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Gas rallies

Prices are on a bull run and demand looks robust

After spending much of the early part of the year struggling to crack $2, US natural gas prices have mounted a comeback. Heading into October, Henry Hub prices had doubled from their early March lows and broken through $3 per 1,000 cubic feet for the first time in more than 18 months. It has come as much-needed relief for ailing natural gas producers.

The multi-year run up in natural gas production was finally broken after a sustained period of sub-$2 prices. The number of rigs drilling for gas in the US was down to just 92 in late September, less than half from a year earlier and not nearly enough to keep output growing. Total production in late September was 79.7bn cubic feet per day, down 2bn cf/d from a year earlier. Even the mighty Marcellus shale in Pennsylvania is slipping, with output off by 0.7bn cf/d over the past six months.

What has been striking is how slow gas drillers have been to chase higher prices. Even though prices are double what they were in March, and strip prices for this winter are around $3.30/'000 cf, the rig count is at the same level it was in the spring. Companies are likely trying to capture higher returns to help repair their balance sheets before deploying more investment-a sign that, for now, returns are more important than output growth.

Also bullish for gas has been strong demand from the power sector, where gas has become the fuel of choice for utilities, and new demand for pipeline exports to Mexico and liquefied natural gas shipments from Cheniere's new Sabine Pass plant. After the warmest summer on record across much of the US, power burn is up 4bn cf/d from last year, or around 15%, to 31.7bn cf/d. Exports through new pipelines into Mexico have averaged about 3.5bn cf/d, up around a quarter from last year. Shipments through Sabine Pass have averaged around 0.6bn cf/d this year.

Shrinking supply and surging demand have helped eat through a record storage glut built up last winter, though stocks are still running at the high end of the five-year average.

While the fundamentals paint a bullish picture for the near term, dangers lurk that could undercut prices. For one, higher natural gas costs could hit the fuel's price advantage over coal, which would dent demand. Prices differ from region to region and each plant has its own cost structure, but Henry Hub was more expensive than Central Appalachian Coal prices in June and July for the first time in more than a year, according to the Energy Information Administration. If prices remain at more than $3/'000 cf, natural gas could start to give up some of its gains in the power sector.

Supply is also a worry. While gas drilling activity remains muted, a buoyant oil sector lifted by higher crude prices is picking up the pace, and with higher oil output will come more associated gas volumes. The Permian basin, for instance-where oil drillers are piling in-is not just a prolific oil site, it is also a major gas producer, with output at around 6.9bn cf/d in September-about 40% of the Marcellus's output. And that figure is almost certainly headed higher in the months to come as new wells are brought online. Around 1.1bn cf/d of new gas processing infrastructure is expected to start up in 2016 and 2017 alone in anticipation of new associated gas production hitting the market. Volumes will pick up in the Bakken and Eagle Ford as well once oil drilling activity returns to those areas.

Still, America's gas industry looks to be on the up. Producers have shown that they are able to produce huge amounts of shale gas at prices much lower than people previously thought possible. Gas at $2 is probably not sustainable, but $3 gas-very cheap by historical standards-and $50-60-a-barrel oil should be enough to fuel production growth. That supply will underpin an emergent LNG-export industry, which should have around 7bn cf/d of capacity by 2020. It will also fill around 8bn cf/d of new pipelines carrying gas into Mexico. Closer to home, coal's protracted decline will continue to be a boon to the gas industry, though it will have to fight with an emboldened renewables industry for its share of the spoils.

Appalachian peak: shale gas production (bn cf/d). Source: EIA

 

Flow reversal: US gas imports and exports (bn cf/d). Source: EIA

This article is part of a report on US energy. Next article: The great transformation of US power

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