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'Tectonic Shift' Predicted in U.S. Natural Gas Demand by 2020

When U.S. natural gas prices finally moved into $4.00/MMBtu territory earlier this year, there wasn't any rush to ramp up onshore activity, but as each month passes, it's becoming clear that a "large wave" of domestic demand is about to unfold, according to Barclays Capital.

U.S. gas markets should face demand growth of more than 14 Bcf/d between now and 2020, but demand may be capped by operators' ability to deliver supply, said analysts Biliana Pehlivanova and Shiyang Wang.

"Demand growth is now taking the leading role for natural gas markets, and we believe it will carry prices higher in the next few years. We believe prices would have to rise from current levels for production growth to meet an average annual incremental consumption of 2 Bcf/d in the next seven years."

A combination of factors to 2020 will require a magnitude of U.S. gas supply growth that "opens the door for the bulls to tout hefty, longer-term price forecasts." With the "right price signals, producers stand ready to quell the heated demand with a tidal wave of output. In the past five years, natural gas production has grown by an average of 2.64 Bcf/d each year, with cash prices averaging $4.80/MMBtu," said the analysts.

Prices at $4.50-5.00/MMBtu "are high enough to motivate enough gas drilling to meet projected demand: a healthy recovery from recent $2.00 prices, but still low enough to preserve a cost advantage in the U.S. relative to other manufacturing economies. We expect natural gas prices to average $4.35/MMBtu in 2015, and $4.75/MMBtu in the longer run."

Cash prices aren't the "perfect indicator of what producers receive for their gas" because many hedged more than 30% of current annual output and more than 15% of the following year's output, said analysts. "Also, the economics of most U.S. locations drilled in the past few years in part were underpinned by liquids prices, they said. There also is a lot of excess gas supply from associated gas in oilfields.

"Importantly, by far the largest source of production growth in recent years has come from the Marcellus Shale, which offers among the lowest cost gas in the nation, and remains profitable in the current price environment. Still, gas prices matter, and if production has to grow to meet increasing consumption, prices would have to rise to entice a producer response."

The huge shifts in domestic gas supply-demand have been well illustrated, with a lot of press going to the big U.S. natural gas export projects. Analysts also see a lot of demand growth through the end of the decade tied to several other factors, some big, some small. A big factor are environmental regulations taking effect in 2015, which could shutter up to 25 GW of coal-fired power with more plants shut through the end of the decade, increasing gas consumption by 2 Bcf/d. Also, Mexico's gas pipeline capacity is set to expand by 3.5 Bcf/d by 2016 and by the end of the decade it's seen siphoning about 3 Bcf/d.

Barclays analysts see a huge demand increase from the industrial sector, where gas demand increased by almost 600 MMcf/d year/year in 2012. By 2020 it could rise to 3 Bcf/d (Barclays' estimate), and by as much as 6 Bcf/d. In addition, natural gas vehicle growth should account for only 0.2% (170 MMcf/d) by 2017, but it could double from 2017 to 2020 to about 250 MMcf/d.

Barclays' forecast suggests that gas will remain decoupled from oil for the foreseeable future. "Yet oil prices do matter for the gas markets...While U.S. gas prices have won independence from their older oil sibling with the success of shale gas, the two remain close relatives at heart."

Drillers often drill for both gas and oil, and investment decisions put the two commodities in competition for drilling dollars.

"An increased availability of oil drilling targets has already pulled rigs away from natural gas plays," said analysts. "A discovery of new and even larger shale oil resources could siphon more rigs away from natural gas, even at higher gas prices. On the contrary, a collapse of oil prices could make natural gas drilling targets more attractive, even if gas prices remain unchanged."

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