HardAssetsInvestor

Written by Sumit Roy  |

April 12, 2012

Natural Gas Report: Price Could Fall To $1 Or Rise To $3 Depending On Production Levels

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The natural gas market is facing an unprecedented glut. We examine the latest outlook.

Natural gas prices were little changed today after the Energy Information Administration reported that storage operators injected 8 bcf into storage last week. That was below market expectations that were calling for an injection close to 18 bcf, but excluding a one-time accounting adjustment of 10 bcf, the figure was in line with estimates.

Earlier this week, natural gas plunged below $2/mmbtu for the first time in 10 years, as the unprecedented glut of inventories in the U.S. and Canada weighed on already-depressed prices.

NATURAL GAS

It is impossible to say when the free fall in prices will end, but until there is meaningful erosion in the supply surplus, the market will continue to fear the possibility of a storage overflow scenario later this year.

At 2,487 bcf, U.S. inventories are a whopping 880 bcf above the year-ago level and 937 bcf above the five-year average.

In Canada, inventories total 493 bcf, which is 297 bcf above the year-ago level and 288 bcf above the five-year average.

Combining the two, North American natural gas inventories are now a whopping 1,177 bcf above the year-ago level and 1,226 bcf above the five-year average (calculated using a slightly different methodology than the EIA).

According to the EIA’s latest estimate, total storage capacity in the United States is 4,352 bcf, or 1,865 bcf above current levels. Meanwhile, the typical injection over the remainder of the season is 2158 bcf.

Thus, injections must be tempered by close to 300 bcf over the course of the next six months in order to ensure that storage levels remain below capacity limits. That’s approximately 50 bcf/month, or 1.7 bcf/d.

That is not necessarily a huge tightening of the supply/demand balance, but much of the “easy” cuts in supply and increases in demand have already taken place. Incremental improvements will take increasingly lower prices and that is what the price free fall is accounting for.

The biggest question that remains is, How much will output decline in response to the cutbacks in drilling activity? The number of rigs drilling for natural gas hit a fresh 10-year low last week at 647.

NATURAL GAS RIG COUNT

Ironically, however, the latest EIA survey showed that natural gas production reached a new peak in January at 72.85 bcf/d — 6.1 bcf/d, or 9.1 percent, higher than the year-ago level.

As many have pointed out, while drilling activity targeting natural gas specifically has been reduced significantly, intense drilling continues in oil/liquid-heavy plays. But those plays often produce natural gas as a byproduct; thus, the task to meaningfully bring down gas output may be much more difficult today than in past cycles.

Most analysts concede, however, that the sharp pullback in natural gas drilling will reduce output down the line. As it concerns prices, the question is when that will happen and by how much.

If output begins to decline within the next few months, prices could stabilize or even rise back toward $3 by next winter. If not, prices may plunge toward $1 as the market forces producers to shut-in production by pricing under cash-operating costs.