World Natural Gas Markets: Natural Gas Price Forecast Update The ...
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World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? FirstEnergy Natural Gas Price Outlook Nymex US$/Mmbtu NEW Old $4.16 $4.16
Aeco Cdn$/Mcf Old NEW $3.99 $3.99
UK NBP US$/Mmbtu Old NEW $4.76 $4.76
2009
Average
2010
Q1 Q2 est. Q3 est. Q4 est. Average est.
$6.25 $6.25 $6.70 $6.80 $6.50
$4.99 $4.25 $5.25 $5.50 $5.00
$6.05 $5.95 $6.35 $6.56 $6.23
$4.93 $3.86 $4.79 $5.00 $4.65
$6.50 $6.50 $6.95 $7.30 $6.81
$5.58 $4.65 $5.65 $6.00 $5.47
2011
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$6.75 $6.75 $7.00 $7.50 $7.00
$5.25 $5.25 $6.00 $6.50 $5.75
$6.48 $6.22 $6.44 $7.22 $6.59
$4.84 $4.75 $5.53 $6.26 $5.35
$7.25 $7.00 $7.25 $8.00 $7.38
$5.75 $5.50 $6.25 $7.00 $6.13
2012 Average est.
$7.50
$6.25
$6.84
$5.90
$8.06
$6.79
2013 Average est.
$7.50
$6.50
$6.77
$6.17
$8.19
$7.08
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg, Enerdata; est. refers to forecasted value.
We have chosen to make sharp reductions to our natural gas price forecast in the near-, medium- and long-term. The average price expectation for 2010 has been reduced by US $1.50 per Mmbtu to US $5.00 per Mmbtu. The price outlooks for 2011 and 2012 have been reduced by US $1.25 per Mmbtu, to US $5.75 and US $6.25 per Mmbtu, respectively. Long term prices are now projected at US $6.50 per Mmbtu, down from US $7.50 per Mmbtu, previously. Key takeaways from this forecast update include: • Having to acknowledge a much weaker pricing situation than expected in Q1 2010 and a higher finish for storage at the end of March 2010, we have sharply lowered our nearterm price expectations to US $5.00 per Mmbtu for 2010. Long-term prices have also been sharply reduced to US $6.50 per Mmbtu from US $7.50 per Mmbtu. • For natural gas minded investors, we are advising that gas prices have likely hit bottom near current levels, but any price recovery will be slow. Going selectively long in Q2 2010 is advisable, but also waiting for several fundamental changes in the marketplace to take place is strongly recommended. • The market is currently gripped by an intense fear of oversupply and potential full storage by October 2010. This fear will not dissipate until there are consistent downward shifts in U.S. supply, rig counts, and LNG imports, combined with further improvements in demand.
April 9, 2010
• We believe that U.S. storage will not test capacity limits in 2010 and that there is disconnect in place between fundamentals and prices, which will take time to correct. • High storage levels in Canada are providing a consistent short-term price bearish signal, again suggesting holding back on an immediate investor push into the natural gas space as a result of the bottoming of prices. • U.S. and Canadian gas supplies are expected to fall in tandem in 2010, while LNG imports slow more than anticipated by many. Demand strength is expected to improve further, helping to realign balances in 2010 as the injection season progresses.
To the Point. The steady meltdown in
natural gas prices in Q1 2010 has forced us to reevaluate our price outlook and make some sharp downward adjustments. In the very near-term, we believe prices have bottomed out and will stage a slow recovery to above US $5.00 per Mmbtu as unnecessary oversupply fears in the marketplace slowly dissipate. For the medium and longer term, we have also sharply lowered our price expectations to the US $6.25 to US $6.50 per Mmbtu range, seeing the break even economics for unconventional gas closer to this range, and as the price range that will be needed to keep demand growth at a more even pace to prevent undersupply situations from developing in the marketplace. This is also a price range which we believe is sufficient to draw in necessary large volumes of LNG and balance the market as needed. We feel near-term upside beyond our forecast is entirely possible should there be a faster reconnect between prices and the fundamentals, which we see as not pointing to a gross oversupply situation in 2010. Upside for the medium and longer term could very well come from reassessments of the economics of unconventional gas resource plays, which may prove to be much higher than current estimates, and if there is a significant move to push gas use deeper into power generation and/or transportation uses.
For the Natural Gas Minded Investor. Natural gas
is too cheap. It probably never should have got this cheap to start with. With some days that have recently been
Analyst: Martin King 403-262-0625 • [email protected] Calgary Office • 403-262-0600
Page 1 of 9 The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. While the accuracy or completeness of the information contained in this document cannot be guaranteed by FirstEnergy Capital, it was obtained from sources believed to be reliable. FirstEnergy Capital and/or its officers, directors and employees may from time to time acquire, hold or sell positions in the securities mentioned herein as principal or agent. FirstEnergy Capital (USA) Corp., a member of the Financial Industry Regulatory Authority, is a wholly owned subsidiary of FirstEnergy Capital Holdings Corp. and operates as a Broker-Dealer in the United States.
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? Figure 1: Nymex Natural Gas Futures Price US $/Mmbtu $14.00
$14.00
$13.00 $12.00 $11.00 $10.00 $9.00
2008 Avg: US $8.90 2009 Avg: US $4.16 2010 YTD: US $4.92
$13.00
(to April 8, 2010)
$10.00 $9.00
$12.00 $11.00
$8.00
$8.00
$7.00 $6.00
$7.00 $6.00
$5.00
$5.00
$4.00
$4.00
$3.00
$3.00
$2.00
2008
$1.00 $0.00
2009
$2.00
2010
$1.00 $0.00
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Many market watchers are projecting storage to not only surpass last year’s record high storage levels at the end of October, which saw a short term collapse of prices in the face of storage congestion, but are going further and thinking that storage will rise to full once again, even with additional storage capacity in place. Our assessment of the fundamentals is that this will not happen, a disconnect between prices and fundamentals is in place, and that the fear is overdone along with the recent decline in prices (Figure 3).
BCF 4,250
3,500
The bullish sounding price call that was proposed in our previous outlook for natural gas has proven to be completely wrong, evidenced by the significant meltdown in prices. Despite getting the call for natural gas storage direction and levels correct for most of the first quarter, prices completely disconnected from this usually potent price driver. In fact, we still believe that there is a significant disconnect between current and forward looking fundamentals and prices, which will eventually reestablish itself in the coming two quarters and push prices to more reasonable levels (Figure 2). For now, fear is
2,250
Figure 2: U.S. Nymex Henry Hub Natural Gas Price Realizations and FCC Forecast US $/Mmbtu $8.00
$8.00
$7.00
$7.00
$6.00
$6.00
$5.00
$5.00
$4.00
$4.00
$3.00
Actuals
$3.00
$2.00
FCC Forecast (Apr. 2010)
$2.00
$1.00 $0.00 Jan-09
$1.00 $0.00
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Forecast
Market is looking at storage rising to full and well beyond last year's level in October 2010.
4,000
under US $4.00 per Mmbtu (Figure 1), it is also too cheap to ignore anymore. However, this is also a market living in stark fear of oversupply. A fear so palpable that it has driven natural gas to the cheap levels that have been seen recently, and from which it may take some time to recover.
Nymex (as of Apr. 8, 2010)
Figure 3: United States Working Gas Storage Levels at the End of October
3,750
Source: FirstEnergy Capital Corp., Bloomberg.
April 9, 2010
3,807
3,674 3,796
3,250 3,000 2,750 2,500
2,000 2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: FirstEnergy Capital Corp., US DOE/EIA.
No matter. This is a market that is looking for significant changes before the choking grip of fear can be released and allow prices to rise to more reasonable levels. Certain changes to alleviate the fear of perceived oversupply will have to come in the form of some or all of the following: 1. Quantitative evidence of greater U.S. domestic supply slippage. 2. Lower U.S. gas rig counts, especially horizontals in key resource plays. 3. Slowing or reduction in U.S. LNG imports. 4. Evidence of greater capture of demand, especially in the power generation market. 5. Eventual slowing of storage injection rates to, or below, historic average rates. All of these potential indicators should be watched closely for signs that prices have bottomed out and are on the road to recovery. There may already be signs emerging that suggest a price bottom has been put in place. First, U.S. LNG imports have slowed appreciably below last year’s levels and look to be staying that way in the near term (Figure 4).
