The ongoing boom in natural gas production pushed prices to ten-year lows this year. But new research from Canaccord Genuity suggests there’s a heavy price correction en route, and we could see prices hit $4 by the end of this year.
Major reasons include slowdowns in gas-directed exploration and production, as well as a reduction of the enormous storage surplus on gas-fueled power utilities. This isn’t surprising, since commodities markets are inherently volatile.
Prices tanked at $1.90 per million metric British thermal unit (mmBtu) back in mid-April, then shot up to $3.29 around the end of July (a rise of over 70 percent). They dropped to $2.88 on Monday (roughly 13.9 percent).
The April downturn took place just as the storage surplus expanded, thereby triggering higher demand as more and more utilities opted for gas instead of expensive coal. Thus, prices rose due to heavy demand; now, as demand drops back down, prices remain high. Since gas producers can only sustain so much of low prices, they reduced production.
“Gas directed drilling has overcorrected to the downside against the backdrop of extraordinarily weak gas prices,” explained [Canaccord’s John] Gerdes, noting the E&P industry “has cut gas-directed activity to [about] 450 rigs, which is markedly below the 650-675 gas rigs necessary to maintain long-term market balance.” The market, the analyst explains, is undersupplied by 1.5 to 2 billion cubic feet per day in a weather-normalized basis.
Inventories ought to top out at around 4,000 billion cubic feet before dropping sharply. By April next year, analysts believe it could be as low as 1,750 billion cubic feet, rising back up to 3,500 billion cubic feet by November of 2013. Supply promises to remain more or less stable through the first half of 2013, with possible gains early on as wells currently being created begin producing.
Overall, despite the recent “correction,” natural gas prices are likely to keep climbing with the Fed’s announcement of another round of stimulus possibly giving it a bump.
According to Gerdes, Cabot Oil & Gas (NYSE: COG) has a 10 percent potential upside should prices hit $4 and upside close to 60 percent if prices remain around $4. Other companies to watch out for are Chesapeake Energy (NYSE: CHK), Apache Corp. (NYSE: APA), ConocoPhillips (NYSE: COP), and Exxon Mobil (NYSE: XOM) – in other words, the usual suspects.
As storage levels subside and demand creates a floor under prices, it’s more than likely that natural gas will rise to at least $4 and remain in the general neighborhood for a while. Also, winter is coming—more reason to suspect gas will ride high for some time to come.