Daily Letter 1 Energy -- Oil and Gas, Exploration and Production John Gerdes 1.713.331.9443 jgerdes@canaccordgenuity.com NATURAL GAS UP ON BULLISH EIA STORAGE REPORT Storage overview The EIA reported an 89 Bcf storage build, 3 Bcf below the 92 Bcf build consensus. The East region showed a 46 Bcf build, the Producing region a 32 Bcf build and the West region showed an 11 Bcf build. Storage stands at 2,053 Bcf, ~24.9% below last year and ~3.9% below the five-year average. The data suggests the market is ~5.8 Bcfpd oversupplied on a weather-normalized quarterly moving average basis. Notably, gas was up $0.04 in response to the storage report. Supply/demand trends Over the past four weeks, gas-fired power demand has run 9.8 Bcfpd lower y/y, Canadian net imports are up 0.8 Bcfpd, Mexican net exports flat y/y, and LNG send-out is down ~0.3 Bcfpd y/y. Industrial demand has been ~1.2 Bcfpd higher y/y the past month. The price relationship between coal and gas has evolved toward incremental strength in coal-fired power generation and corresponding weakness in gas-fired power generation. In 2013, we anticipate coal-fired power generation should rise 100+ TWh (or ~2.3 Bcfpd), while gas-fired power generation should decline ~90 TWh (or ~1.9 Bcfpd). Recent U.S. supply data indicate Feb. 13 production averaged 66.2 Bcfpd, implying a more accelerated recovery from ~1.2 Bcfpd erosion observed late- 12 and early- 13 than our prior expectation. We anticipate U.S. supply was stable from Feb. 13 through Apr. 13 near ~66.2 Bcfpd and will erode fractionally thereafter in 13. In our optimistic view, rig activity should accelerate from ~350 rigs to ~400 rigs by mid-year and average ~435 rigs in 2H/13. Thesis In the wake of extremely weak gas prices, the E&P industry cut gas-directed activity by almost 60% to ~350 rigs recently, which is solidly below the ~550 gas rigs we estimate are necessary to maintain long-term market equilibrium. Reversion to colder-than-normal late winter weather and the potential onset of sustained US onshore supply erosion appear to firmly support our ~$4 average gas price this year. Our average 13 gas price forecast reflects an unchanged outlook for $4.25 in 3Q/13 and $4.50 in 4Q/13. In 14, given the need to increase gas-directed drilling activity ~40% (~550 gas rigs) to maintain market equilibrium, a ~$5.25 NYMEX gas price signal seems necessary assuming the E&P industry is comfortable remaining ~20% free cash flow negative. Canaccord Genuity is the global capital markets group of Canaccord Financial Inc. (CF : TSX CF. : LSE) The recommendations and opinions expressed in this research report accurately reflect the Investment Analyst s personal, independent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For important information, please see the Important Disclosures section in the appendix of this document or visit Canaccord Genuity s Online Disclosure Database.
Daily Letter 2 US STORAGE Inventory picture On May 17, US gas in storage was 2,053 Bcf, ~24.9% below last year and ~3.9% below the five-year average. Cooling season to date, a net gas storage build of 336 Bcf is above last year s 272 Bcf build and below the five-year average 427 Bcf build. Figure 1: US natural gas storage 4000 US Natural gas inventories (Bcf) 3500 3000 2500 2000 1500 1000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Five-year range Five-year average 2013 2012 f Year-ago comparison Last week s 89 Bcf injection was less than last year s 95 Bcf build as degree days were up ~42% compared to year-ago levels. Figure 2: Y/Y comparison of changes in US gas storage Injections/(Withdraws) (Bcf) 125 100 75 50 25 0 (25) (50) (75) (100) (125) (150) (175) (200) (225) (250) (275) Jan Feb Mar Apr May Jun Aug Sep Oct Nov Dec 2012 Injections/(Withdrawals) (Bcf) 2013 Injections/(Withdrawals) (Bcf)
Daily Letter 3 WEATHER DATA Weather-normalized change Assuming the same weather as last year, US storage data implies a ~5.8 Bcfpd y/y oversupply condition on a quarterly moving average basis. Figure 3: Weather-normalized Y/Y storage change vs. gas price Over/(Under) Supply (Bcfpd, 13-Wk. MA) 6 4 2 0 (2) (4) $6 $5 $4 $3 $2 $1 NYMEX Natural Gas Price ($/Mmbtu) (6) 1/09 7/09 1/10 7/10 1/11 7/11 1/12 7/12 1/13 $0 Over/(Under) Supply Gas Price Source: EIA, Bloomberg, Canaccord Genuity Degree days Customer-weighted degree days were 58 last week, up ~42% y/y and 1.5% above the long-term average. Cooling season to date, TDDs are ~14% higher than year-ago levels and ~3% above the long-term average. Figure 4: Total degree days Total Degree Days 175 150 125 100 75 50 25 0 Apr May Jun Jul Aug Sep Oct Source: NOAA, Canaccord Genuity Long-term Range Long-term Average 2012 2013
