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Wood Mackenzie: Gas Price to Relink with Oil Around 2012

Natural gas and oil prices will reconnect again in the United States, according to Wood Mackenzie's Ed Kelly, vice president of North American gas and power. When the relinkage occurs will depend upon the long-term race between U.S. domestic supply growth and the growing reliance on gas for power generation.

"Domestic supplies could insulate North American gas prices from rising oil prices over the next three to four years, but our analysis concludes that around 2012 there will be a relinkage to the oil price," said Kelly at the Annual American Association of Petroleum Geologists meeting last week in San Antonio. "Under current market conditions with oil pricing over $100/bbl, a relinkage would mean gas prices of as much as $13-14."

However, Kelly cautioned that there would be clear indicators before a relinkage occurs, one of which could be a temporary seasonal link to gas prices in the United Kingdom.

Kelly explained the key factor that will hold back the relinkage in the medium term: "High prices and technical drilling advances have spurred record drilling levels and revived domestic U.S. supplies, and this will be enough to stave off the relinkage for the next three to four years."

Most of the domestic supply growth will come from unconventional gas resources, including tight gas, coalbed methane and shale gas. The majority of new supply will come from shale gas -- as much as 3 Bcf/d or between 50% and 60% of all net U.S. production growth expected between 2007 and 2011, Kelly said.

Recently a ConocoPhillips executive told NGI that he sees gas prices being driven up by higher full-cycle production costs, particularly in the unconventional resource plays (see NGI, April 21). Will Hussey, ConocoPhillips senior vice president for origination, downplayed the influence of oil prices on what he believes is a new era of higher natural gas prices based on North American production costs.

During his presentation Kelly outlined two schools of thought on summer natural gas pricing. One is that gas will need to move up to parity with oil prices -- either residual fuel oil in the $12 area or the UK gas price in the mid to upper $10/MMBtu range in order to meet storage refill demand. However, in Wood Mackenzie's view, Kelly said prices in the high $8 to low $9 range would be sustainable regardless. "Storage requirements are high, but supply growth and weak power demand drivers will push healthy storage injections at a gas price in the high $8 to low $9/MMBtu level, even below the comparable UK level," Kelly said.

While recessions are typically bearish for gas prices, the nation's current economic slowdown is different, Kelly said. Oil has become a hedge against the U.S. economy, so weaker growth in the gross domestic product seems to boost oil prices, he said. Industrial demand is supported by relative weakness in U.S. gas prices. And although power demand growth has been weak, it has not been as weak as expected given the economic conditions.

Some of the factors that have a part to play on the North American natural gas demand and supply balance, according to Wood Mackenzie, include the impact of rising coal prices, power sector demand and the influence of carbon legislation, the shifting Canadian supply/demand balance and an associated reduction in gas exports to the United States, and the building and cancellation of coal plants.

"The picture beyond 2011 remains uncertain due to the lack of viable alternatives to continued reliance on natural gas for power load growth," said Kelly. "Gas supplies are growing and will do so in the midterm but beyond 2012 these level off. This leveling, combined with a quick growth rate from the power sector, could mean an increased reliance on LNG [liquefied natural gas]. However, relying on LNG will tie gas prices more tightly to oil. Hence in the long term, if oil prices remain high, we could see gas prices following suit."

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