US natural gas prices are refusing to budge higher with the rest of the energy complex:
This has led some to wonder why, especially since natgas rig counts are actually decreasing. According to Baker Hughes, the number of rigs drilling for natural gas has dropped 58 per cent from a peak of 1,606 on September 12, 2008.
Nevertheless, as Bloomberg reported on the wire earlier this week, the US energy department was still predicting stockpiles to reach a record 3,800bn cubic feet by November.
A lot of that, of course, has to do with the fact that rig counts are a lagging indicator. But, as Bank of America-Merrill Lynch’s energy team point out on Thursday, a lot of that also has to do with the recent explosion in the development of unconventional natgas production – the biggest of which comes in the form of shale gas.
Shale gas is the extraction of natgas situated in pockets, pores or fractures within the ground via the newly improved and far more economic process of hydraulic fracturing.
As Merrill state (our emphasis):
Unconventional natural gas production in the United States has been a true game-changer. Due to compelling economics, unconventional output is still rising in the shale plays. Producers report early success rates, reduced drilling times, highly productive wells and finding costs as low of as $1.50/MMBtu in some areas. On our estimates, many shale plays have returns of 20%+ on current calendar 2010 NYMEX natural gas prices. Severe storage constraints might surface in some areas, causing cash prices to sink. In turn, lower nat gas cash prices could negatively impact Henry Hub and force further production shut-ins.
In other words, because shale gas makes such long-term economic sense for producers, even collapsing natural gas prices in the interim are not currently enough to disincentivize its production. Which means in the short-term, you can expect further price pain according to the analysts as available storage continues to fill-up.
So what’s the worst that can happen? Well, one reason physical natural gas traders claim unlimited futures positions are a must in their industry is because unlike crude oil or other commodities natural gas that is already produced is much more difficult to store. Any excess supply on any given day must have the means to be used, go into storage, or it gets wasted.
In fact, in that way natural gas trading bears more similarity to central banking than commodities trade, because if natgas traders (also known as shippers) fail to deliver enough on a sudden bout of demand or conversely risk overloading the “system” because demands suddenly falls, the pipeline network risks falling out of balance with potentially dire side-effects. This is why spot prices can be hugely volatile.
As storage tightens to record levels, the chances of a major price collapse become ever more possible due to the practice of discounting gas in regional systems when capacity is full. As Merrill states (our emphasis):
The risk of nat gas storage congestion is very real The US natural gas market faces the risk of severe and unprecedented storage congestion this fall. Producing region inventories currently stand at 1.07 tcf, 43% above last year and just 5 bcf shy of the previous record achieved at the end of November 2007 (Chart 3). Fortunately, storage capacity in the producing region has expanded to 1.27 tcf, but utilization will likely rise to previously untested levels, potentially putting enormous pressure on the pipeline system. The United States is not alone here: Canadian storage is also at risk of being maxed out in a matter of weeks, particularly in the Western region.
And that, by the way, is a literal reference to “enormous pressure”. Push too much natgas into the system, and it does pose potentially explosive problems. As Merrill concludes:
Involuntary curtailments could cause cash to plunge. As a result, severe storage constraints might surface particularly in areas like East Texas. If gas can no longer be stored, cash or spot prices may have to sink to force shut-ins and completion deferrals in a number of producing areas, a development that could ultimately impact Henry Hub. Prices in the Rockies and South West as well as Aeco in Canada are already extremely depressed, with the Opal Hub trading below $3/MMBtu.
Here, by the way, is a pictorial account of how Merrill expects storage dynamics to develop through the third quarter:
Related links:
Super-natural gas - FT Alphaville
Anything but therm in the US – FT Alphaville
Rig counting – FT Alphaville