Daily Letter 4 Forecast NOAA forecasts 52 TDDs this week, down 5.5% y/y and 7% below seasonal norms. In its latest 6-10 day forecast, NOAA forecasts colder-than-normal conditions along the western US and warmer-than-normal weather in central and eastern U.S. Figure 5: 6-10 day temperature forecast Source: NOAA, Canaccord Genuity For June through August, NOAA predicts warmer-than-normal temperatures across the U.S. and normal temperatures in the northern U.S and West Coast. Figure 6: March-May temperature forecast Source: NOAA, Canaccord Genuity
Daily Letter 5 US GAS MARKET THESIS Substantive gas-to-coal power displacement now necessary to rebalance the gas market Since the start of the last year s injection-season, a ~900 Bcf y/y storage overhang has inverted to ~800 Bcf less gas in storage as a consequence of 4+ Bcfpd stronger gas-fired power demand in 12 and slightly colder-than-normal 12/ 13 winter weather. Gas-fired power generation, in a low gas price environment, served as the corrective mechanism to eliminate the storage surplus. As we suggested then, natural gas prices reached their nadir last April. Yet, the necessity of low gas prices, and corresponding anomalous strength in gas-fired power demand, has receded and gas-fired power demand should decrease significantly this year. Given our ~$4 gas price expectation this year, we expect gas-fired power to fall 2+ Bcfpd in 13 as coal-fired generation recaptures last year s transitory coal-to-gas switching, which is normalized for underlying structural de-emphasis in coal-fired generation. Maintaining gas price forecast this year, increasing gas price next year $0.25 to $5.25 We are largely maintaining our expectation that NYMEX gas prices average $4 in 13 and increasing our long-term forecast $0.25 to $5.25. Our analysis/outlook implies the marginal cost of supply resides outside the Marcellus Shale and requires ~$5.25 gas to capitalize certain non-marcellus gas assets sufficiently to generate modest growth. Our 13 estimate is in line with the strip, while our long-term forecast is ~$1 above the 14 strip. Gas-directed drilling overcorrected to the downside with extraordinarily weak gas prices In the wake of extremely weak gas prices, the E&P industry cut gas-directed activity by almost 60% to ~350 rigs recently, which is solidly below the ~550 gas rigs necessary to maintain long-term market equilibrium. Gas storage meaningfully lower y/y entering the 13/ 14 heating-season As shown in the chart below, gas in storage exited the 12/ 13 heating season ~800 Bcf below year ago levels, against the backdrop of only ~2% colder-than-normal winter weather. Our analysis suggests November 13 gas-in-storage should approximate 3,200 Bcf, which would be ~700 Bcf below last year and ~600 Bcf below 10/ 11. If this storage trajectory materializes, we expect natural gas to approach $5 late this year. Storage should struggle to exceed 3 Tcf entering the 13/ 14 heating season In 12, storage entering the cooling season was ~900 Bcf above year-ago levels though exited the 12/ 13 heating season ~700 Bcf below a year ago. We project a storage refill in 13 comparable to 12 (~1,400 Bcf) as supply and demand erode similarly (1.2/1.1 Bcfpd). Normalized inventories, mild US supply erosion implies need to increase gas-directed activity We expect US gas supply to erode fractionally this summer assuming gas-directed drilling activity averages ~400 rigs the first three quarters of this year. In 2H13, we expect gasdirected rig activity to modestly incline assuming gas prices recover to $4+. Without a $4+ gas price signal and corresponding increase in gas-directed drilling, our November 13 storage projection of ~3,200 Bcf could actually prove optimistic. Overall, our expectation is the US gas rig count averages ~430 rigs this year. Our US gas supply projection this year includes ~3.0 Bcfpd gas production growth associated with oil-directed drilling activity. Our associated gas supply projection anticipates a relatively stable oil rig count at ~1,350 rigs.
