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Analysts Pessimistic on Outlook for U.S. Gas Prices

Emerging unconventional resources, especially from shale, could result in lower-than-expected natural gas prices for the next five to 10 years, a Barclays Capital analyst said Wednesday.

"Shale, along with other low-cost unconventional gas, could provide 75-90% of new gas supply over the next several years and set the marginal cost of new supply," wrote Barclays' Tom Driscoll in a note to clients. "It's 1985 all over again," he said, referring to the period when gas markets were deregulated.

"It took 20 years for average wellhead gas prices (in real terms) to return to the levels of the early 1980s," Driscoll wrote. In that period of time, gas prices reacted in tandem with oil at a ratio of around 10-12:1, which was much more volatile than the 6:1 ratio that was more or less constant beginning around 10 years ago.

Even though the U.S. gas drilling rig count has fallen by around half since last September (see Daily GPI, May 27), 4Q2009 production likely will be flat compared with gas output in 4Q2008, said the Barclays analyst.

"While production is certain to fall sharply later this year as a result of limited storage capacity, we believe significant excess storage capacity will carry over into 2010 and perhaps into 2011," Driscoll said. The market will be oversupplied on average an estimated 4 Bcf/d in 2009 and 3 Bcf/d in 2010, Driscoll said. More efficient horizontal rigs are profitable even when gas prices are materially below $6/Mcf, he added.

Outside the United States, the global gas glut has driven down spot prices everywhere, and the situation will only get worse for sellers over the next few years as the market increasingly favors buyers, said Wood Mackenzie's Noel Tomnay, head of Global Gas, Gas & Power Research.

"The combination of the global slide into economic recession, the dramatic growth in gas availability from unconventional sources in North America and the largest wave of new LNG [liquefied natural gas] supply ever to hit the global market have contributed to a global gas glut," Tomnay said.

According to Wood Mackenzie's analysis, withdrawing gas supply from the global market will be needed to prevent a collapse of spot prices: a collapse that could materialize as early as this summer.

The supply/demand outlook in the Atlantic, including North America, is mostly dependent on the actions of European gas suppliers, such as Norway and Russia, and it is within the gas suppliers' power to decide how much LNG will enter the European market, according to Wood Mackenzie. The UK-based researcher estimates that 140 billion cubic meters (bcm)/year of discretionary pipe gas and flexible LNG will compete for an average of around 70 bcm/year of contestable market from 2010 to 2012 in Europe.

"It is clear the availability of piped gas and LNG in the Atlantic will remain higher than demand for some years," said Tomnay. "But it is not clear whether major piped exporters to Europe, including Russia and Norway, will be prepared to back out discretionary gas to accommodate new LNG into the European market and sustain reasonable price levels in Europe. Or, alternatively, whether these same suppliers will seek to maintain market share and be prepared to drive down prices to shut out new LNG."

If the new LNG doesn't find a home in Europe, Wood Mackenzie, like other energy analysts in recent weeks, is warning that North America will become the global safety valve to release the gas overburden.

"Effectively higher LNG imports will result in lower-priced gas in North America; therefore the actions of European piped gas suppliers will have a significant impact on prices in North America," Tomnay said. "LNG is therefore likely to displace indigenous gas in North America, requiring further reductions in drilling rigs in the near term as the market seeks a new clearing price that will encourage development of sufficient gas to balance the market."

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