The Market Is Ignoring the Demand Side of the Natural Gas Equation

The past couple of years there has been focus on increasing natural gas supplies, but most ignore surging demand that isn't being met with higher drilling. With natural gas inventories plunging to 11-year lows last week, the market needs to start including the demand side in the equation. One of the best examples of the increase in demand is the recent facility built by Nucor  (NYSE: NUE  ) in La.

The biggest mistake most make is assuming that abundant supplies in the ground will turn into production by E&P companies. The ironic part of the equation is that producers have left natural gas areas of the Haynesville Shale, (and other surrounding plays), while industrial and chemical plants are moving into the Gulf Coast.

Natural gas producers that stayed in the region such as Southwestern Energy (NYSE: SWN  ) and Comstock Resources (NYSE: CRK  ) will benefit the most from surging demand, with existing operations along the coast.

Total demand
While all of the focus is on the weekly natural gas report supplied by the EIA, the totals are based on the standard economic equation of demand and supply. Typically, the focus is only on the increase in supply due to the shale gas gains. The demand side is regularly ignored, and without a balance, the market will face the same volatile prices as it has in the past.

In the latest monthly report from the EIA, gas consumption over the last five years has soared. Total consumption in 2009 was 22,910 billion cubic feet, or Bcf. Total consumption by 2013 soared to 26,035 Bcf. In January, consumption jumped to 3,219 Bcf from 2,757 Bcf two years ago. Part of the increase was due to the polar vortex winter, but in reality, a lot of the gains in monthly consumption are coming from the Nucor plant and industrial and electric power switching to natural gas from coal.

New Nucor plant
Nucor built the plant on the Mississippi River close to New Orleans with the idea of creating a higher quality product using domestic workers, while taking advantage of low domestic fuel costs. The plant produces direct reduced iron, or DRI, from this plant with the potential of building a coke plant, blast furnace, pellet plant, and steel mill at the site, in what could be a $3.4 billion complex. At the current prices of natural gas, DRI is significantly cheaper than conventional steel making.

In the case of the new Nucor plant, it utilizes an incredible 25 Bcf of natural gas a year or the equivalent of the amount used by Manhattan, according to this interview with the CEO on CNBC. You should note how most discussions regarding the steel industry benefiting from low natural gas prices never discuss the impact of higher demand caused by the new facilities.

Gulf Coast producers to benefit  
Any natural gas producer still focused in the La. area is likely to benefit from the surge in expected demand along the coast. One primary beneficiary could be Southwestern Energy with operations focused on the Fayetteville Shale in Arkansas along with other plays in Texas and Oklahoma.

While the company saw fourth quarter production surge 18% due to Marcellus Shale growth, production in the Fayetteville Shale remained stable at 123.2 Bcf. With nearly 5 Tcf of reserves in the Arkansas area, the company is set up to benefit directly from a Gulf Coast demand surge.

Comstock Resources has moved from a Haynesville Shale-focused dry gas producer to a more evenly focused oil producer in the Eagle Ford Shale. The company, however, has the assets and current production in the Haynesville Shale to shift back with the increased demand of the area.

Current reserves in the North La. area sit at 344 Bcfe, which amounts to roughly 60% of total reserves. Due to a lack of drilling, natural gas production declined 31% in the fourth quarter, but the large asset base close to the Gulf Coast remains ready for higher gas prices.

Bottom line
When reviewing the plans of industrial companies to increase usage of natural gas and the suppliers to cut back usage, it leaves a big void in the market. In this case, Nucor built a huge plant to utilize a large amount of natural gas with plans to expand, while Comstock Resources continues to cut back its production. The combination could lead to supply disruptions and higher natural gas prices down the road, especially with inventories already very tight.

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