Gas Producer Hedging Gains as Rally Chances Dim: Energy Markets

Natural gas producers are increasing forward sales of their U.S. output for a second year, a sign they see little prospect that prices will rebound from their lowest level for any winter in the past nine years.

Energy companies have sold about 54 percent of their 2011 oil and gas production, up from 49 percent last year and 47 percent in 2009, according to a Barclays Capital analysis of 37 producers. By selling output now, companies ensure they get paid today’s prices for future production, a so-called hedge that protects them from declines.

Natural gas, which accounts for about 23 percent of U.S. power generation, has fallen 13 percent in New York during 2011, extending a three-year drop, as improved technology for drilling in shale formations boosted production to the highest in almost four decades. Prices haven’t been so low in any winter since 2002, according to data compiled by Bloomberg. They may slide a further 12 percent in “coming weeks,” a Bank of America- Merrill Lynch report on Feb. 16 showed.

“Most gas producers are not really expecting the market to turn around in 2011,” said Biliana Pehlivanova, a New York- based analyst at Barclays Capital, the securities unit of Barclays Plc, the U.K.’s third-largest bank. “Prices have remained depressed, and they want to be protected.”

Photographer: Derick E. Hingle/Bloomberg

Natural gas producers are increasing forward sales of their U.S. output for a second year, a sign they see little prospect that prices will rebound from their lowest level for any winter in the past nine years. Close

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Photographer: Derick E. Hingle/Bloomberg

Natural gas producers are increasing forward sales of their U.S. output for a second year, a sign they see little prospect that prices will rebound from their lowest level for any winter in the past nine years.

Gas for March delivery on the New York Mercantile Exchange fell 2.5 cents, or 0.7 percent, to $3.843 per million British thermal units at 11 a.m. London time.

Average Prices

Futures may average $4.37 per million Btu in 2011, according to the median of 12 analyst estimates compiled by Bloomberg since Nov. 15. That compares with $7.118 per Btu in 2007, the last year the fuel posted an annual gain. The average so far this year is $4.324.

Prices will probably fail to reach $6 in 2011, said Mark Hanson, an analyst with Morningstar Inc. in Chicago. Gas last traded above $6 about 13 months ago and hasn’t traded below that price for an entire year since 2002. Bank of America-Merrill Lynch predicts it will drop to $3.40 in the weeks ahead.

Chesapeake Energy Corp., the most active U.S. driller, has hedged 96 percent of its gas production for 2011, compared with 5 percent for its oil, it said in an investor presentation this month. That compares with 61 percent of its gas and 59 percent of its oil last year. The Oklahoma City-based company had an average 75 percent of its gas hedged at this time of year from 2006 through 2008, its annual reports show.

‘Strong Growth’

Selling gas forward at about $6 may allow Chesapeake to realize $1 billion in hedging gains in 2011, helping it drill more wells and boost earnings by about 40 percent, Jeff Mobley, senior vice president for investor relations and research, said during the Credit Suisse Group Energy Summit in Vail, Colorado, on Feb. 10. The company has the most oil and gas rigs operating in the U.S., according to date published by Baker Hughes Inc.

“Despite lower commodity prices, we’ve hedged fairly well and can maintain our drilling activity to provide pretty strong growth over the next few years,” Mobley said at a Bank of America Merrill Lynch credit conference on Nov. 17.

Range Resources Corp., which holds the second-most drilling permits in Pennsylvania’s Marcellus shale-gas formation after Chesapeake, has hedged 84 percent of its 2011 gas production at an average floor price of $5.56 and an average ceiling price of $6.48 per million Btu. The Fort Worth, Texas-based company hedged 69 percent of last year’s gas at an average floor price of $5.53, it said in a January 2010 financial update.

No Benefit

The discrepancy in gas hedging levels versus oil underscores how traders are betting that economic growth will buoy prices for crude while near-record supplies limit gains for gas, according to Peter Beutel, president of Cameron Hanover Inc., a New Canaan, Connecticut energy-advisory company.

“It seems that as the economy strengthens, or there’s a little bit of bullish news, crude oil, heating oil and gasoline jump,” Beutel said. “Natural gas doesn’t get any benefit.”

The U.S. natural-gas market is oversupplied by between 1 billion and 1.5 billion cubic feet per day, David Pursell, a managing director at Houston-based Tudor Pickering Holt & Co. LLC, said in an e-mail Feb. 15.

U.S. gas production averaged about 61.8 billion cubic feet a day in 2010, the highest since 62 billion a day in 1973, according to the Energy Department in Washington. Production this year will average 62.32 billion, department estimates show.

“Our view is that 2012 is probably when you’ll see a turnaround in natural-gas prices,” Hanson said.

Surplus Erased

Natural gas in storage fell to 6.3 percent below the five- year average in the week ended Feb. 11 as below-normal temperatures boosted demand and disrupted drilling operations, Energy Department data show. The frigid weather hasn’t been enough to correct a supply-demand imbalance, according to Barclays Capital.

“Demand has staged only a modest recovery, and in our view, demand growth is slower this year than at this point last year,” Barclays’s Pehlivanova said in a Feb. 1 note to clients written with James R. Crandell and Michael Zenker “As a result, supply levels now greatly outstrip demand levels, and we do not see a turning point in the near future for supply, demand, or inventory levels.”

Gas consumption in November by industrial users, which account for about 28 percent of U.S. demand, was 1.9 percent below the levels of the same month in 2007, before the start of the global financial crisis, according to Energy Department data.

To contact the reporter on this story: Christine Buurma in New York at cbuurma1@bloomberg.net

To contact the editor responsible for this story: Dan Stets at dstets@bloomberg.net

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