Michael Zenker has a bachelor’s of science in nuclear engineering, but it doesn’t take that kind of smarts to know what’s wrong with the natural gas market: too much gas and too little demand.

Even so, Zenker crunches a lot of numbers as a managing director and the head of natural gas and power research for Barclays in New York City. He looks at production numbers play by play, imports from Canada, how many billions of cubic feet utilities are using, storage, and much more.

He has been watching the gas markets for more than 20 years. Before joining Barclays in 2007, he was a managing director at Cam-bridge Energy Research Associates (IHS CERA), where he led the global gas and power teams. Before that, he led the gas and power trading group at SoCal (Southern California Edison), one of the larger utilities in the nation. There, he was responsible not only for trading, but for pipeline and storage management and power-plant dispatch.

Oil and Gas Investor called Zenker recently to see if there is any hope ahead for gas producers. He had just returned from a quick day trip to Williston, North Dakota, to see the Bakken oil boom firsthand. There, he saw a lot of trenches dug beside the roads, waiting for gathering lines—and a lot of associated gas being flared.

image- Michael Zenker

Investor Mike, it’s 102 degrees in Houston today—won’t that help gas prices?

Zenker Hot weather will boost demand some, no question about it. But that’s the tricky part of the market this year—if warmer-than-normal weather appears, it creates the need for more gas, and then the price rises and it won’t displace coal. What’s defining gas prices more than anything right now is coal—but we find if prices rise, it trims demand from coal displacement. We think gas prices are too high relative to coal, but this is going to be self-correcting.

Investor What is your take then for the second-half 2012 price?

Zenker Unless it’s hot all summer, we think it stays at about $2.50 per MMBtu through October. Once we get past that point, the market could bounce back to $3. That’s nothing rip-roaring, but at least we’d be off the lows. In fact, we think the lows are behind us for this year.

Investor That’s good news. After October you say the market gets reset. Why?

Zenker There’s only a finite amount of gas storage out there and we have a record storage fill. But it won’t be enough to push 2013 prices down to 2012 prices. The good news is, the market has seen a wave of new storage capacity added in recent years, but I think that has largely played out. We see very little interest in adding new storage now.

Investor Why is that?

Zenker The way the math works, you need to have a $1.00 or $1.20 spread between the winter and summer prices to allow storage to capture enough value. This year storage capacity will be 4.15 Tcf.

Investor What can gas producers look forward to?

Zenker We think U.S. gas production is already on a slow decline. There is some evidence of that, but the market is still skeptical. We simply don’t think associated gas production is going to grow fast enough to offset the production cuts from lower gas drilling.

Investor You are basing that on the government’s 914 data?

Zenker That, and we also look at pipeline numbers and other proprietary data we have. The EIA-914 data has been directionally the same as these other sources. February and March showed production pulled back a little, and April will probably be flat to up a bit. We think the May and June data, when they come out, will show a chunkier drop in production.

Investor Define chunkier.

Zenker We think production will be down 150 million cubic feet a day every month for the rest of this year. By August we should know whether or not U.S. production is really declin- ing much. There will probably be enough of a decline to convince the market and we could see a decent rally.

Investor How much of a pop in price do you foresee?

Zenker We think the market will be a little overly enthusiastic about this when it happens, and it could go to $4 for the 12-month strip for 2013. Our forecast for next year is $3.25 on average, per MMBtu.

Investor To clarify, how much U.S. gas production is there now?

Zenker In the Lower 48, it is 63 billion cubic feet (Bcf) a day and consumption is about 68. It’s been growing: in 2009 Lower 48 production was 55.3 Bcf a day and now it’s 63, so we’ve increased it by 8 Bcf.

We get some imports from Canada—about 5.4 Bcf a day—but that’s been declining for some time. We do export a small amount to Mexico too, about 1.5 Bcf a day. That was only 850 million a day in 2009, so it’s been growing.

Investor Can that kind of production growth continue given these low gas prices?

graph- gas production change / gas displacing coal

Zenker I do not expect production to grow this year. It has peaked for this year. It’s not that producers can’t do more, but they are mostly drilling for liquids and oil now. We think in 2014-2015 we’ll get back to gas-production growth, but probably not at the same pace as we saw in 2009, 2010 and 2011.

Investor It all comes down to demand.

Zenker Right. There’s not much new demand on the horizon in the near term in our view. Almost 10% of gas consumption now comes from displacing coal.

We have coal displacement as a more or less permanent part of the market, but that means the price of gas is wedded to the price of coal. One’s outlook for coal defines one’s outlook for gas. The spot price for coal is below production costs in many regions of the U.S. which reflects a lack of buyers out there. The coal industry itself has slashed production to try to balance the market.

Longer term we believe gas is in permanent competition with Appalachian coals.

Investor They are both in a race to the bottom to cut production.

Zenker Exactly. A happy consequence is gas producers are drilling less, so we inject a little less and we see a modest strengthening in prices. Coal will reclaim some market share next year on the expectation that gas prices come up a bit.

Investor What’s your view on liquefied natural gas (LNG) exports?

Zenker We think 20 Bcf a day of projects are seeking approvals in the U.S. and Canada, but there will be two limiting factors: one, there is finite buyer interest and you need long-term, credit-worthy contracts to finance these projects. Two, the DOE is obliged to look out for the public good, so it is unlikely to permit enough exports to move gas prices in the U.S. higher.

We think by the end of the decade, 4 Bcf a day will be exported from the U.S., but we are not picking particular projects, just an amount. And then we see another 1 Bcf from western Canada. We do view Canada as being the most advantaged place in North America to export LNG, because it is closer to the Asian market and there is a lot of gas in British Columbia.

When Korea Gas Corp. signed its agreement with Cheniere, we saw that as very significant, because it was the first long-term contract in the world tied to Henry Hub prices.

Investor How will U.S. exports affect the world?

Zenker Four Bcf in the context of a global market of about 31 Bcf a day won’t dislocate prices. The appetite for LNG has been greater than expected, and it’s going to 33 Bcf a day later this year. It’s a great time to be selling LNG, as the wave of new supply from Qatar and Peru is online now and buyers and sellers have a lot of confidence that there is enough market appetite for new contracts.

Investor What price will encourage U.S. producers to drill for gas again?

Zenker We think $4.50. The long-term prospects for gas will be determined by what happens in oil and liquids, because producers can make so much more money drilling for those. NGL returns are declining some, but not enough to make gas wells more attractive.

Investor What are the best plays for returns?

Zenker The early results out of the Mississippi Lime look very good. Each year there seems to be a new, better play. First it was the Bakken, then it was the Utica….

The Eagle Ford hasn’t peaked, and in fact is still growing because of associated gas. It was making about 2 Bcf a day in April. The Haynes - ville has rolled over though. It’s making a little below 5 Bcf a day, yet it peaked at 5.3.