Jan-12
Source: FirstEnergy Capital Corp., Bloomberg.
a difficult thing to overcome, and the pace at which it dissipates in this market will determine whether natural gas prices are on the slow or fast road to recovery. The degree of perceived oversupply and the fear of this oversupply are directly connected to how full storage is expected to be at the end of the current injection season.
Second, the growing controversy surrounding data collection and accuracy on U.S. domestic supply, and its apparent very robust nature, seems to be coming to a boil. Given what has been a strong and growing disconnect in the form of the balancing item (Figure 5) for U.S. natural gas data, the severe negative bias in this item in recent months has prompted the U.S. DOE to reassess its supply data, Page 2 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
then prices are unlikely to rise strongly in the medium- to long-term, as well.
Figure 4: United States Imports of LNG by Month BCF 70
70
Dashed line indicates forecast. 60
60
50
50
40
40
30
30
20
20
10
2008
2009
10
2010
0
0 Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: FirstEnergy Capital Corp., Waterborne Energy Inc., US DOE/EIA.
Figure 5: U.S. Natural Gas Balancing Item BCF/d 4.0
For the near-term, the wait is on for the negative swing in rig counts and supply. Prices will have to remain low enough for now to capture demand and convince the market that enough of the gas oversupply is being diverted from storage to the burner tip. This means prices staying competitive with coal prices and maintaining a strong presence in the power generation market (Figure 6). As such, prices sub-US $5.00 per Mmbtu may be with us until the second half of this year to maintain this demand capture and avoid any sharp upward response in shale drilling and rig counts. Furthermore, by the summer, it should become more clear whether the price meltdown in Q1 2010 has done the job of aligning all of the necessary supply and demand responses to generate lower gas storage injection rates, and that another full storage situation is being avoided by October 2010.
4.0 Supply Underestimated and/or Demand Overestimated
2.0
2.0
0.0
0.0
Monthly (2.0)
12 Mnth Mov. Avg.
(4.0) Supply Overestimated and/or Demand Underestimated
(6.0) (8.0) Jan-07
April 9, 2010
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
(2.0) (4.0) (6.0)
Jan-10
Jul-10
(8.0) Jan-11
Figure 6: Price of Natural Gas versus Price Spread of Appalachian Coal to Distillate Fuel Oil US $/Mmbtu $24.00 $21.00 $18.00
$24.00
Coal-Distillate Fuel Oil Spread Henry Hub Natural Gas Price
$21.00 $18.00
$15.00
$15.00
$12.00
$12.00
$9.00
$9.00
$6.00
$6.00
$3.00
$3.00
$0.00
$0.00
Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
with a potential for downward supply revisions to be released by the end of April. Should the negative nature of the balancing item be the product of overestimated supply (more likely) than underestimated demand (less likely), then a downward revision to supply levels should be another sign that prices have hit bottom and that the price meltdown has accomplished some of its job of alleviating fear and oversupply. Even if U.S. domestic supply levels are revised down, the revisions may be more in conventional gas supplies than in unconventional shale gas supplies. Given that future supply growth is anticipated to come more from shale gas, then there is still fear that the shale gas plays can rapidly respond at prices north of US $5.50 per Mmbtu, and likely north of US $5.00 per Mmbtu. As such, any near-term price rally off the recent lows is likely to be capped by a fear of rapid rise in shale gas supplies accompanied by a further increase in rig counts. Moreover, until there is quantitative evidence that shale plays are performing less strongly than thought (which may happen with the supply revision) and/or there is greater definition concerning (higher?) all-in supply costs for the shale resource plays,
Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Source: FirstEnergy Capital Corp., Bloomberg.
For the gas minded investor, this is the slow road for price recovery. We see current natural gas prices as having reached bottom by becoming cheaper than coal and placing the economics of most conventional and unconventional plays in a questionable position (Figure 7). Even so, it will still take time for fear to dissipate and for prices to mount some kind of recovery to levels we think are more reasonable above US $5.00 per Mmbtu. For now, staying at market weight or underweight (likely your position already) on natural gas levered names is advisable with the bottoming of the market, but fear of oversupply is still preventing any price upside from firmly taking hold and should hold back building a new equity position for now. However, consider taking a serious look at getting selectively longer toward the middle of the year as we expect that the fear of oversupply should be steadily dissipating by then as it becomes more clear that natural gas prices had simply become too cheap earlier this year. By then, it will not be fear of filling storage, but the fear that storage may not be quite full enough. Page 3 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
generation demand form the backbone of demand growth this year and going forward.
Figure 7: Estimated Break Even Price for Various North American Natural Gas Basins $9.00
Industrial demand is expected to rise modestly (Figure 9), but could easily be stronger than we are forecasting given the more recent and real-time activity from key gas consuming sectors, such as steel production and chemical manufacturing. We remain very heartened by the still very strong performance of the manufacturing sector, with recent gains in the ISM index, reminiscent of some of the strongest rebounds from recession seen since the early 1980s (Figure 10).
$8.00 $7.00 $6.00
Average: US $5.80/Mmbtu
$5.00 $4.00 $3.00
ra
ni te W M as ar c h E el D ag lus ee le p for Bo d s Pin sie ed r P Ba ic ale e Pi rne an ne tt ce da (T le ier (F 1) Fa lan y k H ett ) ay vi ne lle sv ille Po wd U in er ta R J M i v on e a on tn R a r ( C h ey t o B (8 n ( M) s t CB ag M W e ) o M od Ho frac on fo rn k t n rd R ) ey (A iv (4 rk er st om W a a H ood W ge ) or f sh ford atte r ac ) o Fa e C (An nbe ye an ad rg ttv yo ar Alb il le n ko er (N (CB ) ta o (D n-C M) Pic B eep ore e a B ) Je an rne as an ce tt ( in) M ( H T ie ar i g r 2 ie hla ) M ( T nd an ig s nv ht ) G Ba ille as rn (C ) et B M t( Ti ) er 3)
$2.00
G
April 9, 2010
Figure 9: U.S. Industrial Sector Natural Gas Demand Growth (Excludes Combined Heat & Power Operations)
BCF/d 1.0
0.6
Demand. We have steadfastly remained fairly bullish on
natural gas demand prospects for 2010 and beyond. Between modest recovery in industrial demand (worldwide) and power generation (North America), we have long felt that natural gas demand growth has not been getting a fair shake (and the appropriate more price bullish response) from the market for some time, so obsessed it has been with supply/rig count trends. In fact, more positive data continues to emerge that solid industrial and power generation demand growth is underway. A broader realization of this trend should form part of the reconnect between prices and fundamentals that we believe will be emerging in the next few months and help to push prices to gradually higher levels. More importantly, this demand growth could easily sop up much of the feared oversupply, should prices be determined to stay low near current levels for an extended period of time. We are maintaining our expectation that U.S. natural gas demand remains quite robust in 2010, rising near 3 Bcf/d versus 2009 (Figure 8). Although the residential/ commercial sectors are getting a cold weather-aided boost in the early going of this year, both industrial and power
0.5
0.2
0.0
(1.9)
0.5 (0.7)
0.1
(1.5) (0.3)
(1.0)
3.0
3.7
Forecast
(2.0) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
BCF/d 2.0
Figure 10: U.S. Industrial Gas Demand versus ISM Manufacturing Index 75.0
1.5
70.0
1.0
65.0
0.5
60.0
0.0
55.0
(0.5)
50.0
(1.0)
Industrial Gas - YoY Change ISM Index
(1.5)
2.1 1.3
1.0
(2.8)
(2.0) 0.1 (0.9) (0.9)
0.3
(0.9)
(1.0) (2.0) (3.0) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
(3.0) Jan-08
45.0 40.0 35.0 30.0
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
25.0 Jan-11
Source: FirstEnergy Capital Corp., U.S. DOE/EIA, Bloomberg.
