OUTLOOK '11: Steady road of mid-$4.00s/MMBtu natgas prices ahead

27 December 2010 22:12  [Source: ICIS news]

A Chesapeake Energy natural gas well in the USBy Ryan Hickman

HOUSTON (ICIS)--The forward curve for the NYMEX Henry Hub natural gas futures price looks like a road with few peaks or valleys and values in the mid-$4.00s/MMBtu.

With unprecedented levels of supply, more than 900 rigs burrowing deep into shale gas fields around the US and the economy slowly rising off the mat from 2009's knockout punch, 2011 natural gas pricing projections show no real opportunities to deviate on either side of the expected 2010 average.

The US Energy Information Administration (EIA) expects the average front-month contract price for 2010 to finish at $4.37/MMBtu, which is about the midpoint for most major pricing forecasts for 2011.

Analysts at investment bank Credit Suisse have pinned next year’s average front-month futures price at $4.50/MMBtu, while consultants at Gelber and Associates forecasted $4.25/MMBtu. In its latest short-term energy outlook, the EIA said year-ahead natural gas prices would settle at $4.33/MMBtu.

Credit Suisse pointed to US shale gas producers’ ability to quickly turn on production in low-cost shale plays as the reason for the relatively-static pricing outlook.

Both the investment bank and the EIA predicted an uptick in production of around 0.7bn cubic feet/day as gas drilling activity remains up more than 20% from the end of 2009. At that time, there were around 775 running rigs and prices flirted with $6.00/MMBtu.

The drilling output in prolific shale plays such as Pennsylvania's Marcellus, Louisiana's Haynesville, Dallas-Fort Worth’s Barnett and the liquids-rich Eagle Ford fields in south Texas brought US inventories past 2009's record peaks by November 2010.

Recent joint ventures between North American independent shale producers such as Chesapeake and Talisman and large energy conglomerates such as China National Offshore Oil Corporation (CNOOC) and Statoil have kept working capital available for drilling companies.

Those companies recently came together for deals in the Eagle Ford shale, which has attracted production as a result of its high natural gas liquids content. That turns the gas into higher profits because its sale is linked to oil prices running at about three times the value of natural gas.

The expected supply overhang as a result of flat-lining demand and what appears to be a mild winter back end has not only put a lid on pricing, but also has tempered any erratic price swings in the market that were commonplace 10 years ago, according to analysts at Barclays Capital.

“Not only has production growth dampened volatility, but also the changing face of production should make price spikes less severe,” the analysts wrote in a recent report, referring to the ability of producers to realise immediate yields from new shale play drilling.

The result is a futures market that does not show prices above $6.00/MMBtu for a full calendar strip until 2019, leaving little opportunity for producers to hedge their production at a decent price.

US shale producer Southwestern Energy said in a recent outlook for its 2011 costs that the company had locked in fixed NYMEX prices next year for about a quarter of its projected production at an average floor price of $5.43/MMBtu.

A couple of years ago, US producers hedged production at prices that were well above current pricing prospects and have kept drills running even though production costs could be below the NYMEX traded value.

But those premium hedges are expected to start expiring in the first and second quarters of 2011, said Pax Saunders, a natural gas analyst with Gelber and Associates in Houston.

Without a forward curve presenting striking hedging positions for producers, drilling in the US could begin to decline as the high-priced hedges roll off.

“You’ll see the rig count pull back and eventually see prices rise into the winter into $5s and $6s [per MMBtu] again,” Saunders said.

But there will be some selling at those high US winter prices, drilling will rise back into the 900s and the prices that impact chemical commodity values will sink back into the mid-$4.00s/MMBtu again, Saunders said.

“Then I think we’ll start the cycle all over again.”

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By: Ryan Hickman
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