Does today’s gas market remind you at all of 2001? If you’re an energy analyst at Friedman, Billings, Ramsey & Co. (FBR) it does. In a research note last week, a trio of FBR analysts enumerate exactly how the current market is like 2001, and how it’s not.
In 2001, prices spiked and then collapsed below cash operating costs, production was essentially flat, the economy was heading downward but interest rates were cut, coal prices spiked and then receded, inventories were bloated and producers began dropping rigs, shutting in production and then recorded full-cost ceiling write-downs.
What’s different today, though, is that oil is about $60/bbl, not $20/bbl. Gulf of Mexico production is half what it was in 2001. Exploration and production (E&P) company balance sheets are in much better shape. Decline rates are higher, about 34%/year versus 30% in 2001, and the onshore rig count is 1,500 versus 950 in 2001.
“Natural gas has fallen dramatically in the past year, and investors are worried that this will be the winter of their discontent,” wrote the FBR analysts. “Amaranth’s decline has also weighed on the sector (see NGI, Sept. 25). We see similarities to 2001, when gas fell from $10.20 to $1.74 but rebounded in 2002, even as storage was at record levels. We maintain our bullish outlook on the E&P sector but recognize that the near term looks volatile.”
The analysts predict that the gas storage overhang — currently about 380 Bcf or seven days of total U.S. demand — should be bled off by declining production, rebounding industrial demand and normal winter weather. A sensitivity analysis of stocks in FBR’s universe suggests the stock market is pricing in roughly $5.50/Mcf gas prices while the Nymex strip is at $7.50-$8.00/Mcf for next year and 2008. FBR notes that high initial decline rates across the major U.S. basins provide support despite “robust” rig counts and capital programs. “We have begun to see producers shutting in marginal wells as prices hover below cash margins in high-cost basins.” For instance, Chesapeake Energy said Wednesday that it shut in 125-150 MMcf/d of gross production (see related story).
Despite inventories that are 13% greater than the five-year average, FBR predicts that storage will return to normal levels by spring. Overall, U.S. production is down 1% annually, with onshore flat and the Gulf declining at 7%/year. Basis has narrowed considerably over the last three months in the Midcontinent and Texas. Basis has widened in the Rockies, where there are high storage levels and pipeline constraints, and in Appalachia, where there are high storage levels. “We think Texas and Midcontinent players are arbitraging storage and could use the current environment to hedge basis.”
FBR says industrial demand is picking up. Demand growth is expected particularly in the chemical sector, leading to as much as a 2.5% increase in total industrial demand. “…[W]e expect industrial demand from the chemical sector to increase in late fall, increasing demand by about 0.5 Bcf/d. More specifically, there is about 10% or so of ethylene capacity shut down for planned and unplanned maintenance that will start back up around the end of October.”
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