Monday, December 21, 2015

Natural Gas: "...What It Will Take to Balance the Gas Market in 2016"

January futures 1.909 +0.142 up 8.0%.
February's         1.992 +0.123 up 6.6%

From RBN Energy:
The U.S. natural gas market is facing an ultimatum. Natural gas storage inventories are carrying such a daunting surplus, that prices already at 21-year lows for December, seem primed to go even lower should supply or demand fail to cooperate and balance the market. A warm winter so far and the very real prospect of hitting a storage celling before next winter mean that something has to give.  Today we wrap up our series on the gas supply/demand balance with a look forward to how 2016 could pan out.

In Part 1, we showed how drilling productivity gains kept production volumes firm in 2015 in spite of substantial headwinds from lower oil and gas prices, drilling budget cuts and falling rig counts. Producers this year decreased drilling times and drilled more wells for every operating rig. Average initial production (IP – typically the output in the first 30 days) rates climbed, as did IP additions per rig per year. For instance, EOG Resources this year drilled wells in one-third the time it took in 2011, drilled three times more wells per rig each year, and produced double the volume from each well in its first 30 days. And all of that translated to five times more volume produced for every rig than in 2011. So while fewer rigs were operating, those that were operating were much more prolific than they were in 2011 or even a year ago. Using data from the Energy Information Administration’s Drilling Productivity Report, we then looked at average production per rig for entire basins, and found that EOG’s productivity gains are no exception. Productivity improvements have been occurring in varying degrees across all the major shale basins, and for both oil and gas rigs.

In Part 2 we showed the impact these productivity gains have had on drilling costs and producers’ internal rates of return (IRR). For instance, a sampling of producers’ investor presentations showed that drilling and completion costs (D&C) had come down an average 25% versus 2014 across five major shale production regions (Anadarko, Permian, Eagle Ford, Bakken and Utica) as of 3Q2015.

When we factored in that 25% reduction in D&C costs at early December prices ($40/Bbl oil and $2.10/MMBtu gas), our IRR model results for representative wells indicated that producers could eke out minimal but positive returns in some areas. We then considered the scenario that drilling costs continued falling since Q3 another 15%, down a total of 40% versus 2014 levels, and a remarkable thing happened:  IRRs, particularly in the Northeast dry gas plays, began to come close to 2014 levels when prices were much higher.  These types of productivity gains and drilling cost reductions are what have kept the production volumes resilient in 2015.

Winter No Show
The catch, as we mentioned last time, is that if producers take that as a cue to keep on producing and demand does not keep pace, then the price pressure will only intensify. The market has had a front seat to that show over the past month. Production hasn’t grown much in some months but it hasn’t given up much ground either. Meanwhile, gas demand has been a no-show. While lower gas prices are stoking gas demand higher on a per-degree basis (demand per degree Fahrenheit is running higher than in the past), the uplift from that has not been nearly enough to offset the effects of mild weather on heating demand. As a result, gas prices have fallen over the past few weeks to 21-year lows. As of last Friday, the CME/NYMEX Henry Hub January futures contract settled at $1.767/MMBtu, the lowest settle for trading in December since 1994.

But this dynamic can only go on so long. Even if drilling cost reductions can keep pace with the falling commodity prices and prop up IRRs, the gas market could now be approaching another constraint for supply:  gas storage capacity.

Storage Ceiling?
Total U.S. storage inventory reached an all-time record high of 4,009 Bcf on November 20, 2015, and has been racking up an ever-growing surplus versus year-ago and five-year average levels ever since because warmer weather so far this winter has meant lower withdrawals than usual. The latest Energy Information Administration (EIA) weekly storage report for the week ended Dec. 11 showed inventories at 3,846 Bcf, 541 Bcf higher than last year, and weather forecasts suggest that could keep growing over the next few weeks to over 600 Bcf. If the market were to carry that surplus forward, inventories would theoretically be upwards of 4,500 by November 1, 2016. However, that can’t happen realistically because the known physical capacity limit for storage is lower than 4,500 Bcf.

True, the total working gas design capacity for U.S. storage is around 4,665 Bcf, according to the EIA. But if you take the highest observed inventory level for each individual storage facility as reported to the EIA over the last five years and add them all up, it comes to a total of only 4,336 Bcf. That number represents the demonstrated maximum working gas storage capacity in the U.S.

However, those facility-specific peak inventory levels are non-coinciding, meaning they have never before all peaked simultaneously in order to reach that total. So in reality the actual demonstrated storage capacity is much less than 4,336 Bcf. In other words if the current surplus of production (supply) over demand continues we would hit the theoretical storage “ceiling” sometime before next winter.  That is pretty unlikely.  In reality, the market will  find some other way to balance apart from storage.

2016 Scenarios
To find out how that might pan out next year we ran some storage scenarios at various demand levels to shed light on what it will take for the market to balance in 2016.

Figure 1 below shows total U.S. natural gas market historical storage through December 11, 2015 (blue line) together with estimated storage inventory levels through the end of 2016 (dashed lines) under various demand scenarios and assuming that Lower-48 production stays at about 72 Bcf/d and no LNG exports materialize in 2016. The 2015 inventory peaked at an all-time high of 4,009 Bcf (marked by the black straight line) and currently stands at 3,846 Bcf as of the week ended Dec. 11, which is above the previous 5-year range (gray shaded area). The red straight line across the graph marks the demonstrated maximum storage capacity mentioned above of 4,336 Bcf.

To project inventories forward through November 1, 2016, we used historical supply/demand data from PointLogic Energy to select proxy years to represent high and low demand cases for the balance of winter 15-16 and summer 2016. Demand in these cases includes consumption from the power, industrial and residential/commercial sectors, as well as exports to Mexico, but does not include storage activity.

For the balance of winter demand (bal winter – today through March 2016), we built two scenarios:  a high-demand case using the record demand from the “Polar Vortex” winter of 2013-14; and a mild demand case using the previous winter 2012-13 demand, which was warmer....MORE
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