2.7
2.4
2.0
0.0
Forecast
0.2
(1.5)
(2.5)
BCF/d 5.0 4.0
(1.4)
(0.5)
(2.0)
Figure 8: U.S. Natural Gas Demand Growth
0.3
0.3
Despite the power generation sector already getting a nice boost from very cheap natural gas prices of late, and which should be able to capture and keep some of the coal market for awhile, the aforementioned improving industrial activity and overall recovery in the U.S. economy should place power generation demand on very solid footing for more growth in the next couple of years (Figure 11). Additional demand could come this year via the potential for low western snow pack and reservoir levels to boost western gas use for power this summer by as much as 1 to 2 Bcf/d depending on severity of heat in the region. Page 4 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
BCF/d 2.5
Figure 11: United States Natural Gas Demand Growth in the Electric Power Sector
1.0 0.5 0.0
Figure 12: U.S. Domestic Natural Gas Supply Growth BCF/d 3.5 3.0
2.0 1.5
April 9, 2010
1.0
0.9
0.9
1.2
2.1
2.0
1.0
1.0 0.6
0.4 (1.5)
2.6
2.5
1.7
1.5
0.6
1.0
1.3 0.5 (1.9)
0.0
(0.5)
Forecast
1.2
0.8
0.5
(0.5)
2.5
(1.5) (1.3)
(1.1) 0.1
(0.5) (1.0)
(1.0)
(1.5)
(1.5)
Forecast
(2.0)
(2.0)
(2.5) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Though more localized in terms of its impact to the western states, this could be a very important safety valve to relieve high storage levels in Western Canada this summer (more about this below). Overseas gas demand for LNG is also looking to be more dynamic than originally thought. Between some industrial recovery in Japan and South Korea, strong uptake into China and India, counter seasonal demands in South America, and storage refill into Europe, LNG demand in major consuming regions is doing much better than originally thought at the start of the year. It does not take much of a swing in Asian LNG demand to quickly neutralize most or all of the perceived LNG oversupply that some had forecast for the United States this year. In fact, we have already lowered our U.S. LNG import expectations because of better than expected LNG demand (see supply discussion below). Overall, we see potential for North American and overseas gas demand to do even better than our more optimistic expectations. All that the latest price meltdown has done is essentially lock in this strong demand performance. The sooner the market comes to this realization of demand strength, the more likely that prices should rise to more reasonable levels that we see as being more consistent with a tighter market balance than is widely recognized.
Supply. It is the supply side of the market equation that
has been creating most of the consternation and general price bearishness for the North American and global natural gas markets. Only when there is some clear indication that supplies are slipping or not as robust as originally thought (see earlier investor discussion), will prices break out of their bearish mood and start to move higher. Parallel to this has to be signs of a rig count downturn in North America, given the strength seen for rig counts since late in 2009, especially horizontals.
Source: FirstEnergy Capital Corp., US DOE/EIA.
For now, we have moderated our expectations for U.S. supply losses in 2010 to near 1 Bcf/d, seeing the early strength in rig counts this year as translating into more steady supplies in the early going of this year (Figure 12). However, with what we see as a likely reduction in the rig count in the near term due to low prices, has resulted in us merely shifting our decline profile forward in time so that it now overlaps into 2011. As such, the previously anticipated turnaround in U.S. supplies is less vibrant in 2011, with only a more positive picture emerging in 2012 and inline with our outlook for stronger prices. Part of that previous discussion on signals for a price turnaround in 2010 focused on the emergence of a reduction in rig counts. Although a certain portion of U.S. drilling activity has been focused on lease retention in key resource plays and has been less sensitive to price, we do think that we are on the cusp of a plateau or a downturn for the rig count based on the price meltdown that has affected near and forward natural gas prices (Figure 13). In addition, it is unclear if many of the resource plays are able to handle more horizontal rigs than are currently running, and even the future availability of horizontal rigs, Figure 13: U.S. Natural Gas Directed Drilling vs. Three Month Lag of 12 Month Gas Strip Price US$/Mmbtu $14.00
No. of Rigs 1,600 1,400
$12.00
1,200
$10.00
1,000
$8.00
800
$6.00
600 400
$4.00
Gas Directed Drilling Rigs (lhs) Nymex 12 Month Strip Price (rhs)
$2.00
200 Jan-04
$0.00 Jan-06
Jan-08
Jan-10
Source: FirstEnergy Capiral Corp., Baker Hughes, Bloomberg.
Page 5 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? given current high use rates, is being questioned. As such, between more structural limitations on the rig fleet and the collapse in prices, we expect rig counts are on the verge of shifting to a downtrend. Given the usual lags in drilling activity, this should begin to translate into less supply by H2 2010, especially given the additional time for conventional gas plays, which have been barely touched in the past year, to continue to accumulate declines and affect overall supply (Figure 14). Figure 14: Year-over-Year Change in U.S. Marketable Natural Gas Supply
BCF/d 7.0 6.0 5.0
Forecast
4.0 3.0 2.0 1.0 0.0 (1.0)
Alberta bring bottled up molecules to the market. In addition, overall Canadian supply should stabilize or rise as new offshore supplies arrive from the Deep Panuke project on the East Coast by H2 2011. Our outlook for U.S. net imports of Canadian gas does not see that significant of a downward move, despite the Canadian supply downturn this year (Figure 16). This is a two fold situation. On one hand, exports to the U.S. from Western Canada may receive a boost later in the injection season as a potential early refill for storage levels in Western Canada sends more gas south of the border looking for a home. Second, the fairly robust supply situation for the U.S. Northeast via growing supplies out of the Marcellus formation and greater general availability thanks to pipeline expansions into the region, will likely translate into more gas flowing from the U.S. and into Eastern Canada. The end result is little change in overall Canadian net exports.
(2.0)
Figure 16: United States Net Imports of Natural Gas from Canada
(3.0) BCF/d 12.0
(4.0) (5.0) (6.0) Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
April 9, 2010
10.0
8.9
Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
Canadian supplies remain locked in a downward track to at least the end of 2010. In fact, our aggressive sounding expectations for an additional loss in excess of 1 Bcf/d for Western Canadian supplies may end up being too conservative, given the recent meltdown in prices (Figure 15). Originally, under our previous more aggressive price outlook, drilling activity was supposed to ramp up through the summer and into the next winter season, and remain elevated above 2009 levels. Now, we expect little to no drilling recovery above 2009 activity levels, even with the new Alberta royalty structure in place, which could translate into deeper supply losses this year. Beyond 2010, some modest supply recovery is still expected as new pipelines into unconventional gas regions of B.C. and Figure 15: Western Canada Natural Gas Field Receipt Supply Growth
Mmcf/d 600
484
200 0
77
(299)
7.0
6.7
6.9
6.0 4.0 2.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
With respect to U.S. LNG imports, we have been trimming our expectations for 2010 and may trim them further still (Figure 17). With the recent low natural gas prices and poor netbacks seen for most U.S. import terminals, virtually Figure 17: U.S. Annual Average Imports of LNG
BCF/d 4.0
Forecast
147 210
147
Forecast
8.2
8.0
Forecast
388
400
9.0
100 (1,039) (1,200) (416) (638)
3.5
3.2
3.0 2.5
2.2
2.1
(200)
2.0
(400)
1.8 1.4
1.5
(600)
1.6 1.2 1.0
1.0
0.6
(800)
1.7
0.7
0.6
0.5
(1,000)
0.0
(1,200) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., company pipeline postings.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Page 6 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? all spot LNG that may have been available for the U.S. market this year has been finding a home elsewhere in the world. In this respect, one of the early aforementioned signs for a potential bottoming of prices has already emerged. Although we still expect some increase in LNG imports, especially in H2 2010, our outlook is still far more conservative than many others. A growing realization that LNG supplies are not building toward a larger wave should help to further neutralize oversupply fears in the market. Although we see some further gains for LNG imports post-2010, the aforementioned robust LNG demand picture could very well further reduce these expectations. Global LNG supplies do continue to rise by our latest assessment in light of the numerous projects that have come into service in the past 12 months, along with several more expected later this year (Figure 18). Although spot LNG prices have suffered, oil-linked prices have held up quite well, thanks to robust oil prices. As such, we expect that spot LNG flows will remain more limited from some suppliers as maintenance cycles for existing trains are extended, the ramp up of new trains will be more drawn out, and discretionary supply reductions take place, helping to limit the oversupply of LNG globally. When all is said and done this year, we expect that LNG supplies will show far less growth than many had anticipated. Figure 18: Global LNG Liquefaction Adds BCF/d 6.0 Yemen LNG Train 1
5.0
QatarGas Train 5
4.0
QatarGas Train 7
Tangguh Train 2
RasGas Train 6
QatarGas Train 6
3.0 Sakhalin Train 2
2.0
Darwin Train 1 Trinidad Train 4
1.0 0.0
Camisea Train 1
Tangguh Train 1 Yemen LNG Train 2 QatarGas Train 4
RasGas Train 5 Snohvit Train 1 NWS Train 5 NLNG Train 5 EG LNG Train 1 NLNG Train 6 Sakhalin Train 1
2006
2007
2008
Gladstone Train 1
Skikda Rebuild
2009
RasGas Train 7
Pluto Train 1
2010
2011
Souirce: FirstEnergy Capital Corp.
