- Last week’s natural gas injection to storage was above the 5-year average.
- The weekly changes in storage seem to explain only 5% of natural gas prices mainly during winter.
- Natural gas consumption is falling down.
The price of natural gas changed direction and added over 4.3% during the past week. The Henry Hub ended close to $4 - the highest level in the past three weeks. United States Natural Gas (NYSEARCA:UNG) also recovered in the past few days. Moreover, other natural gas related stocks such as Chesapeake Energy (NYSE:CHK) also rose by 2% during last week. This rally comes after the recent strong buildup was higher than normal but slightly below expectations. Will natural gas continue to rise?
Injections to storage - do they matter?
Before we dive into the recent developments in the natural gas market, does the change in natural gas storage impact the price of natural gas? Let's consider the changes in the price of natural gas on Thursday, when the EIA releases its weekly update on storage, production and consumption.
In the chart below are the difference between last year's injection/extraction and weekly changes in storage (on the x-grid); and the daily percent change in the price of natural gas on Thursday over the past year (on the y-grid).
This means, as the injection to storage picks up above last year's levels, the price tends to rise on Thursday. This result, however, isn't very impressive, because this storage shift can only explain 5.3% of the volatility of natural gas prices (even though it is a significant correlation). But hold on it gets worse: This regression is a bit misleading, since it takes into account both the injection season (summer) and extraction season (winter). If we break down to injection season and extraction season, the correlation during the summer (injection season) nearly disappears and it only holds up during the winter. This result only means the initial market reaction on Thursday holds up during winter and not during summer time. It doesn't mean we shouldn't put weight on the high injections, because over time they are likely to impact the direction of natural gas prices.
Circling back to the recent updates: Last week, the natural gas injection was 82 Bcf, which was 33 Bcf above the 5-year average but 14 Bcf below last year's injection. Following this release on Thursday natural gas fell by 1.5% only to bounce back on Friday.
The U.S natural gas storage tends to rise during this season, because the demand for natural gas isn't high as in the winter while the production remains robust. In the past few weeks the injections to storage were higher than normal. Conversely, the current storage levels are well below the 5-year average by roughly 20%. The low storage was after the winter consumption in the residential and industrial sectors was significantly higher than normal: Between December 2013 and February 2014 the consumption in these sectors was over 18% higher than last year. But since then, the demand has plummeted: During May, the demand in the residential and industrial sectors fell by 44% and 30%, respectively. So we saw a sharp rise in storage.
The injections to storage in the past few weeks were significantly higher than normal and if this high injection pace continues, this could bring back up storage levels to normal levels by the start of the extraction season at the beginning of November. Specifically, in the past four weeks the injection pace was, on average, close to 80% higher than normal. Based no this pace, we get the following chart.
The chart above shows the buildup in storage (in blue) and the potential buildup in storage over the next several months (in red strips), assuming the buildup will remain roughly 80% above the 5-year average. The red line is the 5 year average storage.
This means, if the storage buildup continues at its elevated pace, storage could reach 3,900 Bcf by the first week of November. So we could see the price of natural gas coming slowly down to normal levels for the season, which is around $3.5-$3.7 in the coming weeks.
One issue to bring up storage levels is a robust production. Last week, U.S natural gas production remained nearly flat but was 5.2% higher than last year. If the production remains high and stable, this could bring keep the injections to storage above normal levels.
Conversely, the demand continues to contract mainly in the power, residential and commercial, which account for three quarters of total U.S total consumption. Thus, if the demand keeps falling and the production remains robust, we could see an ongoing high buildup in storage.
The recent recovery in the price of natural gas may not last long and we could see natural gas changing direction and resuming its downward trend in the near term. For more see: Is Chesapeake Regaining Our Confidence?
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.