Absent an extremely hot summer or strong hurricane activity in the Gulf of Mexico, natural gas prices may drop enough this year to reach a parity with coal prices, a Bank of America (BofA) analyst said Wednesday. BofA cut its full-year 2006 spot gas price estimates to $6.50/MMBtu from $7.15, well below the current Street consensus of $7.80.
BofA slashed its estimated 2Q2006 composite spot price to $6.15/MMBtu from $6.75, cut 3Q2006 prices to $5.75 from $7, and cut 4Q2006 prices to $6.75 from $7.65. The 2007 forecast remained unchanged at $7.50/MMBtu.
“Our concern at this juncture is still that natural gas prices continue to drop leading up to next winter without another severe hurricane season in the Gulf of Mexico and/or a much warmer-than-normal summer,” said BofA analyst Robert Morris. “We would point out that the contango in the [New York Mercantile Exchange] Nymex futures curve clearly anticipates another more active-than-normal Atlantic Basin hurricane season along with the view that the ‘clock is reset’ November 1 with regard to natural gas storage levels and prices, which is a widely held view with which we do not necessarily agree.
“In the meantime, crude oil prices have lost the ability to set the floor for natural gas prices since the full 2.0 Bcf/d of residual fuel oil capable of switching in the U.S. to natural gas has already done so. But underlying our overall view on natural gas prices near term is our projection that, absent some intervention by Mother Nature, natural gas storage will continue to sharply exceed historical seasonal average levels through much of next year.”
Energy analyst John Gerdes of SunTrust Robinson Humphrey/the Gerdes Group, believes the storage surplus will push gas prices even lower through the next several months.
“Storage surplus, slow recovery in industrial demand, growth in coal/nuclear power generation, some increase in [liquefied natural gas] LNG imports (Trinidad, Nigeria, Egypt) and storage limitations suggest a sub-$6/MMBtu natural gas price the next several months,” Gerdes wrote. “Given ample natural gas supply, a sub-$6/MMBtu natural gas price into this fall appears necessary to stimulate sufficient growth in industrial gas demand to prevent production curtailments later this injection-season.”
Gerdes added that “production curtailment may result as gas storage limitations (estimated storage capacity — 3.4-3.5 Tcf) elevate transportation system pressure. Notably, given growth in coal/nuclear generation and last summer’s 10% hotter than average weather, gas-fired power generation should exhibit more modest growth in ’06. Conversely, in ’07, less gas in storage exiting the heating-season (assuming normal weather), stronger growth in gas-fired power generation and relatively modest acceleration in supply growth should require some rationalization of industrial gas demand and thus a higher average gas price ($8/MMBtu).”
As pipeline storage builds, Morris said it would be difficult to gauge how much production might be lost, “but it could be as much as 2.0-3.0 Bcf/d, in our opinion. If this still doesn’t prevent gas-on-gas competition, particularly in the fall shoulder period with little heating or cooling load demand and storage facilities approaching ‘full,’ then it is conceivable that natural gas prices would drop to parity with coal wherein some utilities would scale back coal-fired electric generation and switch to or start up natural gas-fired peaking units, thus creating incremental demand for natural gas to help balance supply and demand ahead of the winter.”
Currently, a drop in natural gas prices to be at parity with coal, specifically Appalachian coal in the Northeast where switching might first occur given relative pricing and coal-fired emission costs/constraints, would put prices at about $5.25-$5.75/MMBtu, per BofA’s or at a composite spot equivalent of $5.00-5.50/MMBtu.
The market, said Morris, has often been “head faked” by a slow down in the pace of storage injections in the fall. “Overall, we attribute a high probability that there will still be further downside to natural gas prices relative to oil prices at some point leading up to next winter. In addition, it is certainly plausible that natural gas prices could remain below residual fuel oil prices, or at a ratio to [West Texas Intermediate] WTI spot oil prices of more than 9.0:1 through much of next year. However, we are continuing to assess the supply and demand variables as summer kicks off and we recognize the odds that Mother Nature could intervene in the meantime.”
The National Oceanic and Atmospheric Administration, AccuWeather and Colorado State University are calling for above-normal activity this season but a less active season than a year ago (see Daily GPI, June 11; June 7; June 1). In total, Morris noted that the forecasts are calling for up to 17 named storms versus 28 last year, including eight-10 hurricanes versus 15 last year, with around five becoming major hurricanes at Category 3 or higher, versus seven in 2005.
Assuming normal temperatures and no hurricane-related production shut-ins, BofA models continue to project natural gas storage levels will exceed 3.6 Tcf at the beginning of November. “Nonetheless, we are confident that storage can physically be filled to 3.5 Tcf and believe that 3.6-plus Tcf is certainly attainable.”
BofA is projecting U.S. supply, excluding the resumption of hurricane-related shut-ins) will increase by about 0.8 Bcf/d year-over-year for July through October. Morris estimates Canadian imports will rise slightly by 0.1 Bcf/d. LNG imports also will grow slightly to 0.6 Bcf/d, “as more cargoes are diverted to the United States from Europe given the improvement in domestic natural gas prices relative to prices in Europe since mid-March and LNG import facilities continuing to take advantage of the economic arbitrage between current spot and January 2007 futures prices. Gas exports to Mexico are expected to rise slightly to 0.1 Bcf/d.
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