With natural gas stocks at levels below the seasonal norm after a summer of market rebalancing, analysts at Bank of America Merrill Lynch (BofA) Monday lifted their 2013 average gas price forecast by 25 cents to $3.75/MMBtu.

“In periods of temporary tightness, we could see spot prices briefly spiking above $4/MMBtu,” they said in a note. But this doesn’t mark the end of unpleasantness for the long side of the gas market.

“We see little upside to forward prices next year as structural consumption still has to catch up with supply,” the analysts said. “In our view, U.S. natgas output remains too high, and we expect 0.2 Bcf/d of growth next year.”

Producers are dropping rigs in high-cost plays but are drilling more in lower-cost areas where there is high liquids content, areas such as the southwestern Marcellus Shale and the Eagle Ford in South Texas. “Factoring in efficiency gains, gas supply from liquid shales is expanding strongly,” they said. “Thus the market is subject to a tug of war between production falling fast in dry gas shale areas and growing quickly in lower-cost areas with a high liquid content.”

On the demand side, coal-to-gas switching will fall by 1.8 Bcf/d as gas production slows and prices rise, they said. Total gas demand will contract by 0.6 Bcf/d and inventories will be elevated next year, they said. “If natural gas prices run up too quickly, the relative advantage of gas over coal disappears rapidly and power generators will switch back into coal.”

Coal-to-gas switching will remain necessary to balance the gas market, and this will cap gas prices at $4.30/MMBtu, barring “outright production declines,” the analysts said.

The analysts gave a nod to the Marcellus Shale, where production “is growing at a remarkable speed.” Dry gas production in the region is 5.6 Bcf/d, up from an average of 3.5 Bcf/d last year. “In previous years output expanded by 1 Bcf/d in 2010 and 2.2 Bcf/d in 2011 because of favorable production economics in the region,” the analysts said.

Further growth is expected in the southwestern portion of the play where liquids-rich production supercharges drilling economics, setting breakeven prices as low as $1.50/MMBtu, they said.

On top of that, infrastructure buildout in the Marcellus region is relieving bottlenecks. This year, 2 Bcf/d of pipeline capacity is expected to be added, the analysts said. Another 3.6 Bcf/d is slated to come online next year. “On our estimates, about half of the total pipeline capacity will be incremental, allowing producers to unlock new supply.”

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