U.S. natural gas supplies should limit winter price rise

NEW YORK - Nearly record-high production and comfortable inventories are likely to limit U.S. natural gas price gains this winter, even if the heating season turns out to be colder than normal.

"Supply and demand fundamentals clearly point to an extended period of price moderation," said Stephen Thumb of Energy Ventures Analysis, a consulting firm in Virginia.

"Production is up, and if you look at storage, we could head into winter with the second highest inventories ever."

Even with colder weather this month and ongoing Gulf Coast production problems caused by hurricanes, natural gas prices have been unable to rally, sinking more than 50 per cent from their July highs to the $6.50 per mmBTU area.

While prices could still pop if early winter weather stays cold, most analysts agree any spikes should be temporary, with strong gains in domestic output likely to keep bulls in check.

In a recent report, Goldman Sachs lowered its winter outlook for natural gas prices to $7.60 per mmBTU, down 20 per cent from its previous estimate of $9.50.

"Despite lowering our price forecasts, we maintain that U.S. natural gas prices are currently undervalued as concerns about economic growth and the current financial turmoil ... have exacerbated downward price pressure on natural gas," the report said.

EVA's Thumb did not rule out a brief run to $10 during an extreme cold snap this winter, but said prices should mostly trade between $6.75 and $7.50 during the peak heating season.

SHALE PRODUCTION BOOM

After nine years of almost no growth in U.S. gas production through 2006, output has been on the rise over the last two years, growing some seven per cent this year with another four per cent gain expected next year.

According to U.S. Energy Information Administration data, domestic gas production could hit 22.4 trillion cubic feet in 2009, or 61.3 billion cubic feet per day, its highest level in 35 years and just shy of the 1973 all-time high of 22.6 tcf.

The sharp gains have come primarily from shale gas, or gas trapped in sedimentary beds found across North America.

While more difficult and costly to extract, increased output from shale has more than offset conventional well declines and falling imports of Canadian and liquefied natural gas, factors that helped drive natural gas prices to 2-1/2 year highs above $13 per mmBTU early this summer.

And even with daily Gulf Coast gas production still cut by more than a third, or 2.7 bcf, and cumulative cuts likely to approach 300 bcf due to recent storm damage, inventories are still going to head into winter at a near record 3.4 tcf.

Utilities typically build gas supplies from April through October to help meet November-through-March heating demand.

Data from EIA this week showed total gas in storage of 3.347 tcf was two per cent below last year's record highs but three per cent above the five-year average.

An extremely cold winter could quickly chip away at supplies and turn sentiment more bullish, but most analysts agree a normal winter will not be enough to lift prices much.

RECESSION IMPACT

Analysts also said a weak economy will dent demand and further loosen the overall supply-demand balance.

"We think the economy is in recession, and if you take away demand growth, which is what a recession will do, how do you maintain gas prices at $7?" said Kevin Petak at Virginia-based consultants ICF International.

But while demand will slip in a sluggish economy, analysts also note that domestic supply growth in 2009 will slow if gas prices remain below $7 and tight credit makes it more difficult for producers to raise the money needed to keep output growing.

"Gas goes into a looser balance for the next year because of the recession (and strong production growth), then goes back into a tighter balance in 2010," Petak said, adding he expected drilling activity to slow late next year.

Petak expects gas prices to average $6.80-6.90 in the fourth quarter, then possibly sink to the $5 area next year as the economy slows before rebounding to $7.30 in 2010 as economic activity finally picks up and supply growth slows.