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US gas bulls beware

US gas production has been stronger than expected. The market will be hoping for a scorching summer and a quick ramp up of LNG facilities

The market has turned against US gas price bulls, again. Production is rising again from key shale plays. The power burn is lower than it was last year. Stocks remain near their five-year highs thanks to a relatively mild summer. New export capacity ramping up in the second half of the year will soak up some of the glut, but the market's focus is likely to remain fixed on the healthy supply side of the ledger.

The Appalachian Marcellus and Utica shale plays have led the output recovery. Combined production from the two prolific shale plays topped 24bn cubic feet a day for the first time ever in July, close to a third of total US gas output, after growth stalled in 2016. Production from the region is running nearly 10% higher than a year ago.

Signs of resurgent Appalachian shale gas output snuffed out the latest run-up in prices. Henry Hub rose sharply in the second quarter, up 35% from a trough of $2.56 per 1,000 cubic feet to $3.40/'000 cf in May. Prices fell back to around $2.75/'000 cf in early August.

Production momentum should continue over the second half of the year, and beyond. The rig count is up and gas producers are still improving their completion techniques, squeezing more from each well. But crucial to growth is the start-up of long-awaited new pipelines in the northeast. Some 2.5bn cf/d of new pipeline capacity in and around the Marcellus and Utica plays is due online this year, and the 3.25 bn cf/d Rover pipeline, if it is able to overcome its regulatory hurdles, will be among the projects adding further capacity in 2018. Send out capacity from the Marcellus and Utica shales will rise steadily to around 35bn cf/d by 2020, up nearly 60% from today, according to projections from Bernstein, an investment bank.

The new pipelines will be a boon to Appalachian producers, allowing for a new era of growth. On top of removing a physical constraint on growth, the pipelines should lift prices for northeast producers, even if more supply is bearish for Henry Hub prices. Marcellus and Utica gas has sold at a steep discount to Henry Hub in recent years because it has been effectively trapped in a glutted local market. At certain points, northeast price hubs have traded at less than half Henry Hub and have fallen to as low as $1/'000 cf. But the new pipelines will expand the links between Marcellus and Utica producers and markets in the Gulf Coast, Midwest and Canadian markets. With producers gaining more options, northeast prices will have to rise to converge with these other markets to keep gas in the region. So even if Henry Hub prices fall on rising northeast output, those producers will be seeing rising realised prices.

It isn't just the mighty Marcellus and Utica shales that are driving growth, though. Associated gas production from areas that have enjoyed more oil drilling is also on the rise, especially from the Permian. America's largest oilfield is also emerging as a gas stalwart. The Permian is already responsible for more than 10% of US gas output at 8.6bn cf/d, and is growing fast. Permian output over the first eight months of this year is 17% higher than it was over the same period in 2016. The Permian looks set to break through 10bn cf/d in early 2019.

All hail the Haynesville

Perhaps most surprising for gas markets has been the revival of the Haynesville shale play. Output from the region had collapsed by nearly half from a peak of nearly 11bn cf/d in late 2011 to 5.7bn cf/d by the end of 2016. But the play's ideal location near new liquefied natural gas export hubs along the Gulf Coast and pipelines to Mexico, along with improvements in fracking techniques, has seen a resurgence of activity in the once-forgotten area. Output is up 1bn cf/d, nearly 20%, in just the first eight months of the year.

The Marcellus, Utica, Permian and Haynesville plays alone have added 3.5bn cf/d of output already this year—a roughly 5% boost to supply.

With a healthier than expected supply side of the market, they have been counting on strong demand to pick up the slack. So far, they've been disappointed. A relatively mild summer across the US, combined with increased competition from cheap coal and rising renewables, has seen demand for gas slip in the power sector. A scorching August would bring much needed relief to gas markets.

Key in the second half of the year will be the start-up of new LNG-export capacity. Trains three and four of Cheniere Energy's Sabine Pass facility will start ramping up over the second half of 2017, with combined capacity to suck up 1.16bn cf/d. The smaller Cove Point facility in Maryland in the northeast will also start up later in the year, though it won't start to take in significant volumes until 2018. The market will be watching these facilities closely to see how much of their capacity they are using. A glutted global gas market risks much of that capacity sitting idle.

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