Short-Term Trend in U.S. Natural Gas Prices Point Higher
We all remember our Economics 101 lesson that price is the equilibrium point between supply and demand, and that fact has not changed. Right now, there are a plethora of opinions about the future direction of natural gas (NG) prices, both immediate and long-term, and you have probably heard most of them. Suffice to say, with the range of projected NG prices so wide, I decided to take a hard look at the data and keep my projected view of NG prices on a very short-term timeframe. Quite frankly, looking out more than one year is pure speculation even if it’s based on educated analysis.
The U.S. Energy Department (EIA) reported that U.S. gas inventories were 2.2 trillion cubic feet (Tcf) for the week ending February 22nd, a decline of nearly 6% year-to-date (YTD) compared to last year for the same period; however, storage remains 16% above the five-year average. Comparing the YTD averages since 2008, NG still remains above prior years except for 2012. So we have good news and bad news, good that 2013 NG levels are running below 2012, bad that NG levels still remain at very high levels.
Let’s look at the good news; it appears that NG production has slowed in early 2013. I looked at my NG database that covers U.S. NG production; year-over-year production 4Q 2012 to 4Q 2011 is flat at roughly 0.0% with the multinationals down 4% YoY on the quarter, and the U.S. Independent E&Ps up only 2% YoY on the quarter.
I say only, because from the 1Q through the 3Q of 2012, the YoY production growth comparisons on the quarter were 10%, 10% and 11%, respectively. This indicates that NG production growth has slowed down, particularly among the E&P group that has driven unconventional shale NG production over the last five years.
So far, on the supply side it appears that we are seeing a slight tightening. On the demand side, this week, we have seen demand strengthen compared to last week and to the comparable period last year. However, much of the recent firming in demand is attributable to weather, as 2013 has been colder than 2012, and we still have ten months to go in 2013.
Much can happen: continued hurricane interruptions to production, a warmer than usual summer and so on. But should NG demand remain at roughly 2012 levels and NG production growth continue to slow, then it is increasingly probable that NG prices may firm on average above the $3.25 to $3.53 Mcf level that the Energy Information Agency (EIA) is forecasting for 2013.
In 2012 NG prices averaged $2.75 Mcf, the YTD average for spot Henry Hub (HH) is now $3.32 Mcf or 28% above the YTD average ($2.60 Mcf) for the comparable period in 2012. Given the recent trend for HH spot prices graphed below, — NG has been dancing between its 50 (short-term) and 200-day (long-term) moving averages — it now appears poised to push above the 50-day trend line aided by the recent bout of colder weather.
I think it is reasonable to expect an average range of $3.50 to $3.75 Mcf for 2013, maybe even slightly higher; a colder March than last year would provide a short-term tailwind for NG prices pushing above $3.50 to $3.60 Mcf over the next month.
Possible headwinds over the horizon further into 2013 will be U.S. economic growth stalling out closer to 1% for the first half of 2013, and continuing to drag along at 1% to 2% for the back half of 2013.
However, for E&P producers, NG prices below $4.00 Mcf continue to provide unprofitable margins once all-in costs of finding and development costs are factored into the equation. So investors in NG producers will have to continue to wait for significant demand and sharper production growth pullbacks to emerge to provide a catalyst for share prices to move significantly higher. Even low cost producers as Cabot Oil & Gas (COG) and Range Resources (RRC) will see their shares continue to be highly volatile, as NG prices since 2004 remain at their nine year lows.