With the market broadly of the view that the US market enjoys ‘infinite' supply of low cost natural gas, and the forward curve in agreement (backwardation) we have taken a closer look at supply trends on a multi-year view. The Marcellus alone is incapable of addressing US demand in 2013/14, in our view. To meet consensus expectations surrounding supply (g pp y 1.0 Bcf/d, 1.5% yoy declines in 2013e) the market needs to add rigs. At current productivity outside of the Marcellus (total production/rig), we see higher activity (~25 dry gas rigs) needed to support 2013/14 demand. We expect this to support deferred NG prices, as $4.50+/mmbtu prices are likely needed to incentivize supply. Within we outline a multi-year view of Marcellus supply, and the implications for the broader market.
Despite seasonal loosening, the market looks finely balanced with an eye to end-Oct storage
Our recommendation has been to not chase levered equities following a late-winter rally, despite more aggressive than consensus expectations surrounding supply restraint (see slide 16). Flat price is likely rangebound this summer (+/- $4/mmbtu), with gas to coal switching the risk. Should balances remain tight, storage expectations for October (~3.7 Tcf) will continue to support the curve. We see upside to DB commodities research 2014 forecast of $4.25/mmbtu. The downside risks are gas to coal switching, the return of nuclear facility outages (~4.3 Bcf/d on a NG equivalent basis in March), and tough yoy weather comps (2012 summer CDDs were 18% above normal).
A more constructive backdrop for the equities
Notwithstanding near-term risks into the shoulder, tighter balances are supportive for the commodity and the equities. This is in stark contrast to the headwinds for domestic crudes (differentials, risks to demand). For the E&Ps, we see on average 10% upside to our 2014 estimates (EPS) from a $0.50/mmbtu move in the CAL14 strip with more revisions to come post Q1 calls. Expect the potential for increased supply (rig activity) to be a key topic on Q1 conference calls. We are more focused on the time lag to supply response (~6-9 months) and the implication for near-term balances.
Eoin Treacy's view Natural gas prices plummeted to a low near $1.90 a year ago and have been trending steadily higher since. The decline in prices prompted many utilities to make the switch from coal to natural gas in order to capture the value presented by this extraordinary move. As a result coal miners and higher cost producers of natural gas have experienced a stiff headwind. With natural gas now trading above the psychological $4 area the incentive to revisit coal as a feedstock has increased.
The Coal/Natural Gas ratio peaked near 30 last April and has halved since. A sustained move above 20 would be required to question the medium-term downward bias. Since natural gas prices have rallied enough to begin to encourage both switching to low cost coal and dry gas wells, there are probably limits to how far natural gas prices can rally in absolute terms. Nevertheless, a sustained move below $4 would be required to question potential for continued higher to lateral ranging.
Since coal miners have fallen so aggressively, there is capacity for a re-rating if utilities begin to switch back to coal as a feedstock. Some of the better performers in the sector have been in the MLP space. Alliance Resource Partners LP yields over 6% and is testing the upper side of a six-month range. A sustained move below the 200-day MA would be required to question potential for some additional upside. Alliance Holdings GP LP found support above the 200-day MA on successive occasions since January and hit a new 14-month high today. A sustained move below $50 would be required to question medium-term scope for additional upside.