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US natural gas prices continue to be depressed even as there is a strong rally in crude oil prices. The prospects of natural gas is linked to coal prices and any upside movement of the latter could only lead to increase in coal-to-gas substituition which has already hit 3 bcf/d and further potential for growth is still large, according to a Merrill Lynch analysis.

Volatility in US natural gas has spiked as significantly as it did in 2006. At that time it was insufficient storage capacity that led to the spikes forcing Merrill Lynch to describe the market as ‘Nutty Natty’. Inventories could rise to 3.85 tcf before the start of winter and storage constraints could surface again leading to volatile trends.

Falling industrial gas demand, global glut will continue to put bearish undertones in the market and the weakness will roll over into 2010. Prices at the Henry Hub briefly spiked by $1.20/MMbtu to $4.50/MMbtu over two weeks at the start of May, but bearish fundamentals and above-normal storage injections quickly pushed the price back below $4/MMbtu. Broadly, US natural gas prices have been more tightly correlated with coal prices this year than with crude oil on a daily basis, as coal-to-gas substitution has been the only saving grace to a weak natural gas balance


Falling demand and prices have led to cuts in new US natural gas drilling programmes but that has not made an impact on production.

According to EIA data, aggregate dry gas production declined slightly in January but picked up again in February by 0.68 bcf/d MoM. Pipeline data signals that production remained elevated through May, registering YTD declines of only0.21 bcf/d or 0.4%. This is rather unusual. Previous drilling cycles (with the exception of 1997) indicate that domestic gas production should be way into its decline by now

Companies have lowered 2009 capital commitments by about 40 %. Another possibility is that of increased LNG supplies into USA through imports which could dampen natural gas prices, Merrill Lynch observed. In contrast with oil and coal, a major problem for the LNG market is that China can not soak up the global surplus due to import constraints.Thus, there is now a risk of LNG imports rising above 2.5 bcf/d in 4Q09 and 1Q10.

Prospects for US natural gas looks extremely weak in case there are near-term sharp price increases that could lead to increased LNG imports. In addition, any sustained rise of natural gas above and beyond $5/MMBtu could lead to rigs being brought back to the market, dampening the outlook for next year.

Assuming normal weather patterns, the gas market balance is unlikely to improve significantly until at least the middle of next year.

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