With storage injection rates at record levels, natural gas market bulls are starting to get nervous.
The gas bulls look anxiously to a repeat of last winter's extreme cold to keep prices from entering into a freefall. But the bears suggest that last winter was an extreme anomaly and that $10/MMbtu is unlikely to reappear. However, a full-blown price collapse is equally unlikely.
Weather variables
An unexpectedly cool summer has kept a lid on electricity demand for gas. The result: gas prices piercing what was widely perceived as a $5/MMbtu floor.
In the near term, such weather patterns are forecast to continue. Temperatures through the end of September are predicted to be mostly normal to below normal across much of the eastern US and South; above-normal temperatures are likely to reign across the West and parts of the Northeast. While hurricanes often put a prop under gas prices by shutting in production, the massive power outage caused by Hurricane Isabel instead will pull down gas demand from its usual seasonal levels in an already cool summer in the East.
The slippage in weather-related demand adds incentives for arbitrageurs to inject now and sell forward, according to UBS Investment Research analysts. This comes on top of a record injection (for comparable weeks) of 102 bcf into storage for the week ended Sept. 13. Given current forecasts, that could leave the year-to-year storage deficit at a paltry 175-225 bcf by mid-October, according to UBS. The likelihood is strong that storage will enter the heating season Nov. 1 close to the comfort zone of 3 tcf.
Such an outlook has shrunk the futures strip for New York Mercantile Exchange natural gas to less than $5/MMbtu.
Will winter come to the bulls' rescue again? Perhaps, but not to the degree seen last winter, according to Morgan Keegan & Co. Inc. analysts, who see $5/MMbtu as a more likely average for the coming season. Even with normal winter weather (read: cold), storage looks to end the heating season at 800 bcf. A look at last winter's record low storage levels—including record draws ahead of the heating season—provides the explanation for the $10/MMbtu that prevailed for last winter's peak average.
Fuel, economic variables
Can fuel-switching, then, come to the bulls' rescue? Don't bank on it, says Morgan Keegan. Resid prices act as a price floor during cold winters and as a price cap during warm winters. Morgan Keegan's forecast for oil prices is $28/bbl for NYMEX crude. Considering that oil prices of late have slipped a bit below that level and that near-term supply looks to increase in lockstep with demand, fuel-switching isn't expected to be much of a factor this year. That compares with last winter, when soaring natural gas prices helped fuel oil double its usual market share.
Morgan Keegan also envisions coal, nuclear, and hydro maintaining their market shares in the months ahead.
What about nonweather demand variables, namely a recovering economy? While that might have been a factor in other years, Morgan Keegan maintains that last winter's gas price shock has already done its damage.
"As gas prices soared [last winter], many industrial consumers permanently shuttered operations, moving facilities abroad," the analysts said. "It is very unlikely the sector has recovered or ever will recover."
Even the widely acknowledged decline in US gas production won't salvage the bulls' hopes, Morgan Keegan contends, adding that the case for this factor should not be overstated.
Wild cards
What these analysts don't mention is the prospect of wild cards beyond the weather. And those wild cards center on oil markets.
Iraq remains a volatile factor in oil markets; indeed, the slow restoration of Iraqi oil supply keys a tempered outlook for oil prices. The relentless sabotage and attacks on personnel there suggest strong prospects for that ramp-up to remain hobbled.
The situation in Nigeria also remains tenuous. But it is Venezuela where the biggest market surprise could happen. President Hugo Chávez's continuing success in beating back a recall election push could spell worsening civil strife in that, leading to a repeat of last winter's Venezuelan supply outage. And the resulting oil price spike and consequent fuel-switching back to gas could be the anomaly this year that last winter's brutal cold was for gas prices.
(Online Sept. 19, 2003; author's e-mail: [email protected])
