North American Natural Gas - Heating Season and Winter Update

Executive Summary

For the winter heating season, which runs from November 1st 2011 to March 31st 2012, cool temperatures (and resulting demand for space heating), the state of the economy, and sustained production and storage levels are expected to have the largest moderating impact on natural gas prices.  Based upon a consolidation of expert consultants’ forecasts,  Alberta natural gas prices, which have the largest influence on most Canadians’ natural gas costs, are expected to remain low over the heating season, averaging 3.57 C$/GJ.

The main drivers of natural gas prices this heating season are expected to include:

INTRODUCTION

The North American natural gas market is currently characterized by a number of key trends: producers continue to focus on unconventional (shale) gas plays and in particular those with high natural gas liquids content; natural gas storage levels are robust; US natural gas production continues to climb while Canadian production has levelled; and low prices persist. 

PRICE

The monthly Intra-Alberta (AECO) price for natural gas settled below 4 Canadian dollars per gigajoule (C$/GJ) over the first 9 months of the year.  Monthly prices ranged between 3.36 and 3.99 C$/GJ, and compared to 2010, the year-to-date average AECO natural gas price is down by almost 13%.

DRILLING

Drilling can be a good leading indicator of future natural gas supply. In both Canada and the US, annual natural gas directed drilling activity plummeted after 2008, due to lower natural gas prices. Prices fell largely on account of the economic downturn and higher natural gas production. Higher production was initially driven by the increased use of horizontal drilling and hydraulic fracturing (which can access more gas with fewer wells).

While drilling activity has slowed down in Canada, natural gas directed drilling activity in the US is on a slight upswing. More precisely, the number of natural gas wells drilled in Canada through September 2011 is down 5% relative to last year. By comparison, the number of gas directed wells drilled in the US is up 16% through July 2011.

NATURAL GAS SUPPLY

The supply of natural gas in North America continues surge on account of increasing shale gas production in the United States. Natural gas production in the U.S. has increased by 19% since 2006 and year-to-date information (through July) indicates that production is up over 6% from levels at this time last year.

By year-end, the US Energy Information Administration (EIA) predicts that total U.S. marketed natural gas production will have increased by 6.4%¹.  Looking further ahead, the US EIA expects marketed natural gas production to average 65.8 Billion cubic feet per day (Bcf/d) in 2011, growing to 66.9 Bcf/d in 2012.²

The Canadian supply picture stands in contrast to the U.S. supply picture. While U.S. production has grown since 2006, Canadian natural gas production has fallen by 15% in the same time period. Through July 2011, Canadian production is slightly ahead (~2%) of production last year. However, by year end, a number of industry-generated forecasts expect 2011 Canadian production to fall below the 2010 production level.

Looking beyond 2011, Canadian natural gas production is expected to decrease over the next few years.  In particular, the National Energy Board’s (NEB) mid-range case estimates deliverability to be 4.89 Trillion cubic feet (Tcf) in 2011, falling to 4.82 Tcf in 2012 and 4.67 Tcf in 2013³. However, shale and tight gas activity in Canada’s two most prolific unconventional gas plays (Horn River and the Montney) is expected to rise over this same time period.

Canadian natural gas production growth has lagged behind that of the U.S. mainly because of the relative immaturity of shale gas development in Canada, as well as low gas prices and time-limited requirements to develop the resource in most U.S. States. As Canadian shale gas is more aggressively developed in the future, many analysts believe total Canadian natural gas production will increase.

STORAGE

The amount of natural gas in storage follows a seasonal pattern. In the summer, when natural gas demand is low, gas is injected into storage. Storage volumes peak in the fall and are drawn down in the winter during periods of peak demand.

With healthy storage levels throughout 2011, Canadian natural gas storage rose above the 5-year maximum level for the month of October and is now resting at over 90% of capacity.⁴ Strong storage levels are just another indicator that the natural gas market is well supplied, putting further downward pressure on prices.

In the US, year-to-date working gas storage data (through August) indicate that monthly storage levels are, on average, 6% lower than they were throughout 2010. However, the US Energy Information Administration (EIA) “expects that inventories… will come close to last year’s levels towards the end of the 2011 injection season.”⁵A recent EIA weekly update (which is based upon preliminary data) estimated that working gas in storage was 3.6 trillion cubic feet (Tcf)⁶, equivalent to about 85% of US underground natural gas storage capacity. Therefore, storage levels in both Canada and the US should be sufficient to meet any unexpected changes in demand this winter, which will provide some market stability and help moderate prices.

