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Gas Bears Prepare for Harsh Winter, Prices Below $7 in '09

Even with the hurricane-related disruptions from Gustav and Ike in September, prompt Henry Hub prices have remained below $8/MMBtu since the end of August, and as Gulf of Mexico production slowly recovers, supply strength elsewhere, economic weakness and a warm winter may pull winter gas prices below $7 by early next year, energy analysts predicted last week.

All signs point to supply strength and demand weakness in the months ahead, and the U.S. natural gas market will rely on storage draws for a smaller proportion of winter supply than in previous years, Barclays Capital energy analysts wrote in an Energy Special Report, "A Bearish Winter Awaits Natural Gas." The report, written in part by former Lehman Brothers energy analysts, was put together by Barclays' Edward Kott, Daniel Guertin and Edward Morse. (London-based Barclays plc purchased Lehman's advisory businesses, including its trading and research arm, in September (see NGI, Sept. 22).

The Barclays analysts forecast gas balances for the upcoming winter in the Lower 48 states, and the balances "demonstrate that we anticipate relatively low storage draws through the winter. Most notably, as Gulf of Mexico supply continues to recover [from hurricanes Ike and Gustav], we expect net storage injections to continue well into November rather than the end of October."

In 2007, the analysts noted that net gas injections continued into the first week of November. This year "there may be an additional two or three weeks of injections. We expect November to yield nearly 70 Bcf of net additions to storage, which would bring peak storage roughly equal to last year's record 3.55 Tcf peak and possibly higher."

The Barclays analysts are forecasting a net storage draw of 1.59 Tcf from November through March 2009, which would be well below last winter's 2.31 Tcf draw.

"Combined with record or near-record peak storage in November, this indicates end-March inventories of 1.9 Tcf -- a full 200 Bcf above the previous high storage mark coming out of the heating season," noted the Barclays team. "Of course, an unexpectedly cold winter would prompt larger storage draws through March. But under our current weather assumptions, the U.S. gas market will head into the 2009 injection season with a running start and sustained supply strength that will conspire to push prices lower during the summer. Unless a very cold winter is followed by a very hot summer, the market will see falling prices and discussions of whether producers will curtail supply by the end of next year."

The stock market declines, which extended across the energy sector on Monday, brought the market more in line with Barclays' view for the next two quarters, said the analysts.

"Despite Monday's $0.523/MMBtu plunge of the New York Mercantile Exchange prompt contract to $6.835, we still believe that natural gas has more room to fall through the fourth quarter, particularly should the market see net injections into the second half of November, as we anticipate," said the analysts of last week's market action. "However...we foresee continued price weakness through 2009 as a widespread supply response to lower prices is likely to be delayed due to producer hedging and lags between drilling plans and when gas arrives in the market."

Meanwhile, analysts with Raymond James & Associates Inc. said last week that oversupply concerns may keep gas prices depressed through 2009, and a soft floor of around $7/Mcf "could easily be breached" if the domestic rig count isn't severely cut.

Even if the gas rig count drops, "we still look for production shut-ins near the end of next summer, hence our $6/Mcf 3Q2009 forecast," wrote Raymond James' J. Marshall Adkins, Kristal Choy and Christopher Butschek in their October monthly report. "Our 2009 forecast of $6.75/Mcf remains 20% below futures pricing and nearly 30% below the Street, suggesting that natural gas' precipitous decline may not be over quite yet."

The Raymond James energy team called a "mayday" on U.S. gas prices in September, slashing its domestic price forecast for 4Q2008 to $7.50/Mcf from $10, which at the time was 40 cents lower than the futures price and nearly $4 below Wall Street's consensus (see NGI, Sept. 15). Adkins and company noted that gas prices now have fallen 50% from summer peaks.

"While post-hurricane offshore production shut-ins (nearly 3 Bcf/d) remain a concern, surging onshore supply and questionable demand growth continue to weigh on prices," said the Raymond James analysts. "Even after over 200 Bcf of production shut-ins from Hurricanes Gustav and Ike, storage may still end the summer injection season near last year's record level. This would leave the U.S. awash in gas this winter, potentially calling for a substantial cut in the rig count and production shut-ins to bring the market back into balance. As a result, we also lowered our 2009 forecast from $7.50/Mcf to $6.75/Mcf."

The market, said the Raymond James team, is finally beginning to realize the magnitude of U.S. gas production growth, which they estimated was up 7% in the first half of 2008.

"Over the past few weeks (before the two hurricanes), this supply growth was the primary driver behind our string of massive storage injections, over 4 Bcf/d more than last year after adjusting for weather," said the analysts. "Second, extraordinary easy weather comps for this upcoming winter will make it difficult for cold weather to bail us out this time, as it was already cold last year."

Assuming normal winter weather, Raymond James is forecasting winter-ending storage in excess of 1.8 Tcf, nearly 600 Bcf higher than the year before. "Should gas storage exit winter at levels anywhere near this, the market will be in for a serious correction," said Adkins and his team.

Coal-to-gas fuel switching also remains limited, the Raymond James analysts said. "Previously, it had been suggested that coal provides a floor to natural gas, with power plants switching between the two at a level in the $7/Mcf range. Since then, we've learned that coal-to-gas switching faces a series of difficult hurdles, and, even if it clears all of these hurdles, is limited to 2 Bcf/d due to shipping constraints."

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