The natural gas price declines in early July mirrored a broader sell-off in commodities and occurred before bearish data became available, but most of the price adjustments resulted from the “sudden loosening of the supply and demand balance,” which was evident in storage data issued by the Energy Information Administration, Lehman Brothers analysts said Monday. Early in the summer the market appeared tighter than a year earlier, but it’s now “significantly looser” and U.S. inventories are forecast to close the deficit by the end of the injection season.
To illustrate their point, Lehman analysts Ed Morse and Dan Guertin compared weeks in the summer of 2007 with similar weather patterns.
“Weather for the week ending Aug. 3, 2007 yielded 85 population-weighted cooling degree days (CDD), similar to the weeks ending July 23 and August 10 this year (82 and 83 CDDs, respectively),” wrote the duo. “U.S. inventories grew 42 Bcf for that week in 2007, but net injections for these two weeks in 2008 reached 65 Bcf and 50 Bcf, with the latter number biased downward by approximately 10 Bcf of offline supply largely because of Tropical Storm Edouard. These numbers indicate that the U.S. market is operating nearly 3 Bcf/d looser than at the same time last year on a weather-normalized basis.”
The U.S. natural gas supply/demand balance “should grow looser relative to last year through the remainder of the injection season. Combined with August and September weather that we forecast to be significantly cooler than last year, we expect gas inventories to reach 3.52 Tcf by the beginning of the heating season, nearly closing the deficit to last year’s record level.”
What’s behind the build-up? Morse and Guertin echoed some other energy analysts in their assessment.
“The remarkable growth of U.S. domestic supply has been the story of this year’s gas market,” wrote Morse and Guertin. “On the strength of booming unconventional supply, U.S. natural gas supply is up 7-9% year-over-year. This supply increase has more than made up for the decrease in imported gas that drove fears of market tightness earlier in the summer. Although imports are down significantly from last year, the story of U.S. gas imports is a principle reason why we expect the market to continue to loosen relative to last year.”
Net gas pipeline exports this summer are off from a year ago, they noted. In June and July, they said net pipeline imports were down an average of 1.3 Bcf/d, owing to cutbacks in Canadian exports to the Lower 48 and slightly higher U.S. gas exports to Mexico.
“We expect Canadian exports to the U.S. to continue declining relative to last year over the coming months, but slowing Mexican demand growth should marginally temper the drop in net pipeline imports,” said the analysts. “Recent monthly economic data suggest influence from the U.S. slowdown, which should dampen gas demand south of the border as electricity demand, which drives Mexican gas use, is largely dependent on industrial demand.”
Liquefied natural gas (LNG) imports are well below last year’s levels, noted the analysts, but they “reveal a key reason why we expect the U.S. market to loosen further relative to 2007. LNG imports averaged 3.1 Bcf/d from April through July of 2007, but just 1.1 Bcf/d over the same period this year, a level barely above minimum contracted volumes.
“The year-on-year difference, however, masks the fact that the bulk of LNG declines occurred at the end of the 2007 summer; LNG imports dropped to just 1.0 Bcf/d by October of last year. This decline amounted to a nearly 2 Bcf/d supply disruption over the last 10 weeks of the 2007 injection season — a disruption that cannot occur this year because of already low LNG imports. Although the July-August 2008 natural gas market is already much looser than it was in 2007, we expect it to loosen further because of the absence of significant LNG declines.”
The U.S. gas supply outlook has improved, but the Lehman team questioned where the same supply was earlier in the summer when low storage levels prompted the remarkably high gas prices.
“New unconventional supply, after all, did not appear overnight,” wrote Morse and Guertin. “Part of the answer lies in a corresponding increase of gas demand from the industrial sector that helped to mask surging supply. Industrial demand has since tapered off, allowing domestic supply to find its way into storage.”
EIA data, they noted, “show that industrial demand was up by 9% year-over-year from March through May and gas-intensive industries, particularly metals, remained largely resilient through June. Production in these industries, however, dropped off notably in July as the advantages of less-expensive gas and the weak dollar seem to have finally been trumped by the global economic slowdown. It is no coincidence that this midsummer industrial slowdown coincided with suddenly bearish storage numbers.”
Weather, of course, is the unknown variable in the Lehman forecast, and the analysts noted that attempting to forecast storm-related supply disruptions is a “difficult task because of highly skewed historical data.” For their inventory forecast, the analysts built 60 Bcf of shut-in supply into their model.
“Although we expect above-normal temperatures through the remainder of the injection season, we forecast them to stay significantly below last year’s levels,” they wrote. “The reduced cooling load relative to last year should play a large role in helping U.S. inventories close the deficit relative to 2007.”
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