US gas market oversupplied in 2011, to average $3.94/MMBtu: Barclays

Washington (Platts)--19Jan2011/542 pm EST/2242 GMT

Natural gas prices will average $3.94/MMBtu in 2011, investment bank Barclay's said in a note to clients.

While gas prices may fall as low as $2/MMBtu this year, analyst James Crandell said power generators switching to cheaper gas from coal will provide the buffer that prices need to stay in the $4/MMBtu range.

"While supply growth will likely outstrip core demand again this year, a large, price-responsive component of demand, in the form of coal displacement, should mop up that extra supply," Crandell said in the note published late Tuesday.

"Our analysis suggests that the market will not test the limits of coal displacement this year, creating a soft floor on prices just below $4," he added.

Gas producers will keep drilling in spite of the low prices, Crandell noted, because much of their production is hedged at prices higher than $4/MMBtu. Crandell thinks producers will only slow drilling and shut in production if prices fell to $2/MMBtu and stayed there for a prolonged period, a prospect he doesn't see happening because the power market will sop up the cheap gas instead of burning coal.

Eastern power markets will be the first to switch to gas, Crandell said, where it will start displacing coal when it reaches $5.50/MMBtu. This displacement will grow to 3.75 Bcf/d at $4/MMBtu.

Last year in all of the US, gas picked up 2.4 Bcf/d of power demand from coal at an average price of $4.38/MMBtu, Crandell estimates.

Overall, he forecasts the gas market will again be oversupplied by 2 Bcf/d as industrial, commercial and residential demand doesn't grow beyond 2010 levels.

"The supply side would likely join the response as well," Crandell said.

"While well-hedged producers will continue drilling in a $4 gas market, we expect that in a $2 market, not only would a wave of producers revisit drilling budgets, but a number would also consider shutting in existing production."

--Bill Holland, bill_holland@platts.com

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