4
Gas Futures Prices Bullish he year 1996 is likely to mark a new record T price in the life of the NYMEX Henry Hub contract. Natural gas is in a major bull market in the face of low storage inventories, unusually cold winter weather, vibrant consumption growth, and an apparent decline in production deliverability.December 1995 marked the tran- sition as spot futures catapulted above $2.00 and exploded up to $3.72 a million BTUs. January 1996 futures settled at $3.45, February 1996 at $2.34,March at $2.84,and April at $2.78, shedding the bearish environment of the past two years. Exhibit 1 shows our price forecast for the 1996 average daily settlement of Henry Hub futures. Spot futures averaged $2.43 during the first 58 trading days of 1996, versus $2.05 in the fourth quarter of 1995 and compared to $1.50 in the first three quarters of 1995. The underlying fundamental framework sug- gests that futures for the summer and autumn injection months-June through October-are relatively undervalued. These contracts recently settled in the mid $2.20~ for June and the low $2.00~ for October. We are bullish, although expiration price highs on these injection months are unlikely to match those of the 1995-96 winter. Our conservativemodel suggestsupside potential to be $2.25-2.50 for the spring, $2.15-2.40 for the summer, and $2.00-2.25 for the autumn. We expect prices to trend higher into expiration with potential to burst through the upper end of these ranges, if spring temperatures are below normal or summer temperatures are above normal. We expect the price of residual fuel oil to serve as a floor during this period of strong natural gas prices. Demand is highly elastic and some customers are able to switch from fuel oil to natural gas, if natural gas suddenly becomes less expensive than fuel oil. In such a case, BTUs would revert back to natural gas. In late March, industrial grades of residual fuel oil (1-percent sulfur delivered to the US. Gulf) are near $2.70- 2.75 a million BTUs. Fuel oil could slip as low as $2.00-2.25 during the summer or autumn. Rita Beale There is minimal risk that oil prices will collapse in the second half of 1996 below this level, which is roughly equivalent to WTI crude near $14-15 a barrel. With such a floor, natural gas is likely to find excellent buying interest and fundamental support on any dip into the $1.80- 2.00 a million BTUs range through the end of October 1996. We expect the price of residual fuel oil to serve as a floor during this period of strong natural gas prices. For end users, we recommend buying these injection month contracts on price dips due to potential for price spikes and the expected difficulty of simultaneously meeting strong in- jection demand and rising consumption. It may also be tricky this year for short hedgers to establish long-term positions due to the under- lying bullish fundamental structure. Fundamental support is expected to emerge from the dual need to refill historically low work- ing gas storage and simultaneously meet vibrant consumption. Our 1996 consumptionforecast for growth of 315 billion cubic feet at 21.91 trillion cubic feet is conservative and on the low side of industry expectations. Stronger prices than our forecast are likely to emerge if U.S. natural gas production falls short of our forecasted growth of 712 billion cubic feet at 19.42 trillion cubic feet. Sharply higher production is required to meet both consumption and injections. Some slow- down in fuel substitution,especially in the second half of 1996, is also required to balance the market. High oil prices in early 1996 are forcing industrial end users to compete for scarce natural gas. Our monthly model presses storage injections to their ~~~ ~ ~ ~ Rita Beale is first vice president, sales, and energy analyst for FIMAT Futures USA, Inc., in Houston. MAY 1996 NATURAL GAS 0 1996 John Wiley & Sons, Inc. 17

Gas futures prices bullish

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Gas Futures Prices Bullish

he year 1996 is likely to mark a new record T price in the life of the NYMEX Henry Hub contract. Natural gas is in a major bull market in the face of low storage inventories, unusually cold winter weather, vibrant consumption growth, and an apparent decline in production deliverability. December 1995 marked the tran- sition as spot futures catapulted above $2.00 and exploded up to $3.72 a million BTUs. January 1996 futures settled at $3.45, February 1996 at $2.34, March at $2.84, and April at $2.78, shedding the bearish environment of the past two years. Exhibit 1 shows our price forecast for the 1996 average daily settlement of Henry Hub futures. Spot futures averaged $2.43 during the first 58 trading days of 1996, versus $2.05 in the fourth quarter of 1995 and compared to $1.50 in the first three quarters of 1995.

