24th September Natural Gas: A Cyclical. Downturn

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1 24th September 213 Natural Gas: A Cyclical Downturn

2 Jan'13 Feb'13 Mar'13 Apr'13 May'13 Jun'13 Jul'13 Aug'13 Sep'13* Oct'13* Nov'13* Dec'13* Sept 24, 213 Somya Dixit Research Analyst Supply and Demand Scenario US has always remained one of the top producers of natural gas. In the recent past US has shown a phenomenal growth in oil and gas production. The main reason behind the exponential growth is the introduction of advance techniques such as hydraulic fracturing and horizontal drilling. Kunal Shah Research Head Exhibit-1 Exhibit-2 kunal.shah@nirmalbang.com Total Marketed Production Total Marketed Production Source: EIA, NB Research * Exhibit-1 depicts the boom in the gas output since 29 and production outpacing consumption in the US in 213. Production rose almost 17% from 29 to 212 and stood around billion cubic feet per day in 212. The production is continuously rising and EIA expects the average production to reach by the end of 213, increase of almost.73 or 1% compared to 212. It would be the third straight year of record high production. On the other hand, consumption has shown only 1% of growth since 29 and it is expected to show a minimal growth of just.23 or.4% in 213 as compared to 212. Consumption is expected to average around 7 by the end of 213 as compared to average production of in 212. Exhibit-2 shows the production and consumption trend of natural gas in the year 213. In the start of the year due to the late arrival of winter season in the US we have witnessed a sharp increase in the consumption of the gas. In the first three months of 213 consumption averaged around 88 which dropped to an average of 9.3 in the Q2 213 as summer season didn t pick up in the US and temperatures remained below normal degrees dampening the power demand in the nation. On the other hand every year major gas producing fields go for maintenance in the winter season. Due to which we have seen a drop in the production numbers in the Q1 213, which gradually picked up in the Q2 213 when fields restart after maintenance and is expected to grow further. If we consider the EIA estimates for production and consumption for the coming four months then the production is expected to outpace the consumption by

3 Jan'12 Feb'12 Mar'12 Apr'12 May'12 Jun'12 July'12 Aug'12 Sep'12 Oct'12 Nov'12 Dec'12 Jan'13 Feb '13 Mar'13 Apr'13 May'13 Jun'13 July'13 Aug '13 Sep'13* Oct'13* Nov'13* Dec'13* Jan'1 Feb'1 Mar'1 Apr'1 May'1 Jun'1 July'1 Aug '1 Sep'1 Oct'1 Nov'1 Dec'1 Jan'11 Feb'11 Mar'11 Apr'11 May'11 Jun'11 July'11 Aug'11 Sep'11 Oct'11 Nov'11 Dec'11 Sept 24, 213 Sector wise consumption Exhibit-3 Exhibit Exhibit- Exhibit Source: EIA, NB Research US natural gas consumption mainly comprises of four sectors,, and. The sectors demand varies depending upon the seasonal demand such as the residential, commercial and industrial demand is highest in winter season due to the increased heating demand. And the electric power demand is highest in the summer season due to the increased air conditioners demand. However, this year due to unusual mild temperature across the US in the summer season the power demand wasn t very impressive. One of the main reasons for lower natural gas consumption for power generation was the higher natural gas prices, which was constantly trading above $ /mmbtu. Generating power with these elevated prices becomes very expensive for power companies when other substitutes for natural gas are available in the market. The adjoining charts (Exhibit: 3-6) depicts that the contribution of residential and commercial sector is highest in the fourth and first quarter of every year and electric power in the second and third quarter of every year. However, this year due to the mild weather conditions and temperatures below normal in the US in Q2 213, the electric demand remained subdued resulting into lower consumption. 2

4 Jan'12 Mar'12 May'12 July'12 Sep'12 Nov'12 Jan'13 Mar'13 May'13 Jan-1 May-1 Sep-1 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Percentage Gigawatt Hours Sept 24, 213 Generally, July and August is considered as the time frame when the consumption of electric power is highest. However, this year due to the late pick-up in summer we have not seen any major demand from the power sector. This year EIA expected the electric power consumption to average 3.22 approx in July 13 and August 13. However the consumption was much lower than the expectation, it stood around and further it is expected to remain depressed in the coming months. Coal, Natural Gas and Nuclear power plant The major sources for generating electric power in the US are coal, natural gas and nuclear power plants. These three inputs contribute more than 8% of the total power generation in the US. Out of which nuclear power plants has the lowest operating cost, however the construction and maintenance is very expensive. If we look at the percentage share natural gas and coal power plants contributes the most while the nuclear power plants contributes the lowest share. However, coal and natural gas are the most preferred sources by power companies; both are the best substitutes of each other. Power companies keeps shifting from coal to gas and vice versa depending upon the price variation. Exhibit-9: Percentage Share Exhibit-1: US Output Natural Gas Coal Nuclear Source: Bloomberg, EIA, NB Research For example, Exhibit-9 depicts that during April 212 the percentage share for power generation from coal and natural gas was equal for the first time as natural gas prices were trading at record lows. In deciding whether to use coal or natural gas for electricity, the price of the particular input is very critical. Further, in the month of March 213 natural gas prices peaked to $4/mmbtu, rising more than a dollar compared to the levels of April 212. In response, electricity generators used 16% less natural gas this March compared with March 212.Reasons for the increase included late arrival of the winter weather in the US, a tighter supply and demand balance for natural gas. Also, in the last week of March 213 natural gas storage fell below its -year average level 3

