Natural Gas: Clean Fuel with a Dirty Little Secret

Includes: CHK, COG, GDP, UNG, XTO
by: Nathan Weiss

The natural gas market has a dirty little secret: The U.S. natural gas market is currently massively oversupplied. We believe that E&P companies know this, with Goodrich Petroleum (NYSEMKT:GDP), XTO Energy (XTO), Cabot Oil and Gas Corp (NYSE:COG) and Chesapeake Energy (NYSE:CHK) coming to public markets in recent weeks to raise capital in the face of near-record natural gas prices.

The dirty secret is not obvious, until you spend some time with the data. While natural gas demand is expected to increase by 1.42% in 2008, from 65.42 BCF/d to 66.35 BCF/d, domestic natural gas supply increased from 52.97 BCF/d in May 2007 to 57.14 BCF/d in May 2008! This is a stunning 4.17 BCF/d supply response in the midst of a .93 BCF/d increase in demand. The natural gas markets are currently 3.24 BCF a day oversupplied!

Despite the massive growth in natural gas supply, the amount of natural gas in storage began the year 358 BCF lower than in 2007 and today is only 367 BCF lower. How can the market be massively oversupplied when storage levels are constant versus 2007? There were 152 days from January 1 to May 30. If the market was truly oversupplied by 3.24 BCF/d, we should have seen storage increase by 492 BCF. Where did nearly 500 BCF disappear to?

LNG imports have decreased significantly. From January 1 to May 30, 2007 the United States imported an estimated 377 BCF of LNG, in total. During the same time period in 2008, imports totaled 139 BCF of LNG - a level our research shows to be near the absolute minimum contracted levels. The lack of LNG imports has benefited natural gas storage levels to the tune of 238 BCF so far in 2008. This will become apparent in the headline storage data shortly.

We are currently comparing monthly LNG imports of 3.04 BCF/d in May 2007 to 1.02 BCF/d in May 2008, providing a 61 BCF per month benefit to YOY storage levels. LNG imports declined sharply after August of last year. After importing 2.82 BCF/d in August of 2007, the U.S. imported only 1.39 BCF/d in September, 1.03 BCF/d in October and .67 BCF/d by December. Natural gas inventory levels from September onwards will increase by 60-72 BCF per month YOY due to the easier comparisons versus 2007.

A major source of ‘hidden demand’ this year has been increased exports of natural gas to Mexico and Canada. Exports to Mexico have increased from .627 BCF/d in the first four months of 2007 to 1.27 BCF/d in the same period in 2008. Exports to Canada have increased from 235,375 MCF (1.96 BCF/d) in the same period in 2007 to 385,752 (3.21 BCF/d) in 2008, an increase of 1.25 BCF/d.

Attacks on Mexican gas pipelines in July 2007 caused some damage, but were quickly repaired. Six blasts in early September hit pipelines in the Gulf coast state of Veracruz, causing further damage and increasing demand for imported natural gas. The expected startup of the Energia Costa Azul project, which has their natural gas capacity fully contracted, recently occurred as they announced that they were ready to begin commercial operations on May 15. Half of the incoming gas will be marketed by Sempra and half by Shell.

By the second half of the year, this project will bring in .21 BCF/d of natural gas to Sempra. The Mexican Secretaria De Energia expects that Mexican natural gas imports from the United States will be equal in 2008 versus 2007, before declining by 17.34% in 2009 as Mexican LNG imports increase. Exports to Mexico have increased natural gas demand versus by 96 BCF through April 30, 2008. In Canada, despite natural gas production declining by over .50 BCF/d so far in 2008, natural gas injections are expected to be 210-220 higher in 2008 versus 2007.

Essentially the U.S. is exporting natural gas to Canada to help them increase storage levels. Our models indicate that in 2008 Canada should be exporting .92 BCF/d less natural gas than in 2007, due to production declines and increased demand in Canada. This indicates that we are sending .33 BCF/d more natural gas to Canada than is needed to offset their reduction in potential exports. The ‘artificial demand’ of .33 BCF/d equals 50 BCF so far in 2008.

We can now account for 395 BCF of the 492 ‘missing’ BCF of natural gas. A total of 238 BCF has been given to the global LNG market via reduced U.S. imports. A total of 50 BCF has been given to Canada for storage and 97 BCF has been given to Mexico to offset production losses from terrorism and to help them ‘get by’ until their LNG programs ramp up later this year and in early 2009. We do not believe these effects can occur again next year.

Disclosure: none