Despite the current 53% gas storage surplus compared to the five-year average, gas storage levels could still end the injection season near a normal full level if spot gas prices decline to $5.00-5.50/MMBtu and displace coal during June and July and there is significant gas liquids stripping due to high liquids prices, according to a new analysis done by Citigroup analysts Gil Yang and Brian Chin.
The analysts said lower gas price levels could trigger significant fuel switching from power generators away from coal to natural gas. "Our proprietary bottom-up analysis shows that meaningful switching would begin to occur at $6.50/Mcf natural gas, while the entire excess gas position could be burned off at an average summer natural gas price of $5.50/Mcf." In order for summer prices to come close to that average, however, June futures will have to fall to $5, they said, arguing that was possible even with $70/bbl crude oil futures.
If gas prices remain elevated through June and July, the analysts said the "opportunity for increased summer gas consumption from power generation fuel switching would become limited as time grows shorter, increasing the likelihood of a more dramatic impact on near-term commodity prices toward the end of the summer."
They noted the market may need to absorb 400-500 Bcf of gas beyond normal consumption levels this summer just to get working gas in storage to historically high levels of 3.4-3.5 Tcf. "We remain concerned that filled-to-capacity storage conditions could create gas-on-gas competition, putting pressure on prices in coming months." The Citigroup analysts recently considered the possibility that aggressive liquids stripping could reduce gas supply, and lower prices could prompt higher than normal industrial consumption. However, the impacts were found to be far less significant that the switchability of coal-fired power generation to natural gas.
After examining 5,000 power plants in every region of the country, analyzing each region's mix of generation and calculating how often each plant would be online at certain prices, the analysts determined that significant gas demand could be triggered if gas prices fall below $5.50.
"Should summer strip gas prices drop below the $7 threshold, we would anticipate a pickup in incremental summer demand of 250 Bcf at $6.50 gas (versus $9) and about 300 Bcf at $6 gas," they said. "At $5.50/Mcf gas prices, we forecast that about 500 Bcf of incremental summer demand will be created that could effectively eliminate the entire excess storage position."
The Citigroup analysts said their analysis includes transportation costs and emissions credits with the price of coal. "Actual switching to natural gas from coal would likely occur only when plant operators believe that the gas price will be more attractive for an extended period of time (we believe three to six months) and hence the importance of the summer strip, as it is costly to cycle coal plants. This is a major friction of switching..."
They also cited low coal inventories as another factor that could influence this possibility. Citigroup coal analyst John Hill believes there currently is a 30-day inventory of coal versus a more normal 50-day inventory. As a result there may be an incentive to switch to gas if prices fall in order to provide time to build coal inventories.
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