Commodities | Jan 08 2009
By Chris Shaw
As with most commodities, natural gas went through a year of exceptional volatility in prices in 2008. Sector watchers at Barclays Capital note the moves reflected a shift in market focus from initial concerns of whether or not supply would prove to be adequate to a perception that increases in production were outpacing demand.
Entering the northern winter of 2008/09, inventories were at their second highest level of the past 10 years and the group notes this pushed down prices. There are few signs of improvement for the coming year given the expectation inventories will hit an all time high during the course of 2009.
At present, the market’s major supply and demand factors are fighting something of a battle for supremacy. The group points out there has been a sharp fall in drilling activity and this has implications for supply, while demand expectations are falling in line with weaker economic data.
Breaking this down further, the group notes at the current pace of decline for drilling activity, production growth in the natural gas market could come to a stop as early as the June quarter of this year. This is a steeper fall than had been expected.
As evidence of this, Barclays notes there are now 339 drilling rigs that have gone out of operation since the peak in activity in August of last year. The decline is thanks to a combination of low forward prices and less access to capital for those companies involved in exploration.
If this pace of decline continues, the group estimates inventories may build to just 3.5 trillion cubic feet by the end of the 2009 injection season. This suggests the market could return to balance by late in 2009 rather than the middle of 2010 as previously suggested.
But the demand side also needs to be factored into the equation and this makes the outlook more difficult to read, as any return to a market balance would require stronger US economic growth. Barclays expects as much, forecasting US GDP growth of 2% in the September quarter this year and 3% in the final quarter.
But recent economic data suggests such a growth outcome will be a tough ask, as overall the group predicts the US economy will contract by 1.7% for the full year,. This is well down from the 2.5% growth predicted as recently as last September.
It must be noted there is both industrial and power demand for natural gas, with industrial demand remaining relatively inelastic to the state of the broader economy. In contrast, power demand is far more elastic, but has been helped of late by weather conditions. A colder than expected start to the current Northern Hemisphere winter has already reduced storage overhang expectations.
As a result, the group has lowered its inventories estimate for the end of winter to 1,605 billion cubic feet from 1,805 billion cubic feet previously. Such a level would be less bearish for prices, in the group’s view, particularly as it matches revised estimates for the end of October 2009 storage estimates of 3.63 trillion cubic feet, down from 3.8 trillion cubic feet previously.
In terms of price forecasts, the group expects a 2009 average of US$6.36/MMbtu this year and US$7.16 in 2010, down from US$9.05 in 2008.