Genuity is maintaining a $5.00/MMBtu gas price.
“The marginal cost of supply outside of the Marcellus [Shale] requires $5 gas,” the analyst noted. The forecast is now 2 cents below the futures strip, while the long-term gas price forecast is 15% above the 2014 strip. The price forecast implies “continued industry cash flow outspend.”
Canaccord Genuity’s “bottom-up analysis suggests the U.S. gas market is on the precipice of a supply rollover,” said Gerdes. The review includes 1.2 Bcf/d of incremental gas output in 1Q2013 associated with 300 incremental gas well completions in the Marcellus Shale. The analysis implies that Marcellus output “should grow by 2.8 Bcf/d during the course of this year and 2.5 Bcf/d in ’13…”
Gas output associated with liquids development is projected to increase 2.1 Bcf/d this year and 1.7 Bcf/d in the coming year.
Offsetting this growth, however, are declines in the Haynesville and Barnett shales. In the Haynesville production is expected to fall 1.2 Bcf/d “during the course of this year and 1 Bcf/d in ’13,” while “Barnett Shale output falls 0.4 Bf/d this year and 0.1 Bcf/d in ’13. More notably, the remaining U.S. supply base net of the incremental growth in gas production associated with liquids development erodes 2.5 Bcf/d (6%) during the course of this year and 2.4 Bcf/d (6%) in ’13.”
The analysis of overall U.S. onshore supply indicates a decline of 1.3 Bcf/d, or 2%, this year and 1 Bcf/d, or 2%, in 2013.
The U.S. gas rig count is forecast to average 560 rigs this year, and rise by 30 rigs in 2013 and then reach 660 rigs in 2014, according to the analyst. The oil rig count, meanwhile, is expected to average 1,400 rigs over the next two years.
U.S. E&Ps in 2010 and 2011 outspent cash flow by 40%, he noted. Assuming a $2.80/Mcf and $90/bbl prices on the New York Mercantile Exchange (Nymex), with on average 1,370 oil rigs and 560 gas rigs, “we project the gas industry will be 60% free cash flow negative.” Next year a $4.00 gas price and a $90 oil price (Nymex) and slightly higher domestic drilling rates — averaging 1,400 oil rigs and 590 gas rigs — “reconciles with a cash flow outspend of 40%. Notably, in a $5 gas price, $90 Nymex oil price next year, gas-dominant E&Ps on average are roughly free cash flow neutral.”
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