Storage. It is the perception of oversupply in the
marketplace that most acutely comes into focus when considering the natural gas storage situation in North America. Although we feel that this view of oversupply is incorrect and will lead to storage levels at the end of the injection season in October 2010 that are lower than most expect (see Figure 3), the market’s current view is that storage is likely to be filled to maximum capacity once again before the end of the injection season. In other words, a retest of capacity in 2010, as was nearly the case in 2009, is expected once again, and this is what has led to the very low prices situation at the end of Q1 2010.
April 9, 2010
To be sure, storage exited March 2010 at higher than anticipated levels thanks to a very mild March (Figure 19). In fact, the exit looks little different from the situation at the end of March 2009. This higher exit has shifted the timing and magnitude of when we expect a storage deficit to appear and persist (Figure 20). This also underlies why we expect prices to remain somewhat muted in the early going of the injection season.
BCF 2,000
Figure 19: United States Working Gas Storage Levels at the End of March
1,750
1,656 1,660 1,458
1,500 1,250 1,000 750 500
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Figure 20: United States Deficit/Surplus in Working Natural Gas Storage Levels 900 800 700 600 500 400 300 200 100 0 (100) (200) (300) (400) (500) (600) Jan-08
Year-over-Year Deficit/Surplus Deficit/Surplus to 5-Year Average Forecast
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Source: FirstEnergy Capital Corp., US DOE/EIA.
However, given the supply-demand mix that we expect to materialize, average injection rates should be slightly lower than those seen in 2009 and may prevent storage levels from rising much beyond those seen at the end of October 2009. We expect that downside surprises for the storage exit are more likely this year than upside surprises given the depths to which prices have been sent recently (i.e. strengthening demand into flat to declining supply). It is Canadian storage where concerns about oversupply have truly come to the forefront, although there could be some offsets provided by western gas burn for power generation (see demand section). Despite expectations for a strong withdrawal season, the latest season turned out to be something of a bust, resulting in one of the more dull Page 7 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? storage withdrawals in recent years. This has allowed Western Canada storage levels to exit at much higher rates than anticipated (Figure 21). Given earlier than anticipated injections getting underway in March, we expect that Western Canadian storage capacity may be tested again before the end of the summer. This may result in wider basis to U.S. pricing benchmarks for the last couple months of the injection season, and be reflected in what will be strength in exports to the U.S. prior to the end of the injection season. In the here and now, the high storage exit at the end of March and potential retest of capacity, provides a definite short-term price bearish signal, further adding to our slow price recovery scenario for this year.
BCF 600
Figure 21: Estimated Daily Western Canada Natural Gas Storage Level 600
Estimated Working Gas Capacity: 534 BCF
550
550
500
500
450
450
400
400
351.7
350
350
300
300
250
250
200
200
150
150
100
100
50
5 Yr. Hi-Lo
2007
2008
0 Jan-1 Feb-12 Mar-25 May-6 Jun-17 Jul-29
2009
2010
50 0
Sep-9 Oct-21 Dec-2
Source: FirstEnergy Capital Corp.
European storage levels look to have exited March 2010 a hefty 450 Bcf higher than the Russian supply disrupted levels of one year earlier (Figure 22). Although this may look to be price bearish, it is encouraging from an LNG perspective in that it is the major LNG importers of Europe such as the UK, France, and Spain where storage levels have been drawn down to levels much lower than one year ago. As such, we expect the European storage refill season to be quite robust and supportive of greater LNG
uptake into this region. Aiding matters for uptake of LNG should be a desire to minimize purchases of mostly oil price-linked Russian gas supplies, a partially mandated shift away from coal generation in Spain, and still expanding storage capacity in other parts of the European Union. Obviously, this also helps to support the lower LNG import-lower U.S. gas storage scenario outlined earlier.
Conclusions. Despite pricing path similarities between
Q1 2009 and Q1 2010 (see Figure 1), the current set of drivers in the marketplace are very different. Early 2009 was marked as a time when global economic activity was still bottoming out versus the current climate of solid and accelerating expansion. Standing in opposition to what was still rapidly expanding supply in early 2009, are growing questions in early 2010 over the dynamic nature of U.S. domestic supply growth in the aftermath of a huge rig count decline in 2009, followed by a sharp acceleration in horizontal drilling in 2010. Is supply growing or slowing more or less than thought? Finally, given important supply and demand questions, can storage be refilled as quickly in 2010 despite exiting the heating season at nearly identical levels as in 2009? Until there is greater resolution on many of these questions (and others) as the year progresses, it will be the slow road to recovery for prices, especially in a market where fear of oversupply in 2010 is even more acute than in 2009. This market needs additional catalysts, as well as resolutions to these questions, before the all suffocating price bearishness gripping the market can be relinquished. We firmly believe that catalysts and answers to these questions will emerge that will support higher prices than are currently in vogue on the Nymex strip and on the Street (Figures 23 and 24), but that the price recovery will be more gradual and measured than previous price recoveries. Nevertheless, there is still real price upside from what we see as a bottoming for natural gas prices at the start of Q2 Figure 23: Expectations for Price of Henry Hub in 2010
Figure 22: European Gas Storage Levels
(As of Apr 8, 2010 survey; Nymex value as of Apr. 8, 2010) US $/Mmbtu (Consensus estimate does not include Nymex value) $7.00
BCF 2,400
2,400
2,200
2,200
2,000
2,000
1,800
1,800
1,600
1,600
1,400
1,400
$4.50
1,200
1,200
$4.00
$6.50
FirstEnergy
$6.00
Consensus
$5.50
Nymex
$5.00
1,000
2007-2008
1,000
$3.50
800
2008-2009
800
$3.00
600
2009-2010
600
$2.50
400
$2.00
400 Nov
Dec
Jan
Feb
Mar
Apr
Source: FirstEnergy Capital Corp., Gas Infrastructure Europe.
May
Jul
Aug
Sep
April 9, 2010
Oct
$5.45
$5.00
$4.55
1
2
3
4
5
Source: FirstEnergy Capital Corp., Reuters.
6
7
8
9 10 11 12 13 14 15 16 17 18 Analyst
Page 8 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? Figure 24: Expectations for Price of Henry Hub in 2011 (As of Apr. 8, 2010 survey; Nymex value as of Apr. 8, 2010) US $/Mmbtu (Consensus estimate does not include Nymex value) $8.50 $8.00
FirstEnergy
$7.50
Consensus
$7.00
Nymex
$6.36
$6.50
$5.75
$6.00 $5.50
$5.28
$5.00 $4.50 $4.00 $3.50 1
2
3
4
5
Source: FirstEnergy Capital Corp., Reuters.
6
7
8
9 10 11 12 13 14 15 16 17 18 Analyst
2010. Prices have been driven down to the point where sizeable gas users can lock in very attractive low prices, most supply plays are uneconomic, forward pricing for suppliers looks abysmal, especially when many current nicely priced hedges put in place for 2010 begin expiring later this year, and U.S. LNG imports may trail last year by a growing margin at such low prices. In light of these challenges (and opportunities), storage refill on both sides of the Atlantic looks to be increasingly difficult rather than increasingly easy in 2010.
April 9, 2010
huge production rates and reserve sizes, will prove to be higher than are currently being estimated. Given what seems to be a herd mentality in trying to find the next cheapest and higher productivity shale play, in light of very little hard information on recoveries and costs for existing ones beyond Producer press releases, the disappointment factor (and higher prices) is building for when much more information will be available one to two years out and costs likely appear higher than originally estimated. By then, supplies in North America and overseas should be much tighter in the face of what will be much firmer demand, and a global LNG market that has run into a lull in terms of supply expansions. For the natural gas minded investor, it is a dizzying array of information and perhaps a market that is more confusing than ever. However, there are always opportunities in any market, and the present low natural gas price environment has become very compelling for many. Just when the market seems to be at its maximum pessimism, that is when it is likely the time to be the optimist and begin looking for near and longer term investment opportunities. The time to look is developing in Q2 2010. Wait for the catalysts and market changers mentioned in the investor section and you might start to feel good about natural gas again.
