Mild Winter Hurts Natural Gas Demand As Shale Exploration Continues Unabated

A mild winter across the U.S. led to lower than expected natural gas demand in December. Natural gas demand for heating purposes appears to have fallen significantly from last year as gas inventory levels in the U.S. were 15% higher over those in the same period last year and 11% higher than average levels over the past five years. ^[1] This lower demand is likely to hurt pricing as underground inventories continue to rise, which will hit the margins of shale gas producers such as Anadarko (NYSE:APC) the most due to the higher cost of unconventional exploration. Gas prices have declined 40% from their peak price of $5.00 /MMBtu in June 2011, falling to about $3 as the supply from sustained shale production is outpacing demand. Oil majors like Chevron (NYSE:CVX) as well as independent explorers like Chesapeake (NYSE:CHK) are also involved in shale activity in the U.S.

We have a $88 price estimate for Anadarko which is about 10% ahead of its current stock price.

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Reduced demand

Increased winter demand resulted in 76 billion cubic feet (Bcf) of gas being drawn from underground stockpiles in the lower 48 states over the week ended Dec 30th 2011. ^[1] This withdrawal is considerably less than the 135 Bcf drawn in the winter last year and the average draw of 106 Bcf over the last five years for the same week. Gas stockpiles in the country were at an all time high in mid-November.

Natural gas demand generally surges in the winter as it is widely used as fuel for heating. The increased demand is generally met through underground stockpiles, which generally show a decline in the cold season. This year’s mild winter has meant that gas demand has remained low, pushing prices lower.

Production continues

Despite the lower gas prices in the U.S., shale exploration activity is attracting more players. ^[2] Over the last few days French major Total SA and some Chinese and Japanese players have announced $8 billion worth of investments in shale acreage, pushing up land prices to peak levels seen before the 2008 crisis.

According to a Bloomberg report there was one case where land prices jumped tenfold in 5 weeks. This rise in acreage prices has pushed players like Chesapeake to liquidate some of the holdings they acquired in the 2007-08 ‘land grab’. Many of the new players are also interested in acquiring shale technology to replicate the process in their home countries.

The entrance of new firms with deep pockets can be seen as a mixed blessing for existing operators. On one side, Chesapeake and other companies have managed to liquidate their some of their holdings to reduce debt and acquire cash to go ahead with drilling. ^[3] On the other hand, sustained activity means that gas output will continue to rise. Around a third of America’s natural gas output came from shale last year, helping it overtake Russia as the world’s largest gas producer. Falling prices can pressure the margins of shale operators as they tend to have higher costs of production.

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1. Natural Gas 2011: An Unhappy Ending, ZACKS [↩] [↩]
2. Shale Bubble Inflates on Near-Record Prices, Bloomberg [↩]
3. ref:1 [↩]