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Raymond James Calls 'Mayday' on U.S. Gas Prices

September 15, 2008
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With natural gas production growth up 8% year/year (y/y) and gas prices down by half in just two months, Raymond James & Associates Inc. Monday slashed its U.S. gas price forecast for 4Q2008 to $7.50/Mcf from $10, which is 40 cents lower than the futures price and nearly $4 below Wall Street's consensus.

The rise in U.S. gas production "has finally caught the eye of the market," noted Raymond James energy analysts J. Marshall Adkins and Christopher Butschek. "With the current y/y gas storage deficit at 150 Bcf, many believe that the gas market must be near a bottom. Unfortunately, we believe that the y/y storage numbers will deteriorate much further over the next six months..."

Substantial supply growth, combined with "incredibly bearish y/y weather comps and limited demand growth" could cause 2009 gas prices to fall below the $7/Mcf drilling threshold to $6.75, the duo wrote in a note to clients. The estimate, which is 75 cents/Mcf below a previous Raymond James forecast, is now more than $3/Mcf below Street consensus and nearly $2/Mcf below strip prices.

"Simply put, our gas model suggests that the U.S. gas market must somehow squeeze out 500 Bcf of gas supply over the next year," said Adkins and Butschek. "The way we see it, such a supply reduction will not happen if gas prices (12-month futures strip) remain above $7/Mcf in 2009. We believe that producers will need to either voluntarily shut in production or reduce drilling activity."

Raymond James' 2009 price forecast of $6.75/Mcf "assumes drilling activity rolls over in early 2009. It is important to note that the market may need to take prices even lower to rebalance the system. In other words, if pressed, we would probably take the under on our new gas price forecast. As we have held over the past six months, such a gas price environment would be particularly bad for North American natural gas-weighted names such as marginal gas producers, pressure pumpers, land drillers and shallow water jackup drillers."

The Raymond James energy team has grown increasingly bearish on U.S. gas prices since the start of the year. In the first half of the year, its bearish stance was "dead wrong, as natural gas prices rallied from nearly $8/Mcf at the beginning of the year to over $13/Mcf in late June. Unfortunately (for our companies), U.S. natural gas prices have been absolutely crushed over the past two months. After peaking at over $13.50/Mcf in early July, natural gas has now fallen nearly 50%. The main drivers of this massive gas price pullback have been 1) the market beginning to understand the magnitude of the U.S. gas oversupply situation and 2) a pullback in the overall commodity markets.

"The good news is that we expect the overall commodity markets to stabilize or even improve in the coming months. The bad news is that we do not see a sustainable improvement in U.S. natural gas fundamentals."

The fact remains, said the duo, "that U.S. gas supplies are screaming higher at a ridiculously high 8% annual growth rate. Since gas demand growth is not growing nearly as fast as supply growth, the U.S. gas market is still headed for a train wreck. Yes, we have had a meaningful pullback in natural gas prices over the past two months, but there is no reason it cannot get worse."

Winter gas storage is expected to move "meaningfully higher over the next six months," wrote the analysts. "The combination of surging U.S. gas supply growth, anemic gas demand growth and bearish y/y weather comparisons lead us to believe that this upcoming winter (2008/2009) could end with over 600 Bcf more in storage than at the end of last winter. Keep in mind that only two months ago, the U.S. had nearly a 400 Bcf gas storage deficit relative to the prior year."

Going forward, the Raymond James analysts expect the y/y gas supply growth rate to slow modestly as "1) we reach the anniversary of Independence Hub's start-up in July, 2) we reach the anniversary of REX-West pipeline next spring, and 3) gas decline rates accelerate. That being said, we model net natural gas supply up over 3.5 Bcf/d during the upcoming winter."

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