The underlying fundamental framework sug- gests that futures for the summer and autumn injection months-June through October-are relatively undervalued. These contracts recently settled in the mid $2.20~ for June and the low $2.00~ for October. We are bullish, although expiration price highs on these injection months are unlikely to match those of the 1995-96 winter. Our conservative model suggests upside potential to be $2.25-2.50 for the spring, $2.15-2.40 for the summer, and $2.00-2.25 for the autumn. We expect prices to trend higher into expiration with potential to burst through the upper end of these ranges, if spring temperatures are below normal or summer temperatures are above normal.

We expect the price of residual fuel oil to serve as a floor during this period of strong natural gas prices. Demand is highly elastic and some customers are able to switch from fuel oil to natural gas, if natural gas suddenly becomes less expensive than fuel oil. In such a case, BTUs would revert back to natural gas. In late March, industrial grades of residual fuel oil (1-percent sulfur delivered to the U S . Gulf) are near $2.70- 2.75 a million BTUs. Fuel oil could slip as low as $2.00-2.25 during the summer or autumn.

Rita Beale

There is minimal risk that oil prices will collapse in the second half of 1996 below this level, which is roughly equivalent to WTI crude near $14-15 a barrel. With such a floor, natural gas is likely to find excellent buying interest and fundamental support on any dip into the $1.80- 2.00 a million BTUs range through the end of October 1996.

We expect the price of residual fuel oil to serve as a

floor during this period of strong natural gas prices.

For end users, we recommend buying these injection month contracts on price dips due to potential for price spikes and the expected difficulty of simultaneously meeting strong in- jection demand and rising consumption. It may also be tricky this year for short hedgers to establish long-term positions due to the under- lying bullish fundamental structure.

Fundamental support is expected to emerge from the dual need to refill historically low work- ing gas storage and simultaneously meet vibrant consumption. Our 1996 consumption forecast for growth of 315 billion cubic feet at 21.91 trillion cubic feet is conservative and on the low side of industry expectations. Stronger prices than our forecast are likely to emerge if U.S. natural gas production falls short of our forecasted growth of 712 billion cubic feet at 19.42 trillion cubic feet. Sharply higher production is required to meet both consumption and injections. Some slow- down in fuel substitution, especially in the second half of 1996, is also required to balance the market. High oil prices in early 1996 are forcing industrial end users to compete for scarce natural gas. Our monthly model presses storage injections to their ~~~ ~ ~ ~

Rita Beale is first vice president, sales, and energy analyst for FIMAT Futures USA, Inc., in Houston.

MAY 1996 NATURAL GAS 0 1996 John Wiley & Sons, Inc.

17

Page 2: Gas futures prices bullish

maximum historical level for each of the months, April through October, and therefore calls on the U.S. industry to outperform all other years. Be- cause of the difficulty of meeting this demanding schedule, the odds are fairly high that the United States will begin the 1996-97 winter with less-than- comfortable working gas in storage.

1 Exhibit 1. NYMEX Natural Gas Futures for Henry Hub Delivery

A=mP--t

Storage Injections The heart of our bullish price forecast lies in

the need for exceptionally strong storage injec- tions from April through October 1996. Our monthly model for 1996 in Exhibit 2 illustrates that working gas storage could slip below 800 billion cubic feet by the end of March. In this scenario, minimal injections of 10.7 billion cubic feet a day are required to rebuild storage to the 3.09 trillion cubic feet level. Our projected injection range for the 1996 injection season is 10.7 billion cubic feet a day on the conservative

1993 1994 19951996f estimate and 12.1 billion cubic feet a day on the 1Q 1.78 2.23 1.48 2.35 2Q 2.23 2.05 1.53 2.15 34 2.22 1.76 1.57 2.05 4Q 2.20 1.73 2.05 2.00

Year 2.11 1.94 1.66 2.14

S o u m H h U T ~ @ .