5 Jan-13 Jan-13 Feb-13 Mar-13 Mar-13 Apr-13 May-13 May-13 Jun-13 Jul-13 Aug-13 Aug-13 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Bcf Bcf Sept 24, 213 Coal is considered as the substitute for natural gas and with the recent rise in natural gas prices, generating power from gas became expensive. So, the power companies started shifting from gas to coal for power generation as coal became more competitive relative to natural gas. Exhibit-1 depicts the total electricity output falling in the US due to slower pick-up in demand. Till now a 3% loss in output is due to the shutdown of several nuclear power plants for seasonal maintenance. However, with the summer season coming to an end and with no expectations of fresh electricity demand coming in the nation output is expected to fall further. Stocks Scenario Exhibit-9 Exhibit Current Stock Scenario year average Last year year average 213* Source: Bloomberg, EIA, NB Research Natural gas inventories are 1.% or 4 Bcf higher than the five-year average and currently stand around 313 Bcf. In the first half of 213 the natural gas inventories fell below the five-year average due to the late pick-up in the winter season. The higher heating demand in the nation and the significant drop in the inventories drove the gas prices higher. However, in Q3 213 the stocks again moved above the five year average due to the mild weather conditions in the US. Further, EIA expects the stocks to peak in the month of October 213 and to be around 3823 Bcf close to the 212 levels. Exports After two years of halt, US finally approved exports of natural gas to non-free trade agreement countries from one of its terminals on 17th May 213. US approved Freeport LNG s Quintana Island, Texas to export LNG to Japan. Under this approval Freeport terminal would export around 2 percent or up to 1.4 for 2 years that is equivalent to. Tcf every year. The next project got approval on 7 th August 213 (approximately after two months from the Freeport s approval). The export terminal in Lake Charles, Louisiana, was given a conditional license from the Department of Energy to ship liquefied natural gas to all countries. The export terminal was allowed to export 2 of natural gas up to 2 years. In total US has 26 applications under process waiting for approval. Other than Freeport there are other major gas export terminals waiting such as Dominion, Sempra, BG Group and Veresen Inc which have already applied for approval of natural gas export license. Out of which Dominion 4

6 Sept 24, 213 Cove Point recently got the approval on 11 th Sept 213 to export up to.77 of natural gas. Till now the US has given green light to.7 of natural gas exports that represents about 8 percent of daily US natural gas output. Energy department had previously signalled that it may take eight weeks gap to review each project. However, the Dominion approval is done prior to the schedule. It is expected that US department of energy may approve as many as seven LNG exports projects by mid 216 which may export about 8. We expect the step taken by the US Energy department to help the natural gas market in the longer term. As of now we do not see any major impact of the approval to export natural gas in the supply as well as the demand side. Conclusion Continuous rise in the production and a slower pick-up in the consumption would keep the natural gas market under pressure in the coming months. In the beginning of 213 natural gas stocks have shown a significant drop due to the late arrival of winter season in the US. However, in Q2 213 due to the mild weather and low power demand in the US we saw early injections of stocks. Inventory build-up exceeding the five year average and production still near record high levels would eventually result into lower natural gas prices. Unfavourable weather conditions and lower demand of natural gas in the nation is expected to continue in the next two months. Continuous increase in domestic production of shale oil and gas in the US has resulted into oversupplied market conditions and we expect built-up in stocks of natural gas to increase in the coming months. Considering the factors discussed above we expect natural gas price to remain depressed in next two months and expect a 1-1% downside in the prices. We expect prices to test US$3-3.2/ mmbtu levels in NYMEX and Rs.2-21/ mmbtu in MCX.

7 Sept 24, 213 RESEARCH TEAM Name Designation Kunal Shah Research Head Vikash Bairoliya Research Analyst Sunit Mehta Research Analyst Ankita Parekh Research Analyst Somya Dixit Research Analyst Ravi D'souza Research Associate Devidas Rajadhikary Technical Analyst Harshal Mehta Technical Analyst Mohammed Azeem Technical Analyst ADVISORY TEAM Sakina Mandsaurwala Commodity Advisor Ishwar Kelwadkar Commodity Advisor Disclaimer: This Document has been prepared by N.B. Commodity Research (A Division of Nirmal Bang Commodities Pvt. Ltd). The information, analysis and estimates contained herein are based on N.B. Commodities Research assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at best, represents N.B. Commodities Research opinion and is meant for general information only. N.B. Commodities Research, its directors, officers or employees shall not in any way be responsible for the contents stated herein. N.B. Commodities Research expressly disclaims any and all liabilities that may arise from information, errors or omissions in this connection. This document is not to be considered as an offer to sell or a solicitation to buy any securities. N.B. Commodities Research, its affiliates and their employees may from time to time hold positions in securities referred to herein. N.B. Commodities Research or its affiliates may from time to time solicit from or perform investment banking or other services for any company mentioned in this document. Address: Nirmal Bang Commodities Pvt. Ltd., B2, 31 / 32, 3rd Floor, Marathon Innova, Opp. Peninsula Corporate Park, Ganpatrao Kadam Marg, Lower Parel (W), Mumbai , India. 6