- Price forecast Henry Hub revised down as a result of high inventories and disappointing demand
- Gas production cut in the Netherlands, but no effect yet on existing production caps
- TTF gas prices lower in the coming months, but political uncertainties create upward risks
Henry Hub gas prices revised down
As a result of the mild winter and record US inventories of natural gas (Henry Hub), gas prices have dropped to levels around USD 2.50/mmBtu. This is extremely low for this time of year. As illustrated in Figure 1, one year ago US gas prices were trading some 45% higher, which was already low from a historic perspective. Nevertheless, since shale technology boosted US crude production, prices more frequently trade at low levels. In 2012, the Henry Hub price even dropped below USD 2/mmBtu. This, too, was the result of a combination of weak demand and high supply. The price collapse led to a huge drop in the number of gas rigs. We see a similar trend today with US oil rigs. As is clear from Figure 2, the number of rigs normally follows the same pattern as prices. After the record low price in 2012, Henry Hub gas prices tripled. Due to speculation, prices dropped too far, and this decline was followed by a technical correction higher. However, this upward price correction was not followed by a recovery of the number of rigs. In fact, the number of gas rigs reached a record low last week. Apparently, gas prices were not high enough to trigger new investments.
Another possibility is that it was not necessary to increase the number of gas rigs since gas production increased anyway as a result of ‘by production’ with oil production. Only time will tell whether this low number of gas rigs will prove to be the absolute minimum. What is clear, however, is that with prices below USD 2.50/mmBtu, production is not profitable. The main question is whether this trend will continue now that the number of oil rigs has more than halved and the first signs are surfacing that oil production could also be hurt by the low oil prices.
As a result of the high inventories, high production and weak demand, we lowered our Henry Hub gas price projections. Our expectation of an increase in the gas price took longer than expected to materialise due to mild weather conditions. This led to lower-than-expected demand, and the extra by-production with shale oil production meant supplies remained much higher than expected. In Q1 2015, the average US Henry Hub gas price was USD 2.81/mmBtu. For the second quarter, we expect a similar price. We do foresee a price recovery in the second half of the year due to the decline in US crude production. The average Henry hub gas price is expected to be around USD 3.00/mmBtu in 2015, and USD 3.50/mmBtu in 2016 (table 1).
Gas production in the Netherlands under further pressure
Recently, the Dutch High Court cut back gas production around Loppersum (Groningen) to almost zero. The decision is seen anticipating the examination of further procedures in September. According to the order of the High Court, gas production in Loppersum is only allowed when security of delivery comes into play, in addition to the gas production which is needed to keep the clusters open. The judge did not find it necessary to completely close down gas production in Groningen. Minister Kamp (economic affairs) responded by immediately cutting back the gas production in Loppersum in compliance with the decision.
The mild winter, and thus the weak demand for gas in the first quarter, enabled implementation of the lower production for H1 2015. At an earlier stage, Minister Kamp had already lowered the H1 2015 production cap to 16.5 bcm. Around 1 July, the minister will set the production cap for full-year 2015. For now, however, the production cap is set at 39.4 bcm. The High Court decision is aligned with the lower cap on gas production in H1 2015 but, for now, does not further limit the full 2015 production levels.
The effect on the TTF gas price was limited to some increased volatility without resulting in strong price rallies. The Dutch (and other European) gas inventories are well filled after the mild winter and the mild spring weather is resulting in weak demand, allowing the gas inventories to be restocked. Although some production has been cut back due to seasonal maintenance, increased LNG (liquefied natural gas) is dampening the effects. This increases the chances of a repeat of last year’s scenario when gas prices came under pressure during the first half of the year (Figure 3) and is the main reason we expect the TTF gas price to decline over the coming months (Table 1). Upside risks still remain and are primarily focused on the political uncertainty surrounding the Dutch gas production cap (decision in July), and the ongoing tense relations with Europe’s top gas supplier, Russia.
United States as the new oil swing producer?
The role of non-OPEC countries, like the US and Canada, is steadily increasing and this is leading to a loss of market share for OPEC countries. By focusing more on market share, Saudi Arabia has essentially let go of its role as the world’s swing producer. From now on, it is up to the market to set prices and find a balance. For the moment, Saudi Arabia is unwilling to lower its production to create more (price and volume) stability, while the US is progressively seen as the new swing producer. Several large international banks, energy companies and even former Fed president Alan Greenspan believe that US shale oil will be used to stabilise the market. In our view, this is an unlikely scenario.
A typical feature of swing producers is a willingness to stabilise the market by adjusting production levels. This stabilisation does not have to come from the price, but can also be in the form of stable (global) oil production. For decades, Saudi Arabia – together with the United Arab Emirates – adjusted its level of oil production to create such a stable market. To be able to do this, an oil supplier must have reserves which can be put into production rapidly, if needed. This could be the case, for instance, if demand rises (resulting in higher prices) or if supply is unexpectedly impacted in other regions/countries. However, even more important is the need to balance the market in case of oversupply. An oil swing producer must be willing to produce below its maximum production capacity to create stability.
This last factor is exactly what seems very unlikely in the case of US oil producers. After all, shale oil wells are quickly depleted. About 80% of the oil is produced within two years. This means investment needs to be high to find new wells and keep up production, as well as production growth. US oil production is mainly concentrated among relatively small companies, which are heavily financed because of the high need for investment. Due to the low oil price, many such investments are under pressure. These small companies need to keep production at maximum capacity in order to meet their instalments and to get new funding. An advantage of the low oil price is that these companies are taking a critical look at the cost of production and starting to focus more on innovation. A good example is the increased production efficiency per well. This has risen significantly over the past few months. Given these reasons, it seems unlikely that the US, or more accurately the small companies within the US, will produce below their maximum production capacity to balance the oversupply in the market.
Still, this does not automatically completely rule out this possibility in future. If some of the smaller companies go bankrupt they will be taken over by larger, more liquid, oil producers. As a result, production may be cut back or even shut down, leading to ‘storage’ of these shale oil reserves and a sort of reserve capacity. In theory, this could be used as a flexible production buffer. Nevertheless, it seems likely that, if production is restarted again, it will be at full speed in order to boost the company’s cash flows and profits rather than used as a flexible production buffer to stabilise the world market. We believe that, as soon as the market has stabilised, the OPEC (read Saudi Arabia) will resume its role as the global swing producer. Although this could take many years, the rise of oil demand in emerging countries in Asia (China, India) must ultimately be balanced by increased production in the Middle East.