February 12, 2008

Over The Barrel: Natural Gas - Supply Overview

A key consideration in analyzing natural gas prices is the sources of supply and their availability to the market. Key factors determining the availability of supply domestically are:

• Dry natural gas production
• Net imports
• Net withdrawal and injection from storage.

Dry natural gas production represents the sum total of supply after processing losses that are removed from the gas stream in the production of consumer grade natural gas. These losses include non hydrocarbon gases such as water vapor, carbon dioxide, helium, hydrogen sulfide and nitrogen.

Dry natural gas production has shown a sharp increase reaching a daily rate of 53.8 bcf/d in December, well above the 51 bcf/d in December 2006. A large portion of the increase is attributed to the coming on line of the Independence Hub natural gas pipeline in July. The platform is the deepest production platform, in 8,000 feet of water, and largest offshore natural gas processing facility in the world. This deep water platform has begun to reach peak production of as much a 1 bcf/d in January.   

As we move through 2008 production should stabilize, particularly if the trend in new gas rigs continues to stagnate as the Baker Hughes report currently suggests.  Due to the sharp increase in the cost of materials and staff, new investment has been discouraged as prices fell back sharply from record highs reached in 2005. Nat gas rig totals in the U.S. have fallen from their high of 1,527 in August of 2007 to stand at 1,424 currently. The declining rig count is likely to persist given the weak price relative to petroleum.

Net imports are comprised of imports through pipelines mainly from Canada, and of LNG primarily from Trinidad. For December, net imports are forecast to have totaled 9.0 bcf/d, compared with 10.04 bcf/d in December 2006. The decline reflects lower imports from Canada due to limited availability.  The tighter supply is attributed to colder weather conditions drawing down storage and greater Canadian usage do to the processing of oil sands. LNG imports also fell sharply as demand from Asia and Europe strengthened with new import facilities opening.  Fears of disruptions of European supplies from Russia also encouraged more active demand. These fears are likely to persist due to unresolved differences between Russia and the Ukraine over the pricing of natural gas.  

The withdrawal from stocks is also an additional source of natural gas. Storage is typically used so that adequate supplies are available when demand is seasonally higher. These inventories are stored in underground storage reservoirs. The largest storage is in depleted reservoirs where oil or natural gas had previously been extracted. This form of storage is the most economic since infrastructure such as pipelines is typically in place. Aquifers are also utilized but these are the most costly. Salt caverns also make good storage for natural gas. These caverns are in use for the storage of crude for the Strategic Petroleum Reserve, and also make excellent storage for natural gas due to their impermeability and ease with which the gas can be pumped out.  

                  Working Gas in Underground Storage Compared with 5-Year Range

There are two classifications for gas in storage. Base gas is that used to maintain pressure within a storage facility in order to get the natural gas out of the reservoir when it is needed. Working gas is the gas utilized to meet actual demand. Through January, working gas in storage totals 2,062 bcf, well below last years levels of 2,379 bcf and compared to the 5 year average of 2,000 bcf. The colder weather conditions in the Midwest and favorable prices relative to petroleum products have helped draw down inventory from what had been burdensome levels early in the winter. Working gas in storage will typically be drawn down to its lowest levels in late March and rebuilt to its highest levels in late November. The withdrawal in stocks during the winter is seen as an addition to supply availability.  

Although production levels do not change radically and are generally stable in the intermediate term, other conditions will play a roll. Adverse weather in the Gulf of Mexico can impact both gas processing and well production.  Over a ¼ of U.S. production is concentrated in the gulf. Given the relatively weak hurricane season over the past two years and uncertain economic prospects, the market will likely be slow to reflect a risk premium. Nevertheless, given the fundamentally constructive environment due to weaker production levels and competition in Asia and Europe for LNG imports, the market may not be as flush with supplies this summer to meet cooling needs as it has been over the past few years. 

The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation.  The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition.  The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company.  Copyright © ADM Investor Services, Inc.

Charts Courtesy of DTN/EIA