Commodities | Jun 30 2010
By Chris Shaw
Barclays Capital is bearish on gas prices in 2011, but this has not stopped the group from examining what factors or combination of factors could swing the market into a more bullish pricing environment. The group suggests such an outcome requires a benchmark price of US$8 per MMBtu, which compares to its expectation prices remain at around US$4.10 per MMBtu in 2011.
Barclays Capital's far more bearish price forecast for natural gas is based on the expectation supply remains strong, coming in well above the needs of the residential commercial and industrial sectors. This means gas will need to continue to displace coal-fired generation to avoid over filling storage capacity both this year and in 2011.
This occurring to the required extent is unlikely in the group's view, hence its bearish outlook for natural gas prices. This means achieving a more bullish pricing environment of US$8 per MMBtu is a tough ask according to Barclays, as their doesn't appear to be any single event that could push prices to such a level.
To achieve such a price Barclays estimates there would need to be a drop in supply or jump in demand of about 4Bcf (Billion cubic feet) per day, an amount equal to around 7% of US production in 2009.
The group suggests the most likely single event that could achieve such a shift in the market is a severe hurricane that disrupts production. But such a hurricane would need be more severe than the combined impact of hurricanes Rita and Katrina, so making this a low probability outcome.
Alternatives in terms of causing a shift in the market include a drought in capital markets, as gas producers are basically refiners that attempt to turn fresh capital into natural gas. If capital markets were to tighten, drilling activity would also be likely to come down but Barclays estimates the rig count would need fall to around 555 rigs from a forecast 743 rigs next year to deliver a 4Bcf per day decline in output.
A decline in forward prices would help, as if forward prices were to decline sharply producers would find it less attractive in terms of hedging 2011 production. Such hedging is an important pre-condition to drilling in the view of Barclays, as it allows companies to protect their capital budgets. As a result, under-hedged producers would likely trim their level of drilling activity in 2011.
But for prices to reach US$8 per MMBtu the current rig count would need fall by about 40% and given producers are about halfway through their 2011 hedging programs this appears unlikely according to Barclays.
Other factors such as cold weather and new environmental restrictions on drilling are simply not enough to generate a significant increase in prices according to Barclays, especially as industrial demand has limited room for any further substantial growth.
In summary, Barclays sees a number of events that could cause a rally in in natural gas prices, though there is no single event likely to be enough to push prices to the US$8 level next year. This is especially the case given weak fundamentals, as the group notes supply is currently growing faster than core demand at present.