Longer term, we believe that costs for many of the hot resource plays, despite much of the hoopla surrounding
Page 9 of 9
WWW.FIRSTENERGY.COM
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? FirstEnergy Natural Gas Price Outlook Nymex US$/Mmbtu NEW Old $4.16 $4.16
Aeco Cdn$/Mcf Old NEW $3.99 $3.99
UK NBP US$/Mmbtu Old NEW $4.76 $4.76
2009
Average
2010
Q1 Q2 est. Q3 est. Q4 est. Average est.
$6.25 $6.25 $6.70 $6.80 $6.50
$4.99 $4.25 $5.25 $5.50 $5.00
$6.05 $5.95 $6.35 $6.56 $6.23
$4.93 $3.86 $4.79 $5.00 $4.65
$6.50 $6.50 $6.95 $7.30 $6.81
$5.58 $4.65 $5.65 $6.00 $5.47
2011
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$6.75 $6.75 $7.00 $7.50 $7.00
$5.25 $5.25 $6.00 $6.50 $5.75
$6.48 $6.22 $6.44 $7.22 $6.59
$4.84 $4.75 $5.53 $6.26 $5.35
$7.25 $7.00 $7.25 $8.00 $7.38
$5.75 $5.50 $6.25 $7.00 $6.13
2012 Average est.
$7.50
$6.25
$6.84
$5.90
$8.06
$6.79
2013 Average est.
$7.50
$6.50
$6.77
$6.17
$8.19
$7.08
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg, Enerdata; est. refers to forecasted value.
We have chosen to make sharp reductions to our natural gas price forecast in the near-, medium- and long-term. The average price expectation for 2010 has been reduced by US $1.50 per Mmbtu to US $5.00 per Mmbtu. The price outlooks for 2011 and 2012 have been reduced by US $1.25 per Mmbtu, to US $5.75 and US $6.25 per Mmbtu, respectively. Long term prices are now projected at US $6.50 per Mmbtu, down from US $7.50 per Mmbtu, previously. Key takeaways from this forecast update include: • Having to acknowledge a much weaker pricing situation than expected in Q1 2010 and a higher finish for storage at the end of March 2010, we have sharply lowered our nearterm price expectations to US $5.00 per Mmbtu for 2010. Long-term prices have also been sharply reduced to US $6.50 per Mmbtu from US $7.50 per Mmbtu. • For natural gas minded investors, we are advising that gas prices have likely hit bottom near current levels, but any price recovery will be slow. Going selectively long in Q2 2010 is advisable, but also waiting for several fundamental changes in the marketplace to take place is strongly recommended. • The market is currently gripped by an intense fear of oversupply and potential full storage by October 2010. This fear will not dissipate until there are consistent downward shifts in U.S. supply, rig counts, and LNG imports, combined with further improvements in demand.
April 9, 2010
• We believe that U.S. storage will not test capacity limits in 2010 and that there is disconnect in place between fundamentals and prices, which will take time to correct. • High storage levels in Canada are providing a consistent short-term price bearish signal, again suggesting holding back on an immediate investor push into the natural gas space as a result of the bottoming of prices. • U.S. and Canadian gas supplies are expected to fall in tandem in 2010, while LNG imports slow more than anticipated by many. Demand strength is expected to improve further, helping to realign balances in 2010 as the injection season progresses.
To the Point. The steady meltdown in
natural gas prices in Q1 2010 has forced us to reevaluate our price outlook and make some sharp downward adjustments. In the very near-term, we believe prices have bottomed out and will stage a slow recovery to above US $5.00 per Mmbtu as unnecessary oversupply fears in the marketplace slowly dissipate. For the medium and longer term, we have also sharply lowered our price expectations to the US $6.25 to US $6.50 per Mmbtu range, seeing the break even economics for unconventional gas closer to this range, and as the price range that will be needed to keep demand growth at a more even pace to prevent undersupply situations from developing in the marketplace. This is also a price range which we believe is sufficient to draw in necessary large volumes of LNG and balance the market as needed. We feel near-term upside beyond our forecast is entirely possible should there be a faster reconnect between prices and the fundamentals, which we see as not pointing to a gross oversupply situation in 2010. Upside for the medium and longer term could very well come from reassessments of the economics of unconventional gas resource plays, which may prove to be much higher than current estimates, and if there is a significant move to push gas use deeper into power generation and/or transportation uses.
For the Natural Gas Minded Investor. Natural gas
is too cheap. It probably never should have got this cheap to start with. With some days that have recently been
Analyst: Martin King 403-262-0625 • [email protected] Calgary Office • 403-262-0600
Page 1 of 9 The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. While the accuracy or completeness of the information contained in this document cannot be guaranteed by FirstEnergy Capital, it was obtained from sources believed to be reliable. FirstEnergy Capital and/or its officers, directors and employees may from time to time acquire, hold or sell positions in the securities mentioned herein as principal or agent. FirstEnergy Capital (USA) Corp., a member of the Financial Industry Regulatory Authority, is a wholly owned subsidiary of FirstEnergy Capital Holdings Corp. and operates as a Broker-Dealer in the United States.
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? Figure 1: Nymex Natural Gas Futures Price US $/Mmbtu $14.00
$14.00
$13.00 $12.00 $11.00 $10.00 $9.00
2008 Avg: US $8.90 2009 Avg: US $4.16 2010 YTD: US $4.92
$13.00
(to April 8, 2010)
$10.00 $9.00
$12.00 $11.00
$8.00
$8.00
$7.00 $6.00
$7.00 $6.00
$5.00
$5.00
$4.00
$4.00
$3.00
$3.00
$2.00
2008
$1.00 $0.00
2009
$2.00
2010
$1.00 $0.00
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Many market watchers are projecting storage to not only surpass last year’s record high storage levels at the end of October, which saw a short term collapse of prices in the face of storage congestion, but are going further and thinking that storage will rise to full once again, even with additional storage capacity in place. Our assessment of the fundamentals is that this will not happen, a disconnect between prices and fundamentals is in place, and that the fear is overdone along with the recent decline in prices (Figure 3).
BCF 4,250
3,500
The bullish sounding price call that was proposed in our previous outlook for natural gas has proven to be completely wrong, evidenced by the significant meltdown in prices. Despite getting the call for natural gas storage direction and levels correct for most of the first quarter, prices completely disconnected from this usually potent price driver. In fact, we still believe that there is a significant disconnect between current and forward looking fundamentals and prices, which will eventually reestablish itself in the coming two quarters and push prices to more reasonable levels (Figure 2). For now, fear is
2,250
Figure 2: U.S. Nymex Henry Hub Natural Gas Price Realizations and FCC Forecast US $/Mmbtu $8.00
$8.00
$7.00
$7.00
$6.00
$6.00
$5.00
$5.00
$4.00
$4.00
$3.00
Actuals
$3.00
$2.00
FCC Forecast (Apr. 2010)
$2.00
$1.00 $0.00 Jan-09
$1.00 $0.00
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Forecast
Market is looking at storage rising to full and well beyond last year's level in October 2010.
4,000
under US $4.00 per Mmbtu (Figure 1), it is also too cheap to ignore anymore. However, this is also a market living in stark fear of oversupply. A fear so palpable that it has driven natural gas to the cheap levels that have been seen recently, and from which it may take some time to recover.
Nymex (as of Apr. 8, 2010)
Figure 3: United States Working Gas Storage Levels at the End of October
3,750
Source: FirstEnergy Capital Corp., Bloomberg.
April 9, 2010
3,807
3,674 3,796
3,250 3,000 2,750 2,500
2,000 2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: FirstEnergy Capital Corp., US DOE/EIA.
No matter. This is a market that is looking for significant changes before the choking grip of fear can be released and allow prices to rise to more reasonable levels. Certain changes to alleviate the fear of perceived oversupply will have to come in the form of some or all of the following: 1. Quantitative evidence of greater U.S. domestic supply slippage. 2. Lower U.S. gas rig counts, especially horizontals in key resource plays. 3. Slowing or reduction in U.S. LNG imports. 4. Evidence of greater capture of demand, especially in the power generation market. 5. Eventual slowing of storage injection rates to, or below, historic average rates. All of these potential indicators should be watched closely for signs that prices have bottomed out and are on the road to recovery. There may already be signs emerging that suggest a price bottom has been put in place. First, U.S. LNG imports have slowed appreciably below last year’s levels and look to be staying that way in the near term (Figure 4).
Jan-12
Source: FirstEnergy Capital Corp., Bloomberg.
a difficult thing to overcome, and the pace at which it dissipates in this market will determine whether natural gas prices are on the slow or fast road to recovery. The degree of perceived oversupply and the fear of this oversupply are directly connected to how full storage is expected to be at the end of the current injection season.
