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Societe Generale SA
Royal Bank of Canada
Goldman Sachs Group Inc/The
Oppenheimer Holdings Inc
Six weeks ago, natural gas bulls were riding high. By Thanksgiving, prices had more than doubled since hitting a decade low of $1.90 per million BTUs in April. Heading into what was supposed to be a cold winter for the U.S.—at least compared with last year—the consensus view was that natural gas prices would be higher in 2013, since about half of all U.S. households heat their homes with natural gas. By the end of December, the median forecast of 22 analysts surveyed by Bloomberg was that natural gas would average $3.75 for 2013.
A few weeks of warm weather later, and a lot of those forecasts look way too optimistic. Prices have fallen more than 20 percent since peaking at $3.90 per million BTUs in late November. With the National Weather Service predicting above-normal temperatures over the next 10 days for the eastern third of the U.S., that downward pressure is likely to continue. “We’re going to see a lot of guys coming in and changing their forecasts,” says Laurent Key, an energy analyst at Societe Generale (SCGLY) in New York. Key expects prices to bottom out around an average of $3.16 in the second quarter before climbing.
“If we end up repeating 2012, those expectations need to come down by about a buck,” says Scott Hanold, an energy analyst at RBC Capital Markets (RY) in Minneapolis. Goldman Sachs (GS) just lowered its 2013 price target by 50 cents, from $4.25 per million BTUs, to $3.75, still above the current price of $3.12.
Natural gas is notoriously volatile, so prices could surge if the weather turns cold and people crank up their heat, but it’s hard to see that demand making up for what’s already been lost. Even if there is a February freeze across the country, that cold snap probably wouldn’t be sufficient to compensate for a mild December, Goldman analyst Johan Spetz wrote in a Jan. 7 research note. Bloomberg News reported Wednesday that Mike Fitzpatrick, editor of the Energy OverView newsletter, thinks natural gas prices could drop as low as $2.20 if the weather stays mild.
The more likely scenario seems to be something akin to what happened last year, when prices fell through the spring and didn’t rise appreciably until people started turning on their air conditioners in May. Part of what helped lift natural gas prices off their lows last April was increased demand from utilities switching from coal to natural gas to generate electricity. But that effect might be more muted in 2013. After getting crushed by cheap natural gas over the last few years, coal appears set to recapture some of that market share in 2013. “Coal has become more competitive against natural gas,” says Lucas Pipes, an analyst at Brean Murray, Carret & Co. Coal prices have gotten so cheap that if natural gas rises to just $3.40 this year, Pipes estimates that would cause 50 million tons of coal demand to come on the market as utilities fire up their coal plants.
The Department of Energy is forecasting that coal will account for 39 percent of all electricity generated in 2013, up from 37.6 percent last year. Meanwhile, natural gas’s continued run of increasing its share of the electricity market may be over. The DOE predicts that natural gas will lose ground this year and next, falling from 30.3 percent of all electricity generated in 2012, to 27.9 percent in 2013, and 27.5 percent in 2014.
On top of that, natural gas production is set to rise by 0.5 percent this year, according to the DOE. After spending the previous 15 months reducing the number of rigs drilling for natural gas, U.S. producers finally started adding to that total in November, spurred perhaps by the prospect of sustained $4 prices. While production has slowed in some places, the Marcellus Shale in western Pennsylvania is still attracting new investment. “Marcellus is an animal. There are still 1,000 wells that haven’t been put online yet,” says Hanold. “That’s going to push production even higher.” Marcellus is also more immune to lower prices. The geology is so good, and the royalty rates so low, that producers can drill profitably even at $2 natural gas prices, he says.
In the end, the fundamental issue that’s kept natural gas prices so low for the last few years—too much supply, inadequate demand—appears here to stay for the foreseeable future. ”Natural gas prices will be dead for at least two more years,” says Fadel Gheit, a senior oil and gas analyst at Oppenheimer (OPY). By dead he means well below $4. “The industry shot itself in the foot by overdrilling,” he says. “Now anybody and their brother can get gas out of the ground and into the system.”