Is The Gulf Coast Gas Storage Development Surge Heading For Boom Or Bust?

Current tightness in U.S. natural gas supply-demand fundamentals has generated a tremendous interest among developers, marketers/traders and the financial community to develop, contract for, and finance storage projects in the U.S. - particularly high deliverability salt dome storage in the U.S. Gulf Coast (USGC).

An unprecedented number of underground natural gas storage projects in the USGC are advancing through various stages of development, with more than 140 Bcf of working gas capacity under construction and at least another 400 Bcf in earlier stages of development. This flurry of development activity represents a possible 60% increase in USGC gas storage capacity from current levels (Figure 1).

Figure 1: Existing and Proposed Gulf Coast Storage Capacity.

However, amid the market optimism and development enthusiasm there is a growing concern. The root cause of storage development (i.e. record levels of gas price volatility), may be dampened if and when all the proposed projects come into service, making return on investment targets hard to achieve. Investors are therefore asking whether there is a storage bubble waiting to burst. Should entities build and assume the risks that are associated with being a developer/owner/operator? What will be the extent of capacity-on-capacity competition and its impact on lease rates? Further, what factors would constrain development to a level which supports at least the minimum threshold returns on investments?

Despite an unprecedented level of storage development activity in the Gulf Coast, several market factors will likely prevent the sector from falling into an overbuild situation similar to what happened in the merchant power sector earlier this decade. Significant geological barriers for entry, expectations of high seasonal price spreads, continuation of elevated and volatile commodity prices that are supported by long-term fundamentals, and significant increases in construction costs point toward a tight storage market for the next eight to ten years.

Natural gas storage value has traditionally been driven by the need to balance flat production rates with volatile, weather-sensitive, demand. This balancing need has increased in recent years as rising commodity prices and overseas competition have caused a sharp decline in U.S. industrial demand. Declines in non-weather sensitive industrial consumption have resulted in a significant increase in the weather-sensitivity of overall demand and contributed to greater levels of volatility. This trend is expected to continue as growth in the demand for natural gas in the residential, commercial and power sectors outpaces that of the industrial sector, particularly in the Southeast U.S.

While demand volatility has increased, the ability of domestic production to respond to shifts in consumption has been limited. Recent increases in productive capacity have not alleviated this tightness as the market has absorbed all incremental supplies. While new unconventional resources such as the Haynesville and Marcellus shale are expected to add to domestic supply, these developments will also likely be characterized by both greater production costs and steeper decline rates. Natural gas supply is consequently expected to be highly responsive to price shifts, thus reducing the probability of a supply glut and fostering high volatility as North American markets remain on a “treadmill” of tight supply and demand.