Summary
Because of the industry downturn, relatively mild winter, and reduced cooling demand in the summer, demand for natural gas has been seriously curtailed. But supply and production levels cannot easily adjust to lowered demand.Thus natural gas futures price hit a 7 year low, dipping below $3 to $2.68 per MMBTU in beginning September 2009, and have been headed lower. Gas prices have tumbled roughly 80% from last year’s high above $13.
Analysis
Reasons
1. Production levels had accelerated over the past few years due to heightened exploration and favorable economics due to increasing pricing. To counterbalance deceases in demand, production turnoff, and delaying new exploration are the alternatives. However on account of a significant lag in the supply/demand balance that even with much lower demand; the supply side is still forced to push its production into a shrinking market.
2. Gas Storage is used for meeting the peaks in demand as in the winter which cannot be supplied by pipeline deliveries alone. Thus one of the major complements of the natural gas market is storage injection. Today, because of reduced consumption levels, much more natural gas is being injected into storage. In fact, storage levels are way ahead of five year levels way ahead of the end of storage injection season (end of October). It has been reported that the Natural gas stockpiles rose by 52 billion cubic feet to about 3.2 trillion cubic feet in the week ended Aug. 21 –21% above year ago levels. Levels are now so high that some experts believe the United States will run out of storage capacity before winter begins.
Impacts
1. This will actually “strand” some natural gas supply and will force "shut ins," when producing wells are shut off (this practice is avoided because some of the gas in the shut in wells becomes unrecoverable).
2.Fertilizer and ammonia companies, which really suffered last year when gas went to $12-13 where eighty percent of these companies use gas to make ammonia to make fertilizer, will benefit greatly from the low gas prices. And of course, it's going to benefit consumers, too.
3.Exploration and production companies, drilling contractors, oil servicing companies, mineral leasing companies and tax collections will suffer immensely. Low gas prices lead to lower production, exploration and reinforce the commodity cycle. Thus a collapse in a part of the cycle is going to pave the way for another part of the cycle.
4.Strangely though, despite the fact that gas prices are dirt-cheap and energy demand has fallen into an abyss, shares of gas producers Chesapeake Energy (CHK, Fortune 500), Anadarko Petroleum (&source=story_quote_link">APC, Fortune 500), and Southwestern Energy (SWN) have climbed an average of 37% so far this year, compared with the S&P 500's 10% gain.
Are there signs of recovery?
Speculators who trade natural gas on NYMEX are betting 2 to 1 that natural gas prices will continue to go down in the near term, as weathermen think an El Niño pattern will persist into the winter; and we may have a mild winter and then you may not get a concentrated gas demand in a cold spike,
Gas producers have responded to the imbalance by cutting back on the number of rigs they operate. Oil-services company Baker Hughes (BHI, Fortune 500) recently reported that 688 gas rigs were active in the U.S., down about 56% from one year ago.
As a result of the current situation, development of new natural gas production is severely curtailed and it is expected that 2010 will have a more bullish sentiment for natural gas price. Additionally, if the economy perks up and there is increased industrial demand, prices will most likely increase significantly with greater volatility.
What can an end user do?
With large purchases of iron ore, copper and oil, China has been taking full advantage of depressed commodities prices and excess production capacity. Now, the Red Dragon is making its presence felt in the natural gas market – landing two blockbuster deals in the past two weeks. The first was an unprecedented $41 billion liquefied natural gas (LNG) deal with Australia, which was announced last week. The deal calls for PetroChina Co. Ltd. (NYSE: PTR) – Asia’s largest oil and gas company – to buy 2.25 million tons per year of liquefied natural gas (LNG) from the Gorgon field in Western Australia over a period of 20 years. It is the largest deal ever brokered between the two nations.
Natural gas, for instance, accounts for just 3% of China’s total energy needs, but its use is expected to grow rapidly as energy demand increases. “China currently consumes about 7.3 billion cubic feet per day, but that is expected to grow at a 10% compound annual rate to 18 billion cubic feet per day by 2020 as per report from Bernstein Research”. China is doing the right thing by securing long-term supplies of natural gas now, while prices are low and supplies are high. It’s taken similar action with other commodities over the past year, stocking up on large amounts oil, copper, and iron ore as prices swooned.
Hence for any company whose financial depend significantly on the price of natural gas it is important that they understand the drivers in the gas market and have specific strategies to react to market conditions. In fact, now is a good time to consider seriously instituting hedge strategies that will take advantage of the low prices and mitigate the inevitable increases next year and further as the economy improves.
Himadri Banerji consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
