US natural gas prices may average $3.90/mmBtu in 2013 from previously estimated $3.75/MMBtu, stated New York based Bank of America Merrill Lynch in its recent commodity weekly.“With inventories now one third lower than last year, we raise our 2Q and 3Q price forecasts to $4 and $3.80/MMBtu from $3.40 and $3.70/MMBtu, respectively, while leaving our 4Q forecast at $4.30/MMBtu,” it added. “We leave our CAL 14 forecast of $4.20/MMBtu unchanged.”
Thanks in part to extremely cold weather and surprisingly strong late winter demand, the US natural gas market has rebalanced rapidly. After a chilly January and February, weather in March was the coldest in 12 years, 21% colder than last year.
As a result, natural gas demand in 1Q13 increased by 2.5 bcf/d above normal because of cold weather. Inventories cumulatively drew by 1,844 bcf this year, which makes it the largest draw in a decade, and over 400 bcf higher than the average draw experienced in the last 10 years.
The spring carryout at the start of April all of a sudden stood at 1.673 tcf, below the 2 tcf that the bank had expected a few months ago, and inventories slipped into a deficit to the 5-year average. With stocks drawing into early April, marking the latest start to an injection season in 11 years, the storage deficit widened to 74 bcf or 4.2%. All in all, the US natural gas market has normalised at surprising speed before the summer.
The elimination of the storage glut catapulted prices into a higher range. Front month natural gas prices broke through $4/MMBtu at the end of March and subsequently through $4.40/MMBtu, before settling back at $4.20, a 21-month high.
Year to date, US natural gas is the best performer among major commodities, up more than 30%. Interestingly, the last time prices settled above $4/MMBtu was in September 2011 which also coincided with the last time that inventories were at a 5-year deficit.
From a fundamental perspective, the move higher seems justified, underscored by a simple regression of near-dated prices on the inventory glut/deficit
According to the bank's attribution analysis, 60% of this year’s 400 bcf excess stock draw down can be traced back to cold weather. The remaining 40% can be attributed to tighter underlying fundamentals, in particular falling production and rising industrial demand, while at the margin nuclear outages also helped.
After 20 months of subdued near-dated gas pricing below the marginal cost of production, which the bank put at $4.30/MMBtu, the market has finally started to rebalance.
No doubt, the elimination of the storage glut will require some reversal in coal-to-gas switching, a prime cause of depressed natural gas prices in the past.
This marks a significant shift in sentiment from 12 months ago when high levels of coal-to-gas switching were needed to ensure October 2012 inventories did not exceed storage capacity.
“Why are we not raising our prices even higher for this summer? While inventories are lower than expected, they are still at the 4th highest level on record. Therefore, the need for coal-to-gas switching has fallen but has not been eliminated,” BofAML noted.
“In our view, a key risk stems from reversing coal-to-gas switching in power generation too sharply as some coal substitution is still required to balance the market. We expect front-month prices to slip back to $3.50/MMBtu in the summer months as coal substitution remains an important price driver this summer,” it concluded.
Source: Bank of America Merrill Lynch