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Gas Production, Prices Poised for Rebound, Says Latest PointLogic Forecast

October 13, 2016 | By Kevin Adler

U.S. gas production has been sharply down in October, settling in range close to 70.5 Bcf/d for most of the month so far. This compares with 71.9 Bcf/d in September and 72.9 in both August and July, and with 73.1 Bcf/d for October 2015.

Does this reduction represent the long-awaited pullback in production that will bring equilibrium to a market where the producers seemed to never say quit? Or is it a temporary lull that soon will vanish as stronger forces encourage more production?

In this edition of Get the Point, we provide an answer through the PointLogic Winter 2016/17 Supply and Demand Outlook. PointLogic is optimistic about near-term demand, cautious about production and encouraged that prices will strengthen. The analysis in this Get the Point is a high-level summary of the deep dive into winter 2016/17 and the 12 months beyond that is being presented at our Natural Gas Next workshops.

Our workshop was presented last week in New York City, and it will be presented in Houston on Oct. 19, and in Washington, D.C. on Nov. 16. For an agenda and registration information, go to Natural Gas Next agenda.

Promising Horizon

The shale gas boom has led to a market condition that we and others have called a “supply push” phenomenon. In a supply push, rapidly rising supply created market opportunities for increased use of natural gas, particularly in power generation, but also in the industrial sector as the U.S. economy has rebounded from the economic crisis. The buildup of new pipeline networks and the expansions and/or flow reversals of others have been major outcomes of the supply push period.

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Today and looking ahead, we see several factors lining up to create a new dynamic: a “demand pull” in which the established supply of gas – and the confidence that more gas at reasonable prices will be available – is leading the way. The demand drivers include rising exports of gas to Mexico and LNG worldwide, gains in residential-commercial and industrial demand this winter, and a likely continuation of strong power burn next summer.

How these factors interact in the next 12-18 months will determine prices for gas and will influence where and how the next wave of investment in the industry will be directed.

Let’s begin by taking a step back a few months. The summer 2016 season started with record gas inventories for that time of year: 2,496 Bcf on April 1, 2016. This was 1,016 Bcf ahead of the same date the prior year.

Record power burn in the 2016 summer helped to bring down gas inventories by nearly 1 Tcf from where they were at the beginning of the summer injection season. PointLogic sees more of the same happening this winter (season begins on Nov. 1), with the res-com sector rising by 3.8 Bcf/d above last year, if temperatures return to their 8-year average.

Overall, we estimate total U.S. demand will be 5.1 Bcf/d above last winter (see graph).

Winter 2016/17 vs. Winter 2015/16 (Bcf/d)

Source: PointLogic Energy

Supply this winter will likely lag behind last year, thus continuing the tightening of inventory levels. PointLogic anticipates that the recently observed decline in domestic dry gas production will continue through the winter, dropping by about 0.6 Bcf/d from last year’s levels for the same time period. Some of the production decline will be offset by gains in imports from Canada (0.6 Bcf/d).

With demand outpacing supply and storage tightening, prices could benefit – and perhaps by more than is expected. Using the CME futures market’s close on Oct. 12, traders see gas just below $3.21/MMBtu for November delivery and a winter peak at $3.52-$3.53/MMBtu for January and February 2017 deliveries, then a dip down to just below $3.23/MMBtu for April 2017.

PointLogic is more optimistic. We see the potential for prices that could be 10 to 20 cents higher (see red line in graph below). For a producer that has not yet sold all its production forward, waiting a while to see if prices rise might be a good course of action.

NYMEX Forward Curve vs PLE Forecast

Source: CME & PointLogic Energy

Gas Production

In the short run, gas production will decline. But eventually, steady or rising prices and rising demand should do what markets always do: incentivize higher production.

What’s interesting is how we will get there. To date, gas production has been surprisingly resilient, as even the loss of a few billion cubic feet per day in the last year is small, compared to expectations. It’s been a story of drillers doing more with less: Rigs are down 70% since January 2015, but production has held steady.

But the ways that production was maintained – improved technology, focus on the best wells in the strongest plays, and working off the inventory of drilled and uncompleted wells (DUCs) – can’t continue indefinitely. In fact, the recent production numbers reinforce that viewpoint. We are perhaps seeing the producers finally running out of the best wells in the best plays, and DUCs have clearly peaked. Producers are finding fewer opportunities in which their activity is profitable under current market conditions.

But, as noted above, new forces are creating a demand pull, and drilling will have to be increased to meet it. We see three paths as the most likely for increased production in the next one to two years: more activity in the Marcellus and Utica Shales; more associated gas from the Permian Basin; and a return to dry gas production in the Haynesville Shale.

The Marcellus and Utica are well-known for producing rapidly rising volumes of gas. But the magnitude of the increase bears repeating: They accounted for 5.1 Bcf/d of gas in September 2011, but surged to 18.7 Bcf/d in April 2015.

Production has continued to grow in the last year-and-a-half, but at a slower rate. As gas prices fell sharply in 2015, producers curtailed some activity, and Marcellus and Utica production in September 2016 was 21.3 Bcf/d. It’s impressive that the regions still added 2.6 Bcf/d of production since April 2015, as it came at a time when the rest of gas producing world cut back by 4.3 Bcf/d. In short, Marcellus-Utica is growing, but it hasn’t been enough to offset the losses in the rest of the country.

Yet, new takeaway capacity is coming online this winter and in the next two years to serve the Marcellus and Utica. As a result, Northeast producers will finally have the ability to move more gas – and PointLogic believes they will respond. In particular, they will be able to capture more share of the Midwest market and are being relied on to supply Gulf Coast power demand and LNG exports.

The scale of pipeline construction in the Northeast is immense. About 2.5 Bcf/d of pipeline projects to move gas out of the Northeast producing areas are due to come in service by the end of 2016, and that’s dwarfed by projects that could come online in 2017 (11.9 Bcf/d of takeaway capacity) and 2018 (10.2 Bcf/d).

Even though all projects probably won’t be finished at their targeted times, by November 2017, sufficient outflow capacity may exist to overtake production (see graph).

Escape Routes from the Appalachia

Source: PointLogic Energy

On a much smaller scale, two other regions could deliver increased amounts of gas in the next year or two. The first is the Permian, where the return of oil drilling is increasing gas production in the form of associated gas. To date, the Eagle Ford has not joined in the rebound, but if oil prices reach into the mid-$50s per barrel for a sustained period, then Eagle Ford production would likely return, and it would bring more gas production with it.

The third source of new gas is the Haynesville. This producing area has some strong competitive edges, such as proximity to the LNG plants that will be coming online and the growing Southeast U.S. power markets. The wells also have high initial production rates.

At sub-$3.00/MMBtu gas, the Haynesville is only attractive for producers with top-tier acreage. However, at $3.50 or $4.00, it is attractive for others in various segments of the play. If the U.S. experiences the anticipated growth in gas demand and the Eagle Ford doesn’t come back, the market needs Haynesville to balance when the new demand pull shows its full effects.

The bottom line: PointLogic's winter 2016/17 winter forecast sees rising demand in the near term, which could lead to increased production in the future.

Join us on Oct. 19 in Houston or Nov. 16 in Washington, D.C. for a full presentation of our forecast for winter 2016/17 and the year ahead in our Natural Gas Next workshop. We will not only cover our supply and demand forecast in depth, but we will review export projections, inventory balances and look closely at the pipeline projects coming online to move gas from the Marcellus and Utica.

The Natural Gas Next agenda and registration information can be found here.

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