NORTH AMERICAN NATURAL GAS FUNDAMENTALS SHIFTING LONG-TERM PRICING
New market fundamentals suggest that a long-term price floor of about $3.50 per million British thermal units (MMBtu) at the Henry Hub has emerged. Excursions below this level are likely to be quickly reversed by market forces and are therefore likely to be brief, for the following reasons:
- Cost of North American production. Data from 2003 suggests that the most expensive regions in the North American supply complex have a total cost above $3.50 per MMBtu. CERA believes it is highly unlikely that North America can increase productive capacity at the wellhead by the large amount necessary to place lower-cost regions on the margin.
- Drilling response. Recent experience indicates that rig activity will fall sharply when natural gas prices fall. A fall in the rig count translates very quickly into a reduction in productive capacity because of the much higher decline rates, particularly in the first year or two of production, that result from modern production technology.
- Flexible liquefied natural gas (LNG) supply. The emergence of a more flexible global LNG market is one of the conditions that CERA believes is an essential element in attracting the investment necessary to enable strong growth in LNG imports. In such a market, LNG sellers are likely to move gas to markets in Europe or Asia in response to a price downturn in North American markets.
- Demand response. Assuming 2002 coal prices, when natural gas prices fall below $3.50 per MMBtu, efficient gas-fired combined-cycle generation will begin to displace the least-efficient coal-fired generation. This increase in gas demand would quickly stabilize falling gas prices.
