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Forecast for strong associated gas production 'undoes the bull thesis'

While rising demand and slowing production growth have started to balance the U.S. natural gas market, a rush of natural gas supply associated with oil production threatens to keep prices from recovering much higher, according to Macquarie global oil and gas strategist Vikas Dwivedi.

Speaking at the LDC Gas Forum Northeast in Boston on June 6, Dwivedi detailed a host of constructive fundamentals that could help support prices as early as this summer, including big demand growth against limited supply growth. But also of note for this summer, Dwivedi said gas-to-coal switching at a $3.60/MMBtu price level could be worth up to 4 Bcf/d of lost gas demand and could result in a season-ending storage level of 3.7 trillion cubic feet by the end of October.

Farther out to the winter of 2017-2018, Dwivedi said after two mild winters, just the return to normal winter conditions would mean a demand increase of 600 Bcf, or more than 3.5 Bcf/d, and could help wear down storage levels to near 1.6 Tcf by the end of March 2018.

Dwivedi also pointed to the reversal of ethane rejection helping to support a more bullish case as the rejection of ethane at its peak in early 2016 was akin to pushing the thermal equivalent of 2 Bcf/d of extra supply into the natural gas market. In the past 18 months, that excess supply has been cut in half to about 1 Bcf/d.

He also noted less "backdoor supply" as the number of drilled but uncompleted wells become fewer and less attractive.

However, production is set to push higher again, which could serve to offset all of these bullish factors. According to Macquarie forecasts, U.S. oil production "is just going to boom," Dwivedi said. "It's just going to keep growing and dragging associated gas production up with it. So you're going to get all of this free natural gas for the next several years."

Dwivedi said the gas market could see demand growth of almost 10 Bcf/d in the next four years coming from almost 6 Bcf/d in liquefied natural gas exports, about 2 Bcf/d in pipeline exports to Mexico and 2 Bcf/d in increased demand in the industrial and power-generation sectors.

However in that same timeframe, the market could see a 9 Bcf/d increase in associated gas production, as well as a 5 Bcf/d increase in wet gas production and 2 Bcf/d of displaced gas demand due to increased renewables penetration.

This means dry gas production would need to drop more than 6 Bcf/d just to keep the market balanced.

"This is what really undoes the bull thesis," Dwivedi said. At 9 Bcf/d, growth in associated gas production "just eats up the demand growth without much left," he said. Combined with wet gas production and the impact of renewables, "the burden on dry gas production isn't just low; it's actually negative. So by our math, gas producers will need to rationalize their supply by about 6 [Bcf/d], which is not bullish. That's distinctly bearish."