Natural gas prices have remained weak and will continue to do so in 2011 on abundant supplies and weak demand. Bank of America Merill Lynch (BofAML) has downgraded its average price forecast for fourth quarter of 2010 for natural gas prices from $5.60/MMBTU to $4.80/MMBTU. BofAML has sharply lowered its 2011 forecast to average of $5/MMBTu from $6/MMBTu.
However, nat gas prices have support at current levels although US natural gas forward prices have gone into a tailspin. However, it is unlikely to dip below $3/MMBtu as it did last year as more robust baseload power demand and continued hot temperatures are pointing towards a lower end-of-season working gas storage level, BofAML analysis said.
The 12-month forward strip now prices at $4.50MBtu, down from $5.15/MMBtu at the start of August and $6.20MMBtu at the start of the year. In fact, every single strip out to 2015 now sits below $6. Against our expectations, even very long-dated US natural gas prices from 2013 onwards sold off, BofAML analysis said.
Shale drilling has been immune to decline in natural gas prices and since 2009, drilling in shale plays has displayed virtually no sensitivity to gas prices at all. BofAML has now projected US natural gas production growth of 0.9 bcf/d this year fand 1.7 bcf/d in 2011.
Weakness in US economy in recent times with lesser economic growth forecast could impact natural gas demand.
Shale gas output up
Shale gas output from Haynesville, Marcellus, Eagle Ford or Granite Wash have skyrocketed since the fourth quarter of last year. These plays are proving to be extremely dynamic, benefiting from continued improvements in gas rig efficiency and well productivity. In the Haynesville alone, production is up about 2.4 bcf/d this year relative to last. According to the latest data, the number of producing wells is up sharply over the past months and the inventory of permitted wells waiting on completion, fracturing or other operations is large. Permitted wells that are not yet drilling are also back at a record high Shale gas is still leading the way.
This summer, gas demand received a immense boost from the ongoing heat wave. Assuming a return to more normal temperatures, BofAML believes that the balance next year could turn out to be worse than this year.
The situation is likely to marginally improve in the fourth quarter of next year as service cost pressures should eventually start to curb the expansion in unconventional gas production. This will allow US natural gas prices to move higher to an average of $5.50/MMBtu in 4Q10. Still, any upside will likely be capped by expected end of October inventory level of 3.9 tcf. Still, storage containment risk will likely be low, given the recent expansion in storage capacity. This will likely keep price volatility muted on a seasonally adjusted basis.
Higher oil prices have improved breakeven economics
The price inelasticity partly highlights the lower breakeven costs of nonconventional gas plays. Breakeven economics in some shale plays can be as low as $3/MMBtu. Moreover, a shift of focus within the industry to condensate and NGLs plays like the Eagle Ford in South Texas have also been driving the drilling recovery as liquid production boosts revenues. Furthermore, production costs have gone down due to efficiency gains.
For instance, Southwestern Energy reported that the average time to drill to total depth improved to 10 days, from an average of 13 days in the second quarter. Because of faster drilling times in the Fayetteville shale, they were able to drop a rig in August. Other producers like Continental Resources also refer to the fact that drill times are falling and the productivity per well is rising. Petrohawk, for instance, reduced drilling times in the Haynesville from 70 days to just 23 days due to more advanced rigs. Moreover, there is strong demand for high-end horizontal gas rigs3. Even if the rig count declines, these highly efficient rigs which reduce drilling times are likely to continue to work.
To make matters worse, Canadian drilling seems to be undergoing a recovery. While Canadian nat gas exports to the US are still shrinking, they are doing so at a lower pace amid signs that the supply decline could slowly come to an end. So far this year, there are 391 rigs working in western Canada, more than double those drilling a year ago. While most of the drilling is geared to oil, gas is also making a comeback. Similar to the US, the recovery is geared to deep and horizontal wells tapping shale or other unconventional reserves, especially in British Columbia. LNG imports will unlikely be an issue, though, and will average marginally above this year's level, BofAML analysis said.
Industrial gas demand is likely to pick up on lower prices and major gas consumers like aluminium producers will shift back to nat gas. There is enormous pent-up demand from the electricity sector as power producers will be building more natural-gas fired power generation plants in the coming years. Combined, this should put upside pressure on US natural gas demand, and eventually, US natural gas prices in the medium-term.