American Natural Gas Markets
Summer Surprise Ahead?
by Joseph Dancy, LSGI Advisors, Inc.
Adjunct Professor, SMU School of Law
April 8, 2004
As the heating season draws to a close it appears that natural gas withdrawals will leave storage levels below the 5-year average, but well above the lows in storage that we saw last year.
Most analysts expect around 1 trillion cubic feet (tcf) of gas to remain in storage at the end of the heating season. The red line in the DOE�s Energy Information Administration�s chart at right is current storage levels, and the gray shading are 5-year high and low storage bands.
While it appears that winter demand has been adequately supplied, the coming quarters will be very interesting ones for the natural gas markets.
First, note that concerns still exist about natural gas supplies in North America. The Gulf of Mexico, one of the largest suppliers of natural gas to the U.S., has seen some incredible declines in production over the last few years.
The accompanying chart on the left illustrates the decline, and was presented by FirstEnergy Capital Corp�s analyst Martin King at a conference in New York City last month.
"A continuation of this trend will keep U.S. natural gas production in a decline mode for the foreseeable future," King said, as "reserve sizes are smaller, decline rates are higher - it's a case of the treadmill running faster."
According to their estimates production in North America, including the Gulf of Mexico, could be 1.0 to 1.5 billion cubic feet per day (bcf/d) or more lower than a year ago. Any gains in production from onshore drilling will be offset by declines in the offshore sector. The decline is significant, they note, and is clearly evident on the chart.
And after reviewing recently released data from the U.S. Department of Interior, FirstEnergy�s King estimates that U.S. natural gas production has been declining 2.5% per year � contrary to the Department of Energy�s Energy Information Administration�s (EIA) estimates that U.S. natural gas production has been increasing around 2% per year. In light of the new data the EIA is revising their production estimates.
With the decline in productive capacity FirstEnergy�s King predicts that storage will be refilled this summer at a rate which will provide 2.866 tcf of natural gas next fall, provided prices remain around $5.00 (U.S.) per thousand cubic feet (see chart below).
The fill rate this spring and summer is expected to average 8.9 bcf/d versus 11.3 bcf/d last year, mainly due to the decline in North American productive capacity. Increases in demand from the power generation sector and industrial users also factor in the lowered fill rate, but to a lesser degree.
If the market expects ending storage levels to reach the 3.0 tcf level we have seen the last two years� and the level that some consider minimum to insure the heating demands of a cold winter are met � natural gas prices will have to move above the $5 mcf level according to FirstEnergy analysts.
On top of these concerns is the fact that last summer demand for natural gas from the power generation sector was below expected levels.
FirstEnergy estimated that natural gas demand last summer was 300 to 400 bcf below normal due to the mild temperatures (see chart below).
This summer they expect natural gas generation demand to increase 100 bcf � and possibly a much higher increase. In either event, this is a significant swing in demand in a short period of time.
The FirstEnergy analyst noted that without the below average consumption of natural gas in the power generation sector last summer, the level of natural gas injected into storage would have been much lower � leaving storage at levels that some might call alarmingly low.
Gas utilities now must work in the spring and summer months to get enough gas into storage to cover their customer�s projected winter heating demands. To do this they will pay whatever cost is required to reach minimum natural gas storage levels.
This summer, unlike last, the gas utilities may have to compete much more aggressively against electric power generators for such supplies, provided generation demand increases to the extent forecast. And industrial demand has been increasing, even at the higher price for natural gas, and is expected to continue to increase with the economic recovery. With crude oil at $36 a barrel, fuel switching to oil is not economic for many of these facilities at current natural gas prices.
If natural gas supplies from North America and the Gulf of Mexico decline to the extent forecast by FirstEnergy, and demand increases from the power and industrial sector this summer, then the only way to efficiently allocate the resource will be through higher prices.
We think the �clearing price� that will be needed reduce demand sufficiently to allow storage to be refilled to 3.0 tcf this summer will be higher � possibly substantially higher � than many investors and analysts expect. The market at this point is relatively inelastic.
In light of these trends Raymond James & Associates, Lehman Brothers, and CSFB have all raised their 2004 forecast for the price of natural gas. FirstEnergy�s King probably summarizes the situation best: "Filling natural gas storage in 2004, in the wake of modest demand expansion, will prove to be a very difficult and strongly priced proposition."
We remain bullish on the sector and continue to be heavily weighted in the sector with companies we find attractive.
© 2004 Joseph Dancy