Natural Gas Price Picture May Change By Late 2012

September 2011, Vol. 238 No. 9

Valerie Wood

The natural gas market today is a completely different market from that of just three years ago. A shortage of supplies has turned into an overabundance, and production continues to outpace demand. In July 2008, the price of natural gas in Louisiana was close to $14 per MMBtu, and according to the Energy Information Administration (EIA), natural gas production levels in the Lower 48 states was 62.78 Bcf/d. Today, the price of natural gas in Louisiana is hovering around $4 per MMBtu, and natural gas production levels in the Lower 48 states have climbed to over 69 Bcf/d.

Historically, as natural gas prices decline, producers curtail drilling efforts, which in turn leads to falling production levels. But, today’s market environment is different because the economics of natural gas production have changed. Advancements in horizontal drilling and hydraulic fracturing technologies have made it possible to produce shale gas economically and, in most cases, at costs that are below the costs of most conventional wells. Not only that, but production costs are continuing to fall due to multiple factors, including: improved drilling efficiencies, reduced operating costs and expenses, higher production yields, and most importantly, natural gas liquids (NGLs).

NGLs refer to the hydrocarbons, such as ethane, propane, and butane, which are byproducts of natural gas production. While each gas supply basin is unique in terms of NGLs, there tends to be a higher presence of NGLs in shale gas plays. Because NGLs are priced in accordance with crude oil prices, producers have ramped up production in NGL-rich shale basins because the production of high-value NGLs helps to lower natural gas break-even prices. This is primarily why production has continued to climb even as natural gas prices have fallen.

Plus, production has also increased because of the shear potential of shale gas plays. In July 2008, Baker Hughes reported that there were slightly more than 1,500 active gas rigs searching for natural gas. Today, that figure has fallen to less than 900. The fact that production levels have continued to climb demonstrates the increased efficiencies and higher production yields.

According to Natural Gas Price Outlook, natural gas prices in 2011 are expected to be comparable to 2010 price levels. However, the outlook highlights the potential for a price momentum change in the second half of 2012. This change is expected to be driven by the following factors:

(1) Natural Gas Production Will Level Out: The same shale production technologies that are responsible for the substantial natural gas production growth can also be applied to crude oil. To date, producers have redirected natural gas drilling rigs to the most profitable gas shale plays, which has kept production on the rise. However, given the price differentials between natural gas and crude oil, it is likely that diversified producers will begin to move drilling rigs away from natural gas and toward crude oil plays.

(2) Anticipation of Increased Demand: While demand is still expected to remain anemic for the next 12-18 months, a change in the perception of demand requirements for 2012 and beyond could initiate a price momentum shift. The potential for LNG exports, increased transition from coal to natural gas-fired generation, and a growing economy lay the groundwork to establish an outlook of rising gas demand.

Other conclusions of the price outlook include:

* Shale production becomes a growing part of the nation’s supply portfolio, virtually eliminating the need for LNG and Canadian imports by 2035.
* New technologies are expected to make accessibility to stacked shale plays increasingly economical.
* The cost benefits of NGLs in shale production have reduced the break-even price point for natural gas producers on average by $1-3 per MMBtu.
* A lack of NGL processing infrastructure could force a slowdown in natural gas production.
* The electric power sector will be the primary driver behind natural gas demand as aging coal-fired electric generation is retired and some nuclear power plant construction is tabled.
* Investigations into the environmental impacts of horizontal drilling and hydraulic fracturing (the technologies used for shale production) are ongoing; the potential for increased regulations remains real.
* Numerous LNG facility owners are seeking to turn their underutilized LNG facilities into export facilities by 2015. If approvals are received, this could dramatically alter the outlook for U.S. natural gas demand.
* U.S. crude oil production is expected to surge over the next three years because of shale production.

Overall, the environment for natural gas prices remains weak going into early 2012. Natural gas prices may dip to $3.50 per MMBtu in late fall 2011, but the potential for a price momentum shift increases as 2012 unfolds. Key ingredients for a price momentum change are economic recovery and a reduction in the net-short positions currently being held by speculative traders.

The outlook concludes that while there appears to be no immediate threats of a changing price trend higher, the downside is somewhat limited. By spring 2012, changing perceptions of the future are expected to impact the forward natural gas price curve, causing it to shift to a slightly higher trading range.

Ultimately, late fall 2011 and the first quarter of 2012 are expected to provide some very good natural gas buying opportunities for 2012, 2013, and perhaps even 2014. Conversely, sellers are going to have to be a bit more patient, awaiting a more improved economic environment and outlook, which isn’t expected to occur until mid-2012 at the earliest.

For more information visit; e-mail: Valerie Wood

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