Balmy days pushing spot gas prices toward sub-$2/MMbtu

Sitting in Houston on a sunny day with 80° F. temperatures-in the dead of winter-underscores all too clearly just what is wrong with natural gas prices these days.

The disappointing heating season has kept gas prices from the $3/Mcf-plus level that the underlying physical fundamentals would otherwise dictate. Given the continuing decline in wellhead deliverability in the US and the steady increase in gas consumption from other, nonheating-related sectors, markets should be much tighter this time of year than they are.

So far this year, degree-day temperatures have been 11% lower across the US than they were at this time a year ago. And last year's heating season was warmer than normal. For the year to date in 2000, the weather has been 16% warmer than normal. For the week ended Jan. 8, temperatures were a whopping 35% higher than at this time a year ago and 24% higher than normal. This week has also proven to be unseasonably warm across much of the US, making it the 10th of the 11 weeks thus far of the winter heating season to be significantly warmer than normal.

The lack of heating load is killing spot gas prices, which fell last week for the second week in a row and are approaching the southern side of $2/MMbtu. For the week ended Jan. 7, spot gas prices fell to $2.07/MMbtu from $2.20/MMbtu and yet were still above last year's level at this time of $1.90/MMbtu.

Futures prices are holding relatively better, however, at about $2.25-$2.40/MMbtu for the next 7 months' contracts. This shows that the futures market recognizes that there is less seasonal volatility than there used to be, which can be ascribed mainly to two things: the growing role of natural gas in the nation's cooling load during the summer; and the aforementioned slide in wellhead deliverability. Simply put, the underlying balance between weather-normalized supply and demand continues to tighten. Looking at futures contracts 12 months out, the average price is $2.42/MMbtu, which is actually a 6¢ increase from last week.

Needless to say, the year-to-year storage deficit continues to shrink. Last week, storage withdrawals totaled 115 bcf, down from 133 bcf the prior week and from 233 bcf for the same week in 1999 but up from the 1998 level of 43 bcf.

The year-to-year storage deficit totaled about 90 bcf last week vs. deficits of 208 in the prior week and 233 bcf the week before that. This deficit is likely to plummet this week as the warm spell crimps demand and given the hefty withdrawal of 203 bcf a year ago.

Looking at gas inventories across the US today, gas in storage totals 2.32 tcf, compared with 2.41 tcf at this time a year ago and a prior 5-year average of 2.12 tcf. Inventories are being held at a comparatively even level across the country-at 71-73% in all the key regions.

Meantime, drilling activity continues to pick across the US and Canada, thanks to strong oil prices. While more rigs will shift to oil from natural gas given the price outlooks, not all of the increased cash flow will go just for oil wells. So, at first glance, one would think the decline in wellhead deliverability is likely to flatten out a bit in the meantime. And if there is an easing in the tightening of underlying physical market fundamentals, then upward pressure on prices from this aspect is going to fade, pulling down prices for the medium term. In addition, more Canadian export capacity continues to come on stream, with Sable Island the latest start-up. Add to that the growing likelihood that much of the rest of the winter heating season is likely to remain warmer than normal, and the market starts to look positively bearish.

But hold on. Based on energy equivalence, crude oil now is selling for about 10 times that of natural gas. That's a huge turnaround from 1998, when gas prices topped those for oil sixfold, on an energy-equivalent basis. While an increase in drilling during second-half 1999-again, in response to higher oil prices-along with an increase in Canadian exports and higher temperatures contributed to this situation, that drilling increase didn't make all that much of a dent in the trend toward lagging gas reserve additions. There is also the situation with the disparity in reserve replacement levels between oil and gas. The reserve replacement for gas in the US is a low 83%, but for oil, it's a paltry 24%, according to the latest data from the US Energy Information Administration. As companies perpetually produce more hydrocarbons than they find (or acquire), they eventually liquidate themselves. So, given the huge disparity in oil vs. gas reserve replacement and the higher oil prices, the bulk of increased drilling in the near future is likely to be directed toward oil and away from natural gas. Last year, natural gas reserves in the Lower 48 declined for the second time during the 1990s, in lockstep with the trend toward lower wellhead deliverability, and this trend isn't likely to reverse soon, even if the boost in cash flow flattens the decline curve a bit. So, in the medium to longer term, prospects still look pretty good for gas prices.

Anyway, all that points to gas prices in the future. For the moment at hand, however, if there isn't an arctic express coming that will last at least a week, then prices could soften still further, at least to the point where the current level of about $2/MMBU starts to look pretty good.