Though optimistic about prospects for stronger long-term natural gas prices, Deutsche Bank on Friday reduced its outlook for 2012 U.S. prices because the domestic market is “still very loose” and industrial demand hasn’t taken up the slack.
The “only way out is for supply to slow and industrial demand to pick up,” said the analyst team led by Adam Sieminski. “The last few weeks of storage data suggest that supply and demand balances are getting a bit better, but this could be a false signal based on storage congestion and weak cash prices. The U.S. gas market is still very loose, in our view, but the way out of this situation is for supply to slow down and industrial demand to pick up, which we feel is a likely development over the course of the next few months.”
The facts have been repeated often: strong growth in shale gas and drilling for liquids has boosted domestic supplies. But demand is still being pressured by the slowdown in U.S. gross domestic product and industrial production, according to the Deutsche team.
“In the medium-term, we believe that U.S. gas is supported by coal competition at about $4.00/MMBtu.” And proposed U.S. Environmental Protection Agency regulations on power plant emissions “could raise this floor,” something other energy analysts believe as well (see Daily GPI, Sept. 26).
“Near-term, however, the gas markets face difficulty. Start-of-winter storage appears to have peaked at a relatively high level near 3,858 Bcf with…balances pointing to an end-of-winter bottom near a record high 1,900 Bcf. This will tend to stifle rallies, even if La Nina conditions lead to colder December-January temperatures.”
Based on the data, Deutsche cut its gas price forecast to $4.25/MMBtu for 2012 from a prior estimate of $5.00. It also reduced forecasts for 2013-2015.
The Deutsche U.S. economics team in September had argued against an imminent recession based on its analysis of the index of leading economic indicators (LEI) and since the late summer “growth scare” the LEI has continued to expand. U.S. economic data in these final three months also continues to “surprise to the upside,” said the analysts.
For the gas markets, the gains indicate that industrial gas consumption may improve as factory production recovers in the coming year in response to stronger consumer demand already being seen, said the analysts. “Electric utility consumption of natural gas should pick up some market share as lower natural gas prices relative to coal encourage switching to natural gas for base-load electric power generation.”
The Deutsche team noted how Central Appalachian coal has competed with gas prices. Because of higher cash mining costs, analysts believe coal shut-ins are more likely than gas shut-ins, and in their view those costs set low-end coal and gas prices. The recent drop in natural gas prices appeared to put some pressure on coal prices, which had been hovering near $74/ton during most of September and October. Appalachian coal at the end of November fell below $67/ton.
Because of the gas-coal spread, most of the fuel switching may have been based on “pure fuel differentials,” which would have already happened.
“However, the long-term contracts utilities tend to have for coal suggest there is likely a good amount of lag in terms of reflecting price fundamentals in switching levels,” said Sieminski and his team. “In our view, the most important factor for increased gas use by power generators in 2012 specifically will be the [EPA’s] Cross-State Air Pollution Rule (CSAPR), which kicks in next year. The much-discussed and anticipated Maximum Achievable Control Technology (MACT) rule (that deals with mercury), won’t take effect till 2015 at the earliest. CSAPR is being challenged in the courts, however, and in the event it doesn’t materialize for 2012 then we estimate there will less gas used in power generation in 2012 than otherwise.”
Other than the impact that weather could have on both residential and electric utility use, the most likely potential for some improvement in the demand outlook for gas “is in industrial use — and will depend on the extent to which factory output responds to what we believe is relatively positive spending data,” said the analysts.
Activity levels in the shale plays have begun to decline, the Deutsche analysts said. “Key to the outlook for 2012-2013 is the slowdown of activity in the Haynesville field, a key driver of gas supply 2008-2011, as leases have been held and producers encounter marginal economics at current prices.
“While activity levels (as indicated by rig counts) have started their decline in Louisiana (Haynesville), the pace of production declines will be a key driver for the supply side of the market. Importantly, the Marcellus [Shale] is growing at a rapid rate and positioned to replace the expected lost production from the Haynesville. Market expectations are for the Marcellus to add 1.5 Bcf/d-plus of production growth in 2012, and while this should more than adequately replace ultimate declines from the Haynesville, this mix shift is likely the most significant driver of the direction of aggregate production growth from the Lower 48 in 2012.”
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