upside. Record-high swing prices of the 1995-96 winter, up to $40 a million BTUs delivered into the eastern and midwestern market areas, could bias companies’ storage targets toward 100 percent of capacity. To reach 3.2-3.3 trillion cubic feet capacity, injection requirements rise to 11.3 to 11.7 billion cubic feet a day. Moreover,

I Exhibit 2. FIMAT Outlook for US. Natural Gas

1996-

Supply and Demand in 1996 (bCllion cubic feet)

19941995 J a n I k b M a r A p r M a y J r m JdAugSepOctNawDec1996f

U.S. -ption -Netimports yI7 2 ; ; g 2,;g a3g 42g 1 , g 1.5g 1 , z 1,;: 1,;g 1 s ; I,%&) 4% 2;rw -S~pplementalfuels 112 132 14 12 12 10 9 10 10 10 9 11 12 13 132 - ‘Balandng h” -264 -258 94 39 105 123 75 -20 35 -20 -25 -105 -131 -173 -3 +stwage,netchg. 305 -444 -668 -480 -210 220 430 375 385 345 350 185 -140 -470 322 - U.S. dry- 18,746 18,704 1,632 1,559 1,663 1,638 1,666 1,596 1,616 1,627 1,551 1,609 1,579 1,680 19,416

UdUlF-hdsQrrIEednt.,enb-mwth Total P 6,- 6,480 5,809 5,329 5,119 5,339 5,769 6,144 6,529 6,874 7,224 7,409 7,269 6,799 6,799 workingw 2,606 2,152 1,481 1,001 791 1,011 1,441 1,816 2,201 2,546 2,896 3,081 2,941 2,471 2,471 Total vs. prior year 317 -486 -584 -565 -561 -388 -279 -261 -99 49 106 94 219 319 319 Workingvs. priory= 284 -454 -553 -532 -534 -364 -221 -1% -102 46 103 87 215 319 319 Totalvs. 3yearavg. 277 -272 -326 -289 -286 -189 -137 -124 -56 6 49 64 113 101 101 Working vs. $year avg. 25 -356 -332 -308 -313 -211 -138 -118 -71 -8 33 65 119 111 111

-chnsc,-paioryerrr

- Supplemental fuels -7 18 0 0 0 1 1 - 1 0 0 0 0 0 0 0 0 0

U.S. COlWmptiOn 2.3 4.1 9.1 5.3 5.6 -1.1 -2.0 1.9 -0.8 4.1 0.8 5.3 -3.3 -2.9 1.5 - Net impolts 11.5 4.5 -9.3 7.6 -2.1 18.4 7.8 6.5 3.4 1.4 4.2 4.1 8.5 7.6 4.4

- ‘Balancing item” 140 -2 -300 44 94 35 0 100 136 -29 -19 -23 -6 34 -99 + storage, fm A g . 771 -246 15 -4 -2 368 34 8 32 80 19 4 -48 -17 -173 - U.S. dryjnudu&on 3.6 -0.2 0.7 7.6 4.9 5.6 4.0 3.3 3.4 5.1 3.4 2.1 2.7 3.4 3.8

Bcfc-4m-pzLMlrrpT

- supplemetrtal fuels -8 20 0 0 0 1 - 1 0 0 0 0 0 0 0 0

U.S. COIlSUmpCiOn 473 843 219 116 118 -19 -31 26 -12 -63 11 79 -63 -66 315 - Net imports 254 110 -22 15 -5 34 16 13 7 3 9 9 18 17 114

-‘Balancingitem” -154 6 141 12 51 32 0 -10 20 8 6 31 8 -44 255 +storase,fmchg. 270 -749 -89 21 5 173 110 28 93 153 55 -7 130 94 766 =U.S .drypduaion 651 4 2 11 110 77 87 64 51 54 79 51 32 41 55 712

S o u m e E W U O E N l l h i l l J G a s M o n l b t y . ~ T ~ ~ .

18 NATURAL GAS MAY 1996 0 1996 John Wiley 8 Sons, Inc.

Page 3: Gas futures prices bullish

injections of 12.1 billion cubic feet a day are required should working gas dip to 700 billion cubic feet by the end of March.

