Natural Gas Output Isn't Slowing Down

| About: The United (UNG)

Summary

The natural gas market continues to struggle.

The output remains elevated despite falling prices.

The consumption in the power sector is expected to pick up this year, which could start bringing up natural gas prices.

Even though the price of natural gas continues to fall, production isn't slowing down. The United States Natural Gas ETF (NYSEARCA:UNG) continues to fall and the rising Contango in the futures markets is likely to adversely impact the pricing of UGN via roll decay. Although the higher Contango signals the market anticipates natural gas prices to start moving up in the following months. But for now, the current market conditions of natural gas are likely to keep prices low until production starts falling or demand picks up.

Production isn't slowing down

In order to curb the rise in natural gas output, prices have come down - the Henry Hub is currently trading at $1.82. But the low natural gas prices have only led producers to become more efficient and not slash their output. The main indicator for the soft natural gas market is the high underground storage, as presented in the following chart.

Click to enlarge

Source: EIA

Currently, the storage is close to 50% above the 5-year average and 67% higher than the storage level recorded back in 2015. And the natural gas market is in a transition from the extraction to the injection season. So the injection season will commence with storage starting at an already higher than normal level.

Nonetheless, this hasn't stopped companies from producing natural gas: Although rig count is at an all-time low - according to Baker Hughes (NYSE:BHI) the number of rigs is at 89, which is 153 fewer rigs or 63% lower than in 2015 - the output remains close to last year's level. And in 2016, based on the latest report by the EIA, the yield is still expected to rise by 0.9%, year on year. Next year production is also estimated to increase by another 2.1%.

So this means unless producers start to cut down their output, the storage will keep rising at a steady pace and prices won't pick up by much (if at all). The other way for prices to start rising again is if the demand rallies. In the current shift from the extraction to injection season, the mix in the total demand will also change: During the winter time the residential and commercial sector tend to account for close to 50% of total demand. But during the rest of the year this ratio falls to roughly 20%.

Conversely, during the injection season, the power sectors account for nearly 40% of the demand, and during the extraction season, it falls to close to 20%. But on a yearly scale all three sectors residential/commercial, power and industrial have close to equal share in consumption of natural gas. Over the past winter, the demand in the residential/commercial sector hasn't done well due to warmer than normal winter.

So now it all comes down to whether the consumption in the power sector will be higher than normal. If the summer will also be warmer than normal, this may drive the demand for electricity. And in any case, the low price of natural gas will likely make more utility companies to use natural gas to generate power - the EIA expects a gain of 3% in 2016 in this sector's natural gas consumption. This year for the first time, natural gas will fuel 33% of total electricity generation; coal's share will contract to 32%. Thus, the power sector could be one the bright spot natural gas currently has.

Bottom line

The natural gas market still faces fundamental problems. So far, low prices haven't led producers to curb their output - only to make them more efficient. So it boils down to where the demand for natural gas is heading. The current low prices could drive up the demand for natural gas in the power sector. So this is one of the main silver linings this commodity currently has. But without a decline in output, it's hard to see prices rally much higher than their current level. For more see: On the Contango in Natural Gas Market

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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.