Posted on July 11, 2006.
Source: EnergyPulse.net
Harry Chernoff, Principal, Pathfinder Capital Advisors, LLC
First, at $70 per barrel, crude oil is trading at more than 10:1 versus the price of natural gas. The long-run average is closer to 6:1. More importantly, natural gas at $6.50/mmBtu (Henry Hub) is trading about 10% below 3% sulfur residual fuel on a Btu basis. This is unusual since residual fuel typically sets the floor price for natural gas. Fuel switching should add a couple of Bcf/d to load.
Second, with basis discounts already exceeding $1.00/mmBtu in the Rockies and parts of the mid-continent and approaching $1.50/mmBtu for late summer futures in several major producing regions, price-sensitive industrial load unrelated to fuel switching will return, adding another couple of Bcf/d to load. Liquids stripping in the NGL industry will absorb another couple of Bcf/d versus long-run averages at current and future relative oil / gas prices.
Third, as summer heat kicks in and peaking plants crank up for the ever larger housing stock, utilities will turn to gas in larger quantities. Additionally, the low price of natural gas will encourage utilities to use more gas and less coal to conserve below-average coal inventories. The combined effect of fuel switching, industrial load pick-up, NGL liquids stripping, and summer peaking demand will absorb at least 5 Bcf/d more than average through the summer, allowing storage to trend towards normal levels by the end of injection season even without a hurricane.
Fourth, the futures markets are saying that Henry Hub gas this winter (and at least the next three winters) will be closer to $10/mmBtu versus today’s $6-7 range. That means the futures markets do not believe we will enter the winter with a sufficiently large storage surplus to keep prices depressed.
Fifth, the natural gas strip is set by winter prices, which are set by heating loads, which are set in the residential sector. The U.S. is rapidly increasing its natural gas-heated housing stock, making five-year average storage levels unrepresentative of the levels required to meet winter heating loads. The storage surplus is nowhere near as large, relative to normal winter loads, as it appears. The excess storage today is a byproduct of last winter’s unseasonably warm weather. Don’t count on it happening again.
Sixth, North American natural gas producers have dramatically increased exploration and production spending in the past few years with little or no net impact on total production. Even a slight pull-back in capital expenditures, without any production shut-ins, will put the already severe depletion curves back into play. Any surplus will disappear in short-order.
Finally, Hurricanes Katrina and Rita combined to shut-in almost 800 Bcf offshore and probably another 100 Bcf onshore and are continuing to shut-in more than 1 Bcf/d, nearly a year later. Hurricane Ivan shut-in hundreds of Bcf the year before. The hurricane season currently forecast, even if only at the Ivan level and far below the Katrina-Rita level, is more than enough to eliminate the current storage surplus.
The bottom line for the bulls: natural gas prices are near a bottom relative to competing fuels, loads are going to pick-up from multiple industrial and power generation uses at current prices, and the storage surplus – which isn’t as big as it appears assuming only average weather – is going to be largely absorbed by the end of injection season without any further price declines. Even a moderately active hurricane season will send spot prices back into double-digits and create a serious problem this winter.
