Gordon Meagher writes: Natural gas prices have not been immune from the broader deflationary forces impacting commodities across the globe. Production gluts and oversupply are testament to the industry’s problems as company’s produce at breakneck speed to stave off bankruptcy after borrowing substantial funds to fund exploration and production projects across the lower 48 US states. Even though an LNG export terminal is expected to come online this quarter, improving the export market capacity, it is unlikely to tackle the problem at its root. Even though the supply-side of the equation can remain very fluid, stimulating demand has proven difficult. Even though certain factors such as the falling rig count are contributing to optimism of a potential rebound, longer-term factors dictate further weakness in prices.

Production Declining

A quick glance at global trade volumes is showing the world economy continues to see the pace of expansion falter, confirmed by the latest IMF downgrade of the global growth outlook. While US natural gas does not have an export ban akin to crude oil, exports have faltered over the past two years. Production steadily climbed over time despite a dip in 2008 and another 2012. At this point, the latest US Energy Information Administration data shows that production has declined from a peak reached in April and while marginally lower, production has mainly flattened. From the point of view of demand, growth is expected to be weak in 2016, growing to just 76.4 billion cubic feet per day compared to 76.2 billion in 2015. While household demand is forecast to slide this year as warmer winter conditions are anticipated, low prices are creating strong incentives to allocate an increased amount of gas towards electricity production

The latest predictions show that gas prices are not expected to rise back above $3 per MMBtu until after January and while increased seasonal demand during the winter months might give gas prices some tailwinds, these factors are likely to be short-lived. Drilling efficiencies continue to rise meaning that any uptick in prices is likely to lead to production growth, a situation which will continue to play downward pressure on prices in the near-to-medium term. Liquefied natural gas exports are expected to help balance-out the pricing dynamic in comparison to the rest of the globe. Prices are nevertheless estimated to remain subdued, with 2016 forecast to average approximately $3.05 per MMBtu. However, based on the current amount of production and no sign of further slowing especially amid increased efficiencies in drilling and production, natural gas prices are unlikely to rebound to those optimistic levels.

Rig Count Still Falling

The latest data from oil services giant Baker Hughes shows that the pain is not yet over for natural gas producers as the recent glut continues to impair companies with high breakeven costs. Natural gas drill rigs continue to be taken offline as evidenced by the two dismantled in the previous week, with the current drill rig count for gas standing at 195, well below the 330 rigs that were operational exactly a year ago. In general, energy drill rigs have fallen by over 50% versus the prior year in a sign of more difficult times to come for exploration and production companies. With energy prices forecast to remain subdued for years to come especially on the back of weak demand from Asia and limited exports, more companies, especially in the tight gas plays are expected to fold as a result. Financing from Wall Street is increasingly difficult to obtain due to a quarterly revaluation of reserves and the fact that increasing credit to firms creating limited cash flow is highly speculative.

The Technical Take

Natural gas prices continue to consolidating within a descending triangle pattern, formed by the emergence of a prevailing downtrend line and horizontal support. The formation has a strongly bearish bias with any move and close below the key support level at $2.440 considered a triangle-based breakout to the downside. Breakout trades are typically accompanied by renewed and expanded momentum and the move is further confirmed by an uptick in trading volumes. With this in mind, Put positions should be initiated on any break of the support level to capitalize on the potential for further downside in Natural gas prices, targeting lows last seen in 2012 at $2.126. However, should the downtrend line be broken to the upside before natural gas prices break lower, it signals a breakdown in the unfolding pattern and could also lead to a potential upside reversal and technical bounce. A break of the prevailing downtrend line is cause for initiation of Call positions targeting $2.832.

Conclusion

Although further downside in gas prices might be limited by the exit of more marginal producers, oversupply conditions are forecast to remain in natural gas. Prices are expected to remain subdued for a longer period of time and despite the fact that government estimates put the average prices above $3 per MMBtu, reality might dictate prices below that level for an extended run. A dropping rig count and increased LNG exports will be positive and supportive of a rising price trend over the coming years, but these developments remain at a distance. However, with winter demand for gas expected to fall and pressure commodity prices unlikely to abate. However, should the trend-line be broken, it could mean a temporary upside respite for prices that involves a technical rebound towards $2.832. However, despite the technical factors, risks remain biased to the downside.

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