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Morgan Stanley slashes natural gas price forecast amid structural pressure

Analysts with Morgan Stanley cut their price outlook for Henry Hub natural gas, including a 27% slash to long-term price estimates.

In a March 28 report, the firm projected that natural gas prices will average above $3/MMBtu in 2017, but it said that structural pressure from oil, productivity improvements and weaker power demand will put pressure on the market in 2018, cutting next year's average price to a range from $2/MMBtu to $3/MMBtu, rather than from $3/MMBtu to $4/MMBtu as previously forecast.

The 2017 price forecast was cut from $3.50/MMBtu to $3.10/MMBtu, while for 2018 the analysts expect the natural gas price to average $2.90/MMBtu, down from $3.20/MMBtu in their previous outlook. Long term, the price will average $2.75/MMBtu, from $3.75/MMBtu previously.

The downside pressure on the natural gas price is driven by a 60% to 70% decline in the breakeven price for oil recoveries in key oil plays, particularly in the Permian Basin, which is driving increased activity and could be setting up a glut of associated natural gas.

Gas productivity improvements have also taken hold, with breakevens across several key plays now well below $3/MMBtu, the analysts said.

By early 2018 pipeline buildout will begin to unleash more low-cost supply from the Appalachian region, narrowing differentials in the region and pressuring Henry Hub prices. Additionally more Gulf Coast production will hit the market from dry gas in the Haynesville Shale and associated gas from the Permian, Morgan Stanley said.

As supply grows, demand will be a mounting challenge as the easing of drought conditions in the western U.S. should drive an increase in hydropower production in the region, displacing natural gas demand in 2017, while longer term, total electricity demand is expected to stagnate and renewable supplies continue to grow, taking market share from gas.

Although natural gas demand was helped higher by coal plant retirements, the increase in renewables offset those benefits, Morgan Stanley said.

Further, while there are questions regarding the impact on the natural gas market from President Donald Trump's plan to roll back the Clean Power Plan, Morgan Stanley's assessment that gas-to-coal switching is a function of economics suggests the reversal of environmental restrictions on the coal industry will have little impact on market dynamics.

Morgan Stanley said that after a one-year increase in coal consumption in 2017 due to sequentially higher gas prices, coal's structural decline is expected to resume.

The analysts cut their 2017 coal burn forecast by about 4% and see only a modest year-over-year improvement, with a majority of gains lost by 2018 due to ongoing competition from gas and growing renewables.