Rescued from 10-year lows by record summer heat and strong utility demand, U.S. natural gas prices should rise 35 percent next year as production growth tapers off and economic activity increases, according to a Reuters poll of analysts.
U.S. consumers and businesses that rely on natural gas caught a break earlier this year when record high domestic production and inventories stoked by a mild winter and a boom in shale gas production pushed prices to decade lows below $2 per million British thermal units.
The steep price slide prompted strong demand from electric utilities eager to switch off coal-fired plants and use cheaper natural gas for power generation, however.
Combined with steady heat this summer that forced homeowners and businesses to crank up air conditioners, inventories that threatened to test the nation's capacity to store natural gas were whittled down, pushing prices higher again.
Next year, declines in dry gas drilling which has become unprofitable at current prices, are expected to slightly slow output and give prices a lift.
In addition, an improving economy was expected to underpin industrial demand and more normal weather should boost residential and commercial gas burn.
While domestic gas inventories are still heading into winter at record highs, most analysts agree that a near normal winter will go a long way in burning up excess gas and set the stage for a tighter supply and demand balance in 2013.
"We do see supply and demand a bit stronger next year," said Shiyang Wang, natural gas analyst at Barclays in New York.
"Production shouldn't be up as much and, assuming more normal weather patterns, we're not going to see as big a supply glut as we had this year."
The Reuters quarterly price poll put the consensus forecast for the average spot price this year at Henry Hub, the benchmark U.S. supply point in Louisiana, at $2.80 per mmBtu, up 9 percent from last quarter's estimate, but still 30 percent below the $4.02 realized average in 2011.
Prices in 2013 were expected to average $3.78, up about 7 percent from the previous price poll published in late July.
For the first nine months of 2012, Hub prices averaged $2.55, down 40 percent from the same period last year. Prices in 2012 are headed for their lowest annual mean since 1999, when the Hub averaged $2.27.
Gas demand was seen improving further in 2014, when stricter rules on emissions forces more inefficient coal-fired plants to shut down. That should help drive prices up another 15 percent to $4.35, according to the Reuters poll.
Of the 25 participants in the poll, there were 14 upward revisions for 2013, no downward revisions and 10 were unchanged. One did not participate in the previous poll. Price estimates for 2013 ranged from a low of $3.25 to a high of $4.50.
UTILITY DEMAND, THE BIGGEST SURPRISE
Historically, coal has had the competitive edge over gas and been the fuel of choice for power generation, previously capturing about 50 percent of the total.
But gas has been steadily gaining market share in the electric power sector, grabbing an estimated 31 percent of total generation this year, up from 25 percent in 2011. Coal's share of power generation was expected to drop to 37 percent in 2012 from 42 percent last year.
Analysts estimate that coal-to-gas switching reached a record high this spring, adding as much as 8 billion cubic feet per day, or 12 percent, to total gas demand compared with the same period last year. Some experts estimate it is still running 4 bcf per day or more above a year ago heading into the peak-demand winter season.
While coal-to-gas switching was expected to taper off somewhat next year due to higher gas prices, analysts note that at least some of the gains in demand will be permanent.
"There are more power generators switching and they've become more nimble and can switch back and forth (between gas and coal) quicker," said Vikas Dwivedi, global oil and gas economist at Macquarie Group.
But Dwivedi cautioned that further gains in gas prices could drive utilities back to coal, adding: "If gas prices range from $3.90 to $4.10, we could lose some switching."
Any let up in coal-to-gas switching, which was a key factor in driving gas prices up nearly 90 percent this year from their spring lows, could force more gas into a well-supplied market.
The Energy Information Administration expects total U.S. gas consumption to slip 0.7 percent next year to 69.3 bcf per day, with gains in demand from residential, commercial and industrial users mostly offsetting a decline in electric power demand as higher gas prices slow utility switching.
Most analysts see a tighter supply/demand balance next year, but they also see a limit to potential price gains.
Utilities typically build up inventories from April through October to help meet 25 percent to 30 percent of peak winter heating needs.
Last summer's record heat helped cut a huge inventory surplus of 887 bcf last spring by 85 percent, but storage will head into the heating season at a record high for the fourth straight year, peaking just below 3.95 trillion cubic feet.
That could still present a huge problem for prices next year if there is another mild winter.
But a near normal winter could eliminate a lot of the oversupply that plagued prices this year.
"A normal winter could add 800 billion cubic feet or more to total demand between November and March," Macquarie's Dwivedi said.
That would help pull stocks down to the 2 tcf area by the end of March, well below last March's record near 2.5 tcf.
"Inventories should come out of a (normal) winter with about 2.1 tcf in the ground. That's not great. It's the second highest ever, but it is more manageable than this year and doesn't point to a $2 price," said Steve Thumb at Energy Ventures Analysis.
PRODUCTION STILL HIGH
Another risk to higher prices in 2013 is production, which is still flowing at or near a record high and not expected to drop much, if at all, next year.
Drilling for natural gas has been in a fairly steady decline for the last year, with gas rigs falling some 55 percent to a 13-year low just two weeks ago. But so far, production has not shown any significant signs of slowing.
The associated gas produced from more-profitable shale oil and shale gas liquids wells has kept dry gas flowing at a brisk pace. And new pipeline capacity scheduled in some bottlenecked shale plays later this year could prompt producers to hook up more wells and add even more gas to supply.
"The debottlenecking of infrastructure in Marcellus (in Appalachia) and Eagle Ford (in Texas) could offset the decline in drilling rigs," Barclays' Shiyang Wang said.
In addition, a strong move up in prices, say above the $4 mark, could make dry gas output profitable in some basins.
"Dry gas (in some plays) goes into the money at the $3.90 level. That would incentivize drilling and production could grow another 1 or 2 bcf per day," Macquarie's Dwivedi said.
EIA expects production in 2013 to be about flat with 2012's estimated record of 68.84 bcfd, but some analysts note that output seems to be flattening and could drop slightly next year.
One bright spot for price bulls is that imports from Canada could fall next year. Just over 10 percent of the total U.S. gas supply comes from Canada.
"Canadian (natural gas) supply is expected to take a sharp fall next year. There's no drilling and that should translate into lower exports to the United States," said Martin King, vice president at FirstEnergy Capital Corp in Calgary.
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