Gas Analysts: Storage Could Fall to Critically Low Levels

If you got a lump of coal in your stocking this Christmas, rejoice. It could be the only thing left to heat your home by the end of winter. There is a growing consensus among gas market experts that there will be a shortage by March if the weather stays normal or colder than normal.

This surprisingly cold winter has reduced gas storage down to record lows for this time of year, and given predictions for more cold weather the storage situation probably is going to get worse before it has a chance to get better. The winter so far has been 21% colder than the 10-year average and 35% colder than last year, according to Salomon Smith Barney. And below-normal temperatures should linger at least through the end of the year, according to the most recent short-term forecasts.

Gas storage, meanwhile, is only 64% full. Last week, the American Gas Association reported that storage fell 158 Bcf during the week ending Dec. 15 to 2,113 Bcf. Working gas levels are 457 Bcf below the five year average and 630 Bcf below levels at the same time last year.

The market acknowledged the storage problem long ago but continues to produce new records nearly each week. Last week was no exception. Futures prices for January delivery are fast approaching $10/MMBtu and some observers believe much higher prices are yet to come unless the weather turns suddenly warmer, a significant amount of demand is removed from the market or a large amount of new supply kicks in.

"It is difficult to identify how the market is going to avoid running out of gas without much higher prices and/or involuntary curtailments unless we have extremely warm weather," said WEFA Inc.'s Ron Denhardt last week. Analysts at Petrie Parkman & Co., Raymond James and Associates, UBS Warburg and Salomon Smith Barney echoed his comments.

All of the analysts agreed that an average pace for storage withdrawals for the rest of the winter would put working gas levels in the negative column, which might be impossible given the pressure requirements for withdrawing gas from storage fields.

"At the rate winter is setting in, by the middle of February we'll be where we usually are in April" in regard to natural gas in storage, said Thomas A. Petrie, chairman of Petrie Parkman & Co. in Denver. "By March 15 we will be in a very serious situation. We'll be digging into pad gas, and who knows how far you can dig into that," he said. If the industry is able to tap into the cushion gas at the bottom of the storage cavern, "you're just going to have to replace it. The shoulder months are going to be unrecognizable."

Analysts at Raymond James and Associates predict an "unprecedented gas shortage in the second half of this winter" and an $8/Mcf spot price average during the first quarter at the Henry Hub. They said storage levels "should fall well below anything we have seen in recent history." Given normal weather for the rest of the winter, storage levels would have to fall to a "completely unfeasible" -280 Bcf of working gas by April 1. "Keep in mind that we have never really tested the gas storage system below +600 Bcf. This means gas prices must continue to rise sufficiently through the second half of the winter to discourage between 5 and 10 Bcf/d of demand in the final 90 days of winter. In other words, the U.S. will likely see some form of price driven rationing of natural gas in the second half of this winter."

Raymond James' projections of storage withdrawals are substantially higher than the five-year average. The firm predicts industry will withdraw an average of 182 Bcf/week through the week ending March 9, but over that period during the past five winters withdrawals have averaged only 120 Bcf/week. Even with 120 Bcf/week, however, there still would be only 673 Bcf of working gas in storage on March 9.

Salomon Smith Barney analysts Robert Morris and Michael Schmidt --- probably the most optimistic of the bunch --- predicted working gas levels would end the winter no higher than 600 Bcf. "We believe that total natural storage levels cannot be drawn down to below 500 Bcf due to physical limitations, which, if the winter maintains its current course, could result in physical shortages of natural gas near the end of this season."

Ronald J. Barone of UBS Warburg said working storage levels probably would fall to 517 Bcf by April 1. "However, given underlying demand creep, the chilly weather outlook (and the fact that three of the prior six years were very mild), we cannot rule out an exhaustion of supplies by April 1."

Demand Reductions Critical

Petrie, Denhardt and the analysts at Raymond James said it will be critical for the gas industry to cast off some demand between now and March. The market already has started to allocate supplies, with industries such as methanol, ammonia and glass opting out because of high prices. Prices continue to post new records and appear likely to cross the $10 mark for the first time in history relatively soon.

"In order to end the heating season with 500 Bcf in storage it will be necessary to have some combination of supply increase or demand decrease that adds up to 6 Bcf/d," said Denhardt. "We simply cannot determine how this will happen."

Denhardt said even if a huge 4% increase in U.S. production occurs during the remainder of the heating season that still would account for only 2 Bcf/d and is very unlikely to occur anyway. "If you assume you lose half of the fertilizer industry (0.8 Bcf/d) and some other industrial gas consumption, you may get 1.2 Bcf/d. This [with the unlikely production increase] all adds up to 3.2 Bcf/d, far short of 6 Bcf/d" required, Denhardt added.

Fuel switching is expected to take at least 1.5 Bcf/d out of the market potentially much more. "This adjustment over about 14 weeks would bring storage levels to a plus 27 Bcf." However prices have to go much higher to knock even more demand out of the market, he said. Denhardt sees the potential for 7.5 Bcf/d of demand to be cut. However, there are a lot of "ifs" involved, he noted. Much of it would come from switching to dirty burning fuels and environmental restrictions stand in the way.

"Thus there is the capability for the market to respond," he said. "However, there has not been an adequate response to date. Again, the question is what price level will be necessary... The numbers tell us that prices of $9/MMBtu at Henry Hub appear to be much too low...," he said. "In fact it is difficult to determine what price will be high enough to balance the market unless we have extremely warm weather. Further, the problem is more severe than prices. There is a serious question of the adequacy of supply at any price this winter."

Denhardt predicts this week's storage report will show another whopper withdrawal of 180 Bcf for the week ending last Friday. That would leave working gas levels, according to the American Gas Association, at 1,933 Bcf, which would be 637 Bcf or 25% lower than last year and 131 Bcf or 6% below the lowest level in five years. "[W]e project that is not enough gas in storage to get through the heating season," said Denhardt. "Others have come to the same conclusion."

For the long-term, Petrie predicts "it will be a two to five year work-out, if you have good policy responses," before there is an optimum supply-demand match.

One of the policy responses that will be critical, the veteran oil and gas analyst believes, is building the Alaska pipeline. "There's a good chance it will be built with Bush as president." Unless the policy responses are forthcoming, the nation faces "a supply-induced recession. We've been living off surplus for a long time." Petrie likened the current situation to 1970 "when we ran out of oil. It took us 10 years to work out of that one."

Rocco Canonica

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