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  • Home>Research & Insights>Sector Rap>Natural Gas Reaches Capitulation

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    Natural Gas Reaches Capitulation

    Supply glut, warm weather, and rock-bottom prices challenge producers.

    Philip Guziec, 06/15/2012

    With the cost of gasoline spiking over $4 per gallon and natural-gas prices falling to 10-year lows, energy concerns have been in the news a lot this year. On April 11, I sat down with two Morningstar equity analysts—Mark Hanson and Avi Feinberg—to dig deeper into what’s going on in the oil and gas sector and what it means to investors.

    Philip Guziec: Update us on the situation with natural gas. It’s a very different story today than it was just a decade ago.

    Avi Feinberg: Today, natural gas is about $2 per 1,000 cubic feet, which is the lowest price in a decade. What’s going on? Well, there’s a confluence of factors here. There is certainly growing production, with shale plays and other unconventional production. Year to date, production is up about 5% in the United States. At the same time, we had a historically warm winter, so demand is off by about 5% so far this year. Combine those factors, and you have record-low natural-gas prices. The question is, How long will this go on? That’s a tough question to answer.

    Guziec: We’ve seen headlines about the United States having a 100-year supply of natural gas. Is that really the case?

    Mark Hanson: Some people say there’s 100 years of supply. But it’s hard to really know exactly how much. Certainly, there is a wealth of supply, and it’s a blessing and a curse.

    On the one hand, firms have found ways to unlock the source rock. Traditionally, they went after pockets of gas; now, they’re actually going after the source—the rock where the gas migrated from.

    The flip side is that the United States has no real ability to export excess supply. We can only store between 60 and 90 days’ worth. We can’t store the stuff in tankers offshore. It’s very difficult to compress and move it to global markets. The facilities involved in that process cost several billion dollars and take several years to construct, so it’s a threeto four-year story before large-scale exporting becomes a reality. In the short term, as Avi said, weather factors and excess supply are going to put pressure on natural-gas prices throughout the summer. Now, that can get worked off in a matter of a few quarters, but those producers that rely almost exclusively on natural gas for their revenue are really going to be challenged.

    On the demand side of things, coal-to-gas switching typically takes place below $3.50 per 1,000 cubic feet. So you’ve seen a pretty big uptick in consumption of natural gas from power producers. Ultimately, the savior of the natural-gas market in the short term could be power generation, where enough people have incentive, given low prices, to work off that excess supply.

    Feinberg: I agree with Mark. Long term, you’ll see more coal-to-gas switching, for sure. We think that that’ll help stabilize the supply-demand balance. But that’s not to say it couldn’t get even uglier in the shorter term. Storage is about 60% above the five-year average for this time of year, closing in on 1 trillion cubic feet above the average. So that’s a lot of gas to work off, and we’re only partway through the injection season.