Analysts: $4.50-plus market likely here to stay

GAS DAILY - Tuesday, January 18, 2005

      Even if liquefied natural gas fulfills its promise to ease the U.S. gas supply/demand balance by the end of the decade, several industry analysts say consumers likely won’t see lower prices anytime soon.

      “Yes, the nation is learning to love $5/MMBtu to $6/MMBtu prices,” remarked John Olson, senior vice president and chief investment officer for energy at Sanders Morris Harris. “The nation doesn’t have much of a choice.”

     Olson said U.S. consumers are finally coming to terms with the fact that rising demand and flat or declining production will mean higher gas bills for the foreseeable future. “Natural gas will continue to be the preferred fuel, regardless of price in many parts of the country,” because it is 14 times less polluting than fuel oil and 32 times less polluting than coal, he said.

     “We are faced with a massive amount of gas generating capacity currently,” Olson said. About 200,000 MW have been added over the past four years and “that would run … about incrementally 11 to 12 Bcf/day. And we do not have enough producing capacity to fill that particular bill unless it’s coming out of storage.”

     Although the country has not found itself in a supply crisis, people are beginning to understand that market tightness is not a short-term phenomenon. “We foresee the usual seasonal roller-coaster in natural gas pricing, but that’s going to be in the context of a seller’s market,” Olson said.

     Last week, a coalition of industrial end-users, environmentalist and energy efficient groups lobbied Congress to adopt a federal energy policy to ease gas-price spikes and volatility. The group cited a sense of frustration in the industrial community and among environmental groups that nobody is acknowledging how much damage persistently high gas prices could have on the nation’s economy.

     Indeed, gas prices have climbed steadily since 2000 despite some occasional ups and downs, said Ron Denhardt, vice president of natural gas services at Strategic Energy & Economic Research.

     In 1999, the average Henry Hub cash price was $2.27/MMBtu, Denhardt said. “In 2000, it was $4.23/MMBtu. In 2001, $4.07/MMBtu; in 2002, $3.33/MMBtu; in 2003, $5.63/MMBtu; and probably it will end up in 2004 at $5.85/MMBtu.”

     Given that trend—and the future outlook for supply and demand—Denhardt said he believes the nation will probably not see gas prices fall below $3/MMBtu again. In fact, “I’d be surprised to see them get down to $4/MMBtu because the cost of bringing marginal gas supplies to the market is much higher than that; $4.75/MMBtu would probably be a pretty safe number,” he said.


     Rising production costs mean higher prices

     While some market participants have blamed hedge funds for artificially pushing futures prices—and therefore cash prices—incrementally higher, Denhardt said funds are only part of the reason the market has entered a new paradigm. One of the biggest factors in the rising price deck: it costs more money to produce gas than it did five years ago.

     “In the 1990s, gas fields were becoming very mature,” Denhardt said. “They had found a lot of the easy stuff and the fields became mature faster than people expected. Now, because they are mature, it’s more costly to bring [the gas] on. That’s particularly true in the Gulf Coast area, where production is declining rapidly.”

     “If prices get low, exploration in the offshore Gulf would really drop because it is so costly to drill there,” which would put more upward pressure on the market, he added.

     Joe Allman, director and research analyst for RBC Capital Markets, said new fields are smaller than they were just a few years ago, resulting in a higher ratio of gas-to-production costs.

     “If it cost $1[/MMBtu] to drill, and before you were finding big fields, the size of the field was one unit to $1,” he said. “Now the fields are not so big. It’s not one unit, it’s 0.5 units, costing two times the amount to find.”

     Although inflation has been relatively benign in recent years, competition for drilling rigs and crews also has caused exploration costs to rise, Allman said. “Because prices are high, companies want to capture the value of these high prices and will drill more, which puts more pressure and more competition for services,” he explained.

     Allman said gas producers today want a floor of at least $4/Mcf-equivalent to continue exploring for new reserves. But he said $4.75/Mcfe is an even better benchmark because when prices fall as low as $4.50/Mcfe, exploration tends to slack off.

     Not even increased LNG imports in the coming years will ease U.S. gas prices substantially because much of that gas will be coming from parts of the world not considered politically stable, according to Allman.

     As a result, the same geopolitical concerns that now keep a floor under oil prices will soon be factored into gas prices, Allman predicted. “Because we are so reliant on other countries for crude oil that aren’t the most stable, it will also be an issue for natural gas going forward.”      

CB