North America is running low on gas. But does this spell a new pricing environment?
Financial Post, November 23
Claudia Cattaneo, Calgary Bureau Chief
Are we running out of gas?
Not yet. But natural gas prices, which have been climbing to new highs almost daily, reflect a market that is increasingly uneasy with the trends.
Storage levels in Canada and the United States are alarmingly low, just as demand is rising for winter home heating. U.S. inventories are down about 10% from a year ago, when winter temperatures were above normal.
Production is flat in both countries, as producers struggle with high depletion rates, labour shortages and a scarcity of new prospects. The continent's major new natural gas frontiers in the Mackenzie Delta and in Alaska will take at least five to seven years to bring on stream because new pipelines have to be built.
Demand, while flat in Canada, is on a long-term growth trend in the United States of 2% to 3% a year, driven by natural gas-fired electric generation as well as home heating. According to Merrill Lynch & Co., natural gas is now used to heat 55% of U.S. homes and the share is rising, with seven out of every 10 new homes being built using natural gas.
Short-term volatility is expected to continue, driven by the weather and oil prices. (If crude declines, big customers will switch to heating oil, putting downward pressure on natural gas prices as well.)
But observers are divided about whether the current imbalance will correct itself by next year -- or whether we are on the verge of a new natural gas pricing environment that just two years ago would have been considered extreme.
Among the bulls are people like Peter Linder, an analyst with Research Capital Corp, who is calling for natural gas prices to average as much as US$6 per million British thermal units this winter on the New York Mercantile Exchange, and $8 per thousand cubic feet in Alberta, assuming a return to a normal and colder winter than in the past three years.
Yesterday, natural gas for December delivery closed at US$6.577 on Nymex, while Alberta spot prices were $7.64.
"I am arguing that [current prices] are here to stay, particularly if we get a more normal winter. And this sets the scene for fantastic gas prices for all of next year," he says.
Mr. Linder says by the end of the winter, North American inventories may approach empty, causing prices to spike even further as the scramble to inject gas for the winter of 2001-2002 continues.
He's also concerned that Western Canadian natural gas production will not increase for several years, while increases in the United States will be minimal.
Even with ambitious drilling programs, producers are struggling with high decline rates because of higher production, forcing them to work harder just to stand still. Compounding the problem is a shortage of new prospects. "Supply and demand is becoming increasingly tight, and the only thing that could save consumers now is a mild winter. Nothing else," Mr. Linder says.
Christopher Theal, of CIBC World Markets Inc., sees moderation returning by next year, with a U.S. supply response helping push natural gas prices back to between US$3.25 and US$4.25 per thousand cubic feet. Mr. Theal's outlook coincides with the market consensus.
While cold weather would see gas price spikes from current spot prices, these prices are not sustainable, he says. Much of the gas price strength in 2000 resulted from the pace at which demand outgrew supply, he wrote in a recent research report, with demand growth at 2.4% and supply growth was 0.7%. Next year, supply will rise 2.9% in the U.S., while demand growth is expected to rise 3.3%, a gap he says is negligible.
So far, investors are brushing off the potential for a crisis. The oil and gas producers' index on the Toronto Stock Exchange is down 16% from its September high, closing at 6253.64 yesterday.
Regardless of which scenario plays out, most analysts are bullish on the long-term outlook for natural gas stocks, since commodity prices will still come in at twice last year's levels even if moderation prevails.
Top Canadian names tilted to natural gas include:
Alberta Energy Co., Canada's largest natural gas producer, with daily production of 1.0 billion cubic feet rising to 1.3 billion cubic feet next year. AEC trades at about 4.5 times cash flow per share, the highest multiple in its class and one of the highest among natural gas companies.
Anderson Exploration Ltd., with a multiple of about 4.8 times, is running the largest exploration program in the Mackenzie Delta region, where there's potential for massive discoveries. Current production of 630 million cubic feet a day is expected to rise to 780 million cubic feet next year.
Canadian Hunter Exploration Ltd. (4.2 times), Rio Alto Exploration Ltd. (4.0 times) and Paramount Resources Ltd. (4.9 times) are the three senior names that produce almost exclusively natural gas.
In the intermediate category, Bonavista Petroleum Ltd. is almost a pure play. This long-time market favourite trades at 6.4 times. Bargains include Genesis Exploration Ltd. (3.3 times) and and Cypress Energy Inc. (3.4 times), both tilted to natural gas.
Mr. Theal says stock prices will receive further support from higher return on equity, as companies continue to focus on profitability and lower costs, and continuing sector consolidation.
But if extreme pricing becomes the norm rather than the exception, it's hard to predict what the market will do: Stock prices could soar, validating the sector's expectations -- or continue to be discounted, as the wait for a more reasonable range drags on.
ccattaneo@nationalpost.com
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