The Disappearance of the Natural Gas Glut
by Bill Powers
Editor, Powers Energy Investor
February 24, 2010
Lost amongst all the noise generated from the Federal Reserve’s discount rate hike and the ongoing saga in Greece, is the disappearance of last fall’s large overhang of natural gas. As recently as November 30, 2009, natural gas storage was 479 billion cubic feet (bcf) over November 2008 levels and stood at an all time record of 3,837 bcf. Since the start of the cold weather in early December, the US has drawn a whopping 1,812 bcf of gas out of storage. The next Energy Information Agency (EIA) report on natural gas storage levels, to be issued on February 25th, will show that storage has been drawn down to levels that are below both last year’s level and the five year average. To put the disappearance of the glut into a different perspective, over the last 85 days, the US natural gas market is more than 5.5 billion cubic feet per day (bcf/d) tighter than the same period last year. How did this happen? Was it completely related to the cold weather? More importantly, what does the huge withdrawal of natural gas from storage this winter mean for heating season ending storage levels and gas prices for the rest of the year?
While the cold weather undoubtedly increased the amount withdrawn from storage, there were three distinct forces that played a major role in the disappearance of last year’s historic gas glut: 1) imports, 2) industrial demand/weather and 3) production.
While official statistics have yet to be finalized on natural gas imports from Canada or liquefied natural gas (LNG), it appears declining gas imports from Canada were largely offset by increased imports of LNG. Given the recent ramp up of liquefaction capacity in countries such as Yemen, Qatar and Russia, US terminal operators have been able to land cargoes at unusually low prices for this time of the year. The below quote was taken from the EIA’s February 10, 2010 Short-Term Energy Outlook:
“Projected U.S. pipeline imports decline by 8.3 percent (0.7 Bcf/d) to 8.1 Bcf/d in 2010 due to the sustained impact of lower Canadian drilling activity and production, as well as increasing demand from oil sands projects in western Canada. A portion of the decline in pipeline imports this year is expected to be offset by imports of liquefied natural gas (LNG), which were double year-ago levels in January as temperatures plummeted and prices jumped. The outlook for higher U.S. LNG imports in 2010 is largely due to recent global LNG supply additions in Russia, Yemen, Qatar, and Indonesia. EIA expects net imports of natural gas to decline in 2011 as flows from Canada remain limited and global demand for LNG strengthens.”
Based on the above information, it appears that total imports actually increased by nearly 1 bcf/d since early December. [Note: I do not view the current level of either Canadian nor LNG imports as sustainable given the massive decline in natural gas directed drilling in Canada and a severe tightening of LNG market in coming years. LNG imports will decline in future years due to dozens of new import terminals coming online in Asia and Latin America as well as increased demand from Europe.]
Undoubtedly, industrial and electricity generation demand has picked up due to the rebounding economy and unusually cold weather. For example, according to the February 22, 2010 issue of Barrons’, US steel output increased approximately 50% for the week ending February 13, 2010 over the same week last year. The strength in the economy which was responsible for a 5.7% growth in GDP in Q4 2009 appears to have at least partially carried over into the first six weeks of this year. The economic rebound, combined with the unusually cold weather, increased total demand by approximately 3.5 bcf/d.
Therefore, we can conclude that if the US natural gas market is 5.5 bcf/d tighter than last year despite imports increasing by 1 bcf/d and demand increasing by 3.5 bcf/d, then production must be down by 3 bcf/d. My estimated production decline is far higher than that of most market observers who continue to believe US gas production has experienced only modest declines since the natural gas rig count began declining in the fall of 2008. Many in the analyst community point to the EIA 914 data, a survey of natural gas producers taken each month to gauge total US production, which indicates US production has dropped by approximately 1 bcf/d. Many believe the data proves that technology has improved drilling efficiency and allowed the industry to produce more gas from fewer wells. I do not buy it. In fact, there are a growing number of market participants including Mark Papa, CEO of EOG Resources and Tudor Pickering Holt who have recently called into question the accuracy of the EIA stats. Here is what Mr. Papa had to say about the current state of the US natural gas market on his firm’s Q4 2009 conference call:
“We look at the 914 data and we try and tie that back to the IHS data [IHS is a consulting firm] and we really can’t tie it back and it looks to us like the 914 data is just consistently overstating particularly in the other states category. The second item we look at in the 914 data is just the balancing item and the balancing item seems to have grown over time. So we have tied our internal models to the IHS data and even though the gas rig count has gone up considerably over the last 4 - 5 months what it tells us is that the production is still going to be down to the tune of about 3 bcf a day relative to December 08 throughout all of 2010…”
Surprisingly, despite ample evidence that the US natural gas market has tightened significantly in recent months, a pattern which is likely to continue throughout the rest of the year, NYMEX natural gas prices are once again in the $5.00 per thousand cubic feet (mcf) range. Some might argue that the market is projecting a reversal of recent production declines or a drop off in demand. Unlike the legions of hyperactive natural gas traders who agonize over every blip in prices, I see the recent decline in gas prices as just noise. While I will be the first to admit that Mr. Market can sometimes be helpful, most of the time he offers up noise that makes holding onto our convictions extremely difficult. For example, I cannot for the life of me see what the market was telling us in the fall of 2007 when the Dow traded over 14,000 on the eve of the worst year for the general market and the most devastating period for the economy in a generation. Instead, I am mostly a fundamentalist. I believe natural gas production is in terminal decline in the US and Canada and this will lead to progressively higher prices over the next several years due to the maturity of the natural gas producing basins in both countries. Based on the heating season ending storage level of approximately 1,400 bcf, I am looking for natural gas prices to rebound from their recent weakness and establish a new floor of over $7.00 per mcf by mid-year. Barring a complete collapse of the US economy, which is not out of the realm of possibilities given the tumultuous nature of our economic times, I see storage levels for the fall of 2010 being significantly below those established in the fall of 2009. This situation will lead to $10.00 per mcf gas prices by the end of 2010 and set the stage for total chaos in the gas market in 2011.
I believe we have entered a period where a lack of market recognition of the rapidly improving fundamentals of the natural gas market has created some great investment opportunities. There are several very well positioned US and Canadian gas producers that I cover in my publication, the Powers Energy Investor, that are poised to capitalize on much higher natural gas prices. If you found this article helpful and would like more information about my publication please visit my website at www.powersenergyinvestor.com.
© 2010 Bill Powers