Timothy D. Kailing

Natural Gas Production Outlook: Decreases Are in the Offing

Ariel,

Intelligent and detailed comment. I don't have time to answer every detail, but the short answer is that you present the sort of scenarios that present a risk to any bullish gas investment at the moment. Particularly if U.S. growth (if any) is anemic, the risks are considerable. And while North American production still dominates the U.S. gas market, one of those risks is that LNG may have sufficient volume to have a real impact on NG at the margins if growth remains weak. Of course, low prices will generally tend to depress LNG, given the non-negligible transport and storage costs. But if, say, some Russian oligarch decides to dump LNG on the U.S. market, that would certainly further crater prices (but why he would want to do such a thing is hard to figure, though).

I also agree with you that some gas companies are more vulnerable, in the medium and longer term, than is gas itself, as their hedging level decays. Overall, I don't dismiss your bearish scenarios at all, but I think the deceleration of U.S. domestic production is not widely priced in by many investors (or even recognized) and is sufficiently important to have a real impact on prices fairly soon, which was why I wrote the article. I think this is likely to have a bullish impact on prices, all else being equal. But as you detail, all else may not be equal. I think there is large uncertainty on the consumption side (as I noted), and you point out that there are still uncertainties on the production side (citing LNG imports especially); both of which means that this is, by no means, a sure thing (rare things, those). If I had to put numbers on it (which I try to do, to optimize my reward/risk as best I can) I would say there is c. 30% probability of more, but probably modest, NG declines from here, but a c.70% probability of increases, and included in the latter is a real possibility of quite rapid price increases, far more than many expect (as they throw in the towel, in many cases). This is an ideal scenario for a levered option play, with known bounded risk, but potentially large returns. But it is no sure thing. As always assess and limit your risk -- unless you have a 100% probability of success, you must limit your downside!

One thought as to rig counts ticking up: it may be a small proportion, but I suspect that some of the activity of late is by producers in tight formations whose production has fallen off so much that they are forced to infill to deliver what they've already hedged.


On Sep 07 03:27 AM Aricool wrote:

> why can't it go under $2? If most of the producers are 100% hedged
> for '09 (hence likely why their stock prices are not in the toilet
> w/ NG price) and they have to produce to keep their valuable leases
> and we have a 100 year supply, then why stop production at any price
> when you're getting top (hedged) $ any how??? Someone needs to explain
> to me why will they given these (and many other simar) factors.
>
>
> Besides, did you notice that rig counts bottomed in early June and
> actually started to uptick in July-Aug. Also, day rates never came
> down enough. Not a good sign if you believe in major production cuts.
>
>
> Also, if you look at the last recessions NG droped to around $2.5-2.7
> in real terms (adjusting for inflation); however, that was when US
> NG production was believed to have peaked, which is why we later
> created infrastructure for LNG imports- and those lows were before
> we became the Saudi-Arabia of NG with massive supplies. So, it would
> stand to reason that we'll see below $2 easy; esp. since we got so
> quickly to $2.5 w/o resistance.
>
> Moreover, I'm very concerned about the long term pricing of NG. I'm
> trying to see it as bullish as you do, but many long-term factors
> seem like it might keep it very low- not the least of which is LNG
> imports from Russia and Arabs when NG gets back over $4.
>
> Have a look at the LNG import spike between end '06 and early '07
> and it tracks *exactly* with a step down of NG price from 7 to 5.
> This is insane that LNG could crush prices during a robust US economy.
> I'm very scared now that with the paltry 2% trend growth expected
> for the US (and EU?) going forward that they'll dump excess Euro
> LNG onto the US and repeat that '06/'07 event. This would almost
> certainly keep NG prices under $4 in the expected weak situation
> for '10. This is a huge uncertainty in playing '09 weakness esp.
> if buying into NG driller/services securities to play the "perfect
> storm" against NG. That is, the LNG would dump just enough supply
> to easily keep the storage full, thus keeping NG exploration and
> cap ex down to a minimum, and b/c most NG producers are only partially
> hedged for 2010 (maybe 30% or less?) then they would get killed in
> 2010 making there hedged supported stock prices 2009 quite high.
> This uncertainty really sucks! Can you discount this scenario?<br/>
>
> the EU is expected to recover more slowly than the US so why (in
> the context of those reports/articles I sent you) won't the LNG plays
> dump what ever they can on the US. As I analyze the charts, the LNG
> chart tells me a very bad story. That is, the June '09 LNG was sold
> at only ~ $4.3 while volumes where a little above that just before
> the '06 event (see above) when NG price in '06 was ~7, and then dumped
> 2X the volume for 6 months and were more than happy to collect only
> $5 in that time. Again, this was when the EU and US were heading
> into a peak earning cycle. This tells me that the LNG players will
> keep US NG prices in the toilet (<$4) until the US (and EU?) are
> in a full recovery. Very, very bad for NG sector stocks for 2010.
> Please debunk this gloom and doom scenario! It seems all too possible
> if the magal V-shape recovery does not materialize in early 2010.
> Hence, why with a weak EU they'll dump there LNG at a (double? june
> '09) high rate and keep the US storage near max, thus NG prices in
> the toilet.
>
> I'd really hate to additionally bet on a V-shape recovery on top
> of the structural NG risks I've discussed. There are much more (risk
> adjusted) profitable bets on a V-shape recovery in the market.<br/>
>
> Betting on a V-shape recover is over the top for a NG bet at this
> point. Also, how can you be so sure that that '06/'07 event (see
> above) won't repeat in 2010?
>
> In summary, NG prices seem destined to go well under $2 well into
> November, and while it may rebound next year LNG will keep it near
> $4 and kill/hurt most US NG producers until the economy fully recovers
> (1-2 years) and get NG price in the $5-6 range.
>
> So, you can try catching a falling knife or put your money in NG
> stocks which will collapse next year when there hedges are gone and
> NG is kept too low b/c of LNG. Seems like NG is a bad bet until
> at least Nov.
>
> Cheers,
> Ariel-
>
>