A flat domestic natural gas rig count, combined with an eroding storage overhang, provide opportunities for U.S. gas prices and related operators to trade higher this year, according to BMO Capital Markets Dan McSpirit and Phillip Jungwirth. Bank of America Merrill Lynch (BofA) also expects higher gas prices on average, but coal may regain some of the market this summer.
The analysts joined a chorus of other energy researchers, who over the past few weeks have predicted that gas prices may move higher this year (see NGI, April 22; April 15; April 8). BMO’s reasoning is simple: even though gas is trading higher, most U.S producers aren’t able to generate enough free cash flow now “to induce the required drilling and production response” that might push the market back into an oversupply position until prices are “roughly $5.00/Mcf.”
Natural gas prices “should remain “in the $4-5/Mcf range in 2013, which is above what we believe the equities are currently discounting, suggesting further upside for the producers,” wrote the analysts. BMO’s Henry Hub gas price forecast from 2013 through 2015 remains set at $4.00/Mcf on average.
Gas prices have rallied by about 30% since February and are up more than $1.00/Mcf this year, with the front month climbing 4% last week to $4.41/Mcf. Abundant gas resources “can be drilled economically at prices below current levels,” but getting the gas drilling activity to move higher probably isn’t in the cards. U.S. working gas in storage ended last week at 1,704 Bcf, 4% below the five-year average of 1,782 Bcf and 32% below last year’s level of 2,501 Bcf.
Natural gas equities, however, have not responded “with the same enthusiasm” as prices, said McSpirit and Jungwirth. Gas company “shares have recently weakened relative to the underlying commodity, and all have now underperformed natural gas during 2013 with certain issuers even lower on the year.”
BMO is recommending gas-weighted companies over oil-weighted producers. The top gas-weighted recommendations in the BMO coverage group include Canada’s Encana Corp., ARC Resources Ltd. and NuVista Energy Ltd., as well as EQT Corp. and Range Resources Corp. Other recommendations include gassy U.S. producers Cimarex Energy Co. and Goodrich Petroleum Corp.
Motley Fool’s Arjun Sreekumar in a recent note offered more reasons for higher gas prices over the long-term. Future gas supplies “may be much lower” than anticipated if shale production tapers off as quickly as some suggest. Also, the “massive gap” in global gas prices has led many petrochemical, steel and fertilizer manufacturers to launch U.S. projects to capitalize on cheap supplies, which would reduce supplies.
Of concern for the gas bulls may be the latest — and future — gas-fueled power generation statistics. The Energy Information Administration (EIA) last week issued data on U.S. electricity generation, fuel costs and power prices for February (see related story).
“All parts of the country, except for Florida, saw a significant year/year decrease in electricity generation from natural gas due to the significant increase in regional natural gas prices,” EIA said. “Generation from coal and other fossil fuels displaced natural gas generation.”
“There is long-term support: for West Texas Intermediate crude prices of about US$85/bbl, with the near-term drivers — including gasoline demand and slowing economic growth — suggesting that “further downside to crude prices remains,” said the BMO team.
In a note on Thursday, BofA analyst Sabine Schels said 2013 gas prices in the United States should move higher after the biggest storage drawn down in a decade left inventories below the five-year average. The surge in futures to 21-month highs above $4.15/Mcf should fade this summer, however, as more power plants move back to burning cheap coal to generate electricity. Prices then are forecast to strengthen once again later this year.
The investment bank upped the 2013 price forecast to $3.90/Mcf on average this year, versus a previous forecast of $3.75. Prices could tumble for a period this summer to $3.50 on average. The 2014 forecast of $4.20/Mcf was maintained. Using gas in power generation instead of coal is needed to support gas prices long-term, said Schels.
“A key risk stems from reversing coal-to-gas switching in power generation too sharply, as some coal substitution is still required to balance the market. Coal substitution remains an important price driver this summer.”
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