Second, the growing controversy surrounding data collection and accuracy on U.S. domestic supply, and its apparent very robust nature, seems to be coming to a boil. Given what has been a strong and growing disconnect in the form of the balancing item (Figure 5) for U.S. natural gas data, the severe negative bias in this item in recent months has prompted the U.S. DOE to reassess its supply data, Page 2 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
then prices are unlikely to rise strongly in the medium- to long-term, as well.
Figure 4: United States Imports of LNG by Month BCF 70
70
Dashed line indicates forecast. 60
60
50
50
40
40
30
30
20
20
10
2008
2009
10
2010
0
0 Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: FirstEnergy Capital Corp., Waterborne Energy Inc., US DOE/EIA.
Figure 5: U.S. Natural Gas Balancing Item BCF/d 4.0
For the near-term, the wait is on for the negative swing in rig counts and supply. Prices will have to remain low enough for now to capture demand and convince the market that enough of the gas oversupply is being diverted from storage to the burner tip. This means prices staying competitive with coal prices and maintaining a strong presence in the power generation market (Figure 6). As such, prices sub-US $5.00 per Mmbtu may be with us until the second half of this year to maintain this demand capture and avoid any sharp upward response in shale drilling and rig counts. Furthermore, by the summer, it should become more clear whether the price meltdown in Q1 2010 has done the job of aligning all of the necessary supply and demand responses to generate lower gas storage injection rates, and that another full storage situation is being avoided by October 2010.
4.0 Supply Underestimated and/or Demand Overestimated
2.0
2.0
0.0
0.0
Monthly (2.0)
12 Mnth Mov. Avg.
(4.0) Supply Overestimated and/or Demand Underestimated
(6.0) (8.0) Jan-07
April 9, 2010
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
(2.0) (4.0) (6.0)
Jan-10
Jul-10
(8.0) Jan-11
Figure 6: Price of Natural Gas versus Price Spread of Appalachian Coal to Distillate Fuel Oil US $/Mmbtu $24.00 $21.00 $18.00
$24.00
Coal-Distillate Fuel Oil Spread Henry Hub Natural Gas Price
$21.00 $18.00
$15.00
$15.00
$12.00
$12.00
$9.00
$9.00
$6.00
$6.00
$3.00
$3.00
$0.00
$0.00
Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
with a potential for downward supply revisions to be released by the end of April. Should the negative nature of the balancing item be the product of overestimated supply (more likely) than underestimated demand (less likely), then a downward revision to supply levels should be another sign that prices have hit bottom and that the price meltdown has accomplished some of its job of alleviating fear and oversupply. Even if U.S. domestic supply levels are revised down, the revisions may be more in conventional gas supplies than in unconventional shale gas supplies. Given that future supply growth is anticipated to come more from shale gas, then there is still fear that the shale gas plays can rapidly respond at prices north of US $5.50 per Mmbtu, and likely north of US $5.00 per Mmbtu. As such, any near-term price rally off the recent lows is likely to be capped by a fear of rapid rise in shale gas supplies accompanied by a further increase in rig counts. Moreover, until there is quantitative evidence that shale plays are performing less strongly than thought (which may happen with the supply revision) and/or there is greater definition concerning (higher?) all-in supply costs for the shale resource plays,
Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Source: FirstEnergy Capital Corp., Bloomberg.
For the gas minded investor, this is the slow road for price recovery. We see current natural gas prices as having reached bottom by becoming cheaper than coal and placing the economics of most conventional and unconventional plays in a questionable position (Figure 7). Even so, it will still take time for fear to dissipate and for prices to mount some kind of recovery to levels we think are more reasonable above US $5.00 per Mmbtu. For now, staying at market weight or underweight (likely your position already) on natural gas levered names is advisable with the bottoming of the market, but fear of oversupply is still preventing any price upside from firmly taking hold and should hold back building a new equity position for now. However, consider taking a serious look at getting selectively longer toward the middle of the year as we expect that the fear of oversupply should be steadily dissipating by then as it becomes more clear that natural gas prices had simply become too cheap earlier this year. By then, it will not be fear of filling storage, but the fear that storage may not be quite full enough. Page 3 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
generation demand form the backbone of demand growth this year and going forward.
Figure 7: Estimated Break Even Price for Various North American Natural Gas Basins $9.00
Industrial demand is expected to rise modestly (Figure 9), but could easily be stronger than we are forecasting given the more recent and real-time activity from key gas consuming sectors, such as steel production and chemical manufacturing. We remain very heartened by the still very strong performance of the manufacturing sector, with recent gains in the ISM index, reminiscent of some of the strongest rebounds from recession seen since the early 1980s (Figure 10).
$8.00 $7.00 $6.00
Average: US $5.80/Mmbtu
$5.00 $4.00 $3.00
ra
ni te W M as ar c h E el D ag lus ee le p for Bo d s Pin sie ed r P Ba ic ale e Pi rne an ne tt ce da (T le ier (F 1) Fa lan y k H ett ) ay vi ne lle sv ille Po wd U in er ta R J M i v on e a on tn R a r ( C h ey t o B (8 n ( M) s t CB ag M W e ) o M od Ho frac on fo rn k t n rd R ) ey (A iv (4 rk er st om W a a H ood W ge ) or f sh ford atte r ac ) o Fa e C (An nbe ye an ad rg ttv yo ar Alb il le n ko er (N (CB ) ta o (D n-C M) Pic B eep ore e a B ) Je an rne as an ce tt ( in) M ( H T ie ar i g r 2 ie hla ) M ( T nd an ig s nv ht ) G Ba ille as rn (C ) et B M t( Ti ) er 3)
$2.00
G
April 9, 2010
Figure 9: U.S. Industrial Sector Natural Gas Demand Growth (Excludes Combined Heat & Power Operations)
BCF/d 1.0
0.6
Demand. We have steadfastly remained fairly bullish on
natural gas demand prospects for 2010 and beyond. Between modest recovery in industrial demand (worldwide) and power generation (North America), we have long felt that natural gas demand growth has not been getting a fair shake (and the appropriate more price bullish response) from the market for some time, so obsessed it has been with supply/rig count trends. In fact, more positive data continues to emerge that solid industrial and power generation demand growth is underway. A broader realization of this trend should form part of the reconnect between prices and fundamentals that we believe will be emerging in the next few months and help to push prices to gradually higher levels. More importantly, this demand growth could easily sop up much of the feared oversupply, should prices be determined to stay low near current levels for an extended period of time. We are maintaining our expectation that U.S. natural gas demand remains quite robust in 2010, rising near 3 Bcf/d versus 2009 (Figure 8). Although the residential/ commercial sectors are getting a cold weather-aided boost in the early going of this year, both industrial and power
0.5
0.2
0.0
(1.9)
0.5 (0.7)
0.1
(1.5) (0.3)
(1.0)
3.0
3.7
Forecast
(2.0) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
BCF/d 2.0
Figure 10: U.S. Industrial Gas Demand versus ISM Manufacturing Index 75.0
1.5
70.0
1.0
65.0
0.5
60.0
0.0
55.0
(0.5)
50.0
(1.0)
Industrial Gas - YoY Change ISM Index
(1.5)
2.1 1.3
1.0
(2.8)
(2.0) 0.1 (0.9) (0.9)
0.3
(0.9)
(1.0) (2.0) (3.0) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
(3.0) Jan-08
45.0 40.0 35.0 30.0
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
25.0 Jan-11
Source: FirstEnergy Capital Corp., U.S. DOE/EIA, Bloomberg.
2.7
2.4
2.0
0.0
Forecast
0.2
(1.5)
(2.5)
BCF/d 5.0 4.0
(1.4)
(0.5)
(2.0)
Figure 8: U.S. Natural Gas Demand Growth
0.3
0.3
Despite the power generation sector already getting a nice boost from very cheap natural gas prices of late, and which should be able to capture and keep some of the coal market for awhile, the aforementioned improving industrial activity and overall recovery in the U.S. economy should place power generation demand on very solid footing for more growth in the next couple of years (Figure 11). Additional demand could come this year via the potential for low western snow pack and reservoir levels to boost western gas use for power this summer by as much as 1 to 2 Bcf/d depending on severity of heat in the region. Page 4 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery?
