Natural gas crumbled nearly 12% this week, as the free fall in the commodity continues. Prices have now decisively broken below the $3.81 March lows as we initially called for back when gas was trading above $5 in June. While the prospect for storage and pipeline congestion has diminished somewhat given the year-over-year storage deficit that has developed on the back of what may turn out to be the hottest summer in recorded history, if we are correct in our call for a record September injection, such concerns may reemerge in the coming weeks. Incidentally, we have seen Western hubs plunge below $3/mmbtu as storage in the region approaches capacity.
More significant than the decline in flat prices over the past month is the continued deterioration in forward price expectations. The 12-month strip now sits in the $4.20’s and is at the lowest levels since 2002. As we have stated in the past, there is a structural imbalance in the natural gas market, which can only be corrected through relatively low prices, and that is what we are seeing.
Taking a look at Thursday’s inventory report, the EIA reported a 40bcf injection, slightly above consensus near 38bcf. The market has been shrugging off inventory reports in recent weeks, as six weeks of electric generation output above 90,000 GWh has kept natural gas demand in the segment elevated, masking the significant weather-adjusted imbalance.
Looking forward, the near-term fate of gas prices will be determinant on a combination of September injections, the U.S. economic outlook, and winter weather forecasts. We think weather-adjusted balances could be as much as 2 or 3bcf/d oversupplied relative to five-year averages, leading to a record injection this fall and perhaps even record overall inventory levels in November. Such a scenario in itself would lead to continued weakness in prompt month gas prices, likely toward $3/mmbtu. Moreover, the U.S. economic outlook has deteriorated in recent weeks and months, suggesting that natural gas demand in the industrial production segment could slow, perhaps leading to an additional 0.5-1bcf/d deterioration in balances. Finally, early winter weather forecasts are calling for a warm winter, which is obviously an extremely bearish prospect. All things considered, there is a distinct possibility of a $2-handle in the coming weeks, thus we would continue to hold prompt month short exposure.