Natural gas is developing into a very different market from oil, one that offers plenty of opportunities for investors to make big profits in 2013.
There are two contrasting dynamics when it comes to natural gas prices. First, the amount of recoverable volume has been accelerating, thanks to increasing unconventional (shale, tight, coal bed methane) reserves and technological improvements to extract it.
A rise on the supply side would generally reduce prices, especially if the number of operators continues to increase. More gas moving on the market from more suppliers results in a downward pressure on prices.
The second dynamic, however, is moving in the other direction, enticing the increase in drilling and expansion of infrastructure. This factor considers the demand side, and there are at least six major trends colliding to increase the prospects for gas usage as we move through 2013.
As a result, I expect gas prices to see a 25% increase from current levels… here’s why.
1) Winter Chill Increases Natural Gas Demand
The first factor driving price increases will come from a colder winter throughout the United States. Traditionally, gas prices have been quite sensitive to seasonal shifts. The overly mild winter in the East last winter was enough to depress gas prices across the board. In 2011, NYMEX futures contracts declined to less than $2 per 1,000 cubic feet (or million BTUs).
The price has recovered to as much as $3.90 recently, although it is currently down to about $3.50. Nonetheless, the recovery (largely a result of companies pulling drilling rigs out of service and reducing the number of new wells) combined with a colder winter will provide a base pushing the price $4 as we start the new year.
The other five elements are more directly affecting on demand increases moving forward. These will have primary effects on the gas balance between anticipated needs and drilling volume.
2/3) Industrial and Petrochemical Usage on the Rise
The second and third elements are increasing industrial and petrochemical uses for gas. Industrial use has been building for a while, but it is one of the last demand factors to emerge during an economic recovery. That is now beginning to kick in.
However, petrochemical usage is resulting in an appreciating demand situation. Gas, natural gas liquids, and byproducts are replacing crude oil and oil products as feeder stock for an entire range of petrochemicals – from solvents and polymers, to plastics and fibers.
The intense competition over where the next “crackers” will be located in the U.S. is clear testimony to the added demand coming from petrochemicals. These facilities will break down gas flows, making the feeder stock ingredients more accessible. This development is also putting some additional weight on the processing of “wet” gas, raw material containing value-added by products.
4) Natural Gas Fleets Expand Across the U.S.
The fourth demand factor is the increasing use of natural gas as a vehicle fuel. We have been witnessing a rise in interest here for several years, but the move to using liquefied natural gas (LNG) and compressed natural gas (CNG) to replace gasoline and diesel has been gaining strength.
Entire fleets of heavy-duty trucks have been retrofitted across Canada, while refueling terminals have been popping up near interstates in the U.S. to service company-designated vehicles. The cost savings in fuel is significant, usually representing more than two dollars per gallon.
The downside is on the infrastructure side. It will take several years of heavy capital investment to provide the network of transport pipelines, storage and terminal facilities, filling stations, and related requirements.
And we must consider the cost of retrofitting engines. At an average of $35,000 per vehicle, it will remain an obstruction for some.
I expect to see an increase in natural gas-as-fuel usage continuing, but remaining on the truck side for 2013. Personal autos will stay a niche market in the near-term. Still, this will comprise an improving demand area for natural gas.
5) Electricity Consumption from Gas Set to Spike
It is in the last two categories that the demand will surge.
Fifth is the massive transfer underway from coal to gas as the preferred fuel for generating electricity. Coal will remain a fuel of choice in several sectors of the world and will still be cost effective in certain regions in the U.S. But the days of “King Coal” in the generation of electricity are drawing to a close.
The figures here are massive. The American market is replacing more than 90 gigawatts (GW) of generating capacity by 2020, virtually all of this coal-fired. In addition, the phasing in of non-carbon regulations (cutting mercury, sulfurous, and nitrous oxide emissions) will add another 20 GW to the retirement agenda, once again coming almost exclusively from coal.
Each 10 GW transferred to natural gas will require an additional 1.2 billion cubic feet of gas per day. If only 50% of the expected transition from coal to gas occurs, the added demand will eliminate three times the current total gas in storage nationwide.
This demand factor alone has been the reason operators have continued to extract gas for much of 2012 at wellhead costs higher than can be gained from the sale to market, while hedging the resulting volume forward in futures contracts. The companies know this windfall is approaching.
6) U.S. LNG Trade Set to Go Global
The sixth element is likely to dwarf all the others, as it is the single most significant change in the energy market for the next several decades.
This is the impending export of LNG from the U.S. to global markets. None of this will be happening in significant volume before 2014, but its impact is already noticeable.
Back in 2005, we would all be discussing how much U.S. domestic gas demand would be covered by LNG imports. At the time, the prevailing opinion was as much as 15% annually…and as early as 2020.
With the rise of significant shale gas reserves, and the development of techniques to extract it, imports are a thing of the past. Attention has turned to exporting the surplus internationally as LNG.
Last week while I was in Moscow, Russian natural gas giant Gazprom again gave an estimate. They now believe that the U.S. will account for 9-12% of the world’s LNG flow before 2020 from 0% today.
Major exporting terminal projects are underway, and Washington gave its initial approval with the release of a much-anticipated report last week. American operating companies recognize the LNG market will provide a major outlet for surplus production.
The only question is whether this will increase domestic gas prices and stifle economic recovery. This has been a political issue bounced around throughout the recent campaign. But the answer to this is a resounding “No.”
This fear of rising prices to local consumers resulting from an increase in exports rests on a chimera that domestic supplies would be cut below effective demand levels. Consider only this simple observation in response. At current trends, the U.S. could increase gas production at least 25% per year for the next four decades or more.
Now doing so would be idiotic; it would destroy the market and its pricing mechanisms. But it indicates a simple fact. Additional supply is no longer a problem.
Natural Gas Prices Set for Big First Quarter
With all of these elements coming into the picture, what is the answer to the question posed at the beginning?
Where will gas prices be on March 31, 2013?
All of the factors above will not be hitting at the same time, and a prolonged economic slump in the U.S. and continuing angst in Europe may put their own kibosh to a full return of demand.
But I am looking at an average price of $4.35 per 1,000 cubic feet for near-month NYMEX gas futures by March 31 (assuming that Washington gets its fiscal house in order). That would be more than double the price a year earlier, and about 25% higher than the current price.
And the prospects moving forward look even more promising.
Companies have learned to stagger production to reduce gluts. That will mean improving returns as all of the demand elements mentioned above start moving into place.
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