Longer-term outlook for natural gas bullish, too

(Author's note: This is the third of a three-part series on the North American natural gas market.)

We've looked at the current robust state of the North American natural gas market and the looming near-term prospect of price spikes in the coming winter heating season in the respective first two parts of this series. Are the longer-term prospects bullish as well?

As with any other commodity, natural gas is subject to the laws of supply and demand. Right now, supply is a bit on the tight side, with the prospect of getting tighter in the winter-assuming a return to normal winter weather and thus a return to historically typical demand growth. So prices are topping $4/Mcf, and some analysts speculate the stage is being set for price spikes to as much as $7/Mcf this winter.

Looking at the demand picture, signs point to continued strong growth trends, paced by steady growth in gas demand in the electric power sector.

The current strong prices for natural gas is having something of an impact on demand, however. Recently, ammonia/urea plants in Arkansas and Louisiana have shut down or scaled back production pending a decline in natural gas prices, and a methanol plant was shuttered by a contractual force majeure invoked specifically by the high price of natural gas.

Nevertheless, the driver in the natural gas market demand picture is residential: power generation for cooling in the summer and gas heat in the winter. Analyst Dain Rauscher Wessels notes that at least 13 gas-fired electric power plants have started up in the US just since May. If fired at their peak rates, that would add 13 bcfd of natural gas consumption, or about 2.4% of the US daily total. In addition, more than 200 gas-fired power plants have been proposed for construction in the near future.

Natural gas prices certainly will be capped at some point, as demand eases in response to price pressures-which it alread has, to a minor extent-and in response to cooler temperatures in the fall. Supply will increase in response to those same price pressures. But how much will supply increase? That's the critical question in the North American market today. Reduced wellhead deliverability, which is the result of a decline in drilling activity that in turn is the result of low oil and gas prices, has been the primary reason natural gas storage is low and supplies have been tight this year. Drilling activity is picking up again, in response to strong oil and gas prices-and most of that renewed activity is directed toward natural gas (in large part because most producers see natural gas having better long-term prospects and oil prices facing so much uncertainty and volatility because of OPEC's (really, Saudi Arabia's) ability to affect markets. In other words, hardly anyone believes $30/bbl oil is here to stay, but many market observers think $3/Mcf gas might stick around a few more years-certainly at least $2/Mcf gas.

Why is that? If natural gas must also obey the laws of supply and demand, why can't we assume that the spike in drilling activity will eventually boost supplies enough to depress gas prices again, as it has in the past?

It certainly isn't for lack of resources. According to a recent report by the Gas Technology Institute (the organization created by the merger of the Gas Research Institute and the Institute of Gas Technology), technology advances will underpin the industry's ability to expand US and Canadian gas supply. The expansion of North American gas supply that is under way can be maintained for the next 15 years because of the following factors, GTI says:

In addition, there is the continuing growth in contributions from unconventional sources, such as coalbed methane and tight sands. The deepwater Gulf of Mexico and deep onshore Gulf Coast, Permian basin, and Midcontinent regions will account for a growing share of US gas production. GTI projects the central and western gulf will account for 8 tcf of the market by 2015 and the deep-horizon onshore to account for 3.5 tcf, while Canadian gas production grows to 7.7 tcf in 2015 from 5.8 tcf.

So if all this growth in gas supply is on the horizon, then why the bullish outlook?

Because it's all in the timing. Note the GTI time frame: 2015. While drilling activity is up from levels seen a year ago, it hardly constitutes a boom. So if producers are flush with cash, and demand for oil and gas is strong, then why isn't there a boom? One needs only to look at the current decimated state of the industry for an answer. A few years ago, producers and service-supply companies were already voicing concern about the lack of equipment and especially the lack of qualified personnel to undertake the job needed to meet expected growth in oil and gas demand. Then the 1998 oil price collapse hit and devastated the already thin ranks of the industry. From the biggest majors to the smallest independent and in all levels of service and supply companies, skeleton crew staffing is the norm. And companies are notoriously wary of price volatility, so any push to staff up again is likely to be gradual and in small increments; that's also a recognition of the gains in productivity that have been enabled by advances in technology, especially in computing. Wariness over prices is a big part of the reason companies have opted to use that extra cash window to buy up reserves and other companies that were still a bargain, or to pay down their debt and buy back their own stock-all with an eye to boosting their own profile in the eyes of Wall Street.

Many of the people who were dumped in the latest industry slump are not coming back to it-some have been through more than one downturn and are simply fed up with the uncertainty and volatility of oil and gas markets. Colleges and universities are graduating and enrolling only a tiny fraction of the students needed to fill the ranks of tomorrow's industry. The salaries that cash-flush producers will be throwing at a new generation will also attract technical professionals from other industries and disciplines who will undergo a frenzy of cross-training to help fill the oil and gas industry's depleted ranks.

All of this will go a long way toward meeting that bullish supply outlook that GTI sees in 2015. But what about tomorrow? And next year? Or even 2005?

Industry just can't rebuild its capacity fast enough to meet US gas demand growth in the near to mid-term with US supply. And even Canadian supply is constrained by pipeline capacity. While some US LNG import capacity is likely to be added, timing is a crucial consideration here as well. In addition, there are likely to be constraints on US pipeline capacity, as environmental opposition has delayed a number of key projects-notably in Florida and the US Northeast. So even an increase in wellhead deliverability and imports may be reined by the physical infrastructure downstream.

Again, it's all in the timing. And the timing suggests that $2-3/Mcf gas will be around for awhile-certainly through 2001 and, quite possibly, a few more years beyond that.

OGJ Hotline Market Pulse
Latest Prices as of July 28, 2000

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