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Is Another Natural Gas Slump Forming?

I have been bullish on the outlook for natural gas over the last two years, but there are growing indications that the party may be over the fossil fuel.

Over the last year, natural gas has lost 15% and most natural gas producers such as Painted Pony Energy Ltd. (TSX:PONY) have seen their stock fall by a similar amount.

There is every indication that natural gas prices will remain depressed for the foreseeable future. 

Now what?

Natural gas has become the transitional fossil fuel of choice to replace coal as the primary fuel for electricity generation because of its low carbon emissions.

And this, along with it being favoured source of energy for heating and localized supply shortages, saw some analysts tip that natural gas would surge in value.

That has not occurred. After hitting an almost five-year high in January 2018, natural gas has weakened sharply to be trading at under US$3 per million British thermal units (MMBtu).

Natural gas prices will remain weak over the remainder of 2018 and into 2019 because of massive U.S. gas supply gains and growing upstream efficiencies that are supporting ever higher production levels.

According to the U.S. Energy Information Administration (EIA) August 2018 U.S. dry gas production grew to 82.2 billion cubic feet per day (Bcf/d), an increase of 0.7 Bcf/d over the previous month.

The EIA is forecasting that 2018 U.S. dry natural gas production will average 81.0 Bcf/d for the year, which would set a record high and be 10% greater than 2017.

More daunting is that 2019 production is expected to rise again and average 84.7 Bcf/d which is 5% higher than the forecast for 2018. That considerable production growth will continue to weigh on natural gas prices.

While natural gas production growth has remained relatively flat in Canada, the world’s fourth-largest gas producer, there has been a significant spike in drilling activity as upstream producers boost investment in their operations.

This is evident from the latest rig count, where the volume of active rigs soared by 22 compared to a week earlier, seven of which were gas rigs.

That will lead to a marked increase in Canadian production volumes as highlighted by Painted Pony’s second quarter 2018 results, where natural gas production shot up by 44% year over year and natural gas liquids output grew by a whopping 98%.

The driller is continuing to invest significantly in developing its natural gas acreage despite realizing an average price for the second quarter that was 28% lower than a year earlier.

For 2018, Painted Pony has budgeted $185 million of development capital to fund the drilling of 29 wells and the completion of another 31 wells.

Nonetheless despite weaker prices, Painted Pony continues to report a solid operating netback underscoring the profitability of its operations.

For the second quarter, it announced a netback of $1.95 per million cubic feet (Mcfe) produced, which was 8% higher year over year, underscoring why it continues to expand production.

So what?

The outlook for natural gas is less than optimistic despite signs that demand will keep growing at a decent clip. This is because of the surge in production, which will continue to rise as upstream producers ramp up drilling activity.

There is every sign that supply will easily eclipse demand growth keeping a lid on natural gas prices and making producers such as Painted Pony unattractive investments.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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