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U.S. NatGas Prices 'Seemingly Hopeless,' But Oil Poised for Bull Run, Says Raymond James

U.S. natural gas prices look terrible again this year and could decline another 25% from 2015 as the structural oversupply continues, Raymond James & Associates Inc. said Monday.

The domestic gas market glut should persist even as associated gas from onshore oil production declines, said analysts J. Marshall Adkins, Pavel Molchanov and John Woodiel.

For the third time since August, the analysts reduced their forecast for 2016 Henry Hub prices, this time to $2.00/Mcf from $2.35. The long-term price deck now is set at $2.50 from $2.75. In October, the Henry estimate was cut by 90 cents to $2.35 (see Daily GPI, Oct. 5, 2015). Two months before that, they reduced their price forecast for 2016 to $3.25 from $3.55 (see Daily GPIAug. 31, 2015).

U.S. gas prices are "seemingly hopeless" and should "continue to be ugly" without strong demand. One year ago, Adkins and his colleagues had forecast Henry would average $3.00 for 2015, which at the time was more than 10% below the futures strip. However, the model wasn't bearish enough because of weak industrial demand and milder-than-normal weather-related demand.

"We believe that many of the drivers that drove our bearish gas call last year will continue into 2016," the trio wrote. Core gas supply in the United States essentially was flat through last year, but increased Northeast pipeline takeaway capacity this year could drive supplies higher by 2.4 Bcf/d -- even on lower drilling.

Weak industrial gas demand growth, "modest" incremental gas exports to Mexico and only a small amount of liquefied natural gas (LNG) exports, the domestic gas market looks to be oversupplied. The glut only will be solved by "increased demand from price-induced switching from coal-fired to gas-fired generation; less drilling and completion activity; shut-in wells; and/or extreme seasonal weather patterns."

By 2017, the analysts are a bit more bullish as more demand sources should emerge, driven by increased Mexican gas exports, decreased imports from Canada, a gradual ramp-up in LNG exports, moderate industrial demand gains and an assumed reversal to "normal" winter weather.

"Looking beyond, it has become abundantly evident that U.S. gas producers can grow supply at a pace of more than 3 Bcf/d with gas prices at relatively low levels," Adkins said. "There is also the longer-term reality that rising wind and solar penetration will be curtailing domestic expansion in gas-fired power generation," while improving Northeast basin differentials "should also be a modest tailwind...and keep a lid on Henry Hub prices"

Meanwhile, global oil fundamentals "are now looking very bullish," with West Texas Intermediate (WTI) prices expected to firm by the second half of the year -- the first time Raymond James has issued a bullish forecast in four years.

Oil prices are expected to bottom in the first half of the year, "probably 1Q2016," and then "rise substantially in the back half, averaging $50 WTI for the year but exiting the year closer to $70."

With WTI now trading in the $30s and the 2016 futures strip near $40, oil prices currently are "way too low," analysts said. "In fact, the lower oil goes near term, the higher it will likely overshoot the true balancing point in late 2016 and 2017. Given the lower-than-expected oil prices to start the year, we are modestly lowering our 2016 WTI forecast from $55 to $50 but keeping our long-term price deck at $70."

Based on the price forecast, Adkins and company expect the U.S. rig count to get worse through the first six months.

"From December, we think that the total U.S. rig count will decrease by an additional 150 total rigs (21%) over the next six months before bottoming at 550 rigs. Keep in mind, 2016 capital budgets are being set right now, with oil prices sub-$40."

On a year/year average basis, analysts expect the 2016 U.S. rig count to average 620 rigs, down 355 rigs (36%) from 2015.

"We expect to see a moderate recovery in the second half of 2016, with the rig count adding just over 200 rigs from the trough in June through December. The recovery should accelerate in early 2017, adding 463 rigs (75%) on average in 2017, year/year, as new capital budgets are set in a higher oil price environment."

The growth in the rig count likely will lag cash flow growth because labor and service availability likely becomes a major constraint on the ability to meet demand.

"This should be compounded by oilfield service pricing increases as the market for services gets tighter," analysts said. "As such, we expect a portion of these rigs to be deferred to 2018, when we expect to add another 275 rigs (25%) on average, year/year."

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