Gas price risk mainly upside

May 10, 2004
The fundamental drivers of US natural gas prices are pointing increasingly to sustained higher levels in the near term as well as the long term.

The fundamental drivers of US natural gas prices are pointing increasingly to sustained higher levels in the near term as well as the long term.

While there is some downside risk for the former, more analysts are placing their bets that gas prices will remain fairly high throughout the year. And some suggest that US gas prices have embarked on a secular change toward the upside, departing from the usual short-term cycles.

Near-term outlook

As the summer cooling season approaches, signs abound that the US gas supply-demand balance will tighten this year, despite the current ample state of inventories.

Working gas storage at the end of April was 375 bcf above last year's level at this time, and the recent pace of injection suggests that the current supply-demand balance is looser than last year, according to Ron Denhardt, vice-president, natural gas services, Strategic Energy & Economic Research Inc. (SEER), Winchester, Mass.

For gas prices to remain about where they are, the supply-demand balance would have to average about 1.9 bcfd tighter than last year, notes Denhardt. This would result in working gas beginning the heating season at about 3.15 tcf, about the same as last year.

SEER expects this tigher balance to develop in the coming months, based on forecasts of normal or above-normal temperatures across the nation and an assumption of flat gas supply. Contributing to a bullish gas price outlook this month are high oil prices underpinned by oil supply concerns and forecasts for strong hurricane activity this year.

Unless the Middle East settles down and weather turns unexpectedly cooler, says Denhardt, ". . .speculation and the potential upside from fundamentals will support high price levels."

Longer-term outlook

A key driver of gas prices since deregulation in the US has been the level of oil prices.

That relationship isn't likely to decouple until more US LNG import facilities are in place, contends James L. Williams, Ohio energy economist and head of WTRG Economics.

"When the [LNG import] facilities are in finally in place, gas prices will be set by the international market," he said. "This will take some of the volatility out of natural gas prices."

Williams notes that when gas storage levels are near or above the 5 year average, crude oil typically sells at a premium to natural gas on a btu basis. In fact, while US gas storage now is almost 47% higher than it was at this time last year, it is slightly below the 5 year average. Consequently, as storage remains near normal and oil prices remain high, crude will continue to sell at a premium to gas—as much as $1/MMbtu. That compares with last year, when gas sold at a premium to crude of more than $0.80/MMbtu.

But this situation isn't likely to last long. The latest injection levels have left gas storage on a declining slope, with the year-to-year surplus dwindling and poised for more of the same as the temperatures and cooling demand rise.

No one is predicting a collapse in oil prices. And the gas supply-demand balance is likely to tighten this summer regardless of what happens with oil prices.

These scenarios are harbingers of an outlook in which oil and gas prices both remain high for the foreseeable future, argues J. Marshall Adkins, analyst with St. Petersburg, Fla.-based Raymond James & Associates Inc.

Adkins takes issue with those who see the climbing drilling rig count and operators' burgeoning cash flow as an indicator that another cyclic correction awaits the US gas sector. He contends that oil and gas supply-demand fundamentals today more resemble the 1970s than the short-term cycles of the past 20 years or so. Adkins also points out that US gas production is still falling despite a jump in drilling activity.

"It is our belief that we are in the midst of a longer-term, secular upswing, where oil and gas prices are going to be driven meaningfully higher by limited supplies and increasing global demand," he said. "While the last 20 years of history is useful, it occurred during a period when we had a meaningful gas supply bubble, not a gas supply decline."

On the gas side, then, that means demand destruction as the only recourse. And with economic recovery under way, there is little remaining demand to squeeze out, absent a price regime far higher than today's.

(Author's e-mail: [email protected])

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Latest Prices as of May 10, 2004

May 3 data for IPE prices unavailable due to UK public holiday

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