BCF/d 2.5
Figure 11: United States Natural Gas Demand Growth in the Electric Power Sector
1.0 0.5 0.0
Figure 12: U.S. Domestic Natural Gas Supply Growth BCF/d 3.5 3.0
2.0 1.5
April 9, 2010
1.0
0.9
0.9
1.2
2.1
2.0
1.0
1.0 0.6
0.4 (1.5)
2.6
2.5
1.7
1.5
0.6
1.0
1.3 0.5 (1.9)
0.0
(0.5)
Forecast
1.2
0.8
0.5
(0.5)
2.5
(1.5) (1.3)
(1.1) 0.1
(0.5) (1.0)
(1.0)
(1.5)
(1.5)
Forecast
(2.0)
(2.0)
(2.5) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Though more localized in terms of its impact to the western states, this could be a very important safety valve to relieve high storage levels in Western Canada this summer (more about this below). Overseas gas demand for LNG is also looking to be more dynamic than originally thought. Between some industrial recovery in Japan and South Korea, strong uptake into China and India, counter seasonal demands in South America, and storage refill into Europe, LNG demand in major consuming regions is doing much better than originally thought at the start of the year. It does not take much of a swing in Asian LNG demand to quickly neutralize most or all of the perceived LNG oversupply that some had forecast for the United States this year. In fact, we have already lowered our U.S. LNG import expectations because of better than expected LNG demand (see supply discussion below). Overall, we see potential for North American and overseas gas demand to do even better than our more optimistic expectations. All that the latest price meltdown has done is essentially lock in this strong demand performance. The sooner the market comes to this realization of demand strength, the more likely that prices should rise to more reasonable levels that we see as being more consistent with a tighter market balance than is widely recognized.
Supply. It is the supply side of the market equation that
has been creating most of the consternation and general price bearishness for the North American and global natural gas markets. Only when there is some clear indication that supplies are slipping or not as robust as originally thought (see earlier investor discussion), will prices break out of their bearish mood and start to move higher. Parallel to this has to be signs of a rig count downturn in North America, given the strength seen for rig counts since late in 2009, especially horizontals.
Source: FirstEnergy Capital Corp., US DOE/EIA.
For now, we have moderated our expectations for U.S. supply losses in 2010 to near 1 Bcf/d, seeing the early strength in rig counts this year as translating into more steady supplies in the early going of this year (Figure 12). However, with what we see as a likely reduction in the rig count in the near term due to low prices, has resulted in us merely shifting our decline profile forward in time so that it now overlaps into 2011. As such, the previously anticipated turnaround in U.S. supplies is less vibrant in 2011, with only a more positive picture emerging in 2012 and inline with our outlook for stronger prices. Part of that previous discussion on signals for a price turnaround in 2010 focused on the emergence of a reduction in rig counts. Although a certain portion of U.S. drilling activity has been focused on lease retention in key resource plays and has been less sensitive to price, we do think that we are on the cusp of a plateau or a downturn for the rig count based on the price meltdown that has affected near and forward natural gas prices (Figure 13). In addition, it is unclear if many of the resource plays are able to handle more horizontal rigs than are currently running, and even the future availability of horizontal rigs, Figure 13: U.S. Natural Gas Directed Drilling vs. Three Month Lag of 12 Month Gas Strip Price US$/Mmbtu $14.00
No. of Rigs 1,600 1,400
$12.00
1,200
$10.00
1,000
$8.00
800
$6.00
600 400
$4.00
Gas Directed Drilling Rigs (lhs) Nymex 12 Month Strip Price (rhs)
$2.00
200 Jan-04
$0.00 Jan-06
Jan-08
Jan-10
Source: FirstEnergy Capiral Corp., Baker Hughes, Bloomberg.
Page 5 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? given current high use rates, is being questioned. As such, between more structural limitations on the rig fleet and the collapse in prices, we expect rig counts are on the verge of shifting to a downtrend. Given the usual lags in drilling activity, this should begin to translate into less supply by H2 2010, especially given the additional time for conventional gas plays, which have been barely touched in the past year, to continue to accumulate declines and affect overall supply (Figure 14). Figure 14: Year-over-Year Change in U.S. Marketable Natural Gas Supply
BCF/d 7.0 6.0 5.0
Forecast
4.0 3.0 2.0 1.0 0.0 (1.0)
Alberta bring bottled up molecules to the market. In addition, overall Canadian supply should stabilize or rise as new offshore supplies arrive from the Deep Panuke project on the East Coast by H2 2011. Our outlook for U.S. net imports of Canadian gas does not see that significant of a downward move, despite the Canadian supply downturn this year (Figure 16). This is a two fold situation. On one hand, exports to the U.S. from Western Canada may receive a boost later in the injection season as a potential early refill for storage levels in Western Canada sends more gas south of the border looking for a home. Second, the fairly robust supply situation for the U.S. Northeast via growing supplies out of the Marcellus formation and greater general availability thanks to pipeline expansions into the region, will likely translate into more gas flowing from the U.S. and into Eastern Canada. The end result is little change in overall Canadian net exports.
(2.0)
Figure 16: United States Net Imports of Natural Gas from Canada
(3.0) BCF/d 12.0
(4.0) (5.0) (6.0) Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
April 9, 2010
10.0
8.9
Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
Canadian supplies remain locked in a downward track to at least the end of 2010. In fact, our aggressive sounding expectations for an additional loss in excess of 1 Bcf/d for Western Canadian supplies may end up being too conservative, given the recent meltdown in prices (Figure 15). Originally, under our previous more aggressive price outlook, drilling activity was supposed to ramp up through the summer and into the next winter season, and remain elevated above 2009 levels. Now, we expect little to no drilling recovery above 2009 activity levels, even with the new Alberta royalty structure in place, which could translate into deeper supply losses this year. Beyond 2010, some modest supply recovery is still expected as new pipelines into unconventional gas regions of B.C. and Figure 15: Western Canada Natural Gas Field Receipt Supply Growth
Mmcf/d 600
484
200 0
77
(299)
7.0
6.7
6.9
6.0 4.0 2.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., U.S. DOE/EIA.
With respect to U.S. LNG imports, we have been trimming our expectations for 2010 and may trim them further still (Figure 17). With the recent low natural gas prices and poor netbacks seen for most U.S. import terminals, virtually Figure 17: U.S. Annual Average Imports of LNG
BCF/d 4.0
Forecast
147 210
147
Forecast
8.2
8.0
Forecast
388
400
9.0
100 (1,039) (1,200) (416) (638)
3.5
3.2
3.0 2.5
2.2
2.1
(200)
2.0
(400)
1.8 1.4
1.5
(600)
1.6 1.2 1.0
1.0
0.6
(800)
1.7
0.7
0.6
0.5
(1,000)
0.0
(1,200) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., company pipeline postings.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Page 6 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? all spot LNG that may have been available for the U.S. market this year has been finding a home elsewhere in the world. In this respect, one of the early aforementioned signs for a potential bottoming of prices has already emerged. Although we still expect some increase in LNG imports, especially in H2 2010, our outlook is still far more conservative than many others. A growing realization that LNG supplies are not building toward a larger wave should help to further neutralize oversupply fears in the market. Although we see some further gains for LNG imports post-2010, the aforementioned robust LNG demand picture could very well further reduce these expectations. Global LNG supplies do continue to rise by our latest assessment in light of the numerous projects that have come into service in the past 12 months, along with several more expected later this year (Figure 18). Although spot LNG prices have suffered, oil-linked prices have held up quite well, thanks to robust oil prices. As such, we expect that spot LNG flows will remain more limited from some suppliers as maintenance cycles for existing trains are extended, the ramp up of new trains will be more drawn out, and discretionary supply reductions take place, helping to limit the oversupply of LNG globally. When all is said and done this year, we expect that LNG supplies will show far less growth than many had anticipated. Figure 18: Global LNG Liquefaction Adds BCF/d 6.0 Yemen LNG Train 1
5.0
QatarGas Train 5
4.0
QatarGas Train 7
Tangguh Train 2
RasGas Train 6
QatarGas Train 6
3.0 Sakhalin Train 2
2.0
Darwin Train 1 Trinidad Train 4
1.0 0.0
Camisea Train 1
Tangguh Train 1 Yemen LNG Train 2 QatarGas Train 4
RasGas Train 5 Snohvit Train 1 NWS Train 5 NLNG Train 5 EG LNG Train 1 NLNG Train 6 Sakhalin Train 1
2006
2007
2008
Gladstone Train 1
Skikda Rebuild
2009
RasGas Train 7
Pluto Train 1
2010
2011
Souirce: FirstEnergy Capital Corp.