Over the past seven years, storage injections have aver- aged 8.3 billion cubic feet a day, as high as 10.2 billion cubic feet a day in 1994 and as low as 6.7 in 1991. Exhibit 3 illustrates our conservative storage forecast of 10.7 billion cubic feet a day. Our analysis maximizes storage injections at their highest rate for each of the spring and summer months over the past seven years. It will be tremendously difficult to meet or exceed the highest historical injection level for ev- ery month of the cycle, espe- cially in the face of firm oil prices. The implication is that working gas storage will not meet our minimum target of 3.09 trillion cubic feet on Octo- ber 31, 1996.

The American Gas Associa- tion (AGA) estimates that U.S. working gas stood at 668 bil- lion cubic feet on March 15, 1996. This level was 21 percent

I Exhibit 3. Underground N Injections and Withdrawa (billion cubic *met)

1- 1964 1990 1m- 1992-

Navember Dcoember -329 -752 -395 -W J==Y -365 -248 -545 -524

-570 -253 -285 -389 -256 -131 -162 -303

p- Madl Total Bpitbdrawals

TotllGas,cdMar~h 5,578 5.6% 5,805 5,591 5,233 WorkingGas, end-hhch 1,776 1,875 1,912 1,545 1,829

-Injedbns

Day -10.3 4 9 -9.2 -11.4 -13.8 -W5

43 4 3 1 2 4 1 8 1 Q 9 2 1 8 277 245 261 277 426 403

341 298 214 307 3!3Q 386 2%

A d MY June 355 285 272 323 Juty AuJFt

124 153 148 la6 153 170 192 190f 161 September oaober

Total Injections 1,749 1,555 1,435 1,718 2,084 2.186 1,686 2,295f 1,773 Per Day 8.2 7.3 6.7 8.0 9.7 10.2 7.9 10.7f 8.3 T d G a s , enM)ctober 7,061 7,319 7330 7,288 7,292 7,429 7,315 7,414f 7,291 Working Gas, end-odoba 3,268 3,467 3,369 3,223 2,978 3 , m 2,994 3 , a f 3,196

328 283 200 309 319 343 1% mi 248 216 298 353 324 m

of capacity with a storage deficit of 513 billion cubic feet versus 1995. Our model relies on data generated by the EIMDOE. At the end of January 1996, EINDOE working gas estimates were 147 billion cubic feet above AGA’s. Hence, our model estimates that working gas will be just below 800 billion cubic feet at the end of March. We expect AGA to make the necessary revisions to its data, probably during the spring.

U.S. Consumption Consumption growth accelerated in 1995 in

the face of strong U.S. economic performance, low gas prices, and hot summer temperatures. Further gains are expected in 1996 and 1997; however, the rate should slow considerably due to lower economic growth, oil and coal substi- tution by industrial and electric utility custom- ers, and normal temperatures in the final ten months of 1996. Our model assumes economic growth near 2.0 percent for real U.S. GDP,

following 2.9 percent growth in 1995. Exhibit 2 shows that U.S. consumption in

1996 is expected to grow about 1.5 percent or 315 billion cubic feet to 21.91 trillion cubic feet. This follows 1995 growth of 4.1 percent or 843 billion cubic feet. The rate may accelerate slight- ly in 1997 to 1.8 percent and 396 billion cubic feet, setting a new U S . record at 22.42 trillion cubic feet. The record stands at 22.10 trillion cubic feet in 1972. Our 1996 demand estimate is slightly below industry norms due to the greater perceived impact of fuel-switching away from natural gas.

Trends in the industrial sector are the most important and are primarily dependent on economic growth, relative fuel prices, cogen- eration, and nonutility generation. Our model assumes that growth in this sector decelerates to 2 percent and 170 billion cubic feet at 8.69 trillion cubic feet in 1996, compared to growth of 4.2 percent and 342 billion cubic feet in 1995.

MAY 1996 NATURAL G A S 0 1996 John Wiley 8 Sons, Inc.

