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Resilient Domestic Oil, NatGas Output Pressuring Price Forecasts

Domestic oil and natural gas production are proving resilient despite the drop in rigs, which quashes much hope for higher commodity prices this year, according to analysts.

Jefferies LLC, BMO Capital Markets and Topeka Capital Markets (TCM) analyst teams each reviewed the status of onshore gas and oil plays, and each offered less than promising price forecasts through the rest of 2015 for either commodity. Their forecasts mirror in part an analysis by Barclays Capital late last month, which predicted only a brief bull run for gas this summer (see Daily GPIJune 29).

Jefferies equity analyst Jonathan D. Wolff and his team said domestic gas output appears to have peaked after falling for two consecutive months. In addition, they see limited growth over the near term because of continuing infrastructure constraints in the Northeast and reduced associated gas production.

However, the long-term New York Mercantile Exchange outlook was cut 25 cents to $4.00/MMBtu because "more resilient" gas production than expected and a more conservative outlook for liquefied natural gas exports, Wolff said. Slowing Northeast supplies would be a "major bullish factor" over the long-term.

"The Northeast has experienced a multi-year period of rapid growth growing from just 2 Bcf/d to 20 Bcf/d in five years. Recent growth has been largely helped by reversals of existing brownfield pipelines (from the Northeast to the south and west). But the next phase of growth will require greenfield pipeline construction with longer lead times and regulatory risk."

Jefferies analysts think gas supply likely has rolled over from the peak of 73 Bcf/d to about 72 Bcf/d, based on pipeline scrapes. Additional growth should be limited, with 2016 and 2017 representing "gap years," as Northeast gas production stutters to 1.5 Bcf/d from 3.5 Bcf/d.

BMO analysts said gas prices this year have been been "uninspiring...and we do not see anything that will change that." Analyst Randy Ollenberger and his colleagues said a colder-than-normal winter failed to increase Henry Hub prices through the $3.00/Mcf level as production growth more than offset demand, allowing the 2014 storage deficit to be eliminated.

"For the balance of the year, the drop in the U.S. oil rig count could result in lower levels of associated gas production, but that is not likely to be enough to materially firm up North American prices, in our view," Ollenberger wrote. "We now anticipate that U.S. working gas in storage will exit the summer injection season at roughly 3.8 Tcf, which is roughly in line with the five-year average. Accordingly we believe prices will be range-bound at $2.25-3.00/Mcf."

BMO is even less inspired by Western Canadian gas prices.

"The outlook for Western Canadian natural gas prices is mildly more negative," Ollenberger said. The reversal of the Rockies Express Pipeline (REX) beginning in August is set to create an incremental 1,200 MMcf/d of east-to-west flow capacity, adding to the existing 600 MMcf/d capacity (see Daily GPIJuly 1).

"The REX reversal will...compete with some Canadian exports" to supply the Midwest, BMO analysts said. "In addition, Western Canadian production has continued to grow year over year despite weaker commodity prices. This has erased the storage deficit and supports our view that the spread between Henry Hub and AECO will average 50-60 cents/Mcf in 2015, compared to only 22 cents in 2014."

TCM also reduced its gas price outlook. Analyst Gabriele Sorbara said in a note to clients 2Q2015 Henry Hub prices were reduced by 1.1% to the bidweek actual of $2.67/MMBtu from a previous assumption of $2.70. Full-year gas price assumptions were cut by a penny to $2.94/MMBtu.

Jefferies, BMO and TCM also revised their outlooks for crude oil. Jefferies revised U.S. oil production forecasts higher "given $13 billion in equity deals and myriad debt financings since February. Based on recent May data, oil production is running a good deal higher than expected."

Jefferies updated its 21-basin supply model for recent results, with total supply down slightly for 2015. It now is modeling a gain in U.S. output of 25,000 b/d in 2015 versus the 2014 exit, compared with a previous estimates of minus 300,000 b/d in February, minus 250,000 b/d in April and minus 150,000 b/d in June.

BMO expects crude oil prices to remain "relatively range-bound over the balance of the year" at the $55-65/bbl for Brent and $50-60/bbl for West Texas Intermediate (WTI).

"Positive influences include the fact that petroleum product demand has been relatively strong, particularly in the United States, and the growth in U.S. crude oil production has slowed," Ollenberger said. "On the negative side, crude oil inventories remain at very high levels and the backlog of uncompleted wells has yet to be drawn down. Potentially more worrisome is the fact that OPEC production appears to be increasing. Saudi Arabia continues to increase production and is now producing at the highest level ever, while Iraq has also achieved record levels production and Iran could potentially add as much as 1 million b/d of production."

TCM's Sorbara also adjusted the 2015 WTI oil price assumption to $59.13/MMBtu from $58.39.

Many U.S. oil producers were counting on rising oil prices and continued capital markets activity to maintain production in the second half of 2015 and produce "meaningful" growth in 2016, Wolff said. "But we think a growth rebound will be difficult to achieve amid weak oil prices, high relative debt levels and the markets growing 'fatigue' to fund budget holes through equity issuances."

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