Market Hotline: Gas price uncertainty suggests more volatility

April 8, 2002
The direction of the US natural gas market typically enjoys a consensus. Of course, in the oil and gas business, too much consensus on commodity price outlooks often invites the inevitable sucker punch from reality.

The direction of the US natural gas market typically enjoys a consensus. Of course, in the oil and gas business, too much consensus on commodity price outlooks often invites the inevitable sucker punch from reality. One need look back only to the past year for examples.

Right now, though, there is much contrariness among the prognosticators on the outlook for natural gas prices. With good reason: The price rollercoaster of the past 15 months or so leaves all of us scratching our heads over what will happen next.

The enormous gas storage overhang afflicting the market is beginning to look more each day like the will-o-the-wisp that the unthinkable (and technically impossible) storage deficit was at the end of the heating season in 2001. The conventional wisdom here has been that the collapse in demand, owing to high gas prices a year ago and aggravated by the economic downturn, has been compounded by the surge in supplies from the opportunistic drilling (again, spurred by high gas prices) of last year. Hence the prospect of storage glut and softening prices that loomed, it seemed, just weeks ago.

But gas prices recently have been seen approaching the $4/MMbtu mark again, and some think higher gas prices are here to stay. Others think the recent runup in prices is a phantom, soon to evaporate. And there are those among us market-watchers who would place bets on both scenarios happening-and all in this year.

Case for softness

The market bears mainly take issue with assumptions that US gas deliverability will fall along with the plummeting drilling rig count. They contend that US gas production now is subject to the law of diminishing marginal returns. Houston-based Simmons & Co. International analyst Chris Eades points to the puny increase of only 2.4% in US gas deliverability last year even while the US count of rigs directed toward drilling for gas reached record levels-and was up 30% on the year.

Eades notes that the rigs mobilized to boost the gas rig count beyond 750 will drill wells that yield average incremental production of only 0.15 MMcfd. That compares with an average incremental output of 1.05 MMcfd/well when the gas rig count slips below 500. So it follows that the gas rig count would have to plummet to something like 400 to produce a 9.5% drop in deliverability (a 3.4% decline at 600 rigs), according to the Simmons analyst. But he sees US production falling by only 2.9% in 2002. With demand still somewhat soft then, the market will be supply-long about 2.7 bcfd in the third quarter, triggering a round of involuntary production curtailments to balance the market.

Case for firmness

But there is that question of the recent surge in demand chipping away at the storage surplus. Certainly, the arrival of normal winter temperatures as the season winds down helped, but is also there an underlying rebound in gas demand owing to economic recovery and fuel-switching back away from oil? J. Marshall Adkins, of St. Petersburg, Fla.-based investment banker Raymond James & Associates Inc., suggests there is.

Adkins contends that, with the weather-related demand pull removed from the equation, there has been a huge bullish swing in gas supply-demand in the past 5 months. In that time, the combination of a slump in supply and a surge in demand adds up to a year-on-year swing of 5 bcfd.

So the weather-related draw on storage has exposed a meaningful change in gas fundamentals in the past few weeks, and storage is likely to end up at a comfortable level come the close of the heating season. And that, says Adkins, will mean storage injections this summer will be 40% lower this summer vs. last summer-and more resemble the summer of 2000, with its escalating prices.

Case for uncertainty

Then there is the prospect of a shutdown of numerous nuclear power plants in the US stemming from questions over a design flaw that has been linked to the Oak Harbor, Ohio, plant's woes. Taken together with the strong likelihood of worsening hostilities in the Middle East driving up oil prices, the result could be a spike in gas prices. Such price spikes could crimp demand and spark another drilling frenzy to again overload supply. And the cycle begins anew.

So 2002 gas markets could see a short-but wild-rollercoaster ride.

(Online Mar. 28, 2002; author's e-mail: [email protected])