FocusSub-$3 US natural gas will not last - sources

25 August 2009 21:42  [Source: ICIS news]

US natgas low will not lastBy Ryan Hickman

HOUSTON (ICIS news)--US natural gas trading at seven-year lows below $3/MMBtu has underscored low market fundamentals - record supply overhang, poor demand and depressed production - but sources said on Tuesday that prices will break upward by the end of the year.

"The market's view is that the current overhang is temporary," said Jeff Fetterly, a natural gas analyst with CIBC World Markets in Calgary.

NYMEX contracts for September settled on Tuesday at $2.882/MMBtu, lows not seen since August 2002. But a contango in futures has November prices trading in the low-$4s/MMBtu.

Further out, the first few months of 2010 have futures prices in the low-$5/MMBtu.

"The market is thinking there will be a balancing early next year at some point," said Eric Nuttall, an associate portfolio manager at Sprott Asset Management in Toronto. "I don't think those prices are unrealistic. If there's a drop in rig count, there is going to be a dramatic drop in production."

North American gas drilling activity is down by 56% from the same time last year when the rig count was at nearly 1,600 wells, according to the latest weekly data from oil and gas service firm Baker Hughes.

Analysts said the reduced output - down year over year by about 1bn cubic feet (bcf)/day in July - will start to free up pipelines in the coming months, especially when large amounts of natural gas are taken out of storage in November and into early 2010.

"That's what the futures curve is looking at," Fetterly said.

But prices at a level that dissuades capital investment from drillers, the question comes down to at what price do gas producers restart production at substantial levels.

"At five dollars they start," Nuttall said. "At six dollars they really start and seven dollars it's really game on again."

Fetterly said that even though demand for natural gas has seen a recent uptick from the electrical power sector, the fuel's wider recovery hinges on a comeback in industrial use.

The fall out in industrial demand as the economic slump set in worldwide was what prompted commodity prices to drop quickly off their all-time highs in July, when natural gas futures topped out at $13.694/MMBtu.

But enough gas production continued and US underground storage continued to pile up at a rapid pace.

Pipelines have bulged from newly-tapped shale fields boosting US output while a falloff in industrial use has put demand in a rut.

Unconventional production of natural gas from shale fields such as the Barnett in the Dallas-Forth Worth, Texas area; Fayetteville in Arkansas; Haynesville in Louisiana and east Texas; and Marcellus in the northeast accounted for 1,200 bcf of gas in 2007, according to the Energy Information Administration (EIA).

The government agency projected shale output will make up 18% of total US production, at 4,200 bcf, by 2030.

"Everything has come together for natural gas to really hammer it," said Phil Flynn, senior research analyst at PFG Best,  a brokerage in Chicago. "All of this stuff is having a major impact on the marketplace. We are trading in a totally different market than a few years ago."

Back then, US natural gas players were panicking about the domestic supply situation and the prospects of being an importing nation while prices stayed high, Flynn explained.

Now, domestic supplies are well above 3,000 bcf, the traditional storage benchmark that the industry considers ample enough to handle the winter heating season. The US market hit that number at the end of July, the earliest in history by a month's time.

The EIA said in its short-term energy outlook that total storage would reach around 3,800 bcf by the end of October, when weekly storage reports start recording draws for the cold weather instead of injections.

But Nuttall said no one truly knows what maximum storage is in the US.

Estimates are that it is between 3,800 and 3,950 bcf, Nuttall said, but the US natural gas market has never been in the supply position to really test its limits.

Flynn predicted storage might get close to 4,000 bcf, which he said "is unheard of".

The worst-case scenario is that pipelines become so backed up with fuel that operators force producers to stop sending in material, rig activity comes to a halt and spot natural gas prices could slide down to $1/MMBtu or lower, Nuttall said.

But Nuttall said that is highly unlikely and would be a short-term phenomenon as heating needs would free up pipelines as inventory starts to pare down amid light production.

Petrochemical chemical producers have taken advantage of the soft natural gas as prices go in the opposite direction of strengthening crude oil values.

More petrochemical crackers are switching feedstocks from oil-based raw materials such as naphtha to natural gas liquids (NGL) like ethane.

In an opposite reaction to the lower natural gas prices, a move to lighter feedstocks pushed lower crude C4 output and caused prices for a C4-dependent chemical like butadiene to rise.

Natural gas is also a major power fuel for the US petrochemicals industry and downstream chemicals manufacturers.

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