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2017 natural gas prices could average $4/MMBtu

Amid natural gas prices that are seen as too weak to sustain production growth, a favorable outlook for natural gas export growth and continued strong power-sector natural gas burn, some are bullish on the natural gas market heading into 2017 and beyond.

"I honestly think [an average of] $4[/MMBtu] next year isn't out of the question," S&P Global Platts analyst Bob Yu told the audience at the 15th annual Coal Trading Conference in Manhattan on Dec. 6. "I certainly think it's going to be above $3.50[/MMBtu]. ... It all depends on how cold it gets. Even given normal temperatures I am very bullish."

During a presentation, Yu outlined his case.

"If people want to know what's happening with U.S. gas production, you don't really have to look much further than the Marcellus and the Utica," Yu said.

The two shale plays accounted for 8.8% of shale gas production in January 2007, according to the U.S. Energy Information Administration. The latest government estimates have the two regions accounting for 47.7% of shale gas production.

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Yu said even as natural gas prices fell, high oil prices drove associated gas production higher as producers directed drilling activity toward oil. With the collapse in oil prices, natural gas production growth began to slide.

"With the OPEC meeting, WTI [crude oil] prices did rebound, but we haven't seen a response in rig activity," Yu said. "So until we see a response from the producers, this trend of decreasing associated gas production, it's probably going to continue. And at the very best, it will probably remain flat. So this is a huge risk to production growth going forward."

Despite a decline in rig counts in the Northeast, production has remained relatively flat. Yu said that drilled but uncompleted wells have sustained production even as the oil and natural gas markets have reduced the incentive to drill.

"We estimate that the Northeast is depleting about 150 wells per month. This is a huge risk, because rig activity hasn't picked up," Yu said. "I personally think you need 65 to 70 rigs in the Northeast just to keep production flat once this inventory of wells is depleted. I estimate [these wells] will be depleted in Q2 of next year. Once these wells are gone, if rig activity is still at 40 [rigs] to 50 [rigs], it's almost a certainty that Northeast production will either be flat or will decline. Right now in the Northeast, there's sort of a dilemma. Prices are very low. It's not enough to incentivize production. But if [producers don't drill], within the first month, we'd lose 1 Bcf/d of production."

Turning to demand, Yu said that aside from the mild 2016 winter, temperature-driven power-sector demand for natural gas has not changed much between 2015 and 2016. "Even if prices return to $3[/MMBtu], we're probably still going to have relatively strong power burn demand," Yu said.

But Yu warned that energy efficiency and renewable penetration are a threat to power-sector natural gas demand.

"If the average household uses light bulbs for three hours per day, and a quarter of households switch [from 100 W incandescent bulbs to 18 W LED bulbs], and an average house has 20 light bulbs, you actually shave off 3.5 Bcf/d [of natural gas demand]," Yu said. "And you also have things like demand response and net metering. So all of these things are keeping a lid on total electricity demand growth."

"We're building all these new plants, but we're not really seeing an uptick in demand for electricity," Yu continued. "If fossil fuel generation wants to capture more market share, the only way it's going to be able to do that is to steal market share from [renewables]. Gas market share is in my mind capped. As we see more renewable generation come online, what's going to happen is your renewable share will grow. Your coal and gas is going to shrink."

In the long run, Yu sees exports as the most likely path for natural gas demand growth.

Yu expects 1.3 Bcf/d of LNG export growth from 2016 to 2017: "That growth is mostly inelastic to prices because a lot of it is under contract, and the places we're sending it to really need that gas and it's going to be the cheapest source of supply [for them]."

From 2019 to 2020, Yu exports LNG exports to be 10 Bcf/d higher.

"This is going to put extreme stress on current storage facilities," Yu said. "You could see wild swings in gas prices going forward."

Turning to the overland export route, Yu sees to the 20 GW of gas-fired capacity being developed in Mexico as another sink for U.S. gas production.

"If they can nominate gas, they're going to pull from the U.S.," Yu said. "Currently they're getting their gas supply from LNG imports, which are extremely inefficient and expensive. These gas-fired plants aren't competing with coal. They're competing with fuel oil. And so it's almost a certainty that as soon as these pipelines are built that gas demand will increase. Over the last two years we've doubled the amount of exports we've sent to Mexico. By 2020, we expect to hit 5.5 Bcf/d of exports."

Yu acknowledged the fact that storage inventories peaked at an all-time high poses a short term risk to his bullish outlook, as working gas in storage would cushion the impact of declining Northeast production.

Yu said in the long run, if Northeast pipeline infrastructure is built out faster than expected, it could suppress prices.

According to SNL data, 13.79 Bcf of pipeline capacity expansions are planned for the region, with the lion's share scheduled to enter service in 2018. However, only 2.32 Bcf of the total planned capacity is in either advanced development or under construction.

"A lot of those projects are very high risk, but if they are built and they are timely, then the Northeast will very easily flood the market with gas," Yu said.

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SNL Energy is an offering of S&P Global Market Intelligence, which like S&P Global Platts, is a division of S&P Global Inc.