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A Warm Winter Would Be 'Catastrophic' For Natural Gas

The woes for natural gas drillers continue, with forecasts for prices over the next few years showing a market stuck with oversupply.

“Any hope of higher peak winter prices likely hinges on sustained cold weather,” Bank of America Merrill Lynch wrote in a note last week. “Even then, we believe the upside in prices is limited.”

Rising production has more than offset the steady increase in demand from coal-to-gas switching. Inventories have climbed this year at a faster pace than in 2018, replenishing what had been depleted stocks. For the week ending on October 18, U.S. gas stocks stood at 3,606 billion cubic feet, or roughly 519 bcf higher than for the same week in 2018.

Unlike last year, when natural gas prices briefly spiked, the U.S. is heading into the winter season with ample supplies on hand. “A mild winter across the northern hemisphere or a worsening macro backdrop could be catastrophic for gas prices in all regions,” Bank of America said.

Due to a variety of factors, gas markets could remain in this subdued state for the next few years. By 2021, the U.S. could be sitting on 4.2 trillion cubic feet of natural gas in storage, according to Bank of America, which would be a record high. As a result, there is little room for prices to rise.

The bust in coal markets could also keep a lid on any price increase for natural gas. “With the implosion of Appalachian coal prices (down over 40% YoY), we estimate the soft cap on natural gas prices is currently just over $3/MMbtu, compared to $5/MMbtu a year ago,” Bank of America said. “As such, we lower our 1Q20 price forecast $0.5/MMbtu to $2.5/MMbtu.” Related: Floating Nuclear Power: Chernobyl On Ice Or The Future Of Energy?

For the full year in 2020, the bank expects prices to average $2.35/MMBtu, down from its previous forecast of $2.60/MMBtu. In 2021, prices are not expected to rebound, barely rising to an average of $2.40/MMBtu, according to the investment bank.

Gas exports from Texas to Mexico are on the rise, providing some outlet for a glut of gas stuck in the Permian. However, the unfolding manufacturing downturn is creating “weak domestic industrial demand,” the bank said. Gas demand rose steadily year after year over the past decade, but growth flattened out in 2019. This is a sign of the economic slowdown, which has hit the manufacturing sector particularly hard. Bank of America said it was “growing concerned about industrial natural gas demand.”

The one factor that could erase the expected glut is production growth grinding to a halt. Banks are cutting lending to cash-strapped drillers and investors are fleeing the sector. Shale gas drillers are scrapping rigs and cutting payrolls.

That’s true for much of the shale industry, but some investors and analysts expect gas-focused drillers to be especially hit hard, since natural gas prices have plunged by more this year when compared to crude oil. They also do not have oil revenues to fall back on. “I expect the biggest issues to be with over-leveraged natural gas producers, especially those without firm transportation in geographically-disadvantaged areas,” Brock Hudson, managing director at investment bank Carl Marks Advisors, told Reuters.

Within that gas segment, drillers in the Marcellus and Utica could face particular trouble because the dip in prices is in part due to the flood of gas coming out of the Permian. Because Permian drillers are mainly targeting oil, companies may not slow gas production in response to low prices. Related: Protect The Oil: Trump’s Top Priority In The Middle East

That may result in a longer period of time for the market to rebalance. In the interim, gas-focused drillers in Appalachia could feel intense pressure. Pittsburgh-based EQT, the largest gas producer in the country, has seen its share price fall by half this year.

The upshot is that the financial stress spreading in the gas industry might translate into weaker production growth. “Although it has not been a good move to go against shale production this decade, natural gas production is decelerating,” Bank of America said. “Credit conditions among some of the larger gas producers have deteriorated, but we expect most of the natural gas production in the coming years to come from liquids plays.”

In short, prices are set to remain depressed, and the only check on a deeper slide is the pain inflicted on drillers. “Risk of producer discipline keeps dated prices from completely falling apart, for now,” Bank of America said.

By Nick Cunningham of Oilprice.com

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