Daily Letter 6 US US GAS MARKET OUTLOOK Figure 7: US storage outlook Withdrawal Season Injection Season Withdrawal Season 11/12-03/13 (1) 4/13-10/13 (2) 11/13-03/14 (1) Bcfpd Bcf Bcfpd Bcf Bcfpd Bcf Prior Period Injection/(Withdraw) (1322) 1436 (2221) Fundamentals vs. Prior Period: Supply: U.S. 0.5 81 0.2 49 0.1 19 LNG Imports (0.3) (39) (0.2) (47) (0.2) (27) Canadian Imports, net Exports (1.0) (158) (1.3) (268) (0.7) (105) Total Supply Change (0.8) (116) (1.2) (267) (0.7) (113) Demand: Industrial 1.0 152 0.8 176 0.7 106 Gas-fired Power (0.6) (97) (2.4) (516) (1.2) (176) Temperature/Conservation Variance 3.4 727 (0.0) (0) (0.2) (40) Total Demand Change 3.8 783 (1.6) (340) (0.7) (110) Net Over/(Under) Supply (1) (4.5) (899) 0.3 74 (0.1) (3) Beginning Storage 3908 1687 3197 Storage Injection/(Withdraw) (2221) 1510 (2224) Ending Storage 1687 3197 973 Notes: (1) Y/Y comparison over 151-day withdrawal season. (2) Y/Y comparison over 214-day injection season. Figure 8: Natural gas market outlook Natural Gas Price Forecast ($/Mmbtu) 2010 2011 2012 2013E 2014E 2015E 2016E 2017E Canaccord Genuity $4.39 $4.04 $2.79 $4.02 $5.25 $5.25 - - Futures Market $4.39 $4.04 $2.79 $4.02 $4.36 $4.43 $4.58 - U.S. Real GDP 2.39% 1.81% 2.20% 2.25% 2.75% 2.75% 2.75% 2.75% Incremental Y/Y Change (Bcfpd) Supply: U.S. 2.0 4.2 3.0 0.2 2.2 4.0 2.8 2.0 Canadian Imports (net of exports) (0.2) (1.3) (0.7) (1.1) (0.3) (0.4) (0.4) (0.4) LNG Imports (0.1) (0.2) (0.5) (0.3) (0.0) 0.0 0.0 0.0 Total Supply Change 1.8 2.7 1.9 (1.2) 1.8 3.6 2.4 1.6 Demand: Industrial 1.3 0.6 0.4 0.9 0.7 0.7 0.7 0.7 Gas-fired Power 1.5 0.6 4.3 (2.1) (0.6) 0.9 0.9 0.9 Total Demand Change 2.8 1.2 4.7 (1.1) 0.1 1.6 1.6 1.6 Storage (Bcf) April 1, 1638 1579 2472 1687 973 1034 1568 1729 November 1, 3821 3794 3908 3197 2857 3278 3886 3982
Daily Letter 7 US STORAGE MODEL Figure 9: 13 cooling season Total Degree Days Storage Injection Inventory Level Injection/TDD Week Date Current Yr Ago 16-Yr Avg Current Yr Ago 16-Yr Avg Current Yr Ago 16-Yr Avg Current Yr Ago 16-Yr Avg 14 4/5/2013 118 97 105 (14) 6 18 1673 2478 1401 (0.1) 0.1 0.2 15 4/12/2013 86 108 93 31 23 40 1704 2501 1442 0.4 0.2 0.4 16 4/19/2013 88 72 80 30 47 56 1734 2548 1498 0.3 0.7 0.7 17 4/26/2013 93 79 72 43 28 68 1777 2576 1567 0.5 0.4 1.0 18 5/3/2013 57 81 62 88 30 78 1865 2606 1644 1.5 0.4 1.2 19 5/10/2013 47 56 62 99 61 83 1964 2667 1727 2.1 1.1 1.3 20 5/17/2013 58 43 57 89 77 86 2053 2744 1813 1.5 1.8 1.5 21 5/24/2013 52 46 55 83 71 94 2136 2815 1907 1.6 1.5 1.7 22 5/31/2013 57 70 57 63 62 89 2199 2877 1996 1.1 0.9 1.6 23 6/7/2013 61 52 61 71 67 84 2269 2944 2080 1.2 1.3 1.4 24 6/14/2013 59 56 59 66 62 88 2335 3006 2168 1.1 1.1 1.5 25 6/21/2013 68 69 68 61 57 75 2395 3063 2243 0.9 0.8 1.1 26 6/28/2013 70 69 70 43 39 88 2438 3102 2331 0.6 0.6 1.3 27 7/5/2013 78 101 78 32 33 77 2470 3135 2408 0.4 0.3 1.0 28 7/12/2013 80 92 80 27 28 58 2496 3163 2467 0.3 0.3 0.7 29 7/19/2013 82 93 82 25 26 53 2521 3189 2519 0.3 0.3 0.6 30 7/26/2013 84 92 84 27 28 47 2548 3217 2567 0.3 0.3 0.6 31 8/2/2013 82 87 82 24 24 50 2572 3241 2617 0.3 0.3 0.6 32 8/9/2013 75 92 75 20 20 55 2592 3261 2672 0.3 0.2 0.7 33 8/16/2013 72 77 72 47 47 60 2639 3308 2732 0.7 0.6 0.8 34 8/23/2013 69 61 69 66 66 62 2704 3374 2794 1.0 1.1 0.9 35 8/30/2013 64 71 64 28 28 72 2732 3402 2865 0.4 0.4 1.1 36 9/6/2013 59 80 59 23 27 78 2755 3429 2943 0.4 0.3 1.3 37 9/13/2013 53 55 53 63 67 