Supply Glut Pressuring Natural Gas

In its weekly report last week, the Energy Information Administration (EIA) reported a bigger-than-expected 54 billion cubic feet (Bcf) weekly addition to natural gas stockpiles for the week ended August 21. This takes the current storage level to 3.26 trillion cubic feet (Tcf), which is up 18.8% from last year's level and 18.1% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 516 Bcf above this last year and 500 Bcf above the five-year average.



The build was smaller than last year's 100 Bcf build and the five-year-average injection of 67 Bcf. However, the relentless increase in gas storage levels continue to add to the long list of issues weighing on the commodity. Natural gas prices rallied earlier last year, reaching over $13 per million Btu (MMBtu) in July 2008, before trending down. Prices have since dropped sharply to the current seven-year low level of sub-$3 per MMBtu (we are referring to Henry Hub spot prices here).

Continued strong domestic production (from a number of unconventional natural gas fields) and recessionary consumption (due to the economic downturn), particularly in the industrial sector, are at the core of the commodity's current woes. The supply picture is expected to reverse in the coming months as the lagging effect of the sharp drop in domestic drilling activity takes effect. Partly offsetting the production drop is the expected ramp-up of LNG imports this year.

The commodity’s weak near-term outlook, coupled with the ongoing credit market turmoil, has prompted natural gas producers to curtail capital expenditure plans for 2009. As a result, this has been an extremely difficult period for natural gas and related energy support plays.

Considering the plunge in the commodity prices, we remain cautious on natural gas-focused E&P players such as XTO Energy (XTO), Chesapeake Energy (CHK), EOG Resources (EOG) and EnCana Corp. (ECA). We currently rate shares of these companies as Neutral.

In particular, we remain wary of land drillers such Nabors (NBR) and natural gas-centric service providers such as BJ Services (BJS), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year. We have Underperform recommendations on both the companies.

Comments

[Michael D.:]

Pipelines. Whether stored, produced, pressurized/liquified, and then delivered to markets....everything goes through a pipeline regardless of the commodity price.

Aug 31 09:22 AM

[A Barrel Full:]

What is needed is the last mile. Connect everyone up to the gas supply.

Aug 31 09:58 AM

[Mad Hedge F...:]

I agree. “When do I buy natural gas” is the most frequent question I am getting from clients these days. I can’t blame them, after watching CH4 dive from $13.50/MCF last year to a September contract low of $2.72. Massive new discoveries and an unusually cool summer is causing a looming storage shortage that has hammered longs. Those who dove in early have been punished, with stop outs followed by stop outs. The bizarre thing is that gas went up in flames while crude more than doubled, from $32 to $77, leaving pros stunned and speechless. The crude/gas ratio has soared to an unimaginable 27 times, up from a mere four times in the last decade. On a BTU basis, gas is now only 25% the cost of oil, it burns cleaner, with only half the carbon dioxide output, and is cheaper than high grade coal. Natural gas at these prices is another way of buying oil at $18 a barrel, with less pollution. Industry insiders don’t see it falling below $2/MCF, the breakeven cost of the longest term producers, where the shut off valves will start creaking en masse. Existing gas fields deplete at 25% a year, and the 60% cut in new drilling this year will deliver a rebound in prices by next winter. Longer term, the Pickens plan and the conversion of a large part of our national power generation to natural gas will drive prices higher. In the end, I think the final low will be defined by another Amaranth type disaster, where a super leveraged long hedge fund gets wiped out and is then liquidated under the worst conditions imaginable. In 2007, the Amaranth debacle took gas from $17 to $4 in the blink of an eye. Where Amaranth 2.0 will take us is anyone’s guess. But when it happens, possibly as early as September, other big hedge funds will stampede in like feral cats lapping up spilled milk. If I lived over a giant salt cavern, I would be pumping it full of natural gas now. But since these formations don’t exist in Northern California, I shall have to content myself with the futures markets, where longer dated contracts are selling at big premiums. Email me at madhedgefundtrader@yah... if you need help getting set up on the futures. For those not looking for an “E” ticket ride, it may now be time to Hoover up the leveraged natural gas equity plays like Chesapeake (CHK), XTO Energy (XTO), Southwestern (SWN), and Petrohawk Energy (HK), which appear to have already bottomed.

Aug 31 10:03 AM

[Elliott:]

On Aug 31 10:03 AM Mad Hedge Fund Trader wrote:

> Natural gas
> at these prices is another way of buying oil at $18 a barrel, with
> less pollution.

Really? Wow, I had no idea they could take natural gas and make gasoline, diesel and jet fuel out of it.

Aug 31 11:31 AM

[john s. gordon:]

the relentless collapse of u.s manufacturing has seriously wounded the natural gas business.
> jack

Aug 31 12:28 PM

[Michael D.:]

Can't remember where (Economist?) but I read a fascinating article about the possibility of NG fuelled flight. Super cooling, cool body aircraft (more slippery) can be quite efficient.

Last Mile: This may be correct. There are millions of people within a mile of a pipeline without access.

Cost: Can it replace coal? The infrastructure investment to convert coal plants probably cancels any cost advantage.

Aug 31 12:57 PM

[Mmarrkk:]

Actually Elliott its been done for years, at least since WWII. The South Africans led the way with Fischer-Tropes (sp?). Gas-To-Liquids is a proven commercial process and is even more economic when gas prices are low and oil prices are high. Go to Syntroleum's web site or to Shell and/or Exxon. Make sure you look up GTL, not to be confused with LNG (liquified natural gas). These are two completely different processes.


On Aug 31 11:31 AM Elliott wrote:

> On Aug 31 10:03 AM Mad Hedge Fund Trader wrote:

Aug 31 01:52 PM

[Mmarrkk:]

Fully agree! I'd add that the relentless collapse of u.s. manufacturing was driven in large part by the overreaching of two groups: organized labor and environmental terrorists organizations...both joined at the hip by the Democratic Party! Labor costs have gone through the roof due to benefits packages that don't mirror reality or the competitive nature of the world economy. Keeping up with ever changing environmental regulations that in many cases have no basis in cost/benefit analysis is also a driving force behind manufacturing leaving the country. With that manufacturing base leaving, the natural gas industry has lost a vital demand element.


On Aug 31 12:28 PM john s. gordon wrote:

> the relentless collapse of u.s manufacturing has seriously wounded
> the natural gas business.

Aug 31 05:38 PM

[biomedlives:]

Then U. S. wages, benefits, and working conditions comparable to those in developing countries would "mirror reality", right?


On Aug 31 05:38 PM Mmarrkk wrote:

> Fully agree! I'd add that the relentless collapse of u.s. manufacturing
> was driven in large part by the overreaching of two groups: organized
> labor and environmental terrorists organizations...both joined at
> the hip by the Democratic Party! Labor costs have gone through the
> roof due to benefits packages that don't mirror reality or the competitive
> nature of the world economy. Keeping up with ever changing environmental
> regulations that in many cases have no basis in cost/benefit analysis
> is also a driving force behind manufacturing leaving the country.
> With that manufacturing base leaving, the natural gas industry has
> lost a vital demand element.

Sep 01 10:07 AM

[Mmarrkk:]

Don't have to be comparable to developing countries, but also don't have to be as ridiculous as the UAW contracts that pay folks when they aren't working, that pay them huge percentages over their counterparts at Hyundai and Toyota and Honda plants IN THE U.S.A. Hyundai's plant in Alabama is working well at a fraction of the labor cost of the GM plants around the country. Difference? Union vs non-union.


o
> those in developing countries would "mirror reality", right?

Sep 01 10:41 AM