19

Page 4: Gas futures prices bullish

Natural gas had a competitive advantage for most of 1995 until late in the year. Conse- quently, its market share in the industrial sector surged to 48 percent during the first three quarters of 1995. We expect many industrial end users to switch out of natural gas during 1996 and into residual fuel oil or coal. This will be due to uncompetitive natural gas prices and a weak- ening of oil prices in the second half of 1996.

Consumption by the second largest sector, residential and commercial, is more sensitive to weather variability. In 1995, U S . heating degree days finished 2 percent above 1994 and 1 percent below normal; cooling degree days finished 4 percent above 1994 and 10 percent above normal. New customer additions are expected to continue at a rate of 1.1 million a year for residential units and 230,000 for com- mercial units. The upward trend is being sus- tained by the availability of high-efficiency appliances and the ongoing U S . economic expansion.

Our model assumes that combined residen- tial and commercial usage reaches 8.00 trillion cubic feet in 1996, up 0.9 percent and 64 billion cubic feet over 1995. This assumes normal temperatures in the final nine months of the year. In 1995 the residential sector was flat, down 0.1 percent and 5 billion cubic feet. The commercial sector rose 6.9 percent and 201 billion cubic feet, for a combined gain of 2.5 percent and 196 billion cubic feet.

Natural gas consumption by electric utilities slowed to 7 percent and 207 billion cubic feet at 3.19 trillion cubic feet in 1995, compared to the ll-percent rate of 1994. The utility sector is expected to further decelerate to 2-percent growth and 64 billion cubic feet in 1996 as petroleum, hydroelectric power, and coal re- gain market share. Total U S . electricity produc- tion grew by 3 percent in 1995 and is expected to grow about 2 percent in 1996. Much of the gain of natural gas in the utility sector over the past two years has been at the expense of residual fuel oil.

U.S. Production Our forecast for firm prices is expected to

translate into an increase in productive capacity, especially in the U.S. Gulf, as producers pursue more aggressive supply development. Produc- ers are likely to finally connect new wellhead

production deliverability. This built up over the past two years when prices were soft. They will connect it to onshore pipelines for production and to accelerate extension drilling and mainte- nance programs to increase flow rates from existing wells and fields. Development projects that were deferred in 1995 are also likely to be completed in 1996 on the back of greater price optimism. Gas associated with new deepwater oil fields is also scheduled to come on line in late 1996 and 1997. This production activity could pose a risk to prices later in 1996 if working gas storage injections are unexpectedly near target.

The U.S. oil and gas industry plans to increase exploration and production budgets for 1996 by 11.8 percent to $18.2 billion com- pared to an advance of 4.7 percent in 1995, according to Salomon Brothers Inc.’s annual survey. Majors will lead with a planned increase of 13.4 percent, while independents plan an advance of 9.3 percent. In Canada, operators will cut 1996 exploration and production out- lays by 6.4 percent, compared to the 4.4 percent cut for 1995. Respondents assumed an annual average price of $1.75 for Henry Hub gas and $17.48 for WTI crude.

Preliminary data for 1995 indicate that U.S. dry gas production declined 0.2 percent or 42 billion cubic feet (Exhibit 2). New data hint also to a possible decline in U.S. deliverability over the past two years. Strong cash prices are expected to translate into higher output. How- ever, dry gas production only reached 1,632 billion cubic feet in January 1996, 11 billion cubic feet above January 1995, and 41 billion cubic feet below January 1994. More data are needed to confirm this trend, although a loss in deliverability would make it difficult to meet our 1996 forecast.

A dramatic decline in the number of new gas well completions for two consecutive years helped cap production in 1995. Well comple- tions fell sharply by, 1,707 to 7,189 in 1995, after a decline of 906 to 8,896 in 1994, and compared to the brief resurgence of 9,802 wells in 1993. Gas drilling activity began to pick up in the second half of 1995, holding in the 400 to 430 range, and above 400 in January and February, compared to an average of 385 rigs in 1995,427 in 1994, and 364 in 1993. Oil rigs continued their secular decline in 1995, falling by 12 to 323, versus 335 in 1994, and 373 in 1993.

20 NATURAL GAS MAY 1996 0 1996 John Wiley & Sons, Inc.