Natural Gas Prices Could Double as Energy Majors Scale Down Supplies

By Jason Simpkins
Managing Editor
Money Morning

After an unparalleled fall, natural gas prices could double by next year, as a growing number of idle rigs create a supply crunch.

Natural gas prices have tumbled by about 30% this year, as a steep drop in industrial consumption has undermined demand. However, many of the traders and hedge funds that placed speculative bets on the price decline are beginning to reverse course and bet on a price spike, as dwindling production is starting to outpace slumping demand.

Traders trimmed their net short positions on gas by 11% to 114,064 in the week ended March 10, the smallest since last July, Bloomberg News reported. Also, natural gas futures for delivery in January 2010 are trading at a 49% premium to the April contract, which means speculators are anticipating a price surge.

In its short-term energy outlook - released on March 10 - the Energy Information Administration said that total natural gas consumption is projected to decline by 1.3% in 2009 and then increase by 0.4% in 2010. But many energy companies have idled rigs, scaling down production and increasing the chances of a supply crunch if the economy starts to recover.

Just as natural gas prices have plunged below $3.90 per million British thermal units (btu) from a record-high $13.694/btu on July 2, the number of natural gas exploration rigs in the United States has fallen to 884 from a record 1,606 in September, according to Baker Hughes Inc.

U.S. natural gas rigs fell 15% to an average 1,037 in February, their fifth consecutive monthly drop, Baker Hughes said.

With so many rigs coming offline, fourth-quarter gas production could decrease by 5.2%, Bloomberg reported. That would outpace the relatively acute decline in natural gas demand forecast by the Energy Department.

"When the recession ends and the economy starts booming, we're going to have less natural gas than we do today and prices are going to spike back up," said Larry Nichols, chief executive officer of Devon Energy Corp. (DVN). "The drop in supply will be so steep, it could easily catch up to where demand has dropped to before the recession ends."

It's also likely that more exploration projects will be shelved, and more rigs idled, as economic turbulence continues to linger. The cost of drilling and servicing is double what it was just four years ago, and in that time credit standards have tightened and the cost of borrowing money has increased substantially.

"When everybody sobers up after the first quarter and sees what their real cash flow is going to be, people are going to be very discouraged about how much capital they have to spend and that will depress the rig count even further," G. Steven Farris, chairman and chief executive of the energy company Apache Corp. (APA), told The New York Times.

Theresa Gusman, head of equity research for Deutsche Bank AG's (DB) DB Advisors unit, told Bloomberg that spending on U.S. exploration and production will drop an estimated 40% to $22.5 billion this year.

Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania is among the analysts who believe natural gas will soar back above $7/btu in the next 12 months.

"The next big move for gas is obviously going to be up," said Schork. "If we are higher, I'd expect to see us at $7 by the start of next winter."

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