The risk of a "winter weather reset" of the natural gas market based on depletion of gas in storage has come in higher and sooner than forecast, Barclays Capital analysts said last week. As succeeding waves of super cold plague vast areas of the country, all are watching the storage numbers closely. The volume of gas remaining in storage on March 31 will set the tone of the market for the rest of the year.
Analysts Jim Crandell, Biliana Pehlivanova and Michael Zenker last month offered their top 10 list of surprises for 2009 (see NGI, Jan. 4). Last week they dug deeper into the implications for gas markets and compiled another list of possible surprises in 2010.
"The gas industry lives with the constant threat (to some, hope) that a cold winter can reset the market for the year," said the trio. "Even a market with surplus storage can fall to undersupply if weather is cold enough. As such, this item will be on any list of potential gas industry surprises." The risk for a market reset "is heightened at the moment and this factor is, in our view, the market's best chance for a bullish 2010 trajectory."
On Thursday the Energy Information Administration reported that 153 Bcf was removed from underground storage for the week ending Jan. 1, compared with a five-year average of 78 Bcf. Now analysts are weather forecasters are suggesting that winter has only begun -- along with the storage removals (see related story).
Following an "endless string of milder-than-normal weather, Mother Nature went long natural gas starting in December 2009, and is working her book," said the Barclays analysts. "The forecast calls for more cold weather for some time ahead," and from here, "a further run of cold weather makes a 1.60 Tcf storage finish at the end of March possible. Our own view, which always includes normal weather ahead, calls for an end of March storage inventory of 1.94, still a recent record, but not so bearish as the 2.1 Tcf we were expecting at the start of this winter."
Another possible impact on the gas market this year is coal, which could reclaim market share, said Crandell and his colleagues.
"Stockpiled coal, plus new coal units that have entered service in the past few quarters, add to the headwinds for gas to displace coal," they wrote. "But barring a roaring recovery of power demand, there will still not be enough megawatt-hours in 2010 to keep both gas and coal plants busy. Our view is that coal recovers most, but not all of its lost 2009 market share, but the balance is delicately linked to gas prices."
The markets also face a surprise from only a modest dip in gas supplies, which could grow more than expected, said the team. "At issue, on the one hand, is the accelerating decline rate of gas production, with unconventional and shale gas comprising a growing share of supply, technology pushing initial production rates ever higher and, in turn, further boosting decline rates. On the other hand, companies have high-graded drilling sites, taken on higher specification rigs with more fracturing stages, found more promising shale locations, and boosted EURs [estimated ultimate recoveries]."
If liquefied natural gas (LNG) were to flood U.S. markets, there also could be more "global price linkage" in 2010, noted the trio. Only a few elements of the LNG business need to align "to create meaningful growth in U.S. LNG imports in 2010."
Also to be watched: whether producers are willing to grow the rig count in a $5/Mcf gas market, said the analysts.
"If gas prices are below cost, why drill? Well, it depends on which 'price' and 'cost' one is talking about. With hedging adding significantly to producer cash flow in recent episodes of weak cash prices, cash prices are not a clear indicator of producer revenues. As our equities research colleague, Tom Driscoll, has highlighted in his research, producers with land positions may decide to drill based on going forward, rather than all-in, costs."
What if the gas forward curve dramatically flattens, asked the analysts. "We have seen the price curve flatten in the past several weeks, but this is mostly a rally in the front, not a softening of the back of the curve. What we refer to here is the drop in the back of the curve to roughly match the front. We have seen through 2009 that prices in the prompt year above $6/MMBtu provide inducement enough for producers to hedge and continue drilling. But if the contango in gas melted away, the hedge opportunity would fade with it, potentially restraining the market."
The Barclays team also wondered if U.S. storage could accommodate more than 4 Tcf. Since it appeared to sail past 3.8 Tcf in 2009 "without significant bottle-necking, and with more storage heading to completion in 2010, perhaps 4 Tcf is the new storage limit. As some gas traders have astutely noted, a projected storage finish of 3.8 Tcf will no longer scare the market as it did in the run-up to winter 2009-2010." They said "there is no question that the North American storage complex is bigger and more robust than expected."
Also on a list of surprises for the market this year: breakthrough legislation for gas, said the analysts. If shale gas potential is as robust and cheap as some believe, the gas industry will need a new demand outlet, and "legislation, ushering in either mandates or incentives for new demand sources, would be one way."
There is the possibility of an "energy light" economic recovery in 2010 that could impact the markets, said Crandell and his team. Previous recessions and the "price/hurricane shocks" to the market that disrupted industrial demand in the last 10 years "were not followed by a complete recovery of demand," and some "key gas-intensive industries are still struggling: steel, petrochemicals, refining, manufacturing, building products and pulp and paper. Only fertilizer and oil sands demand for natural gas in Canada have been bright spots."
Another potential surprise for the gas markets is that the capital markets would constrain drilling this year, said the analysts. If capital isn't available to allow producers to get to work, "it could force the drilling discipline that we believe the industry needs. Perhaps a protracted period of disappointing prices, or the failure of a number of producers, would reign in the appetite of the capital markets to fund producers."
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