What's Driving Natural Gas?

Despite the bearish backdrop for natural gas prices due to rising inventories levels, supply exceeding demand, and the emergence of prolific lower-cost shale plays that are flooding the market, the past couple of weeks has been surprisingly good for the commodity.

From its Sept. 4 low, Nymex natural gas futures for October have risen more than 35% to roughly $3.60 per Mcf. The Henry Hub spot price has done even better – up 75% to $3.21 per Mcf.

And experts say the volatility has not been this high since 2006. But companies, clients and experts in research, trading and commodities are scratching their heads in search of answers.

The recent bullish price moves could be explained by a number of factors, according to a report from RBC Capital Markets.

• Supply: Liquefied natural gas (LNG) flows may not flood the U.S. and domestic production could fall swiftly because it is not sustainable at current activity levels.
• Mildly positive natural gas storage injections recently could point to improving economic-based demand.
• A long-term weather pattern with a lack of sun spots appears to have developed, which means we could move into a period of global cooling and higher winter heating demand.
• There could be some short covering going on as lawmakers push for curbs of speculative trading in commodities.
• Long-term value: With sustainable natural gas prices between $6 to $7/Mcf, the trade looks good despite near-term uncertainty.

RBC analysts also note that the consensus was generally bearish on gas for the near term, but supportive of prices at $6 or higher in the second half of 2010.

There seems to be a confluence of fundamental and technical events driving prices higher in the short-term, but no certainty as far a one or two reasons, the analysts said. They think there is a real risk that natural gas could re-test the $2.50 Mcf level again over the next month since storage levels could be maxed out.

“That would cause a lot of pressure on near-term prices as gas-on-gas competition will be significant,” the RBC analysts said.

“In the event that storage fills to capacity, the spot price would collapse as the gas would be essentially worthless,” Research Capital’s Ken Lin said in a report.

For the last six to nine months, people have continually expected the reduction in capital expenditures to reduce supply enough to rebalance the market, the analyst noted.

While current prices are unsustainable since they fall below full cycle replacement costs, he thinks those calling for a recovery may be doing so for quite a bit longer.

The analyst agrees that the longer-term prices for gas are attractive due to factors like increased use for electricity generation instead of coal. However, he expects disappointing results for the third quarter as he forecasts very little drilling activity will occur.

Ultimately, the lack of drilling activity in the natural gas space is expected to diminish supply and close the very wide spread between oil and gas prices.

Mr. Lin recommends investors focus on the names that can survive an extended period of weak natural gas prices, as well as those that have low operating costs and high netbacks to cushion against low commodity prices.

He said:

Barring a significant recovery in industrial demand, the reality is that there is simply too much supply if every company was still on a growth mandate. There will be a period when some of the weaker players are consolidated or disappear, but longer term, natural gas prices will recover to a level that makes sense on a full cycle exploration and development basis.

Comments

[apppro:]

2 words: GREEDY SHORTS!

Sep 18 06:54 AM

[Westy:]

How about speculation in the ETF's ?

Sep 18 07:08 AM

[zorro6204:]

EVEP's John Walker said in a conference yesterday that he expected gas to drop to "pennies" in the next few weeks.

Sep 18 09:23 AM

[Ferdinand E...:]

A really good article on natural gas. Really professional. This is the kind of thing that we need.

Sep 18 10:19 AM

[H. T. Love:]

"A long-term weather pattern with a lack of sun spots appears to have developed, which means we could move into a period of global cooling and higher winter heating demand".

Jeez! Two weathermen agreeing seems as likely as two economists agreeing (I guess they got this from a weatherman somewhere, right?)! NOAA claims that a weak el nino effect will lead to slightly higher than normal temps in the northeast year, and they also call for 50% of the U.S. to have normal to slightly averages temps in the middle portions.

"RBC analysts also note that the consensus was generally bearish on gas for the near term, but supportive of prices at $6 or higher in the second half of 2010".

Fits my view. The unknown is if there really *is* a recovery going on in GDP and capacity utilization that is more than just inventory re-build, which many have called for.

With all government numbers now suspicious, just because it's the government now, who knows if we can believe them?

HardToLove

Sep 18 10:20 AM

[bradiop:]

I find this part of the analysis hard to believe:

Supply: Liquefied natural gas (LNG) flows may not flood the U.S. and domestic production could fall swiftly because it is not sustainable at current activity levels.

There seems to be fair amount of evidence the supply of gas has increased and not going to decrease.

Sep 18 11:24 AM

[GMiki1:]

There's a fair amount of evidence that the depreciation rates of the nat gas wells is high and that we actually are counting on outflow that won't be there when we need it.

