Natural gas: the turnaround kid in waiting

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For years, natural gas has been unloved and undervalued, a commodity whose price has faltered so badly that even some of it its biggest producers have written off the possibility of a comeback for nearly a decade.

But now, a growing number of observers say evidence is mounting that gas prices are nearing a turning point, and that the stage is being set for a revival as soon as the next few months.

A gas price recovery is "just a matter of when, not if," said Peter Tertzakian, chief energy economist at Calgary-based ARC Financial. "It could be as early as this summer - but probably no later than the following winter. … The psyche of the gas market is going to start to change."

The sudden optimism is driven by several factors. In the near term, forecasts of a hot summer are suggesting that demand for natural gas could surge for air conditioning. In the longer term, a recent U.S. initial approval for exports of liquefied natural gas has created expectations that demand from foreign markets, where gas is priced much higher, could help drive up domestic prices.

And in the medium term, those who analyze North American natural gas drilling suggest that the current gas glut may disappear as companies shift their focus to oil - and to drilling less-productive gas wells that, thanks to lucrative liquid byproducts, bring far better returns.

Take these issues together, and some now say gas may have reached its bottom.

"From today's prices, we believe the risks are now to the upside," Adam Sieminski, chief energy economist at Deutsche Bank, wrote in a recent note.

Such a call goes dramatically against the grain of dominant market sentiment. In the past few years, industry has gained the ability to tap huge new reserves of so-called shale gas that had previously been considered impossible to extract. This has triggered what many call a revolution: In a very short period, North America's gas supply has gone from constrained to overabundant. The result was a crash in prices that, after reaching $14 per 1,000 cubic feet in 2006, have hovered around $4 in recent years.

Because shale gas is so prolific, many believe it has created a glut that is likely to keep prices depressed for a long time. Canadian Natural Resources Ltd. has said a recovery is likely two to seven years away. Scott Saxberg, the chief executive officer of Crescent Point Energy Corp., said any suggestion of an imminent turnaround is "wishful thinking."

Ten per cent of Crescent Point's output is gas, but the company is "pretty pessimistic on it over the next five to seven years," Mr. Saxberg said. "Unless there's a huge change in demand, like gas-fuelled vehicles and a whole pile of stuff happening, I find it hard to believe that we're going to ever get above $5 or more."

Yet markets have been surprisingly kind to natural gas products. Take Encana Corp. Despite tumbling profits, the company has handily beat the S&P/TSX composite index this year, if dividends are factored in.

And Mr. Tertzakian believes gas will recover to $6 - still far from the heights of years past, but enough that most producers can substantially boost today's anemic profit margins.

His reasoning stems from several observations. Earlier this year, for the first time in several years, the number of rigs drilling for oil surpassed those drilling for gas. More importantly, those rigs are increasingly chasing so-called wet gas wells that also produce liquids, which sell for more lucrative prices nearer oil. For example, drilling in the "dry" U.S. Haynesville play has decreased over the past year at almost exactly the same pace that activity has increased at the "wet" Eagle Ford and Granite Wash play.

But there is a major difference between those two plays: The average Haynesville well starts production at 8.5-million cubic feet per day. The average Eagle Ford well starts at two million.

So by switching, "you've lost 75 per cent of your productivity," Mr. Tertzakian said. He has developed a proprietary measure of overall rig productivity in the United States. In the past year, it has fallen by more than a third.

That calculation suggests the growth in U.S. gas production could soon slow. That itself would be a dramatic change from the past 18 months, which have seen production soar by six billion cubic feet a day - a nearly 10-per-cent increase.

Still, the scenario that output will keep increasing - particularly amid a round of massive natural gas joint ventures that has seen foreign companies commit tens of billions to new drilling - makes many nervous about prospects for a recovery. Encana, one of the continent's biggest gas producers, for example, declines making a forecast. Spokesman Alan Boras will only say that the company believes prices must eventually rise to $6 per thousand cubic feet to maintain demand.

Or take Tourmaline Oil Corp., whose production is more than 80 per cent natural gas. "The bears are still winning on gas prices," cautioned chief executive officer Mike Rose. But, he added, "the longer-term is starting to look a little better. … I do believe gas prices are going to up. What none of us know is exactly when."