The natural gas market heated up in the past several days even though the injections to storage were much higher than the five-year average in the past week. Does the higher than normal injection to storage impact the price of natural gas and United States Natural Gas (NYSEARCA:UNG)?
During last week, the price of natural gas rose again by 0.62%. Further, other natural gas related assets such as Chesapeake Energy (NYSE:CHK) and United States Natural Gas also increased by 2.5% and 0.46%, respectively.
Despite this modest gain in the price of natural gas, the future market remains in Backwardation as indicated in the chart below.
The chart shows the changes in the difference between the price of natural gas and UNG, which were both normalized to the end of January 2014. In recent months, the Backwardation has kept the price of natural gas close to 12% below the price of UNG.
According to EIA's recent report, underground natural gas storage increased by 107 Bcf and reached 1,606 Bcf. Last year, the storage grew by 95 Bcf - the five-year average injection was 88 Bcf.
The table above shows that last week's injection was higher than last year's injection and the five-year average injection. Moreover, during the past five weeks, the storage injection rate was 24% higher than the five-year rate. But do the changes in storage have a strong impact on the price of natural gas?
As I have pointed out in a previous post, the correlation between the changes in average weekly prices and change in storage from the five-year average is weak. This post only showed the potential effect the changes in storage may have on the price of natural gas. But what is the impact of the EIA's storage report on the price of natural gas on the day of its publication?
To test this potential relation, I have examined the correlation between the daily percent price changes on the day of the EIA's report release in the past year and the shift in storage from last year's injection/extraction.
This variable isn't (by far) the only one to explain the changes in prices and by omitting other variables, which may have an impact on the price of natural gas - the coefficients of a regression could be biased. But the main point isn't to come up with a multi-variable regression to explain other factors that move natural gas. It's made to demonstrate the immediate impact that the EIA report may have on the price of natural gas.
The chart below shows the relation between the two.
As you can see, the gap in storage from last year's storage injection/extraction doesn't have a strong impact on the price of natural gas and explains only 5.5% of the changes in price on the day the EIA's report is released. The correlation is -0.23, which isn't too strong and negative. This means the rise in the gap between this year's injection and last year's - the price tends to fall. I have also checked it for the five-year average and the correlation is even weaker at -0.15.
Therefore, these weak correlations suggest, assuming all things equal (and other certain assumptions), the price of natural gas isn't strongly impacted by the changes in storage. Don't get me wrong, the changes in storage affect the movement of natural gas, but its effect isn't strong. Moreover, the P-value of the coefficient was 0.07, which means a 10% significant correlation (I know, not great but still passable).
This could partly explain why the price of natural gas isn't falling even though the storage is building up at a faster than normal pace.
Finally, the ongoing low level of storage is the other side of the equation, which is currently 35% below the five-year average. The high injection rate won't be enough to bring back up the storage to each normal rate of around 3,700 Bcf by the end of October.
Natural gas prices are still elevated for the season and even if future injections to storage remain higher than normal, they aren't likely to bring down the price of natural gas below $4. The price could come down from its current elevated level if the injections further pick up at a much faster pace. Until then, natural gas is likely to remain high.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.