High Natural Gas Production, Low Demand and Prices: The Interplay

March 2012

• Under current conditions of high production and relatively low demand, prices in the US do not have a reason to rally in a sustained way, and this has consequences for energy prices in Canada. Strong production and a large storage surplus relative to the 5-year average discourage imports from Canada thus allowing Canadian supply to overshadow demand and limit spot prices for the commodity.
• For the longer-term, current prices could force natural gas producers to be more selective in their activities and focus on shale gas deposits, which also contain more profitable ethane and propane (natural gas liquids).

With the current winter more or less complete, natural gas in North America has been trading in a bear market with prices having declined to levels not seen in ten years. The reduced demand for heating due to very mild weather combined with the high output from North American shale gas deposits have resulted in relatively small net withdrawals from storage.

The latest Short-Term Energy Outlook from the US Energy Information Administration (EIA) forecasts that 2,268 Bcf of natural gas will be in storage in the US by the end of the heating season on March 31, 2012. For comparison, 1,552 Bcf was the average amount in storage at the end of the previous five heating seasons. The EIA also forecasts that the end of the upcoming injection season will be marked by a new record high in natural gas storage inventories with 4,038 Bcf by October 31, 2012.

Under the current conditions of high production and relatively low demand, prices in the US do not have a strong reason to rally in a sustained way, and this has consequences for energy prices in Canada. Strong production and a large storage surplus relative to the 5-year average discourage imports from Canada thus allowing Canadian supply to overshadow demand and limit spot prices for the commodity. Power generation prices in Ontario, which already reflect generation oversupply, could be affected as natural gas-fired power plants could dispatch more frequently in peak hours as their input cost falls.

For the longer-term, the current prices could force natural gas producers to be more selective in their activities and focus on shale gas deposits which also contain more profitable ethane and propane (natural gas liquids). Deposits rich in natural gas alone (methane) could continue to be accorded a lower priority as the low prevailing prices make drilling in these particular deposits unprofitable. Chesapeake Energy and Encana among other companies recently announced plans to reduce drilling for methane alone over the course of the year. More companies may implement similar plans in the near future.

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