72 2818 3496 3015 1.2 1.2 1.4 38 9/20/2013 56 53 56 76 80 72 2894 3576 3087 1.4 1.5 1.3 39 9/27/2013 58 63 58 73 77 71 2967 3653 3158 1.3 1.2 1.2 40 10/4/2013 67 56 67 66 72 66 3033 3725 3224 1.0 1.3 1.0 41 10/11/2013 69 89 69 45 51 61 3077 3776 3285 0.6 0.6 0.9 42 10/18/2013 83 62 83 61 67 43 3138 3843 3327 0.7 1.1 0.5 43 10/25/2013 91 69 91 59 65 19 3197 3908 3347 0.6 0.9 0.2 Total: 2135 2191 2123 1510 1436 1963 - - - - - - Average: - - - 50 48 65 - - - 0.8 0.8 1.0 Figure 10: 13/ 14 heating season Total Degree Days Storage Withdrawal Inventory Level Withdrawal/TDD Week Date Current Yr Ago 17-Yr Avg Current Yr Ago 17-Yr Avg Current Yr Ago 17-Yr Avg Current Yr Ago 17-Yr Avg 44 11/1/2013 105 102 105 11 21 18 3207 3929 3365 0.1 0.2 0.2 45 11/8/2013 121 122 121 (2) (18) (14) 3205 3911 3351 (0.0) (0.1) (0.1) 46 11/15/2013 135 142 135 (17) (38) (33) 3188 3873 3318 (0.1) (0.3) (0.2) 47 11/22/2013 142 121 142 (59) 4 (34) 3129 3877 3284 (0.4) 0.0 (0.2) 48 11/29/2013 167 155 167 (79) (73) (90) 3050 3804 3194 (0.5) (0.5) (0.5) 49 12/6/2013 178 110 178 (132) 2 (107) 2918 3806 3087 (0.7) 0.0 (0.6) 50 12/13/2013 190 157 190 (142) (82) (127) 2777 3724 2960 (0.7) (0.5) (0.7) 51 12/20/2013 197 157 197 (136) (72) (117) 2640 3652 2843 (0.7) (0.5) (0.6) 52 12/27/2013 191 202 191 (139) (135) (122) 2502 3517 2721 (0.7) (0.7) (0.6) 1 1/3/2014 190 219 190 (148) (201) (124) 2354 3316 2597 (0.8) (0.9) (0.7) 2 1/10/2014 214 164 214 (173) (148) (174) 2181 3168 2423 (0.8) (0.9) (0.8) 3 1/17/2014 211 186 211 (182) (172) (168) 1999 2996 2256 (0.9) (0.9) (0.8) 4 1/24/2014 208 218 208 (171) (194) (155) 1828 2802 2101 (0.8) (0.9) (0.7) 5 1/31/2014 195 175 195 (153) (118) (139) 1675 2684 1962 (0.8) (0.7) (0.7) 6 2/7/2014 195 189 195 (158) (157) (138) 1518 2527 1824 (0.8) (0.8) (0.7) 7 2/14/2014 187 172 187 (154) (127) (118) 1364 2400 1707 (0.8) (0.7) (0.6) 8 2/21/2014 180 201 180 (135) (171) (105) 1229 2229 1602 (0.8) (0.9) (0.6) 9 2/28/2014 166 172 166 (123) (146) (81) 1106 2083 1521 (0.7) (0.8) (0.5) 10 3/7/2014 152 170 152 (65) (145) (66) 1041 1938 1455 (0.4) (0.9) (0.4) 11 3/14/2014 137 133 137 (25) (62) (39) 1016 1876 1416 (0.2) (0.5) (0.3) 12 3/21/2014 119 163 119 (13) (95) (9) 1003 1781 1407 (0.1) (0.6) (0.1) 13 3/28/2014 109 141 109 (30) (94) (13) 973 1687 1394 (0.3) (0.7) (0.1) Total: 3691 3571 3691 (2224) (2221) (1953) - - - - - - Average: - - - (101) (101) (89) - - - (0.5) (0.6) (0.5)
Daily Letter 8 Investment risks 1) The future revenues, profitability and cash flow of the exploration and production companies covered in this report will depend substantially upon the prices and demand for oil and natural gas. The markets for these commodities are volatile and even relatively modest drops in prices can significantly affect an upstream oil and gas company's financial results and impede its growth. Prices for oil and natural gas fluctuate widely in response to a variety of factors beyond the control of an individual company, including relatively minor changes in supply and/or demand. 2) Estimating oil and gas reserves is complex and inherently imprecise. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and gas reserves is likely to vary from estimates, perhaps significantly. In addition, individual companies may adjust estimates of proven reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond their control.
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