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Natural Gas Prices Poised to Go Higher

Natural gas prices remain cheap, but speculative forces, coal switching and cooler weather should stem near-term selling and lead to a recovery over the coming weeks.

"We would expect natural gas prices to recover quite quickly, potentially reaching $4.50 per million British thermal units by the end of the month, with the chance of slightly higher prices in January if temperatures were to fall below seasonal norms," says Nic Brown, head of commodity research at Natixis.

Prices have been trading at around $3.50 per unit, reflecting the soaring storage build to about 3.85 trillion cubic feet thanks to more moderate temperatures and heating demand in November.

Brown says it won't require a sharp cold snap to put a dent in recent stockpile builds. Even a milder decline in temperatures during the winter months of December and January could increase demand to the point of exceeding supply. Once this occurs, natural gas prices can no longer be held back by storage capacity, allowing for a recovery in the January and February futures contracts.

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"Winter heating demand is inevitable as absolute temperatures fall -- even though they may remain above average," says Summit Energy commodity analyst Eric Bickel. "This seasonal dynamic should bring demand back into the market and provide some support to U.S. natural gas prices."

Brown says his $4.50 target represents the lower-end of a recent trading range, and therefore shouldn't be too difficult to achieve.

The recent, steady decline in natural gas rig counts has also been fueling expectations of a stockpile reduction.

Last week's Baker Hughes' (BHI) rig count report showed that the number of natural gas-focused rigs in the lower 48 states fell for the fifth consecutive week, down 9 rigs, to 856 active natural gas rigs. Over the last 5 weeks, the gas rig count has decreased by 78 rigs.

According to data from Smith Bits, two of the net rig losses last week were in the Haynesville Shale area in Arkansas, Northwest Louisiana and East Texas, where drilling activity has fallen below 100 rigs for the first time since 2009. Since peaking in mid-2010, the Haynesville rig count has fallen, with producers moving away from dry-gas drilling towards liquids-based targets.

"We have seen natural gas rigs drop more steeply than they have in the last year," MLV oil and gas analyst Kim Pacanovsky confirms.

Shale gas well freeze-offs that may occur in Texas during sub-freezing winter periods could also put a dent in inventories and give natural gas prices a lift. Between the Permian Basin in West Texas and the Eagle Ford shale in South Texas, about 4 billion cubic feet a day of natural gas is produced, says WeatherBell Analytics's energy analyst Alan Lammey.

"The dropping natural gas rig count is real," he added.

Lammey expects natural gas prices to hit $3.70 soon. If they can hold at the level, prices might then be able to test the $4 to $4.25 area well before the expiration of the January contract late this month.

Even without the seasonal catalysts, natural gas prices will still be receiving support from price-driven coal to natural gas switching in the power sector and speculative forces. This should consistently keep prices from dropping below $2.50, according to analysts.

"Once you get materially below $3.50 per million British thermal units or so, it becomes increasingly economical for generators -- especially those purchasing coal on a spot basis, and therefore free of contractual restrictions -- to increase their reliance on natural gas compared to coal," says Peter Buchanan, a senior economist and commodity analyst at CIBC World Markets. He says this is one of the main factors preventing natural gas prices from falling further a time of abundant supply.

For the last 18 years, there hasn't been a single day where natural gas prices have settled below $2.50 -- and it is this very trend line that discourages traders from taking short positions below $3, says Nymex floor trader Ray Carbone of Paramount Options.

"What is your reward for getting short below $3?" he says. "Well, for the last 18 years, not more than 50 cents. It's a lot of more on the upside that you can lose. You have reluctance to sell below the $3 level for that particular reason -- the strength of that trend line."

Goldman Sachs analysts say that natural gas prices could soar above coal prices beyond 2013 and be closer to oil prices, if clean air rules such as the Maximum Achievable Control Technology and Cross-State Air Pollution Rule are fully implemented. The analysts have a 2013 price forecast of $4.25.

They've lowered their 2012 forecast to $3.70 from $4.25 due to their expectations of stronger U.S. shale production growth.

Buchanan of CIBC on the other hand expects prices to rise above $4 in 2012 on weaker supply growth and inventory reduction.

ExxonMobil (XOM) said in the company's 2012 energy outlook report Thursday that natural gas demand could increase about 60% from 2010 to 2040 with particular strength in the Non Organisation for Economic Co-operation and Development countries of the Asia Pacific region.

Natural gas-related stocks finished lower Thursday. Cheniere Energy (LNG) tumbled 4.6% to $8.86; Kinder Morgan (KMI) fell 2.9% to $29.55; Kinder Morgan Energy Partners (KMP) ticked down 0.6% to $78.43; Southern Union (SUG) fell 1% to $41.64; Chesapeake (CHK) lost 5.1% to $24.23; TransCanada (TRP) fell 1.2% to $41.56; and Shell (RDS-A) lost 2.2% to $70.14.

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