Tradition Energy analysts on Tuesday piled on to 2011 consensus outlook by several energy teams regarding U.S. natural gas prices. The possibility that prices may strengthen over the coming months appears "challenging," they said.

The energy team at Tudor, Pickering, Holt & Co. Inc. (TPH) followed on Wednesday by slashing its 2011 gas price forecast by $1.00 to $4.00/Mcf. Calgary-based AJM Petroleum Consultants maintained its Canadian gas price forecast for 2011 but cut the 2012 prediction.

Tradition's Addison Armstrong, senior director of market research, and colleagues Eugene McGillian and Chris Dillman issued their guidance in the firm's 2011 Energy Market Forecast: Skating Away on the Thin Ice of a New Day.

The trio remains negative about natural gas prices this year, but they likewise are skeptical about the "sustained upside potential" for oil and refined products because they expect to see a slowdown in global economic growth, too much supply and more on the way, as well as abundant spare capacity.

According to the energy team, New York Mercantile Exchange gas prices this year should average $4.20/Mcf, which is 60 cents less than a forecast a few months ago. Crude oil prices in 2011 should average $88.25/bbl, analysts said.

"We are maintaining a negative bias for natural gas prices for 2011," wrote the Tradition Energy analysts. "Unlike oil or refined products, which experienced some improvement in bullish fundamentals last year, the fundamentals for natural gas are decidedly poor..."

However, "years of watching the natural gas market have given us a healthy amount of respect for the potential for sharp rallies, so we prefer to be cautious when thinking about how prices may swing around in any given year. In fact, in our last couple of natural gas price forecasts, we erred by not being bearish enough. But the fundamentals of natural gas, plus the outlook for the U.S. economy in 2011, will create a challenging environment for prices to move higher."

Gas production levels over the past year have been sustained even with fewer drilling rigs because methods to extract shale and tight gas continue to improve, Armstrong and his team said. Their comments mirror those of other energy analysts in recent months.

"The cost structure to drill using the hydraulic fracturing method, combined with opportunities for producers to hedge their profits in the futures markets due to the shape of the forward curve, should ensure that production levels remain high," wrote Armstrong. "For instance, the break-even cost to drill the first well in a shale play is reportedly around $3.75/MMBtu. If that were not low enough, estimates of the cost to drill additional wells on the same property fall to around $2.00/MMBtu."

The estimated costs don't account for everything associated with shale gas production, "but with futures prices at $4.46 for all of 2011, $5.03 for all of 2012 and $5.36 for all of 2013 producers have plenty of incentive to continue to increase drilling in order to maximize profits."

The TPH energy team, led by Dan Pickering, cut the 2011 Henry Hub gas price forecast to $4.00/Mcf from $5.00. Through March gas prices are expected to average $4.00/Mcf, falling to $3.50 in 2Q2011. In 3Q2011 prices are expected to average $4.00 and climb on average to $4.50 in 4Q2011. TPH's longer-dated price forecast remains unchanged with 2012 at around $5.00/Mcf and 2013 and beyond at $6.00.

The rationale behind the price cut, said Pickering, follows TPH's updated supply study published last October, which suggested that U.S. supply would grow at a rate of 2.5 Bcf/d annually if the gas-directed rig count failed to drop materially (see Daily GPI, Oct. 18, 2010).

"Since we wrote the updated supply report, overall gas-directed rig count has only fallen 28 rigs (3% 4Q2010 from 3Q2010) and the current weather-adjusted storage trends suggest the gas market is still 1.5 Bcf/d oversupplied," he said. "Assuming normal weather the rest of winter and 1.5 Bcf/d oversupplied, storage ends March '11 at 1,867 Bcf," which is 198 Bcf, or 11%, above year-ago levels and 168 Bcf, or 10%, more than prior maximum levels in March 2006.

In TPH's projections for storage through this summer, on normal weather (2,000 Bcf injections) and 1.5 Bcf/d oversupplied (an additional 300 Bcf injection) "would leave storage at 4,200 Bcf, which is well above operational capacity of 4 Tcf. To avoid this overfill, gas prices have to fall to $4.00/Mcf to achieve incremental market share from coal in the power sector.

"Can the market 'fix itself' without lower gas prices? Yes, if the rig count falls 150 rigs in the emerging shale plays (soon!) or cold weather remains this winter, or a hot summer, but remember weather bets also have a downside (warm winter/cool summer)," said Pickering.

AJM Petroleum maintained its 2011 AECO price forecast of C$4.10/Mcf, but analysts lowered their 2012 price prediction to C$4.50 from C$4.70.

"For Canadian natural gas to remain competitive with U.S. natural gas, our prices have to be lower than the American prices," said AJM economist Ralph Glass. "A high Canadian dollar, and an increased supply of natural gas from American shale plays, combined with the U.S. economic recovery strategy to 'keep America working,' is pushing Canadian natural gas out of the U.S. markets. We have to maintain bargain basement prices to keep natural gas moving until we develop viable alternative markets. That will mean a tough year for Canadian natural gas producers."

On Monday analysts with Raymond James & Associates Inc. said the United States would "remain structurally oversupplied with gas until we see a step-change upward in demand" (see Daily GPI, Jan. 4). The Raymond James team expects domestic gas prices in 2011 to average $3.75/MMBtu, rising to about $4.25 in 2012.

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