Front page article today in the WSJ “Glut Hits Natural Gas Prices”. With front month futures hitting $2.774/MMBtu (lowest front-month price since Sept. 2009, lowest winter since 2002), and Henry Hub cash at $2.808/MMbtu), the non-energy world is finally starting to absorb the magnitude of the shale overhang. Heck, this would have happened in 2010 and 2011 if weather had not saved the day. This year, no weather and no save.
Which begs the question: How low can you go? And the follow on – what will prevent the price from going lower?
First things first. Prices can go a lot lower. There are a lot of technical resistance levels that we’ll discuss here over the next few days. But from the perspective of fundamentals, there is a significant overhang of supply with little chance of a significant short term demand response. Production remains strong due to a myriad of factors: (a) producers are hedged at much higher prices, (b) producers with liquids rich gas can be profitable selling NGLs and essentially giving away the gas, (c) associated gas from crude oil production can also be a ‘throw away’ product at today’s crude prices, and (d) foreign investments in U.S. shale mostly include “carry” deals that require drilling and production with little or no consideration of price.
With no weather to speak of, one-handle prices (below $2.00/MMbtu) are not only possible, but likely in the upcoming months. Almost certainly on a sporadic basis. Possibly on a sustained basis.
So the second question. What will prevent price from going lower? The topic that always percolates to the top of the pile when gas prices get cheap is shut-in. Producers will simply shut their wells off until prices go back up, right?
No doubt we’ll be seeing press releases announcing shut-ins coming in the near future. Don’t believe it. Check what the companies announcing shut-ins are telling Wall Street about their prospects for production growth. Usually the same producers that announce shut-ins still predict increases in their production volumes. I call it ‘shut-in by press release’.
That is not to say that there won’t be some shut-ins. But they will be immaterial. Do the math. You can’t shut off a well today, and double up production tomorrow. So volumes shut in today won’t be produced until the end of the well life (or until the well is reworked). Present-worth economics get you every time. Discount the future price back and it is well below a breakeven compared with today’s prices. And BTW, sometimes shut-in can actually damage the well. Depends on the geology. Back in the early 1990’s when prices were below $1.00 and I was with Texaco, we never shut-in a cubic foot for economic purposes.
Back to our question, what will prevent price from going lower? It better be demand. A few years back, Bentek demand numbers indicated a spike when prices dropped below $2.00. So watch demand carefully as prices continue to fall. Only when a combination of fuel switching, storage hoarding and other market responses make a difference on the demand side will the slide come to a halt. Or a freezing cold, continent-wide weather event would do it. Stay tuned to the weather channel.