DEMAND FOR NATURAL GAS

Canadian domestic demand for natural gas is split amongst a variety of sectors. Industrial consumption is highest, at 33%, followed by direct consumption (e.g. power generation) at 28%, residential (22%), and commercial (17%)⁷. Over the coming heating season, industrial demand will be primarily impacted by prevailing economic conditions, while residential and commercial demand will be affected by the weather and the resulting winter space heating requirements. These factors will be addressed in turn in the sections that follow.

ECONOMIC CONDITIONS

Recent reports from several leading Canadian banks agreed with Bank of Canada Governor Mark Carney on his observations that the European sovereign debt crisis, downgraded forecasts for US growth and reduced confidence have led to a deterioration in the global economic outlook. As a small, open economy, Canada will not be immune to the effects.

The OECD expects that the Canadian economy will stave off recession and grow modestly in the last half of 2011. This is in line with RBC, CIBC and TD Banks, who have all downgraded their forecasts for economic growth in Canada to the low 2% range for 2011-2012.  Given the deteriorating economic climate, weakened industrial demand for natural gas could apply downward pressure on the price of natural gas.

Since the natural gas market is largely a continental market, (and since all gas currently exported from Canada is destined for the US) the slowdown in the US may be the biggest area of concern for Canadian natural gas exporters. The Bank of Canada does not expect a recession in the US, but recognizes that the US economy has lost momentum (e.g. weak labour market, US debt downgrade, housing market still in trouble). This, combined with growing US natural gas production, may further reduce demand for Canadian exports of natural gas.

EXPORTS & IMPORTS

Although Canada remains a large net exporter of natural gas, annual exports of natural gas to the U.S. in 2009 and 2010 reached their lowest levels in 10 years (e.g. 3.257 and 3.263 Tcf, respectively). Available year-to-date data for 2011 indicate that gas exports are about the same as they were at this time last year (down by less than 1%).

In view of the fact that the U.S. has been developing their own massive shale gas deposits, U.S. imports of Canadian gas have fallen. Looking ahead, the U.S. EIA “expects that pipeline gross imports of natural gas (into the U.S.) will fall by 4.1% to 8.7 bcf/d during 2011 and by another 3.8% to 8.4bcf/d in 2012.”⁸  The state of the U.S. economy could exacerbate this issue, reducing demand for Canadian gas even further. 

At the same time, imports of natural gas into Canada are on the rise. The annual amount of natural gas imports has steadily increased each year since 2006, and year-to-date imports through August are up 50% over imports in 2010. Reduced U.S. demand for Canadian exports is motivating industry proponents to consider diversifying Canadian natural gas export markets to include Asia via Liquefied Natural Gas (LNG) tanker.

WEATHER

If a winter is unusually cold, residential and commercial demand for space heating will increase, putting upward pressure on the price of natural gas. A milder than normal winter will lead to weaker demand for gas and prices will be moderated.

Environment Canada’s (EC) temperature outlook for November, December and January predicts lower than normal temperatures for the entire country. However, as EC’s second map shows, much of their temperature forecast (as indicated by the grey areas) is little better than chance. The probability that EC’s forecast will be correct is better for all provinces east of Saskatchewan (excluding Newfoundland), plus some southern areas of the Territories.

Using natural gas utility sales to residential and commercial customers in 2010 as a reference point, [e.g. Ontario (37%), Alberta (15%), BC (11%), and Quebec (10%)], expected cooler than normal temperatures in two of the biggest consuming provinces (Ontario and Quebec) should put upward pressure on the price of natural gas over the winter. However, this effect could potentially be moderated by weather in BC and Alberta, since EC’s forecast for these provinces is currently little better than chance.  

SHORT-TERM PRICE OUTLOOK

Taking an average of expert consultant’s forecasts, the monthly wholesale AECO price is expected to average 3.57 C$/GJ and range between 3.30 and 3.65 C$/GJ over the 2011/2012 heating season. If this price range is realized, natural gas prices would model very closely with prices during last year’s heating season.⁹  Industry consultants have forecasted slightly higher natural gas prices for the 2012 calendar year, predicting the average AECO price to range between 3.42 and 3.94 C$/GJ.

Similarly, the monthly Henry Hub price is expected to average 4.31 US$/MMBtu throughout the heating season and range between 3.90 and 4.70 US$/MMBtu.  Throughout 2012, industry forecasts anticipate the Henry Hub price to range from 4.10 to 4.77 US$/MMBtu.  

The two price outlook graphs show that relative to previous years, the wholesale price of natural gas is expected to be low and stable throughout the duration of the heating season.  Consumers should benefit from this pricing level on the commodity portion of their natural gas bills.

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