Nat gas possibly headed much lower

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Unconventional natural gas production in the United States has been a true game-changer. Due to compelling economics, unconventional output is still rising in the shale plays. Producers report early success rates, reduced drilling times, highly productive wells and finding costs as low of as $1.50/MMBtu in some areas. On our estimates, many shale plays have returns of 20%+ on current calendar 2010 NYMEX natural gas prices. Severe storage constraints might surface in some areas, causing cash prices to sink. In turn, lower nat gas cash prices could negatively impact Henry Hub and force further production shut-ins.

In other words, because shale gas makes such long-term economic sense for producers, even collapsing natural gas prices in the interim are not currently enough to disincentivize its production. Which means in the short-term, you can expect further price pain according to the analysts as available storage continues to fill-up.

So what’s the worst that can happen? Well, one reason physical natural gas traders claim unlimited futures positions are a must in their industry is because unlike crude oil or other commodities natural gas that is already produced is much more difficult to store. Any excess supply on any given day must have the means to be used, go into storage, or it gets wasted.

In fact, in that way natural gas trading bears more similarity to central banking than commodities trade, because if natgas traders (also known as shippers) fail to deliver enough on a sudden bout of demand or conversely risk overloading the “system” because demands suddenly falls, the pipeline network risks falling out of balance with potentially dire side-effects. This is why spot prices can be hugely volatile.

As storage tightens to record levels, the chances of a major price collapse become ever more possible due to the practice of discounting gas in regional systems when capacity is full.

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