Very nice, professional analysis. I agree.

Sep 18 11:38 AM

[Mmarrkk:]

bradiop: your "evidence" that there is an increase in gas supply is somewhat short sighted. The additional supply comes from shale gas plays, plays where the wells exhibit a 80% decline ratio in the first year!! At sub $3/mcf, no one will drill these wells for long and when you stop drilling new wells, the old wells are declining quickly and production drop rapidly!


On Sep 18 11:24 AM bradiop wrote:

> I find this part of the analysis hard to believe:
>
> Supply: Liquefied natural gas (seekingalpha.com/symbo...)
> flows may not flood the U.S. and domestic production could fall swiftly
> because it is not sustainable at current activity levels.
>
> There seems to be fair amount of evidence the supply of gas has increased
> and not going to decrease.

Sep 18 01:52 PM

[Aricool:]

Great article! Time to buy Nat Gas. Here are some reasons why:

i) The economy is picking up: Demand is showing signs of life and the manufacturing sector is demonstrating its first signs of growth. One can expect gas demands from gas-fired power plants to rise accordingly.

ii) The oil to gas price ratio: Eventually, I do believe that the relation between the price of oil and gas will resurrect. The recent spike in the oil to gas price ratio to 25x will likely return back to normal in the long run. With the economy picking up and oil futures pointing upwards, one can expect that the gap in this ratio will close.

iii) The weather: We are heading into Q4 which means that winter is approaching! Gas demand typically picks up in the winter months and gas prices historically have done well during this time of the year. Further, as we are at the height of the hurricane season it is quite feasible to see a gulf-based storm emerge in the coming weeks creating a short term supply shortage, allowing inventories to come down.

iv) Environmental policy: The Obama administration is pushing ahead with climate change initiatives that will cut green house gas emissions over the coming decades. Although the plan is not centered on gas-fired energy production at the moment, there is almost no feasible alternative to the power plan that would allow the U.S. to reach its targets in its given timeframes. Most of the power in the U.S. is generated from coal-powered power plants which are a key contributor to the green house gas problem. Getting off of coal and onto emission friendlier power substitutes like wind, solar, and nuclear is a long term project which will likely require a mid-term solution. Gas-fired plants do produce green house gases but much less than their coal-fired counterparts - it would be much quicker and cheaper to substitute coal-fired plants for gas powered ones. This would allow for an interim step in achieving the green house gas emissions reduction time frames.

v) Demand from Emerging Economies: It's a known fact that India and China are consuming more oil, but they are also consuming more natural gas. With gas liquefying techniques improving, the transportation of natural gas across our oceans, as is done with oil, is likely to become more feasible in the future. More accessible gas transportation = more demand from emerging economies = increased prices.

Nat Gas is too cheap. The bull run will stay strong!!! Buy buy buy...

Cheers,
Ari-

Sep 19 05:17 AM

[Ron2008:]

Futures for 2010 are all above $5.50. The drilling and production won't fall off as much as you think.

On Sep 18 01:52 PM Mmarrkk wrote:

> bradiop: your "evidence" that there is an increase in gas supply
> is somewhat short sighted. The additional supply comes from shale
> gas plays, plays where the wells exhibit a 80% decline ratio in the
> first year!! At sub $3/mcf, no one will drill these wells for long
> and when you stop drilling new wells, the old wells are declining
> quickly and production drop rapidly!

Sep 20 07:27 PM

[Aricool:]

Ron2008,

At $4/Mcf (NYMEX) at least half of U.S. projects cannot make a positive return on capital. Many are borderline at $5.5. The weak ones may not make it into next year, thus even less drillers. So incentives to drill a lot next year may be a lot lower than you think, esp. since if we have a average or mild winter, an over supply overhang could persist with high storage until next winter (see 2005 storage stats after '04 max'd storage). That killed most of the '05 NG strip.

Now, if GS is right and NG will be $6-7, drill baby drill.....!

Ari-


On Sep 20 07:27 PM Ron2008 wrote:

> Futures for 2010 are all above $5.50. The drilling and production
> won't fall off as much as you think.
>
> On Sep 18 01:52 PM Mmarrkk wrote:

Sep 21 04:40 AM

[kstock:]

A part of the industrial demand for Natural Gas, may come from CNG vehicles being heavily subsidized in the U.S. Currently CNG buses account for 25% of all Buses used for public transportation in the U.S. To read up on this issue take a read at Yahoo Finance:
finance.yahoo.com/news...

Sep 22 10:30 AM