The prospect of the first significant voluntary production shut-ins in years is looming for the gas industry in about another month or so, according to an informal sampling of opinions among the trading community (“voluntary” means unrelated to a hurricane, pipeline maintenance or force majeure event). While a majority of sources fully expect to see such shut-ins beginning within a few weeks, it’s not a foregone conclusion, said a few dissenters.
Here’s the scenario: A widely anticipated summer clash over supplies between power generators and storage injectors failed to materialize due to milder than normal weather. That left storage buyers free to refill their allotted space at a much faster pace than anyone could have predicted, and at steadily cheaper prices to boot. In addition, a large amount of new production has come on-line over the last year in response to the price run-up of 2000. And although a number of new or expanded storage facilities have been proposed this year, the growth of supply has greatly outrun any actual additions to storage capacity.
Thus, many sources consider it highly likely that toward the end of September or in early October, other than selling for less than production costs, producers will have little choice but to shut in enough gas to prevent a total meltdown of the market.
The transition period from September to October typically is when there is very little weather-related load anywhere, either for air conditioning or heating. That is also about the time that many storage buyers are expected to be topping off their accounts if they haven’t already done so, considering the rapidity of this year’s refill.
That will leave producers with little alternative to shut-ins because the market is unlikely to be able to physically absorb gas sales at current production rates, a large aggregator said. They may consider taking “dirt-cheap prices,” but that would have to be weighed against shut-in economics, he said. Producers “may have to take a short-term hit [until the onset of winter begins raising demand again], but they’ve certainly made a nickel or two over the last year that might tide them over,” the aggregator added. He doesn’t see fuel switching offering any relief, saying gas has recovered essentially all of its market share lost to dual-fuel burners during the high-price period of 2000-01 because gas prices have fallen to much cheaper burnertip levels than oil again.
A Gulf Coast marketer reported discussing with three separate producers recently “the irony of in the same year having some of their highest prices ever in January, then contemplating shutting in gas in October.” Some pipelines are already telling producers that their balancing options are going to be mighty few next month, he said. The pipes won’t hesitate to implement stringent OFOs if that’s what it takes to protect their system integrity from excessive receipts, the marketer said. He concluded that producers “had the luxury of huge windfalls in the first quarter of the year, so they can support the economics shutting in gas for a while without being hurt too much on annual revenue.”
Transco provides an example of the developing situation. It had restricted any due-pipeline makeup nominations to strictly storage withdrawals for the last few days of August. Last Wednesday, Transco said it wanted to sell up to 100,000 MMBtu/d of system inventory at fixed prices for the Sept. 7-16 period (bidders had to be quick on the trigger, though; an email announcing the sale was sent around 10 a.m. CDT Wednesday and the bid deadline was five hours later).
Expectations of approaching shut-ins run the gamut of the market chain, from utilities and end-users back to normally optimistic producers. A source who markets the output of a group of small independents said, “One of my clients told me he’s definitely expecting it [shut-ins] to happen.” The source thinks there are still some feedstock users who cut back operations during the high-price period that can be recovered, but agreed that gas has already regained virtually all of the dual-fuel power generation market.
A Gulf Coast/Midcontinent producer tried to be cautiously optimistic, but acknowledged that “we may need prayer in this situation.” In his company’s experience, “we’ve found the worst [such as fall shut-ins] never happens, that there’s always something that averts it.” At this point there could be a major hurricane disruption of supply (September is typically the most active month of the Atlantic hurricane season) or a streak of freakishly hot or cold weather, he said. But the producer also noted the softness of the overall economy, “so that’s another factor cutting into upcoming gas demand.”
A Midcontinent marketer saw both sides of the coin. He expects shut-ins to happen barring any extraordinary circumstances. “Even a hurricane might not make much difference unless it nearly destroyed offshore production,” he said. Otherwise there would just be some offshore shut-ins lasting three to four days or so, and the industry has plenty of storage to tide it over such an event, the marketer said. “But I’ve observed that it seems when we start approaching extremes, something contrary always happens. An example is the predictions last spring of more huge price run-ups when storage injectors and power generators started to battle it out over gas supplies.”
A Northeast trader sounded a similar theme in saying, “Just as price solved the supply-demand problem last winter, I think it may do the same this fall.”
One of the greatest doubters about significant shut-ins is Rusty Cates, vice president of marketing at Houston-based International Gas Consulting. He grants the possibility of some wellhead cutbacks is there, but doesn’t think they would have much impact in the overall scheme of things. Prices were very low in February 1997, but if shut-ins occurred then they were fairly insubstantial, he noted, adding that shutting in gas “is not an attractive proposition for producers.” If you put gas in storage, you can get it back quickly; but if you shut in a well, the revenue from that output is deferred until the end of the well’s life, “and that’s a very different economic calculation,” he said.
Cates recalled the market of the late 1980s and early 1990s, when shut-ins were nearly a scheduled occurrence each summer as Gulf Coast prices started falling below $1.50. He was a gas buyer at the time, “but there never was any difficulty finding supply” during shut-in periods. At that time producers often used shut-in announcements as way of sending a price signal to the market, Cates said, but it could be negated by other producers stepping up with different evaluations of the shut-in economics “or those trying to send price signals not backing it up” with genuine cutbacks.
We may be approaching the “typical” level of full storage, but that doesn’t mean storage actually is full, Cates said. About 15-20% of storage capacity is often underutilized, as evidenced by AGA’s figures over the last six years, he went on. He acknowledged that the pipelines “certainly have an interest in not giving away free storage, which is what positive imbalances amount to.” But if forward prices are higher than current levels, such as an 80-cent margin between October and January numbers, “people are going to find a place to put the gas and capture that value.”
According to a Houston-based producer, “A slowdown is all but inevitable. Shutting in is not likely; possible, but not likely.” He went on to say, “Any producer I’ve worked with says it is never worth shutting in” unless the action is forced. “The cost is just not worth the risk. Instead, I think what you’ll see is a massive slowdown in drilling. Producers are in this for the long term.”
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