The price of natural gas and United States Natural Gas (NYSEARCA:UNG) rallied, despite the higher than normal injection to storage during last week. Moreover, during the past four weeks, the injections to storage were 24% higher than the 5-year average. Looking forward, what could bring down UNG and the price of natural gas?
During the previous week, the price of natural gas increased by 3.7%. Further, other natural gas related investments such as Chesapeake Energy (NYSE:CHK) and United States Natural Gas also rallied by 3.4% and 3.7%, respectively. For the year, UNG is still up by 12 percentage points over natural gas due to Backwardation in the futures market. The current Backwardation in the future markets is demonstrated in the chart below.
The chart shows the difference between the pricing of future prices of natural gas (for the next month, for the next two month, etc.) and spot price. Whenever the lines are below the zero, the market is in Backwardation. For most of the winter time, this was the case. But the market has stabilized in the past couple of months.
Currently, the future contracts are close to the spot price. This might suggest the market's expectations are that the price of natural gas will remain close to its current price range of $4.4-$4.7. Moreover, the EIA estimates the price of natural gas around $4.5 for the rest of the year. But this estimate has wide confidence intervals, which range between $3.6 and $6.3 by August 2014 (for 95% confidence). This doesn't mean, the price is likely to tumble down to $3.6 in the coming months, but the price could descend below its current range of $4.4-$4.7. One factor that could pressure down the price of natural gas is the buildup in storage.
According to EIA's latest weekly report, the underground natural gas storage grew by 119 Bcf and reached 1,499 Bcf. In comparison, last year, the storage rose by 93 Bcf; the five years average injection was 111 Bcf.
As you can see, last week's injection was above last year's injection and the five-year average injection.
Despite this higher injection pace, the EIA projects the storage will reach 3,400 Bcf by early November - nearly 10% below normal. In comparison, back in March the deviation from normal was more than 55%. The lower deviation from normal could loosen the natural gas market. In order for the storage to rise to its normal level of around 3,700 Bcf, the buildup should pick up by nearly 60% over next several months. If the natural gas injections pick up by such a high margin (improbable but not impossible), my guess the price could come down below $4 by November.
From the demand side, the average U.S. natural-gas total demand slipped by 0.7% (week-over-week). Most of the fall is related to the softer demand in the residential/commercial sector, which was partly offset by the increase in demand in the power sector.
Looking forward, the EIA still estimates the consumption to remain higher than last year's levels.
From the supply side, the gross natural gas supply inched down by 0.35% during last week; this decline was mostly due to lower production, which was partly offset by a very modest gain in Canadian imports. According to Baker Hughes' recent weekly report, the natural gas rotary rig count fell by 6 rig to reach 320 rigs.
Despite this week's modest fall in production, the U.S. marketed production is picking up: During March, the natural gas production grew by 5.5%, year over year. The trend line has also been positive in the past several years (see here chart). Most of this growth is expected to come from U.S. non-Gulf of Mexico sites.
In total, during last week, the natural gas demand contracted, while the supply only moderate shrank. As a result, the EIA's supply/demand balance remained relatively flat with the supply remaining higher than the demand.
The weather and natural gas
The U.S. temperatures were warmer than normal during last week. Looking forward, the weather is likely to play a smaller role in the changes in demand for natural gas in the residential sector. In the next two weeks, the temperatures are projected to be higher than normal mainly in most parts of the U.S. Further, U.S. heating degrees days are expected to be lower than normal. Based on the above, the demand for natural gas in the residential/commercial sector could further come down.
The natural gas market could cool down in the near future but the price isn't expected to plunge to the normal levels anytime soon. If the storage buildup rises at a faster pace (currently buildup is around 24% higher than normal, it will need to pick up to 60%), this could bring the storage to normal levels by November and pressure down by then the price of natural gas to below $4.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.