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Barclays: Gas Supply to Outrun Demand Through 2010

U.S. natural gas production points toward "supply outrunning demand growth" in 2009 and 2010, driving prices somewhat lower compared with the current forward curve, Barclays Capital energy analysts said in a research report.

Barclays' Michael Zenker and George Hopley are projecting U.S. gas supplies to grow by 3.7 Bcf/d this year, 2.6 Bcf/d in 2009 and 1.9 Bcf/d in 2010. Based on the growth, Henry Hub 4Q2008 prices are forecast to average $8/MMBtu, with winter 2009/2009 prices averaging $8.65/MMBtu. In 2009 gas prices are expected to average $8.35/MMBtu, and for 2010 the average gas price was set at $8/MMBtu.

"A prime driver of the change in our outlook is aggregate U.S. supply," which includes domestic supplies, Canadian imports, exports to Mexico and imports of liquefied natural gas (LNG), wrote Zenker and Hopley. In the next few years, supply is seen outpacing demand growth, "resulting in growing storage inventories, year/year, in 2009 and 2010. This is less the case in the remainder of 2008, owing to the running storage deficit this year, but should begin to weigh further on prices in 2009."

On balance the Barclays outlook is bearish, but "there are some supportive elements in the outlook, including industrial and power sector demand, and the dampening influence on domestic (U.S. and Canadian) supply and LNG imports from the lower price trajectory," said the duo. "By contrast, we expect oil prices to remain buoyant, with no force on the near-term horizon strong enough to arbitrage them back into parity..."

Drilling success in developing shale gas is spreading to other plays, with growth in the Woodford and Fayetteville shales "already in evidence, Haynesville next and the Marcellus/Lower Huron to follow," said the analysts. "Other plays, including in the Rockies, will add to this supply. This will lead, in our view, to continued growth in U.S. gas supply into 2009 and beyond."

Supply growth would demand a further ramp-up in drilling, said Zenker and Hopley. "As plays such as the Barnett [shale] peak, new plays must fill in. Yet companies already have the acreage and drilling targets to match and even exceed our growth expectations, but equipment shortages, rising steel costs, need for permits and infrastructure constraints potentially stand in their way."

The biggest hurdle to growing gas output will be the market, they noted. "There is plenty of evidence that producers are sensitive to prices as they trend lower. At least two dynamics are at play: companies seeking to drill only prospects that are at or above their rate of return target might find that at lower forward prices, fewer targets meet their target rates. Secondly, financing available to some producers is tied to forward prices, and, thus, drilling budgets shrink with prices."

Drilling rates were basically flat when gas prices hovered in a range of $7/MMBtu to $9/MMBtu between 4Q2006 and 4Q2007, the Barclays analysts said.

However, Zenker and Hopley said producers have "significant momentum" in their drilling plans over the next six to 12 months, "momentum that even a further dip in prices would not quickly change. Many have made supply growth commitments to investors. A pullback in prices is, therefore, more likely to produce a lagged impact on the rig count. Thus, our supply outlook includes strong growth into 2009, underpinned by this drilling momentum, followed by a slower pace of supply growth in 2010 as, by then, persistent lower prices wear on producer resolve."

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