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Oversupply, Demand Stagnation to Strangle Long-Term U.S. Natural Gas Prices, Says Morgan Stanley

U.S. natural gas is about to enter a cycle of structural oversupply and demand stagnation, which in turn should reduce prices, according to Morgan Stanley.

In a report that provides an outlook for onshore gas explorers too, Morgan Stanley cut its long-term price forecast for Henry Hub to $2.50/Mcf from $2.75.The report was overseen by Devin McDermott, lead U.S. gas and power commodity strategist and head of North American exploration and production/integrated oil research.

“In line with our ‘sub-$3’ thesis...natural gas prices have remained low despite a prolonged period of secular demand growth,” McDermott’s team said. “We see short-term upside in natural gas prices into year-end, but oversupply takes hold in 2019 and accelerates thereafter.”

Beyond 2020, the analysis indicates a shift toward demand stagnation as liquefied natural gas (LNG) exports plateau. And the issues that have pressured prices for several years “should persist,” including growth in associated gas from unconventional oil production
and supple, low-cost supplies “unleashed by new pipelines,” McDermott said.

The below-consensus view would lead to a “structurally oversupplied” market, which in turn is going to slam prices.

Analysts said ethane “offers a more attractive outlook as a shortage of fractionation capacity
supports a period of prices 30-50% above recent history.”

The Morgan Stanley team analyzed how long U.S. demand would grow while consumption remains flat. Gas demand is projected to increase at a 7% compound annual growth rate from 2017 to 2020 as LNG export projects start up.

“However, with the last major project set to be completed in 2020, U.S. export volumes will plateau,” analysts said. “As a result, the secular demand growth cycle for natural gas will come to a close, falling to only 1% annually post-2020.”

Ultimately more gas exports may get underway, but project sanctioning and the amount of time to permit and build facilities could take more than five years, pushing any increases to the mid-2020s and beyond.

Analysts also questioned whether gas supply could continue to increase in a mid-$2/Mcf price world. Morgan Stanley remains “constructive” on oil prices, and because oil prices, not gas, drive marginal supplies “robust growth” should continue in the U.S. onshore, even with a slowdown in the Permian Basin from infrastructure constraints.

Associated gas “should meet 60% of incremental demand through 2020, and will not slow thereafter,” said McDermott and his colleagues. “By 2021-22, associated gas supply growth annually will be 1.5-2.0 times new demand, grinding gas prices lower as a cycle of structural oversupply takes hold.”

A third debate centers around whether higher ethane prices are sustainable.

Fractionation capacity is tight, while demand for more crackers and expanding exports have pushed natural gas liquids prices 145% higher year-to-date, according to Morgan Stanley’s estimates.

“While this significant increase is not sustainable, our collaborative analysis indicates that ethane prices should moderate but remain elevated versus recent history.” The analyst team is forecasting average ethane prices of 40 cents/gallon in 2019, stabilizing to around 35 cents in 2020. At that price, said analysts, ethane would be higher than the average price of 27 cents/gallon over the past two years.

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