Storage. It is the perception of oversupply in the
marketplace that most acutely comes into focus when considering the natural gas storage situation in North America. Although we feel that this view of oversupply is incorrect and will lead to storage levels at the end of the injection season in October 2010 that are lower than most expect (see Figure 3), the market’s current view is that storage is likely to be filled to maximum capacity once again before the end of the injection season. In other words, a retest of capacity in 2010, as was nearly the case in 2009, is expected once again, and this is what has led to the very low prices situation at the end of Q1 2010.
April 9, 2010
To be sure, storage exited March 2010 at higher than anticipated levels thanks to a very mild March (Figure 19). In fact, the exit looks little different from the situation at the end of March 2009. This higher exit has shifted the timing and magnitude of when we expect a storage deficit to appear and persist (Figure 20). This also underlies why we expect prices to remain somewhat muted in the early going of the injection season.
BCF 2,000
Figure 19: United States Working Gas Storage Levels at the End of March
1,750
1,656 1,660 1,458
1,500 1,250 1,000 750 500
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FirstEnergy Capital Corp., US DOE/EIA.
Figure 20: United States Deficit/Surplus in Working Natural Gas Storage Levels 900 800 700 600 500 400 300 200 100 0 (100) (200) (300) (400) (500) (600) Jan-08
Year-over-Year Deficit/Surplus Deficit/Surplus to 5-Year Average Forecast
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Source: FirstEnergy Capital Corp., US DOE/EIA.
However, given the supply-demand mix that we expect to materialize, average injection rates should be slightly lower than those seen in 2009 and may prevent storage levels from rising much beyond those seen at the end of October 2009. We expect that downside surprises for the storage exit are more likely this year than upside surprises given the depths to which prices have been sent recently (i.e. strengthening demand into flat to declining supply). It is Canadian storage where concerns about oversupply have truly come to the forefront, although there could be some offsets provided by western gas burn for power generation (see demand section). Despite expectations for a strong withdrawal season, the latest season turned out to be something of a bust, resulting in one of the more dull Page 7 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? storage withdrawals in recent years. This has allowed Western Canada storage levels to exit at much higher rates than anticipated (Figure 21). Given earlier than anticipated injections getting underway in March, we expect that Western Canadian storage capacity may be tested again before the end of the summer. This may result in wider basis to U.S. pricing benchmarks for the last couple months of the injection season, and be reflected in what will be strength in exports to the U.S. prior to the end of the injection season. In the here and now, the high storage exit at the end of March and potential retest of capacity, provides a definite short-term price bearish signal, further adding to our slow price recovery scenario for this year.
BCF 600
Figure 21: Estimated Daily Western Canada Natural Gas Storage Level 600
Estimated Working Gas Capacity: 534 BCF
550
550
500
500
450
450
400
400
351.7
350
350
300
300
250
250
200
200
150
150
100
100
50
5 Yr. Hi-Lo
2007
2008
0 Jan-1 Feb-12 Mar-25 May-6 Jun-17 Jul-29
2009
2010
50 0
Sep-9 Oct-21 Dec-2
Source: FirstEnergy Capital Corp.
European storage levels look to have exited March 2010 a hefty 450 Bcf higher than the Russian supply disrupted levels of one year earlier (Figure 22). Although this may look to be price bearish, it is encouraging from an LNG perspective in that it is the major LNG importers of Europe such as the UK, France, and Spain where storage levels have been drawn down to levels much lower than one year ago. As such, we expect the European storage refill season to be quite robust and supportive of greater LNG
uptake into this region. Aiding matters for uptake of LNG should be a desire to minimize purchases of mostly oil price-linked Russian gas supplies, a partially mandated shift away from coal generation in Spain, and still expanding storage capacity in other parts of the European Union. Obviously, this also helps to support the lower LNG import-lower U.S. gas storage scenario outlined earlier.
Conclusions. Despite pricing path similarities between
Q1 2009 and Q1 2010 (see Figure 1), the current set of drivers in the marketplace are very different. Early 2009 was marked as a time when global economic activity was still bottoming out versus the current climate of solid and accelerating expansion. Standing in opposition to what was still rapidly expanding supply in early 2009, are growing questions in early 2010 over the dynamic nature of U.S. domestic supply growth in the aftermath of a huge rig count decline in 2009, followed by a sharp acceleration in horizontal drilling in 2010. Is supply growing or slowing more or less than thought? Finally, given important supply and demand questions, can storage be refilled as quickly in 2010 despite exiting the heating season at nearly identical levels as in 2009? Until there is greater resolution on many of these questions (and others) as the year progresses, it will be the slow road to recovery for prices, especially in a market where fear of oversupply in 2010 is even more acute than in 2009. This market needs additional catalysts, as well as resolutions to these questions, before the all suffocating price bearishness gripping the market can be relinquished. We firmly believe that catalysts and answers to these questions will emerge that will support higher prices than are currently in vogue on the Nymex strip and on the Street (Figures 23 and 24), but that the price recovery will be more gradual and measured than previous price recoveries. Nevertheless, there is still real price upside from what we see as a bottoming for natural gas prices at the start of Q2 Figure 23: Expectations for Price of Henry Hub in 2010
Figure 22: European Gas Storage Levels
(As of Apr 8, 2010 survey; Nymex value as of Apr. 8, 2010) US $/Mmbtu (Consensus estimate does not include Nymex value) $7.00
BCF 2,400
2,400
2,200
2,200
2,000
2,000
1,800
1,800
1,600
1,600
1,400
1,400
$4.50
1,200
1,200
$4.00
$6.50
FirstEnergy
$6.00
Consensus
$5.50
Nymex
$5.00
1,000
2007-2008
1,000
$3.50
800
2008-2009
800
$3.00
600
2009-2010
600
$2.50
400
$2.00
400 Nov
Dec
Jan
Feb
Mar
Apr
Source: FirstEnergy Capital Corp., Gas Infrastructure Europe.
May
Jul
Aug
Sep
April 9, 2010
Oct
$5.45
$5.00
$4.55
1
2
3
4
5
Source: FirstEnergy Capital Corp., Reuters.
6
7
8
9 10 11 12 13 14 15 16 17 18 Analyst
Page 8 of 9
World Natural Gas Markets: Natural Gas Price Forecast Update The Fast or Slow Road to Price Recovery? Figure 24: Expectations for Price of Henry Hub in 2011 (As of Apr. 8, 2010 survey; Nymex value as of Apr. 8, 2010) US $/Mmbtu (Consensus estimate does not include Nymex value) $8.50 $8.00
FirstEnergy
$7.50
Consensus
$7.00
Nymex
$6.36
$6.50
$5.75
$6.00 $5.50
$5.28
$5.00 $4.50 $4.00 $3.50 1
2
3
4
5
Source: FirstEnergy Capital Corp., Reuters.
6
7
8
9 10 11 12 13 14 15 16 17 18 Analyst
2010. Prices have been driven down to the point where sizeable gas users can lock in very attractive low prices, most supply plays are uneconomic, forward pricing for suppliers looks abysmal, especially when many current nicely priced hedges put in place for 2010 begin expiring later this year, and U.S. LNG imports may trail last year by a growing margin at such low prices. In light of these challenges (and opportunities), storage refill on both sides of the Atlantic looks to be increasingly difficult rather than increasingly easy in 2010.
April 9, 2010
huge production rates and reserve sizes, will prove to be higher than are currently being estimated. Given what seems to be a herd mentality in trying to find the next cheapest and higher productivity shale play, in light of very little hard information on recoveries and costs for existing ones beyond Producer press releases, the disappointment factor (and higher prices) is building for when much more information will be available one to two years out and costs likely appear higher than originally estimated. By then, supplies in North America and overseas should be much tighter in the face of what will be much firmer demand, and a global LNG market that has run into a lull in terms of supply expansions. For the natural gas minded investor, it is a dizzying array of information and perhaps a market that is more confusing than ever. However, there are always opportunities in any market, and the present low natural gas price environment has become very compelling for many. Just when the market seems to be at its maximum pessimism, that is when it is likely the time to be the optimist and begin looking for near and longer term investment opportunities. The time to look is developing in Q2 2010. Wait for the catalysts and market changers mentioned in the investor section and you might start to feel good about natural gas again.
Longer term, we believe that costs for many of the hot resource plays, despite much of the hoopla surrounding
Page 9 of 9
