Fundamentals are in place for U.S. natural gas prices to recover to "at least" $4.00/MMBtu in 2013, with prices through December averaging $3.50, an energy analyst said last week. The gas supply "inventory overhang is not as bad as was feared," said another analyst.
Since the beginning of the injection season, the year/year (y/y) storage overhang has eroded to 200 Bcf from 900 Bcf "largely on the back of 5 Bcf/d plus stronger year-to-date gas-fired power demand, noted Canaccord Genuity analyst John Gerdes. "In a sub-$3.00 gas price environment, gas-fired power generation served as the corrective mechanism to reduce the storage surplus."
However, the "necessity" for low gas prices and the strength in gas-fired power demand has receded, he said. Gas-fired power demand "should wane late this year with a rise in gas prices." Earlier this month Barclays Capital raised its estimate for average 4Q2013 gas prices to $3.35/MMBtu from $3.00, while Bank of America Merrill Lynch lifted its 2013 average gas price by 25 cents to $3.75 (see NGI, Oct. 15).
The exploration and production (E&P) industry responded to the earlier gas storage overhang by reducing onshore dry gas-directed activity to about 430 rigs, "which is markedly below the 600-700 gas rigs necessary to maintain market equilibrium long-term," Gerdes said. "Specifically, the gas market is currently 2 Bcf/d plus undersupplied on a weather-normalized 13-week moving average basis. Consequently, gas storage should be meaningfully lower y/y exiting the '12/'13 heating season."
Assuming 15-year average winter weather, the Canaccord Genuity analyst expects gas in storage to approximate year-ago levels before the end of this year, which would mean the heating season would end with storage about 600 Bcf below year-end 2011. "If the storage dynamics materialize...our $4 gas price forecast next year clearly has upside bias." U.S. gas supplies should exhibit "modest growth" early next year as gas wells that were deferred this year are completed.
"Our expectation for the gas rig count to average almost 600 rigs next year is highly optimistic, though still results in November '13 gas storage of only 3,300 Bcf," said Gerdes. "Further, without at least a $4.00 gas price signal and corresponding increase in gas-directed drilling activity, our November '13 storage projection is also overly optimistic."
Canaccord Genuity's domestic gas supply projection for 2012/2013 includes 2 Bcf/d per year of gas output growth associated with oil-directed drilling activity, assuming the oil rig count remains slightly above 1,400 rigs through next year. In the coming year U.S. gas prices should return to the 2011 gas price level of $4.00/Mcf, which would "induce a reversion in this year's fuel switching gains, leading to a 1 Bcf/d decline in gas-fired power demand," said Gerdes. He also expects 2 Bcf/d of gas supply growth associated with oil-directed drilling.
For the long-term, Canaccord Genuity is maintaining a $5.00/MMBtu gas price. "The marginal cost of supply outside of the Marcellus [Shale] requires $5 gas," the analyst noted. The forecast is now 2 cents below the futures strip, while the long-term gas price forecast is 15% above the 2014 strip. The price forecast implies "continued industry cash flow outspend."
Canaccord Genuity's "bottom-up analysis suggests the U.S. gas market is on the precipice of a supply rollover," said Gerdes. The review includes 1.2 Bcf/d of incremental gas output in 1Q2013 associated with 300 incremental gas well completions in the Marcellus Shale. The analysis implies that Marcellus output "should grow by 2.8 Bcf/d during the course of this year and 2.5 Bcf/d in '13..."
Gas output associated with liquids development is projected to increase 2.1 Bcf/d this year and 1.7 Bcf/d in the coming year, said Gerdes. Offsetting this growth, however, are declines in the Haynesville and Barnett shales. In the Haynesville production is expected to fall 1.2 Bcf/d "during the course of this year and 1 Bcf/d in '13," while "Barnett Shale output falls 0.4 Bf/d this year and 0.1 Bcf/d in '13. More notably, the remaining U.S. supply base net of the incremental growth in gas production associated with liquids development erodes 2.5 Bcf/d (6%) during the course of this year and 2.4 Bcf/d (6%) in '13."
The analysis of overall U.S. onshore supply indicates a decline of 1.3 Bcf/d, or 2%, this year and 1 Bcf/d, or 2%, in 2013. The U.S. gas rig count is forecast to average 560 rigs this year, and rise by 30 rigs in 2013 and then reach 660 rigs in 2014, according to the analyst. The oil rig count, meanwhile, is expected to average 1,400 rigs over the next two years.
U.S. E&Ps in 2010 and 2011 outspent cash flow by 40%, Gerdes noted. Assuming a $2.80/Mcf and $90/bbl prices on the New York Mercantile Exchange (Nymex), with on average 1,370 oil rigs and 560 gas rigs, "we project the gas industry will be 60% free cash flow negative." Next year a $4.00 gas price and a $90 oil price (Nymex) and slightly higher domestic drilling rates -- averaging 1,400 oil rigs and 590 gas rigs -- "reconciles with a cash flow outspend of 40%. Notably, in a $5 gas price, $90 Nymex oil price next year, gas-dominant E&Ps on average are roughly free cash flow neutral."
Despite weak prices, there is "significant upside optionality" to natural gas, according to Credit Suisse. The "trend is your friend" because the gas supply "inventory overhang is not as bad as was feared," said analyst Arun Jayaram. "Production from unconventional plays is starting to soften...and conventional production could drop significantly in 2013," he said during a conference call.
Jayaram, who is in charge of Credit Suisse's U.S. exploration and production (E&P) coverage, joined other analysts with the firm last week to discuss North American oil and gas markets in the near term.
Lower prices have led many producers to reduce their drilling, but "the 800-pound gorilla of the gas market," Chesapeake Energy Corp., has had a huge impact, he said (see related story). Chesapeake began reining in its capital spending during the second quarter and dropping drilling rigs, and as the No. 2 U.S. gas producer, the cuts have dominoed across the industry. For instance, the producer shut in an estimated 60% of its output in the Haynesville Shale, and it is the biggest player there.
Now there are "cracks in the lowest-cost plays," and a "sharp retrenchment in gas prices is beginning to impact liquids-rich drilling," Jayaram said. "The bear case is when gas prices rebound, there is a mountain of gas waiting to come back, but returns do not support this view." Winter weather, "as always, is the key," he said.
Natural gas continues to have "powerful demand trends" from the chemical industry and because of coal switching for power demand. In addition, gas "appears to be on the 'right side' of the upcoming policy debate." However, a "near-term pause is likely given price-sensitive power demand and flat production," said the analyst.
Is it time for a contrarian call? It's getting close, he said. "Gas futures have plummeted, and the market has now discounted weak gas prices. The question shifts to the timing of the recovery."
The analyst acknowledged that the consensus isn't constructive on gas prices, which are "below the marginal coast of production in nearly every basin" in the U.S. onshore. A "minority of gas bulls are citing the imminent collapse in Haynesville and Barnett" shale production. An inflection point is coming next year. "Efficiencies will elongate the timing of the gas reset...Advances in stimulation and horizontal drilling have massively compressed cycle time."
According to Credit Suisse, it took nine years for the Barnett Shale to reach 5 Bcf/d, while the Haynesville completed the same feat in less than three years. The Marcellus and Fayetteville shales are "set to top 3 Bcf/d in the next few months." The Marcellus play has yet to hit an "efficiency zone" because of two things: infrastructure bottlenecks and E&Ps are motivated to "earn" acreage. "A flood of Marcellus production is likely in coming quarters given hundreds of wells behind the pipe, which will keep a lid on gas prices, despite activity curtailments."
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